The Regulation of International Trade, Volume 1: GATT [1 ed.] 0262029847, 9780262029841

Table of contents :
Contents
Preface
Introduction
1 From GATT to the WTO
1.1 Establishing a Multilateral Trade Order
1.1.1 From Drudgery to Excitement
1.1.2 Attempts to Liberalize Trade at the Multilateral Level
1.1.3 Bretton Woods and Trade
1.1.4 Follow-up to Bretton Woods
1.1.5 Onto the World Scene
1.1.6 The Negotiation of GATT
1.1.7 Entry into Force
1.1.8 Property Rights on GATT
1.1.9 The People Who Made GATT Happen
1.2 Why GATT?
1.2.1 What Did Negotiators Have in Mind?
1.2.2 Economic Theory
1.2.3 Economics Meets the Negotiating Record
1.3 The (Trans-)Formative Years
1.3.1 Flexibility Required
1.3.2 The GATT Recipe for Trade Liberalization
1.3.3 Becoming an Institution
1.3.4 The GATT Rounds of Trade Liberalization
1.3.5 The Transformations of GATT
1.3.6 A Brief Appraisal of the GATT Record
1.3.7 A Few Good Men
1.3.8 A Gentlemen’s Club
1.4 Regulation of Trade in Goods in the WTO Era
1.4.1 The “Old” and the “New” GATT
1.4.2 The Relationship between GATT and the Other Annex 1A Agreements
1.4.3 The Plurilateral Agreements
1.4.4 Single Undertaking Versus “Clubs”
1.4.5 The Protocols of Accession
1.4.6 The WTO Organs Administering Agreements on Trade in Goods
2 Quantitative Restrictions
2.1 The Legal Discipline and Its Rationale
2.1.1 The Legal Discipline
2.1.2 The Rationale for the Legal Discipline
2.1.3 Discussion
2.2 Coverage of the Legal Discipline
2.2.1 General Elimination of Quantitative Restrictions
2.2.2 Quotas
2.2.3 Import and Export Licenses
2.2.4 Other Measures
2.2.5 Measures Not Covered
2.2.6 Attributing QRs to WTO Members
2.2.7 Standard of Review
2.2.8 The Relationship with Article III of GATT
2.2.9 The Relationship with Article VIII of GATT
2.3 Exceptions
2.3.1 Critical Shortages
2.3.2 Standards for Classification, Grading, or Marketing of Commodities
2.3.3 QRs Necessary for Enforcing Governmental Measures
2.3.4 Balance of Payments (Articles XII and XVIII of GATT)
2.3.5 Exchange Restrictions
2.3.6 Infant Industry Protection
2.3.7 General Exceptions (Article XX of GATT)
2.3.8 National Security (Article XXI of GATT)
2.3.9 Safeguards (Article XIX of GATT)
2.3.10 Can QRs Be Permissible in Order to Avoid Dumping?
2.4 Applying QRs
2.4.1 Nondiscrimination, in Principle
2.4.2 Nondiscrimination, in Practice
2.4.3 Discriminatory QRs
2.4.4 Import Licensing in the WTO Era
2.5 Institutional Issues
2.5.1 The Committee on Market Access
2.5.2 Transparency
2.6 Concluding Remarks
3 Tariffs
3.1 The Legal Discipline and Its Rationale
3.1.1 The Legal Discipline
3.1.2 The Rationale for the Legal Discipline
3.1.3 Discussion
3.2 Expressing Goods in a Common Language
3.2.1 The Harmonized System
3.3 The Types of Duties Bound
3.3.1 Reciprocity
3.3.2 OCDs and ODCs
3.3.3 What Is an Ordinary Customs Duty?
3.3.4 What Is an Other Duty or Charge?
3.3.5 Terms, Conditions, and Qualifications
3.3.6 Consolidating Nontariff Barriers
3.4 The Forum for Tariff Concessions
3.4.1 The “Usual” Forum for Binding Duties
3.4.2 Sectoral Agreements
3.4.3 The Information Technology Agreement (ITA)
3.4.4 The Pharma Agreement
3.4.5 Coalitions
3.4.6 Unilateral Action
3.5 The Schedules of Concession
3.5.1 Certification, Rectification, and Modification of Schedules
3.5.2 The Content and Legal Value of Schedules of Concessions
3.5.3 Defining the Tariff Value
3.6 Safeguarding the Value of Tariff Concessions
3.6.1 Change in the Method of Determining Dutiable Value
3.6.2 Import Monopolies
3.6.3 Disputes Regarding the Proper Classification of Goods
3.6.4 Reduction in Par Values
3.7 Renegotiation of Tariff Protection
3.7.1 Maintaining the Level of Concessions
3.7.2 The Participants
3.7.3 The Various Procedures for Renegotiating Tariff Protection
3.7.4 Agreement on the Amount of Compensation
3.7.5 Failure to Agree on the Amount of Compensation
3.8 Charges Exempted from Article II of GATT
3.8.1 Internal Taxes and Charges
3.8.2 Antidumping and Countervailing Duties
3.8.3 Fees and Charges for Services Rendered
3.8.4 Import Surcharges for BoP Reasons
3.8.5 Safeguards
3.9 Withdrawal from GATT/WTO
3.9.1 Withdrawing from the WTO
3.9.2 The GATT Solution
3.9.3 GATT Practice
3.10 Exceptions
3.11 Institutions
3.12 Concluding Remarks
4 Most Favored Nation
4.1 The Legal Discipline and Its Rationale
4.1.1 The Legal Discipline
4.1.2 The Rationale for the Legal Discipline
4.1.3 Discussion
4.2 Coverage of the Legal Discipline
4.2.1 De Jure versus De Facto Discrimination
4.2.2 Measures Covered
4.3 Exemptions
4.3.1 Grandfathering Imperial Preferences
4.3.2 Other Historical Preferences
4.3.3 Imperial and Historical Preferences Today
4.4 The WTO “Club” Must Receive the Best Treatment
4.4.1 WTO Members versus the Rest of the World
4.4.2 As Membership Increases, So Does the Impact of MFN
4.5 Favors/Advantages Must Be Accorded Immediately and Unconditionally
4.5.1 Immediately
4.5.2 Unconditionally
4.6 Defining Origin
4.6.1 The Pre-GATT Years
4.6.2 The GATT Regime
4.6.3 The WTO Regime
4.6.4 Preferential Rules of Origin
4.6.5 The Rise of Global Value Chains (GVCs)
4.7 Like Products
4.7.1 Like Products and Beggar-Thy-Neighbor Policies
4.7.2 Tariff Classification
4.8 Exceptions
4.8.1 Special and Differential Treatment
4.8.2 PTAs
4.8.3 General Exceptions
4.8.4 National Security
4.8.5 Waivers
4.8.6 Nonapplication
4.9 Concluding Remarks
5 Special and Differential Treatment for Developing Countries
5.1 The Legal Discipline and Its Rationale
5.1.1 The Legal Discipline
5.1.2 The Rationale for the Legal Discipline
5.1.3 Discussion
5.2 Toward Special and Differential Treatment
5.2.1 Striving for a Two-Tier GATT
5.2.2 The Content of Part IV
5.3 The Enabling Clause Enters the Frame
5.3.1 An Atypical Birth
5.3.2 The Main Features of the Enabling Clause
5.3.3 The Legal Nature of the Enabling Clause
5.3.4 Donors and Beneficiaries
5.3.5 GSP Schemes
5.3.6 South-South Preferences
5.4 Special and Differential Treatment Other Than GSP
5.4.1 Typology
5.4.2 Transparency Mechanism for Preferential Trade Advantages
5.5 The Wider Picture
5.5.1 Early Years
5.5.2 The DDA
5.5.3 Aid for Trade
5.5.4 Trade, Poverty, and Inequality
5.6 Institutions
5.7 Concluding Remarks
6 Preferential Trade Agreements
6.1 The Legal Discipline and Its Rationale
6.1.1 The Legal Discipline
6.1.2 The Rationale for the Legal Discipline
6.1.3 Discussion
6.2 Why Go Preferential?
6.3 The Legal Requirements for GATT-Consistent PTAs
6.3.1 An Exception to MFN
6.3.2 Notification Requirements
6.3.3 Internal Requirement
6.3.4 External Requirement
6.3.5 The Nature of Review
6.4 Litigating PTAs
6.4.1 Litigation in the GATT Era
6.4.2 Litigation in the WTO Era
6.4.3 Why So Little Litigation?
6.4.4 Is De Facto Tolerance of PTAs an Issue?
6.5 Institutions
6.6 Concluding Remarks
7 Domestic Policies/National Treatment
7.1 The Legal Discipline and Its Rationale
7.1.1 The Legal Discipline
7.1.2 The Rationale for the Legal Discipline
7.1.3 Discussion
7.2 Measures Coming under the Purview of Article III of GATT
7.2.1 Local Content Requirements
7.2.2 All Other Measures Affecting Trade
7.3 Measures Exempted
7.3.1 Government Procurement
7.3.2 Subsidies
7.3.3 Film Quotas
7.3.4 Income Taxes, Social Security, and Payroll Taxes
7.3.5 Investment Protection
7.3.6 Goods in Transit
7.4 The Scope of National Treatment
7.4.1 De Jure, De Facto Discrimination
7.4.2 Duties Bound and Unbound
7.4.3 Domestic Measures Enforced at the Border
7.4.4 Jurisdictional Issues
7.5 Direct Taxes on Products
7.5.1 DCS Products
7.5.2 Like Products
7.6 Other Measures Affecting Trade
7.6.1 Laws, Regulations, or Requirements
7.6.2 Affecting Sale, Offering for Sale
7.6.3 Like Products in Article III.4 of GATT
7.6.4 Less Favorable Treatment (LFT)
7.7 Exceptions
7.8 Institutions
7.9 Concluding Remarks
7.9.1 Nondiscrimination and Efficiency
7.9.2 Asymmetric Information and Its Discontents
7.9.3 In Search of a Smoking Gun
8 State Trading Enterprises
8.1 The Legal Discipline and Its Rationale
8.1.1 The Legal Discipline
8.1.2 The Rationale for the Legal Discipline
8.1.3 Discussion
8.2 Defining STEs
8.2.1 The Law
8.2.2 Practice
8.3 The Obligations Assumed
8.3.1 Nondiscrimination
8.3.2 Commercial Considerations
8.3.3 Adequate Opportunities to Compete
8.3.4 Exceptions
8.4 Transparency
8.5 Institutions
8.6 Concluding Remarks
9 Exceptions and Deviations from Obligations Assumed under GATT
9.1 Exceptions and Deviations
9.2 General Exceptions
9.2.1 The Legal Discipline and Its Rationale
9.2.2 Elements Common to All Listed Exceptions
9.2.3 Public Morals
9.2.4 Humans, Animals, Plant Life, and Health
9.2.5 Imports and Exports of Gold and Silver
9.2.6 Compliance with Laws Not Inconsistent with GATT
9.2.7 Prison Labor
9.2.8 National Treasures
9.2.9 Conservation of Exhaustible Natural Resources
9.2.10 Intergovernmental Commodity Agreements (ICAs)
9.2.11 Government Stabilization Plans
9.2.12 Products in General or Local Short Supply
9.2.13 Complying with the Chapeau
9.2.14 Article XX of GATT and Protocols of Accession
9.2.15 Article XX of GATT and Annex 1A Agreements
9.3 National Security
9.3.1 Balancing Trade Openness and Essential Interests
9.3.2 National Security in a Divided World
9.3.3 Practice
9.4 Waivers
9.4.1 A Transitional Arrangement
9.4.2 Waivers Are Justiciable
9.4.3 Waivers in Force
9.5 Nonapplication
9.5.1 The GATT Regime and Its Rationale
9.5.2 Nonapplication in the WTO
9.5.3 List of Instances of Nonapplication
9.6 Concluding Remarks
Notes
References
Index

Citation preview

The Regulation of International Trade

The Regulation of International Trade Volume 1: GATT

Petros C. Mavroidis

The MIT Press Cambridge, Massachusetts London, England

© 2016 Massachusetts Institute of Technology All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher. MIT Press books may be purchased at special quantity discounts for business or sales promotional use. For information, please email [email protected] This book was set in Times New Roman 10/13pt by Toppan Best-set Premedia Limited. Printed and bound in the United States of America. Library of Congress Cataloging-in-Publication Data Names: Mavroidis, Petros C., author. Title: The regulation of international trade : GATT / Mavroidis Petros C. Description: Cambridge, MA : MIT Press, 2016. | Includes bibliographical references and index. Identifiers: LCCN 2015038275 | ISBN 9780262029841 (hardcover : alk. paper) Subjects: LCSH: Foreign trade regulation. | General Agreement on Tariffs and Trade (Organization) | World Trade Organization. Classification: LCC K3943 .M393 2016 | DDC 382/.92–dc23 LC record available at http://lccn.loc.gov/ 2015038275 10

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For Meritas always, as always

Contents

Preface xxv Introduction xxvii 1

From GATT to the WTO

1

1.1

Establishing a Multilateral Trade Order 1

1.1.1

From Drudgery to Excitement

1.1.2

Attempts to Liberalize Trade at the Multilateral Level 1.1.2.1

The 1927 World Economic Conference: Not Suitable

1.1.2.2

The 1933 World Economic Conference: Prewar Pilots

1.1.2.3

World Trade before Bretton Woods

1.1.3

Bretton Woods and Trade

1.1.4

Follow-up to Bretton Woods

1.1.5

1 2

2 4

6

7 7

1.1.4.1

Hull and Nondiscriminatory Trade

1.1.4.2

The Other Side of the Pond: Meade and the International Commercial Union

1.1.4.3

Bilateral Attempts to Tame Imperial Preferences: Keynes Enraged

1.1.4.4

The Atlantic Charter

Onto the World Scene

7 10

11

12

1.1.5.1

From the Atlantic Charter to the “Suggested Charter”

12

1.1.5.2

US Reciprocal Trade Agreements Act

1.1.5.3

The List of Invitees

1.1.5.4

“We Need to Act before the Vested Interests Get Their Vests On”

14

14

1.1.6

The Negotiation of GATT 16

1.1.7

Entry into Force

1.1.8

Property Rights on GATT 19

1.1.9

The People Who Made GATT Happen

18 20

15

9

viii

Contents

1.2

Why GATT?

20

1.2.1

What Did Negotiators Have in Mind?

1.2.2

Economic Theory

20

23

1.2.2.1

Gains from Liberalization

1.2.2.2

No Gain without Pain: The Case for Trade Agreements

23 26

1.2.3

Economics Meets the Negotiating Record

1.3

The (Trans-)Formative Years: GATT in the GATT Era

1.3.1

Flexibility Required: Grandfathering and the Existing Legislation Clause

1.3.2

The GATT Recipe for Trade Liberalization

1.3.3

1.3.4

1.3.2.1

Tariffs and … Supporting Act

1.3.2.2

Embedded Liberalism

Becoming an Institution

34 36 36

37

40

41

42

1.3.3.1

Goodbye, ITO

1.3.3.2

Functional Institutionalism à la GATT 43

42

The GATT Rounds of Trade Liberalization 1.3.4.1

Bringing Tariffs Down

1.3.4.2

Adding to the Legislative Framework

49

49 52

1.3.5

The Transformations of GATT 57

1.3.6

A Brief Appraisal of the GATT Record

1.3.7

A Few Good Men

1.3.8

A Gentlemen’s Club

1.4

Regulation of Trade in Goods in the WTO Era

1.4.1

The “Old” and the “New” GATT: GATT 1947, GATT 1994

1.4.2

The Relationship between GATT and the Other Annex 1A Agreements

1.4.3

The Plurilateral Agreements

1.4.4

Single Undertaking Versus “Clubs”

1.4.5

The Protocols of Accession

1.4.6

The WTO Organs Administering Agreements on Trade in Goods

2

Quantitative Restrictions

2.1

The Legal Discipline and Its Rationale

2.1.1

The Legal Discipline

57

59 60

73

60 61

64 65

67

73 73

69

63

Contents

ix

2.1.2

The Rationale for the Legal Discipline

2.1.3

Discussion

73

73

2.1.3.1

Negotiating History

2.1.3.2

The Economics of QRs

73 75

2.2

Coverage of the Legal Discipline

2.2.1

General Elimination of Quantitative Restrictions

2.2.2

Quotas

2.2.3

Import and Export Licenses

2.2.4

2.2.5

2.2.6

2.2.7

76

78

2.2.3.1

Import Licensing

79

2.2.3.2

Export Licensing

81

Other Measures

79

82

2.2.4.1

De Facto Export Quotas

82

2.2.4.2

Minimum Import Prices

83

2.2.4.3

Minimum Export Prices

84

2.2.4.4

Trade Balancing Condition

2.2.4.5

Local Content

2.2.4.6

Irrevocable Capital Contribution (Investment)

2.2.4.7

Prohibition to Repatriate Profits

2.2.4.8

Trading Rights in China

84

84

Measures Not Covered

85

85

85

86

2.2.5.1

Customs Duties and Charges

2.2.5.2

Export Taxes

2.2.5.3

Production Quotas

2.2.5.4

Tariff Quotas

2.2.5.5

Trade in Textiles

87

87 89

90 91

Attributing QRs to WTO Members 2.2.6.1

No Need to Coerce

2.2.6.2

Export Cartels

Standard of Review

91

91

93

94

2.2.7.1

The Issue

94

2.2.7.2

The Origin of the Problem

2.2.7.3

Breaking with the Past?

95

96

2.2.8

The Relationship with Article III of GATT 99

2.2.9

The Relationship with Article VIII of GATT 100

76

x

Contents

2.3

Exceptions

2.3.1

Critical Shortages

2.3.2

2.3.3

2.3.4

2.3.5

2.3.6

100 100

2.3.1.1

Essential Products

101

2.3.1.2

Foodstuff or “Other Products”

2.3.1.3

Temporarily Applied

2.3.1.4

Burden of Proof

101

102

102

Standards for Classification, Grading, or Marketing of Commodities 2.3.2.1

Key Terms

2.3.2.2

Burden of Proof

104 104

QRs Necessary for Enforcing Governmental Measures 2.3.3.1

The Test

2.3.3.2

The Rationale

2.3.3.3

What Is a Governmental Measure?

2.3.3.4

Product Coverage

2.3.3.5

Restrictions on Like or Substitutable Domestic Goods

2.3.3.6

Temporary Surplus

2.3.3.7

Compensation

111

2.3.3.8

Public Notice

111

2.3.3.9

Burden of Proof

105

105 105 106

108 108

110

111

Balance of Payments (Articles XII and XVIII of GATT)

111

2.3.4.1

The Rationale

2.3.4.2

Procedural and Institutional Issues

111

2.3.4.3

A Typology of Measures Adopted

2.3.4.4

Invocations

2.3.4.5

Dispute Settlement and Internal and External Institutional Balance

2.3.4.6

Burden of Proof

112 113

114 120

Exchange Restrictions

121

2.3.5.1

Global Coherence

2.3.5.2

Currency Manipulations

121

2.3.5.3

Dispute Settlement

2.3.5.4

Burden of Proof

122

124

125

Infant Industry Protection 2.3.6.1

The Rationale

125

2.3.6.2

Dispute Settlement

2.3.6.3

Burden of Proof

125

126

125

115

104

Contents

xi

2.3.7

General Exceptions (Article XX of GATT)

2.3.8

National Security (Article XXI of GATT)

2.3.9

Safeguards (Article XIX of GATT)

126 126

126

2.3.10 Can QRs Be Permissible in Order to Avoid Dumping? 2.4

Applying QRs

127

2.4.1

Nondiscrimination, in Principle

2.4.2

Nondiscrimination, in Practice

127 128

2.4.2.1

Global Quotas

128

2.4.2.2

Origin-Specific Quotas: Historical Shares

2.4.2.3

Licenses/Permits without Quotas

128

129

2.4.3

Discriminatory QRs

130

2.4.4

Import Licensing in the WTO Era

2.5

Institutional Issues

2.5.1

The Committee on Market Access

2.5.2

Transparency

2.6

Concluding Remarks

3

Tariffs

3.1

The Legal Discipline and Its Rationale

3.1.1

The Legal Discipline

3.1.2

The Rationale for the Legal Discipline

3.1.3

Discussion

130

130 130

130 131

133 133

133 133

134

3.1.3.1

The First Tariff Negotiations

3.1.3.2

The Economics of Tariffs

135

134

3.1.3.3

The Rationale for Tariffs

135

3.1.3.4

Tariff Ceilings and Rigid Tariffs

136

3.2

Expressing Goods in a Common Language

3.2.1

The Harmonized System

137

3.2.1.1

The Need for Common Language

3.2.1.2

The History of Goods Classification

3.2.1.3

What Does the HS Do?

138

137 138

136

126

xii

Contents

3.2.1.4

How Common Is Common Language?

3.2.1.5

Dispute Settlement Regarding Classification

142 143

3.3

The Types of Duties Bound

3.3.1

Reciprocity

3.3.2

OCDs and ODCs: Different Yes, but How?

3.3.3

What Is an Ordinary Customs Duty?

3.3.4

What Is an Other Duty or Charge?

3.3.5

Terms, Conditions, and Qualifications

3.3.6

Consolidating Nontariff Barriers

3.4

The Forum for Tariff Concessions

3.4.1

The “Usual” Forum for Binding Duties: Trade Rounds

3.4.2

3.4.3

145

145 148

148 150 151

152 152

3.4.1.1

Trade Rounds, a Public Good

3.4.1.2

Request—Offer

3.4.1.3

Linear Reductions

3.4.1.4

Harmonized Formula

3.4.1.5

Tiered Cuts

3.4.1.6

Terms of Trade and Tariff-Cutting Techniques

153

153

154 155 155

155

Sectoral Agreements

155

156

3.4.2.1

Distinguishing Sectoral from Critical Mass Agreements

3.4.2.2

The Identity of Sectoral Agreements

157

The Information Technology Agreement (ITA) 3.4.3.1

Why Critical Mass?

3.4.3.2

The Negotiation

3.4.3.3

Dispute Settlement

3.4.3.4

ITA I and II

156

158

158

159 159

161

3.4.4

The Pharma Agreement

162

3.4.5

Coalitions

3.4.6

Unilateral Action

3.5

The Schedules of Concession

3.5.1

Certification, Rectification, and Modification of Schedules

162 163 164

3.5.1.1

A Centralized Process

3.5.1.2

Certification Does Not Confer Legality

164

3.5.1.3

Uncertified Actions

167

165

164

Contents

xiii

3.5.2

The Content and Legal Value of Schedules of Concessions

3.5.3

Defining the Tariff Value: Customs Valuation

3.6

Safeguarding the Value of Tariff Concessions

3.6.1

Change in the Method of Determining Dutiable Value

3.6.2

Import Monopolies

3.6.3

Disputes Regarding the Proper Classification of Goods

3.6.4

Reduction in Par Values

3.7

Renegotiation of Tariff Protection

3.7.1

Maintaining the Level of Concessions

3.7.2

The Participants 3.7.2.1

INR Holders

3.7.2.2

PSI Countries

3.7.2.3

SI Countries

169

170 171 171

171 173

173 174 175

176 177 178 180

3.7.3

The Various Procedures for Renegotiating Tariff Protection

3.7.4

Agreement on the Amount of Compensation

3.7.5

Failure to Agree on the Amount of Compensation

182

3.7.5.1

Procedures Where No Prior Approval Is Required

3.7.5.2

Procedures Where Prior Approval Is Required

183

183

186

3.8

Charges Exempted from Article II of GATT 187

3.8.1

Internal Taxes and Charges

3.8.2

Antidumping and Countervailing Duties

188

3.8.3

Fees and Charges for Services Rendered

188

187

3.8.3.1

Preparatory Work

188

3.8.3.2

Relationship with Article II of GATT 189

3.8.3.3

Measures Covered

3.8.3.4

Standard of Review

189 190

3.8.4

Import Surcharges for BoP Reasons

3.8.5

Safeguards

3.9

Withdrawal from GATT/WTO

3.9.1

Withdrawing from the WTO

3.9.2

The GATT Solution

190

190

191

191

191

181

xiv

Contents

3.9.3

GATT Practice

192

3.10

Exceptions

193

3.11

Institutions

194

3.12

Concluding Remarks

194

4

Most Favored Nation

195

4.1

The Legal Discipline and Its Rationale

4.1.1

The Legal Discipline

4.1.2

The Rationale for the Legal Discipline

4.1.3

Discussion

195

195 195

196

4.1.3.1

The Historic Dimension of MFN

196

4.1.3.2

MFN at the GATT Negotiating Table

4.1.3.3

MFN at the GATT Negotiating Table: The Economics of MFN

4.1.3.4

MFN and Preferential Trade

196 197

199

4.2

Coverage of the Legal Discipline

200

4.2.1

De Jure versus De Facto Discrimination

4.2.2

Measures Covered: Any “Advantage,” “Favor,” Etc.

200

4.2.2.1

Customs Duties and Charges of Any Kind

4.2.2.2

Methods for Calculating the Level of Duties and Charges

4.2.2.3

Rules and Formalities

4.2.2.4

Internal Measures

201

202 203

203

204

4.3

Exemptions

204

4.3.1

Grandfathering Imperial Preferences

4.3.2

Other Historical Preferences

4.3.3

Imperial and Historical Preferences Today

4.4

The WTO “Club” Must Receive the Best Treatment

4.4.1

WTO Members versus the Rest of the World

4.4.2

As Membership Increases, So Does the Impact of MFN

4.5

Favors/Advantages Must Be Accorded Immediately and Unconditionally 206

4.5.1

Immediately

207

204

205 205 206

206 206

Contents

4.5.2

xv

Unconditionally

207

4.5.2.1

The US Attitude toward Conditional and Unconditional MFN

4.5.2.2

“Unconditionally” in Case Law

4.6

Defining Origin

4.6.1

The Pre-GATT Years

4.6.2

The GATT Regime

4.6.3

4.6.4

209

214 216 217

4.6.2.1

Article VIII of GATT 217

4.6.2.2

Marks of Origin

4.6.2.3

False Origin: A Deceptive Practice

4.6.2.4

Efforts to Harmonize

The WTO Regime

217 220

220

223

4.6.3.1

An Agreement to Disagree

4.6.3.2

MFN In, Preferential Rules of Origin Out

Preferential Rules of Origin

224 225

227

4.6.4.1

Out of HWP, Out of WTO?

4.6.4.2

Empirical Studies Reveal a Mess

227

4.6.4.3

Cumulation

4.6.4.4

Complying with Complicated Rules

4.6.4.5

Utilization Rate

4.6.4.6

Rules of Origin for LDCs

4.6.4.7

If No Negotiations, Then What?

228

229 230

231 232 232

4.6.5

The Rise of Global Value Chains (GVCs)

233

4.7

Like Products

4.7.1

Like Products and Beggar-Thy-Neighbor Policies

4.7.2

Tariff Classification: The Dominant Criterion

4.8

Exceptions

4.8.1

Special and Differential Treatment

4.8.2

PTAs

4.8.3

General Exceptions

4.8.4

National Security

4.8.5

Waivers

4.8.6

Nonapplication

4.9

Concluding Remarks

235

238

238 238 238

238 239 239

238

235

235

207

xvi

Contents

5

Special and Differential Treatment for Developing Countries

5.1

The Legal Discipline and Its Rationale

5.1.1

The Legal Discipline

5.1.2

The Rationale for the Legal Discipline

5.1.3

Discussion

241

241 241

242

5.1.3.1

MFN between Unequal Partners

242

5.1.3.2

The Background: Gottfried Haberler versus Singer/Prebisch

5.1.3.3

Import Substitution

5.2

Toward Special and Differential Treatment

5.2.1

Striving for a Two-Tier GATT 246

5.2.2

The Content of Part IV 246 5.2.2.1

Principles and Objectives

5.2.2.2

Commitments

5.2.2.3

Joint Action

247 248

The Enabling Clause Enters the Frame

5.3.1

An Atypical Birth

5.3.2

The Main Features of the Enabling Clause

5.3.3

The Legal Nature of the Enabling Clause

5.3.4

Donors and Beneficiaries

5.3.6

248

248 249 250

250

5.3.4.1

No Obligation to Donate

5.3.4.2

Self-Selection of Beneficiaries

5.3.4.3

Graduation

GSP Schemes

246

247

5.3

5.3.5

243

245

250 250

253

253

5.3.5.1

The Basic Obligation

5.3.5.2

Preferences Requiring a Waiver

253

5.3.5.3

Preferences for LDCs

5.3.5.4

Preferences for Developing Countries

5.3.5.5

Additional Preferences for Developing Countries

5.3.5.6

Excluding Beneficiaries

5.3.5.7

Evaluating the GSP Schemes: Is the Candle Worth the Flame?

South-South Preferences

254

254 262 262

265

271

5.3.6.1

Tariff Preferences

5.3.6.2

PTAs between Developing Countries

271 271

266

241

Contents

xvii

5.4

Special and Differential Treatment Other Than GSP 273

5.4.1

Typology

5.4.2

Transparency Mechanism for Preferential Trade Advantages

5.5

The Wider Picture: Trade and Development

5.5.1

Early Years

5.5.2

The DDA 277

5.5.3

5.5.4

273 276

276

5.5.2.1

The Mandate (and Its Caveats)

277

5.5.2.2

Capacity Building

5.5.2.3

Cooperation with Other Institutions

5.5.2.4

Action for LDCs

278 278

279

Aid for Trade: Integrated, Not Simply Involved 5.5.3.1

The Jewel of the DDA 282

5.5.3.2

Capacity Building in Aid for Trade

5.5.3.3

Infrastructure

5.5.3.4

Increased Productivity

283

5.5.3.5

Adjustment Assistance

283

5.5.3.6

The WTO’s Involvement

5.5.3.7

Aid for Trade: Early Evaluations

283

283

284

Trade, Poverty, and Inequality 5.5.4.1

Why the Question?

285

5.5.4.2

Trade and Poverty

286

5.5.4.3

Trade and Inequality

284

285

286

5.6

Institutions

287

5.7

Concluding Remarks

6

Preferential Trade Agreements

6.1

The Legal Discipline and Its Rationale

6.1.1

The Legal Discipline

6.1.2

The Rationale for the Legal Discipline

288 291 291

291

6.1.2.1

Frontier Traffic

6.1.2.2

Preexisting Arrangements

292

6.1.2.3

Development Tool

6.1.2.4

Insurance Policy

6.1.2.5

US-Canada Rapprochement

293

293 293 293

291

282

274

xviii

6.1.3

Contents

Discussion

294

6.1.3.1

PTAs and MFN

6.1.3.2

FTAs, CUs, and Beyond

294 294

6.2

Why Go Preferential?

6.3

The Legal Requirements for GATT-Consistent PTAs

6.3.1

An Exception to MFN

6.3.2

Notification Requirements

6.3.3

6.3.4

6.3.5

295

300

6.3.2.1

Who Notifies?

300

6.3.2.2

Notify Whom?

302

6.3.2.3

Notify What?

302

6.3.2.4

Notify When?

302

300

Internal Requirement: Eliminate Duties with Respect to Substantially All Trade 304 6.3.3.1

Same Requirement for FTAs and CUs

6.3.3.2

Substantially All Trade (SAT)

6.3.3.3

Duties and Other Restrictive Regulations of Commerce

304

304

External Requirement: No New Protection 6.3.4.1

External Requirement That FTAs Must Meet

6.3.4.2

External Requirement That CUs Must Meet

The Nature of Review

307 307 308

311

6.3.5.1

A Merger Authority, in Principle

6.3.5.2

A Switch in Focus: The Transparency Mechanism

6.4

Litigating PTAs

6.4.1

Litigation in the GATT Era

313

6.4.2

Litigation in the WTO Era

315

6.4.3

299

311

313

6.4.2.1

Institutional Balance: Things Have Changed?

6.4.2.2

The Ambit of Judicial Review

Why So Little Litigation?

315

317

319

6.4.3.1

The Original Sin

319

6.4.3.2

Other Plausible Explanations

320

6.4.4

Is De Facto Tolerance of PTAs an Issue?

6.5

Institutions

6.6

Concluding Remarks

333 333

322

312

305

Contents

xix

7

Domestic Policies/National Treatment

7.1

The Legal Discipline and Its Rationale

7.1.1

The Legal Discipline

7.1.2

The Rationale for the Legal Discipline

7.1.3

Discussion

335 335

335 336

337

7.1.3.1

The Impact of the PPA 337

7.1.3.2

NT, Concession Erosion, and Uncertainty

7.1.3.3

Contract Incompleteness

7.1.3.4

Reciprocity

7.1.3.5

Shallow Integration and Deep Integration

337

338

340 340

7.2

Measures Coming under the Purview of Article III of GATT 341

7.2.1

Local Content Requirements

7.2.2

All Other Measures Affecting Trade

7.3

Measures Exempted

7.3.1

Government Procurement

7.3.2

Subsidies

7.3.3

Film Quotas

7.3.4

341 342

343 343

346 346

7.3.3.1

Negotiating History

346

7.3.3.2

Film Quotas in the WTO World

7.3.3.3

Distinguishing GATT from GATS: A Line in the Sand?

7.3.3.4

GATS before GATT 351

347

Income Taxes, Social Security, and Payroll Taxes 7.3.4.1

The WP on BTA 353

7.3.4.2

The Outcome

7.3.4.3

The Legal Value of the Report

356 358

7.3.5

Investment Protection

358

7.3.6

Goods in Transit

7.4

The Scope of National Treatment

7.4.1

De Jure, De Facto Discrimination

7.4.2

Duties Bound and Unbound

7.4.3

Domestic Measures Enforced at the Border

7.4.4

Jurisdictional Issues

359

364

361 361

362 363

349

353

xx

Contents

7.5

Direct Taxes on Products

7.5.1

DCS Products

7.5.2

365

366

7.5.1.1

Why Include DCS Products?

7.5.1.2

Defining DCS Products

7.5.1.3

From Extant to Latent Demand

7.5.1.4

Applied So As to ASATAP 371

Like Products

366

368 370

376

7.5.2.1

Like Products: The Definition

7.5.2.2

Taxation in Excess

376

379

7.6

Other Measures Affecting Trade

380

7.6.1

Laws, Regulations, or Requirements

7.6.2

Affecting Sale, Offering for Sale

7.6.3

Like Products in Article III.4 of GATT 382

7.6.4

Less Favorable Treatment (LFT)

381

382 385

7.6.4.1

LFT Means No Protectionism

7.6.4.2

De Jure and De Facto LFT 385

385

7.6.4.3

Trouble in Korea

7.6.4.4

Sultans of Swing I (Dominican Republic–Import and Sale of Cigarettes)

7.6.4.5

Sultans of Swing II (EC–Seal Products)

7.6.4.6

Swinging in Echternach

386 390

391

7.7

Exceptions

392

7.8

Institutions

392

7.9

Concluding Remarks

7.9.1

Nondiscrimination and Efficiency

7.9.2

Asymmetric Information and Its Discontents

7.9.3

In Search of a Smoking Gun

392 392

395

7.9.3.1

Origin Neutrality

397

7.9.3.2

Use of the First-Best Instrument

7.9.3.3

Scientific Evidence

7.9.3.4

Necessity

7.9.3.5

Who Bears Adjustment Costs?

7.9.3.6

Consistency

7.9.3.7

International Standards

397

397

397 397 397

397

393

389

Contents

xxi

8

State Trading Enterprises

399

8.1

The Legal Discipline and Its Rationale

8.1.1

The Legal Discipline

8.1.2

The Rationale for the Legal Discipline

8.1.3

Discussion

399

399 399

400

8.1.3.1 Negotiating Record

400

8.1.3.2 Subsequent Practice

402

8.2

Defining STEs

8.2.1

The Law

8.2.2

Practice

8.3

The Obligations Assumed

8.3.1

Nondiscrimination

8.3.2

Commercial Considerations

8.3.3

Adequate Opportunities to Compete

8.3.4

Exceptions

8.4

Transparency

8.5

Institutions

8.6

Concluding Remarks

9

Exceptions and Deviations from Obligations Assumed under GATT 413

9.1

Exceptions and Deviations

9.2

General Exceptions

9.2.1

The Legal Discipline and Its Rationale

9.2.2

Elements Common to All Listed Exceptions

9.2.3

402

403 404 405

406 406 410

411 411

412 412

413

414 414 417

9.2.2.1

Two-Tier Test

9.2.2.2

Burden of Proof

9.2.2.3

Means Are Justiciable, not Ends

9.2.2.4

Pursuing Multiple Means and Ends (What Is a “Measure”?)

Public Morals

421 422 422

427

9.2.3.1

The Scope of Public Morals

9.2.3.2

Necessary to Protect Public Morals

427 430

423

xxii

9.2.4

Contents

Humans, Animals, Plant Life, and Health 9.2.4.1

The Scope of the Provision

9.2.4.2

Necessity

430

430

430

9.2.5

Imports and Exports of Gold and Silver

9.2.6

Compliance with Laws Not Inconsistent with GATT 442 9.2.6.1

The Scope of the Provision

9.2.6.2

The Test for Compliance

441

442 443

9.2.7

Prison Labor

443

9.2.8

National Treasures

9.2.9

Conservation of Exhaustible Natural Resources

444 444

9.2.9.1

Permanent Sovereignty over Natural Resources

9.2.9.2

Jurisdiction

445

9.2.9.3

Exhaustible Natural Resources

9.2.9.4

Exhaustible Natural Resources and Endangered Species

9.2.9.5

Conservation Policies

9.2.9.6

Relating To

9.2.9.7

Proximate and Ultimate Cause

9.2.9.8

In Conjunction with Domestic Consumption or Production

9.2.9.9

The Incidence of the Level of Development

446 447 450

450

451 453 456

9.2.10 Intergovernmental Commodity Agreements (ICAs)

456

9.2.10.1 The Function of Intergovernmental Commodity Agreements 9.2.10.2 ECOSOC Resolution 30(IV)

456

457

9.2.11 Government Stabilization Plans

458

9.2.12 Products in General or Local Short Supply 9.2.13 Complying with the Chapeau

454

459

460

9.2.13.1 Application, Not Substantive Consistency

460

9.2.13.2 Application? Not Substantive Consistency?

461

9.2.13.3 Arbitrary Discrimination, Unjustifiable Discrimination, Disguised Restriction 9.2.13.4 No Effects Test Required

468

9.2.14 Article XX of GATT and Protocols of Accession 9.2.14.1 The Test

469

9.2.14.2 Cases Where the Defense Is Available

471

9.2.14.3 Cases Where the Defense Is Unavailable

471

469

462

Contents

xxiii

9.2.15 Article XX of GATT and Annex 1A Agreements 9.2.15.1

Trade-Related Investment Measures (TRIMs)

9.2.15.2

Sanitary and Phytosanitary Measures (SPS)

9.2.15.3

Agriculture (AG)

9.2.15.4

Agreement on Textiles and Clothing (ATC)

9.2.15.5

Technical Barriers to Trade (TBT)

9.2.15.6

Customs Valuation (CV)

9.2.15.7

Preshipment Inspection (PSI)

9.2.15.8

Rules of Origin (ROO)

9.2.15.9

Import Licensing Agreement (ILA)

474 474

474

9.2.15.10 Antidumping (AD)

475

475

477 477

477 477

477

9.2.15.11 Subsidies and Countervailing Measures (SCM) 9.2.15.12 Safeguards (SG)

478

479

9.3

National Security

9.3.1

Balancing Trade Openness and Essential Interests

9.3.2

National Security in a Divided World

9.3.3

Practice

481

9.4

Waivers

487

9.4.1

A Transitional Arrangement

9.4.2

Waivers Are Justiciable

9.4.3

Waivers in Force

9.5

Nonapplication

9.5.1

The GATT Regime and Its Rationale

9.5.2

Nonapplication in the WTO

9.5.3

List of Instances of Nonapplication

9.6

Concluding Remarks

Notes 499 References 567 Index 591

473

479 480

487

489

490 493

496

493

494 495

479

Preface

Commerce is a perpetual and peaceable war of wit and energy among all nations. —Jean-Baptiste Colbert, economic minister for Louis XVI When goods do not cross borders, soldiers will. —Frédéric Bastiat, 19th-century political economist and member of the French Assembly

I consider myself very fortunate to have learned my trade by giants in this field, in law, in economics, and in political science as well. I spent precious time next to John Jackson at the University of Michigan at Ann Arbor, whose 1969 book World Trade and the Law of GATT made a coherent whole out of GATT Secretariat papers, negotiating documents, and panel reports. It is there that I met Bob Hudec, who very generously spent a substantial amount of his time in the years since sharing his work and thoughts with me. Bob’s and John’s works have been a major influence in the way I see the world trading system, and I think I will never thank them enough for all they have done for me and for the field where I (along with many others) now work. My economist friends are many, and I will name my close collaborators/coauthors alphabetically: Kyle Bagwell, Chad P. Bown, Aaron Cosbey, Gene Grossman, Bernard M. Hoekman, Henrik Horn, Doug Irwin, Phil Levy, Patrick Messerlin, Damien Neven, Tom Prusa, Kamal Saggi, André Sapir, and Bob Staiger; thank you all very much. Jagdish Bhagwati has been my inspirational coteacher and mentor over many years at Columbia Law School. My involvement in two research consortia has been a major catalyst in my understanding of the GATT/WTO regime. Lance Liebman included me in the American Law Institute (ALI) project on “Principles of International trade: The WTO,” where I served as chief reporter along with Henrik Horn. Mark Sanctuary led with skill and bonhomie the ENTWINED project on “Trade and Environment,” where I participated as an invited author, and contributed papers that I coauthored with Henrik Horn, but also with Aaron Cosbey and Bob Wolfe. Working with specialists in various fields made me aware that it is not just the devil, but the entire citizenry of hell that lies in the details. This explains the amount of work

xxvi

Preface

presented here, and hopefully the decreasing number (when compared to previous work) of mistakes, for which I apologize a priori. As always, I had to rely on many people who, instead of going about their lives, generously dedicated a disproportionate amount of their time reading my work. My collaborators, Neil Teller and Carlo-Maria Cantore, pretended that they found it interesting to read my work, and occasionally I believed them when they said as much. But even when I did not, I still passed on chapters for them to read and comment upon. Jonathan Chevry and Marianne Karttunen at EUI also generously shared with me their expertise, and their work. Numerous academics and practitioners have shared their precious experience in their field of expertise with me: Alberto Alemanno, Steve Charnovitz, Antonio Cortês, Bill Davey, Henrik Horn, Rob Howse, Céline Kauffmann, Patrick Low, David Palmeter, ErnstUlrich Petersmann, Frieder Roessler, Alan O. Sykes, Edwin Vermulst, Reinhard Weissinger, and Bob Wolfe. Terry Stewart shared with me various negotiating documents from his priceless archives, and responded to my incessant demands in no time. At the WTO, current and former officials Inge Bauer, Jose Blanco, Tessa Bridgman, John Dickson, Richard Eglin, Marieme Fall de Perez Rubin, Alejandro Gamboa-Alder, Rodd Izadnia, Mark Koulen, Juan-Alberto Marchetti, Darlan Marti, Gabrielle Marceau, Andrea Mastromatteo, Julie Pain, Bruno Ventrone, Peter Williams, Donna Wood, RhianMary Wood-Richards, and Müslüm Yilmaz have helped me with dozens of queries that I have addressed to them, and always in the most satisfactory manner. At the WTO always, Diwakar Dixit, Taufiqur Rahman, Roy Santana, and Erik Wijkström read chapters of my book and provided me with precious comments. Any remaining errors are, of course, my own. Humberto Jimenez, delegate for Ecuador at the WTO, shared with me his experience from participating in various WTO fora. My editor at MIT Press, Jane Macdonald, has been encouraging and absolutely wonderful from the first time we met and shared lunch at the Columbia Faculty House in New York City. It really mattered an awful lot to me to work with an editor who shared my enthusiasm for this work. Susan McClung, Marcy Ross, Emily Taber, and the staff and reviewers for MIT Press provided me with invaluable help and comments that vastly improved the quality of my original manuscript. My debt to all the individuals mentioned above is huge, as is my debt to my family. My wife, Suja Rishikesh-Mavroidis, has yet again put her own career on the back burner in order to help me finish this book. It would have probably been a better allocation of our time if the opposite had happened. My only regret when writing this book is that I spent less time with her, and with our three daughters, Meera-Natalia, Riya-Valentina, and Tara-Eleni. I started making up for all lost time at the precise moment that I had finished this preface. Petros C. Mavroidis Commugny, Switzerland May 2015

Introduction

I have changed my mind a dozen times (and probably will do so in the future) about the structure that a book aiming to explain the General Agreement on Tariffs and Trade/World Trade Organization (GATT/WTO) regime, like this one, should have. The objective I assigned to myself was to write a book that would be accessible to lawyers, political scientists, and economists. To do that, I wanted to ask first the question, “What is the problem the GATT framers tried to solve?” before explaining how they solved it. This is why, borrowing from previous work from economic historians and political scientists, I discuss at great length the negotiating history of each and every legal institution discussed in the two volumes, and have dedicated one full chapter (chapter 1 of this volume) to the negotiating history of GATT, the cornerstone of the world trading system. I have adopted a uniform structure for every chapter in an effort to facilitate the reader accessing the material. With the exception of chapter 1, I have included in every chapter first a discussion of the legal discipline discussed, in its context. It is followed by a discussion of the “completion,” so to speak, of the original contract through subsequent practice (that is, secondary law; e.g., law created by the various WTO bodies, as well as case law). Now what do I mean by “context”? I do not use the term as lawyers typically use it. I intend to cover two different discussions under this umbrella. First is the rationale for the provision, as evidenced in the negotiating record and in case law (and point out discrepancies between the two, if any exist). Then, under what I categorize as “Discussion” in every chapter, I provide the basic economic rationale, as well as the policy background, for each provision discussed. I ask, in other words, what a particular provision is aimed to address, and show cases from the real world that illustrate each point. The reader can thus think about the legal institutions discussed in the two volumes in terms of two benchmarks: the negotiating record (that is, the problem that the authors of the legal institution aimed to solve), and the basic economic rationale explaining the necessity for the institution discussed. The theme “negotiating record meets the economic rationale” permeates the two volumes, and it is a issue that I try to address myself as well. The main part of each chapter consists in a discussion of subsequent practice; that is, the “life” of every legal norm. In this part, I aim to achieve three different goals:

xxviii

Introduction

First, provide a detailed, and not sketchy, presentation of case law. I myself have found it always difficult to teach this field through one leading case. For many reasons, a leading case is often hard to find in GATT/WTO. In my view, the dominant explanation is that WTO adjudicating bodies have an eclectic view of precedent. They do not start their analysis from past case law and see to what extent they should simply confirm it, or, in the presence of “distinguishing factors,” adopt new rulings. They adopt their decisions and use precedent to support them—to the extent that this can be done, of course. They thus “endogenize” precedent in their privileged approach. So I have to follow a different path, discussing the cases that have contributed to the understanding of the various terms. I try to state what the state of the art is at the moment of writing; that is, highlight the prevailing understanding of the various terms today. At the end of the day, my aim is for the reader to know how the various terms in the legal provisions discussed have been, and are today, understood in case law. This is, if you will, a “positivistic” exercise, aiming to simply reflect the state of the art in terms of case law evolution today. Second, I provide the literature that has (in my opinion, of course) contributed useful criticism of the interpretations of the various legal provisions. Criticism could be useful, in my view, if it points to a logical error, but not only for this reason. It could be, for example, that literature criticizes WTO “courts” because they have behaved like principals, not like the agents that they are. The literature has pointed to the negative institutional externalities when this happens. Or, it could be that the WTO courts have been behaving inconsistently, and thus provoking the wrath of the addressees of their decision, and so on and so forth. Third, I offer my own criticism, to the extent that it does not overlap with voices already heard. It is here that I borrow from the methodology we had adopted in the American Law Institute (ALI) project, which I have adapted for the purposes of this work. The function of case law is not simply to settle disputes, for that could be done even without the help of adjudicating bodies. Courts complete the original contract in various ways: by customizing it to a particular transaction; by filling gaps where gaps exist, and absent some lawmaking (e.g., in the area of allocation of burden of proof), where it would be impossible to issue a final decision, and so on. At the end of the day, the picture that emerges will be law (primary and secondary) plus case law; and, looking at this picture, I ask whether the final outcome is reasonable. If the answer is yes, I do not stop the discussion immediately. It could be, for example, that a reasonable outcome is the result of impermissible judicial activism, in the sense that courts have behaved as if they were legislators, interpreting provisions against the will of the framers. Although this might a very efficient way to resolve disputes, it is not recommended. Judicial activism, if perpetuated, might also lead to unsatisfactory outcomes. In similar cases, the negative external effects for the institution should not be underestimated. The WTO members would need to amend the law to preempt similar behavior in the future, and amendment requires consensus across 161 divergent trading nations. Agency costs, so to speak, are quite high.

Introduction

xxix

If not (that is, if I find the outcome unreasonable), I go ahead and ask the additional question of whether the source of unhappiness lies in law (in which case the trade community should be thinking in terms of amending the original contract), or case law (in which case all that is required is a change in direction). My views on this score will be recapped in the concluding section. I pay particular attention in this volume to the various WTO organs. This is an area in which I have been influenced from political scientists with whom I have cooperated over the years. The legislative activity takes place every other decade, more or less, but it is day-to-day operations in the realm of the various WTO committees that move the world trading system forward. In the book Political Order and Political Decay,1 Francis Fukuyama describes institutions in the following manner: “since an institution is nothing more than a rule of law that persists over time, human beings therefore have a natural tendency to institutionalize their behavior.” This fits perfectly well with relational contracts, and there is ample evidence that GATT operated early on within these parameters. The framers of the WTO did not undo the institutional balance that had been struck in 1947. They added new committees, since new agreements were signed, and enriched it through new layers of institutional life, since the WTO provided the “roof” that the International Trade Organization (ITO) failed to provide. One can never say enough about the GATT/WTO institutions. Hudec’s monumental 1993 work, which that I cite extensively in my own research, explains how GATT pragmatism helped transform an agreement into an institution. In this book, I discuss the institution that is called to administer the life of each and every WTO agreement in a separate section, hoping to bring out this often forgotten aspect of GATT/WTO life by focusing on its interaction with the other WTO bodies. Volume 1 focuses on regulation of trade by GATT. Chapter 1 is long, but in my view that amount of detail is quite necessary. Both Jackson and Hudec spent much time trying to understand the negotiating record. Alas, modern WTO courts have relegated its importance by insisting on a narrow understanding of the Vienna Convention, the legal instrument that they use in order to interpret the various agreements. I quote from L. P. Hartley, an English novelist who famously wrote in his 1953 classic The Go-Between, “the past is a foreign country; they do things differently there.” Even if that is so, there is much to learn from the negotiating record, including, crucially, what the GATT framers were after. In my view, knowledge of the past is a key ingredient for a thoughtful understanding of the GATT/WTO regime. This is not to deny that adjustments are welcome—indeed necessary. The need for adjustment, though, is an elusive concept when the historical angle is missing. The next step in chapter 1 is to present in colloquial (but hopefully not vulgar) terms the explanations that modern economic theory has advanced for trade agreements. The scene is thus set for a “negotiators meet economics” play, and the consequences of this discussion.

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Chapters 2, 3, and 4 discuss the disciplining of border instruments—namely, quantitative restrictions and tariffs. It is in chapter 4 that I entertain the discussion on the most favored nation (MFN) clause, the cornerstone of GATT, which binds both border measures (tariffs) and domestic measures. Chapters 5 and 6 focus on the exceptions to MFN, the preferential trade agreements (PTAs), and the special and differential treatment for products originating in developing countries. Chapter 7 deals with all domestic instruments, whereas chapter 8 is dedicated to the discussion of disciplines imposed on state trading enterprises (e.g., state entities through which international trade is being channeled). In Chapter 9, finally, the discussion reverts to the obligations assumed under the GATT, and presented in the first eight chapters. While chapters 1–9 are dedicated to a discussion and analysis of GATT, I present the case law (and other relevant subsequent practice) under the various provisions until December 2014, since this is not a mere historic document, but still a living international agreement. Volume 2 covers the WTO Agreements regulating trade in goods. Since the Kennedy round (in the early 1960s), GATT has added to its institutional arsenal. The current institutional design is the outcome of the successful completion of the Uruguay round (mid1990s), as well as the few areas where agreement was reached during the Doha round (which started in 2001, and had not been concluded at the time of writing). Chapter 1 focuses on all agreements dealing with customs clearance. In chapters 2–4, I present the “contingent protection” instruments—e.g., the three agreements that allow WTO members to unilaterally add to the negotiated amount of protection when a certain contingency (e.g., dumping) has occurred. Chapters 5 and 6 are dedicated to an analysis of the Technical Barriers to Trade (TBT) and Sanitary and Phyto-sanitary Measures (SPS) agreements, which deal with some domestic instruments (e.g., environmental and health policy and consumer information). Chapter 7 is about a WTO innovation, the agreement on Trade Related Investment Measures (TRIMs). It is in this context that I entertain a brief discussion on the wider “trade and investment” issue. Chapters 8 and 9 focus on the two sector-specific agreements that remained outside the GATT disciplines and were reintroduced in the world trading system following the successful conclusion of the WTO (namely, Agriculture and Textiles). Chapters 10 and 11 concern the two plurilateral agreements (namely, Government Procurement and Civil Aviation); that is, the only WTO Agreements that bind only a subset of the total WTO membership. Finally, I discuss in chapter 12 the subject of transparency, a very important GATT/WTO institution aiming to curb uncertainty in trade relations. It is my hope that this book will be helpful to students and practitioners alike, and that it will help them continue the discussion and ask further questions in the years ahead.

1

1.1 1.1.1

From GATT to the WTO

Establishing a Multilateral Trade Order From Drudgery to Excitement

Adlai Stevenson is reported to have said that trade is quite boring, and that its greatest need was for fresh clichés.1 Viewed from the perspective of a statesman, this is probably a wise statement. Until recently, with the emergence of the antiglobalization movement that peaked in 1999 in Seattle, Washington, trade talks rarely, if ever, made headlines. This was probably even more the case when the General Agreement on Tariffs and Trade (GATT), the first contract that (eventually) managed to generate multilateral trade liberalization, was created amid other towering achievements in the post—World War II (WWII) era, such as the advent of the United Nations (UN), the World Bank (WB), and the International Monetary Fund (IMF). To make the case for trade being even less of an issue worth headlines, GATT was an agreement that was supposed to come under a world trade institution: a big trade project, the International Trade Organization (ITO), that never saw the light of day. GATT began its life lame, awaiting the eventual advent of the ITO, which was, alas, never to be. During the first years following its establishment, trade negotiators, usually the rank and file of national ministries, would meet in Geneva, Switzerland, and the surrounding area (Annecy) to discuss the level of tariffs they would be imposing on goods, while other institutions like the Organisation for European Economic Cooperation (OEEC) would attract the highly ranked national officials called to administer the Marshall Plan and discuss the road to development for Europe, and the IMF and the WB, the road to world development. Stevenson, the reputed US statesman, was not off base when one takes all of this into consideration. He certainly would not have anticipated that GATT would become the treaty/institution that would administer trade for the next six decades, and even less the excitement it would provoke, the anti-GATT riots in Seattle fifty years later, and the antiglobalization movement. He might well have been puzzled if he had been around long enough to witness the

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scope that an agreement initially designed to organize a tariff bargain would eventually cover. In Stevenson’s time, negotiators focused on getting goods across the border. In today’s world, many goods are produced in different countries, and national origin is becoming an increasingly elusive issue. This is very much due to the success of GATT. An agreement (in fact, a provisional agreement with no institutional coverage) managed to rally trading nations behind its disciplines, gradually increase its membership and coverage, and thus increase its relevance as well. In Stevenson’s time, the bulk of trade issues concerned the level of tariff imports in a few markets. Today’s trade issues concern the effect of environmental protection on trade, the (multilateral or regional) standardization of production processes, and the defense against socially unacceptable policies. From a GATT embroiled in negotiating tariff concessions at the four- and six-digit level, we have arrived at the WTO, the worldwide regulatory interface. Here is how the story unfolds. 1.1.2 Attempts to Liberalize Trade at the Multilateral Level Trade integration has existed since time immemorial.2 Indeed, forms of trade integration are present in many ancient civilizations and, as we shall see in chapter 4, “Most Favored Nation,” some aspects of the institutions that form an integral part of today’s trade regime have been present since medieval times. It is true, for example, that aspects of the modern MFN, the most favored nation clause embodying the principle of nondiscrimination in international trade, can be traced to treaties signed by Mantua, an important Italian city-state, and even more so in the CobdenChevalier treaty between France and the United Kingdom (UK) in 1860.3 Similar initiatives, nevertheless, were never meant to provide a multilateral “roof” for trading nations. Besides similar regional attempts, there was never an attempt to establish a multilateral trade order before the end of World War I (WWI). The GATT/WTO followed a path that started with the 1927 World Economic Conference: nothing was set in stone then, but whatever happened from that moment onwards until the advent of GATT was more than lines drawn in the sand. 1.1.2.1 The 1927 World Economic Conference: Not Suitable Following WWI (the war to end all wars, as the saying went), the international community was trying to design ways and mechanisms to address the terrible situation it found itself in both at the national and the international level. Of immediate interest to the topic of this volume is the World Economic Conference organized in Geneva in 1927.4 From May 4 to 23, a meeting was convened between fifty nations under the auspices of the League of Nations5 and chaired by Georges Theunis aiming to curb nationalistic beggar-thy-neighbor policies that were perceived as the

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3

reason for the world’s economic troubles. In the words of W. Leslie Runciman (1927, p. 467): The impression left at the end of them was that the Conference was agreeing on two facts: first, that the world’s economic troubles are the result not so much of the material destruction of the war as of the dislocation of international trade that it involved, and second that the artificial barriers to trade introduced in consequence of this dislocation had outlived the conditions which produced them, were too numerous and ought to be diminished.

Naturally, then, trade figured high on the agenda. Three committees were organized dealing with agriculture, industry, and commerce. The latter, chaired by the Dutch delegate Hendrikus Colijn, notorious for his hands-on methods, produced a series of recommendations in favor of taming customs duties, introducing widespread MFN, and addressing both direct and indirect forms of subsidization. It was a remarkable document exhibiting substantial doses of realism, calling for freer rather than totally free trade, understanding thus, that absent incrementalism, the whole endeavor of trade liberalization would be in peril. At the end of the day, though, it was what it was: a collection of recommendations that it was hoped would find their way into future binding instruments. In the words of the conference chairman, Theunis: Our advice and recommendations will in all probability not be followed immediately on the scale we would desire. Great movements frequently experience many difficulties at the outset. But we are convinced that our work is based on true principles, and of the determination to ensure to the best of our power both the peace and the prosperity of the world.6

The chairman of the Committee on Commerce, Colijn, was even clearer on this point: Of course everybody knows that the decisions of the Conference could bind nobody, that the members were present neither as delegates nor as representatives of their country, but solely as individuals. Individuals perfectly free to express their own opinions, perfectly free to arrive at any conclusion they wished, but not able to tie the hands of their respective Governments. Consequently, one can say that the object of the Conference was first of all discussion. Discussion in order to arrive at better understanding of the present-day economic difficulties and conditions; to arrive at an agreement as to the reforms that were necessary. … Its conclusions can only have practical consequences if the intentions of the Conference are translated into actions by the Governments of the various countries.7

The final output, thus, resembled conclusions of an academic conference more than a document crafted by agents of the political establishment. The agreement signed was unsurprisingly weakened by the withdrawal of the UK and the United States (US), and its legal relevance was gradually reduced to redundancy. Cordell Hull, a US statesman who eventually played a key role in the advent of GATT, explained the reason for the US withdrawal in the following terms: This Convention … is … poorly adapted to the present situation and there is very little possibility that other nations may adhere to it. … I am reluctant to take this action at the present time. It is

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important that it not be construed as evidence of any new decision by the American Government to shape its policy on domestic rather than on international lines.8

The trading nations were back at the negotiating table a few years later. They did not have to start from scratch, though. Some of the ideas expressed in this conference did survive, as we will see in the next section. 1.1.2.2 The 1933 World Economic Conference: Prewar Pilots Between 1927 and 1932, the US went through the terrible crisis of 1929, the Great Depression that marked US and world history, as we will see further on, like few events did. Around that time, though, the whole world was in crisis, not just the US. True, the US experienced an abrupt landing following years of superficial (to be generous) prosperity.9 A vicious circle entered center stage: Europe’s economic downfall drove the US economy down, and the troubles of the US economy sank Europe into an even deeper recession. Europe had been in doldrums for some time, as it was coming to grips with the “economic consequences of peace,” to paraphrase Keynes. It is, of course, difficult to draw up an exhaustive list of the reasons for Europe’s troubles. It is even more difficult to decide on the significance of each of them. There is little doubt, though, that Germany’s troubles were a significant factor. Against the advice of British economist John Maynard Keynes,10 onerous post-WWI conditions had been imposed on Germany, which found it difficult to pay the victors for damage done during the war. Deficient payments by Germany meant that the UK and France could not honor their war loans to the US. Europe’s troubles contributed to sinking the US economy into chaos. Runciman (2013, pp. 90ff.) explained that the 1929 crisis signaled, among other things, the end (or severe reduction) of US investment in Germany and, thus, to the intensification of the difficulties that Germany was going through in repaying the victors. The US decision to not renegotiate war loans contracted with the UK and France meant that there was no way out from the vicious circle. To cap it all, in 1931, the UK government decided that the British pound should leave the gold standard, sending out shock waves especially to the French, who were caught unawares by this decision and demanded explanations. It is difficult to ascertain how much this experience veered the US administration toward international cooperation, although the US initiative in bringing about the “London Conference” seems to suggest that this had indeed been the case. In 1933, the London Conference was held from June 12 to July 27 to address all these issues. The conference was the brainchild of US president Herbert Hoover; unfortunately, he left office before it even started, to be replaced by Franklin Delano Roosevelt, who had acceded to the White House in March 1933. Hence, the main proponent of the gathering was absent, and this absence was felt, especially since Roosevelt was not hard pressed to participate in the conference and contribute to its success. In fact, he did not even bother to show up. It was Cordell

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5

Hull, the secretary of state, who headed the US delegation to a conference with a very ambitious objective: to save the world from its economic troubles. Trade featured in the agenda but was not the only topic of concern. It was not even a priority, at least as far as the US leadership was concerned. Roosevelt is quoted in Runciman (2013) as uttering (p. 93): Our international trade relations, though vastly important, are in point of time and necessity secondary to the establishment of a sound national economy. I favor as a practical policy the putting of first things first. I shall spare no effort to restore world trade by international economic readjustment, but the emergency at home cannot wait on that accomplishment.

Roosevelt, a persuaded internationalist, was looking for domestic stability first, which would bring the necessary impetus to engage the US internationally as well. World cooperation would follow. It would be a strong US, not a weakened one, that would engage on the international plane. This was Roosevelt’s vision. Because of this belief, Roosevelt only half-heartedly agreed to participate in the conference. Eventually, he dropped his bombshell only weeks before the start of the London Conference when he announced his decision to take the US off the gold standard as the UK had done. This decision caused uproar. Runciman (2013) reported that Keynes was one of the few who supported Roosevelt in this decision, although he quoted Keynes stating (p. 104): “Roosevelt has about as much idea of where he will land as a pre-war pilot.”11 Be that as it may, the UK and US decisions to take their currencies off the gold standard risked creating a serious imbalance between their currencies and those of the gold bloc countries, particularly France. The devaluation of the dollar and the pound sterling raised import prices and lowered export prices in the US and Great Britain. The subject matter of the conference was, inter alia, the stabilization of currencies, and now the whole endeavor was in peril. Unsurprisingly, the conference ended on July 27 having accomplished nothing. The US decision12 contributed to the downfall of the conference, although one would be too harsh to blame the US alone for the failure to reach the conference’s objectives. This failure made waves because of the high hopes that the announcement of the conference had created. Many thought that it would be brought to fruition. There was widespread criticism of the delegations that, contrary to the 1927 World Economic Conference, were gathered in order to produce a binding text that would help move the world out of the financial mess it had found itself in after WWI. H. G. Wells (1933) put it fittingly when he stated (p. 127): The men who assembled had just as good brains as anyone today, and, as an exhaustive analysis by Moreton Canby of the various projects advanced at the Conference proves, they had a substantial understanding of the needs of the world situation, yet collectively, and because of their haunting paralyzing sense of the Mass and Press behind them and of their incalculable impulses and resentments, they achieved an effect of fatuity far beyond the pompous blunderings of Versailles.

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The failure to agree on a cooperation framework in 1927 was followed by the same failure in 1933. Eventually, in 1936, the US, Great Britain, and France agreed on currency stabilization in the context of the Tripartite Agreement, which some other countries of the gold bloc (e.g., Belgium, the Netherlands, and Switzerland) also observed. This was the only tangible success at the multilateral level until WWII erupted. Obviously, such limited international cooperation was not enough to address the post-1929 situation, never mind to preempt a world confrontation. 1.1.2.3 World Trade before Bretton Woods Following these unsuccessful attempts to coordinate policies, trade policies were unilaterally designed, and the world remained segmented. Coordination occurred in a limited manner, and various national/regional blocs emerged as a result. For example, the UK and its colonies (Commonwealth) were enjoying preferential access to each other’s markets. For its part, the US had in place the highest tariffs in its recent history, by virtue of the Smoot–Hawley Tariff Act. Although its impact on the US GDP has been grossly overstated, as the work of Irwin (2011, pp. 140ff.) has shown, its trade impact was quite dramatic. It also had in place a series of treaties of Friendship, Commerce and Navigation (FCN) with targeted countries, including the 1832 Treaty with Chile, the 1932 Treaty with Germany, and the 1937 Treaty with Siam. FCN signatories, even then, would pay the Smoot–Hawley tariffs. In Southeast Asia, a similar preferential zone existed between Japan and various other countries. Germany had developed its own system of (essentially) barter trade with a few of its neighbors. This was the “Schachtian” view of the world, named after Hjalmar Schacht, the former president of the Reichsbank during the Weimar Republic, who had become a Nazi sympathizer and Germany’s minister of economics during that era. Schacht favored few bilateral relations. After 1936, with Goering replacing Schacht, striving for autarky intensified. Tooze (2006, pp. 86ff.) explains how Germany attempted to realized his vision by first denouncing the 1932 Treaty with the US and putting Germany on course for self-sufficiency with limited trade agreements when necessary, with Austria, Spain, Sweden, and Switzerland. Trade relations, thus, did exist between nations in bilateral and regional arrangements, which were not interconnected through any multilateral agreement.13 World markets were quite segmented, kept apart mainly by high tariffs and various types of quantitative restrictions. Worse, through their unilateral policies, they were shifting costs on each other. Sumner Wells, US undersecretary of state, stated in a 1941 speech: Nations have more often than not undertaken economic discriminations and raised up trade barriers with complete disregard for the damaging effects of the trade and livelihood of other peoples, and ironically enough, with similar disregard for the harmful resultant effects upon their export trade.14

It is against this background that the ITO was conceived as the means to put an end to unilateralism. It was meant to serve as the “commercial leg” informally evoked at the

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7

Bretton Woods conference, the institutional foundation to administer the Havana Charter, an international agreement designed to regulate trade in goods on a worldwide basis. GATT was supposed to be part of the ITO,15 but it turned out to be a substitute for it. 1.1.3

Bretton Woods and Trade

Two important negotiations took place right before the end of WWII, when nations realized in the most awful manner what unrestricted unilateralism can provoke, and trade featured in neither of them: the San Francisco conference, which gave rise to the UN, and the Bretton Woods conference, which gave birth to the WB and the IMF. The UN16 was intended to be the overarching international organization to help avoid another world war; at the risk of vulgarizing, the UN system was designed as a multilateral response to unilateral aggression. The Bretton Woods conference, which took place in that homonymous city in New Hampshire, on the other side of the North American continent from San Francisco, aimed to complement the UN system and address the causes of aggression.17 The intended role of the WB and the IMF, the two institutions established then and there, was to provide technical assistance to address development-related issues and to finance development policies.18 It bears repeating that there was no formal negotiation during the Bretton Woods conference of a commercial leg that would complement the WB and the IMF, although some informal discussions pointed in this direction.19 1.1.4

Follow-up to Bretton Woods

The establishment of a multilateral institution focusing on trade liberalization was very much a shared initiative by the US and UK administrations. The two partners felt that they shared a responsibility for establishing a liberal trade order that would complement the new international architecture (UN, WB, IMF). Shared interests and some remarkable people transformed a noble idea into tangible reality. 1.1.4.1 Hull and Nondiscriminatory Trade It might sound odd to start the GATT narrative with a statesman. After all, if trade liberalization made good sense, anyone in his position would have pursued it. Maybe this is true. As it happened, though, it was Cordell Hull who did so, and his contributions in establishing GATT cannot be overstated. Chosen by President Franklin Delano Roosevelt to serve as secretary of state in 1933, Hull was uniquely positioned to pursue his belief that freer trade20 may lead to economic and political conditions that would be more favorable to peace. He saw a link between trade and peace, in that trade implied communication, and communication, he hoped, would lead to increased understanding of the differences across nations.21 In his own inimitable expression, Hull firmly believed that trade “dovetailed with peace.”22

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Hull had to fight an uphill battle inside the administration in order to advance his ideas. Many economic nationalists were at the time in the payroll of the US government, and they were opposed to free trade, fearing that it might eviscerate Roosevelt’s New Deal policies, such as government price support for farm products. The core of these policies consisted, of course, of government intervention with the intent of correcting the causes of all misfortunes that the US had experienced in the past. Opening up US markets to a flux of imports could be a compromising factor, at least in the minds of some. Luckily, Hull’s beliefs went hand in hand with a substantial dose of realism. The goal he set was not free trade in the sense of zero tariffs, an inconceivable objective at that time, but simply to reduce excessive tariffs and allow some additional growth in foreign trade.23 He was incrementalist, not utopian. Hull believed that the absence of discrimination in world trade relations should be seen not only as part of the US contribution to world peace, but also as a corrective mechanism redressing the adverse trade impact that the imperial preferences had exercised (and were continuing to exercise) on US interests.24 It was around this latter aspect that he would gather support for realizing his innate persuasion. Nondiscriminatory trade liberalization was a costly option for the US (as it would have been to any nation with substantial bargaining power, as the US had at the time), because it allowed free riding. Hull was very aware of the simple economic fact that those with little bargaining power would automatically and unconditionally profit from the tariff promises that those with substantial bargaining power (e.g., the US) had managed to extract from third countries. In a similar vein, they would profit from tariff reductions by the US without necessarily having to pay for them in form of reciprocal tariff reductions.25 The best proof that the US (and Hull) was quite aware of the economic cost of MFN is that before the GATT/ITO negotiations, the US government had not practiced widespread trade liberalization in its trade relations; instead, it had favored “conditional MFN.”26 For Hull, nevertheless, it was ultimately the duty of the US, as a world leader, to adopt a different behavior in the post—WII era and, in this way, to contribute to peace—the long-term objective that GATT should be pursuing, after all.27 In his thinking, economic realism (that is, obliging those who can afford to make reciprocal concessions to the US, to do so) should go hand in hand with contributions to peace (by allowing those who could not afford to pay to profit from the new, less protectionist equilibrium). By reducing its costliness (since free riding would be an option only for those who could not afford to pay, or whose payments were immaterial), the case for nondiscrimination would become more palatable to skeptics. To achieve nondiscrimination, Hull believed that he had to do away with what he perceived to be the greatest obstacle: the “imperial preferences” between the UK and its dominions and colonies that formed the Commonwealth, which were openly discriminatory.28 He went so far as to refer to them, when testifying before the US Congress in 1940,

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as “the greatest injury, in a commercial way, that has been inflicted on this country since I have been in public life.”29 The hostility toward imperial preferences was running deep inside the US administration. Although these preferences as such were decided in Ottawa in 1932, the British government had been practicing a policy of discriminatory trade with its dominions for a long time. Cordell Hull was echoing a sentiment to move to nondiscriminatory trade that had existed for years (since the American Revolution, in fact). Indeed, as Palmeter (2003) noted (p. 140): The American Revolution was fought in part over the issue—the British insistence that the colonies trade with Britain and not with France. Indeed, the Declaration of Independence condemns King George III “for cutting off our trade with all parties of the world.” George Washington recommended a non-discriminatory trade policy to his countrymen in his famous farewell address. Equality of trade was the third of Woodrow Wilson’s Fourteen Points. And the dismantling of the Imperial Preferences was a major goal of US trade policy after the Ottawa Agreements of the 1930s.

The GATT negotiation, in his mindset, would have to introduce MFN in lieu of imperial preferences. Note, nonetheless, that trade between Britain and its Commonwealth partners was not totally uninhibited. The term “imperial preferences” accurately captures reality in this respect. Tooze (2014, pp. 181ff.) for example, mentions that in 1917 India managed to obtain the right to impose tariffs on imports of British industrial cotton goods. Thus, trade in the British empire was preferential but not unobstructed. 1.1.4.2 The Other Side of the Pond: Meade and the International Commercial Union In the UK, there were many voices in favor of preserving the imperial preferences, even from those with a pronounced cosmopolitan outlook. The government favored pursuing a trade deal with the US and other countries, but it was quite reluctant to abandon the system of preferences across Commonwealth countries. Imperial preferences were perceived as a factor in the reinvigoration of the UK economy. Indeed, through this regime, the UK manufacturing industry had privileged access to raw materials around the world. It could, thus, profit from preferential access to necessary inputs when others with competing manufacturing industries (such as the US) could not. Entering into a negotiation aiming to shape the world trading order, the UK government had the unique chance to collaborate with three of the greatest economists that the country ever produced: John Maynard Keynes, James Meade, and Lionel Robbins. The first did not exert much influence on the shaping of the world trade order. He will be remembered for many things, among them his role in steering the Bretton Woods conference to success. But alas, he passed away in 1946 when GATT/ITO was about to be negotiated. The other two were members of the UK delegation to the GATT/ITO negotiation, and Meade should be credited with providing most of the intellectual support for the UK position during this negotiation.

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In Meade (1942), he had already highlighted several features of a possible multilateral trade convention. In his view, an “International Commercial Union” should be established, with three essential characteristics: • Membership open to all states willing to carry out the obligations of membership • No preferences or discrimination (with an exception for imperial preferences) among the participants • A commitment to remove certain protective devices against the commerce of other members of the Union altogether, and to reduce to a defined maximum the degree of protection which they would afford to their own home producers against the produce of other members of the Union30 The scene was thus set for the upcoming transatlantic negotiations. The US would ask the UK to abolish imperial preferences. The UK, in turn, would request from the US meaningful tariff concessions. Two questions, besides the issue of imperial preferences versus US tariff cuts, dominated the agenda of the transatlantic partners: • Who else should participate in the negotiations? • What, besides tariffs, should be the basis for the negotiations? Before we move to provide the responses to these questions, we need to first unravel the shaping of the transatlantic cooperation in the months before the official kick-off of the GATT negotiation. 1.1.4.3 Bilateral Attempts to Tame Imperial Preferences: Keynes Enraged The two countries did not jump directly into an international negotiation. They tried to resolve some of the issues that occupied the minds of policy makers in a bilateral manner. In 1938, the US and the UK already had signed a reciprocal trade agreement, but the results were limited, as the agreement failed to put a dent in Britain’s system of imperial preferences. The agreement went into effect in January 1939 but was rendered moot the following September, when the UK adopted extensive controls on imports, including exchange controls, following its entry into WWII.31 This was the last trade deal before GATT. The US efforts to extract a commitment from the UK to abandon its trade preferences vis-à-vis the other Commonwealth countries did not stop here, though. They were revived thanks to the Lend-Lease program. During WWII, the UK could not afford to finance its war efforts. It turned to the US for help, but that help did not come without consideration. The US Congress passed the “Lend-Lease Act” (enacted on March 11, 1941), and through this legislation, the US government could transfer billions of dollars’ worth of

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equipment and supplies to the UK (and later to other allies as well). Instead of compensation, the UK was required to provide a benefit that the US president deemed satisfactory. The consideration, in its original 1941 formulation in the Lend-Lease Act, would be a commitment by the British “to the elimination of all forms of discriminatory treatment in international commerce, and to the reduction of tariffs and trade barriers.”32 Lend-Lease, thus, was supposed to help the UK solve the difficulties it was facing at the time.33 The consideration for this assistance was the commitment embedded in this provision (Article VII) that the UK would help establish nondiscriminatory trade in the post-WWII period. For the US, this was very much an objective. Britain had kept demand for US products low by blocking conversion of pounds into dollars into the “sterling area” (Britain, and its colonies and dominions), and by controlling the spending of dollars that its colonies and dominions had earned. Members of the sterling area were, of course, trading with each other through the imperial preferences. Steil (2013) reported that Keynes was infuriated by Article VII, since he saw in it the death of imperial preferences, as well as an obligation by the UK to share with the US access to raw materials and its lucrative export markets. He went so far as to call this provision “the lunatic proposals of Mr Hull,”34 assigning to the US statesman the paternity of this proposal. He was not far wrong in thinking this was Hull’s idea. Keynes, under the influence of Meade, eventually revised his original position and stopped insisting on the need to keep imperial preferences intact at any cost.35 The imperial preferences could be negotiated after all, and the question became: What should the consideration be? The ball was slowly moving into the international arena. 1.1.4.4 The Atlantic Charter The qualms about Lend-Lease notwithstanding, the US and the UK continued to cooperate intensely and plan their next steps. While they continued to disagree on the consideration, their disagreement would not bring their cooperation to a halt. The UK government took the initiative and prepared a document that was meant to relaunch their trade negotiation. In August 1941, UK prime minister Winston Churchill presented Roosevelt with a first draft of the so-called ‘Atlantic Charter’,36 which included the pledge that the two countries would “strive to bring about a fair and equitable distribution of essential produce … between the nations of the world.”37 The final version of the Atlantic Charter that was agreed following negotiations between the two governments endorsed nondiscrimination, albeit in terms that could be interpreted in different ways: Fourth, they will endeavor, with due respect for their existing obligations, to further the enjoyment by all States, great or small, victor or vanquished, of access, on equal terms, to the trade and to the raw materials of the world which are needed for their economic prosperity.38

Correspondingly, the US agreed to dilute Article VII of the Lend-Lease Act, enacted on March 11, 1941. The governing economic conditions would prejudge the consideration

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granted, and the US was obligated to take appropriate domestic measures of production, employment,39 and the exchange of consumption and goods in case of an economic slump.40 It read: In the final determination of the benefits to be provided to the United States of America by the Government of the United Kingdom in return for aid furnished under the Act of Congress of March 11, 1941, the terms and conditions thereof shall be such as not to burden commerce between the two countries, but to promote mutually advantageous economic relations between them and the betterment of world-wide economic relations. To that end, they shall include provision for agreed action by the United States of America and the United Kingdom, open to participation by all other countries of like mind, directed to the expansion, by appropriate international and domestic measures, of production, employment, and the exchange and consumption of goods, which are the material foundations of the liberty and welfare of all peoples; to the elimination of all forms of discriminatory treatment in international commerce, and to the reduction of tariffs and other trade barriers; and, in general, to the attainment of all the economic objectives set forth in the Joint Declaration made on August 14, 1941, by the President of the United States of America and the Prime Minister of the United Kingdom. At an early convenient date, conversations shall be begun between the two Governments with a view to determining, in the light of governing economic conditions, the best means of attaining the above stated objectives by their own agreed action and of seeking the agreed action of other likeminded Governments.

As a result, both partners felt they had won something in this battle. Hull maintained that expressing Article VII in general terms did not mean that the US had given anything away since all preferential arrangements fell under its purview anyway. Churchill, on the other hand, defending its acceptance of this provision, stated: I did not agree to Article 7… without having previously obtained from the President a definite assurance that we were no more committed to the abolition of Imperial Preference than the American Government were committed to the abolition of their high protective tariffs.41

Termination of discriminatory treatment was the medium- to long-term objective, but its attainment was conditioned on contingencies. At the end of the day, though, the inescapable conclusion is that the pressure at the bilateral level by the US was not enough to make the UK cave in. The future of imperial preferences would be decided by multilateral negotiations. The Atlantic Charter was only the antechamber of that negotiation. 1.1.5

Onto the World Scene

1.1.5.1 From the Atlantic Charter to the “Suggested Charter” Following the negotiation of the Atlantic Charter, the US prepared two documents, which were based on the Atlantic Charter and reflected a substantial part of Meade’s ideas. Nonetheless, they added to them the US point of view.

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The first document was called “Proposals for an International Trade Organization (ITO),” and was issued in 1945.42 James F. Byrnes, US secretary of state at that time, stressed in the foreword to the Proposals: Nations are now determining the policies which they will apply to trade in the postwar world. It is urgently necessary that these policies should be agreed upon, in order that the world may not separate into economic blocs.

The next step was the issuance of the so-called ‘Suggested Charter’ in September 1946, a document based on the ‘Proposals for an ITO’.43 The idea was to submit this document to various trading nations and see to what extent something along the suggested lines could become the first genuinely multilateral trade agreement binding trading nations. Between September and October 1946, US State Department officials traveled to Canada, Cuba, Brazil, Chile, New Zealand, Australia, South Africa, India, and China to brief them on the Suggested Charter and get their reaction. Irwin et al. (2008) reported mixed reactions to the Suggested Charter: while developing countries like Brazil, India, and Australia were rather negative, developed nations supported it. More precisely, Brazil was lukewarm; India questioned the compatibility of nondiscriminatory trade in a world formed by countries with asymmetric bargaining power; and Australian officials believed that the draft had failed to put sufficient emphasis on efforts to expand domestic demand.44 Canada was most supportive, while the UK criticized the draft charter only to the extent that it differed from its own proposals.45 One US State Department document summarized the reactions in this way: A definite different opinion is to be found in the less-developed countries (Australia, New Zealand, India, China, Cuba, Brazil, and Chile) with regard to the reduction of trade barriers. These countries, deeply concerned with the problem of industrialization and full employment, want to use restrictive measures to protect their infant industries. In general, they remain unimpressed with our contention that subsidies offer the least objectionable method for this purpose. They point out that, while tariffs and subsidies both amount to charges on their economies, the very real difficulties in raising the revenue to pay subsidies make the latter impractical for them. The Cubans are reluctant to give up their preferential position in the US market, as are the New Zealanders in the UK. The British, however, are willing to negotiate on preferences if convinced of the sincerity of the US intention to lower substantially our tariff wall, as a defense against which the Empire preferential system was developed. A major point of difficulty will be faced in connection with our cartel provisions. The Dutch, the Czechs, and the Belgians are not willing to concede that all cartels are bad. They would be willing to have the Charter state that certain practices may have undesirable effects, but they object to having the burden of proof put on those engaging in cartel arrangements, as our draft Charter now provides.46

No one, however, dismissed the submitted document out of hand, arguing that it was an inappropriate basis for an eventual negotiation. In fact, for some, it was a giant step toward a final text. In the words of the Chilean delegate, Mr. Videla, for example, “… the

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Chilean Delegation regarded the Suggested Charter as an admirable basis for discussion.”47 Indeed, the Suggested Charter was put before the GATT negotiators when the negotiation of GATT was officially launched after the end of WWII. 1.1.5.2 US Reciprocal Trade Agreements Act The participation of the US in the international negotiation(s) was substantially facilitated by the enactment of the US Reciprocal Trade Agreements Act (RTAA) in 1934. Irwin (2005, pp. 204ff) states that the RTAA fundamentally changed US trade politics by shifting tariff authority from Congress, which proved very responsive to domestic import-competing industries, to the executive branch, which was more apt to consider the national interest and use tariff negotiations in the service of foreign policy objectives.48

The US president, in other words, could strike deals that representatives of individual states could not: if coal meant more to the US than citrus, Pennsylvania would profit and Florida would suffer, but the US would be better off as a whole. While Florida on its own would have opposed similar deals, the US president could make them happen by allowing compensation of those who lost out from trade openness. Of course, one cannot overstate how important the participation of the US in the endeavor to sign a worldwide trade agreement was. It was the leading world power, the biggest trader, and a key player in the post-WWII reconstruction of international cooperation. 1.1.5.3 The List of Invitees The question of who should participate in the negotiation that would eventually signal the advent of the ITO was given substantial thought. On one end of the spectrum (and based on the information received through the dissemination of the Suggested Charter to a host of trading nations), keeping the negotiation to a few like-minded nations would facilitate the whole process and avoid weakening its quintessential elements. On the other hand, this approach was no guarantee that nonparticipants in the original contract would accede eventually to a contract that they had not negotiated (and influenced). Canada had consistently favored a “nucleus” approach, whereby only like-minded countries should participate. This meant that only countries of the so-called ‘Western bloc’ would be included in the negotiations, and the door would be closed to nonmarket economies (NMEs).49 This argument carried the day in the end, albeit with some modifications. Some developing countries, the views of which regarding the Suggested Charter had been sought, were invited to participate in the negotiation of the ITO. The Union of Soviet Socialist Republics (USSR) was invited as well, but rationally, no one would have expected it to accept the invitation. The group that was invited to negotiate the multilateral trade agreement in 1946 consisted of Australia, Belgium, Brazil, Canada, Chile, China, Cuba, Czechoslovakia (before

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it became a socialist country), France, India, Lebanon, Luxembourg, Netherlands, New Zealand, Norway, the Union of South Africa, the USSR, the UK, and the US. The USSR, as expected, declined the invitation to participate.50 1.1.5.4 “We Need to Act before the Vested Interests Get Their Vests On” The negotiation was formally launched following the establishment of a Preparatory Committee for the ITO in 1946.51 The Preparatory Committee held its first meeting in London that same year. It did not take long for negotiators to realize that the endeavor to successfully negotiate the ITO was quite formidable. The sheer number of issues on the table and the alreadyreceived reactions to the Suggested Charter signaled a negotiation that would be cumbersome and delicate, even among basically like-minded countries. The negative reactions did not recede, as countries were becoming increasingly aware of the amount of sovereignty that they would be transferring to the international plane as a result of their accession to the ITO. Although the term “globalization” was invented dozens of years later, some participants effectively reacted to it by invoking the “assault to sovereignty” as the reason to block some far-reaching initiatives to integrate. Indeed, a far-reaching agreement had been put on the table dealing with both state and private barriers to trade liberalization. Issues such as social dumping and domestic employment policies, which many wanted to keep within the realm of national discretion, were on the agenda.52 The ITO project reflected a level of unprecedented ambition to address barriers that segmented markets. GATT was simply one of the chapters that fell under the aegis of the ITO, designed only to address state barriers to trade liberalization. It focused on quotas and tariffs (e.g., eminently negotiable policy instruments). It kept important regulatory choices, such as employment policy, within the exclusive domain of state sovereignty. In fact, it did not even mention them by name, since, as will be discussed later in this chapter, commitments were made on all domestic policies without naming them one by one, and the plan was meant to ensure that commitments on tariffs would not be circumvented through subsequent unilateral action. The GATT looked to be a feasible, realistic exercise compared to the ITO project. It did not take long before skeptics regarding the feasibility of the wider agenda, the ITO, multiplied. Unsurprisingly, negotiators decided already during their first meeting in London on a bifurcation between GATT on the one hand, and the wider ITO agenda on the other: GATT would be negotiated on a separate track from the ITO. Its limited and less controversial content almost guaranteed a swift conclusion of the negotiations. It was thought, thus, that through separate negotiations, trading nations could quickly realize substantial gains from trade liberalization (by focusing on state barriers to trade). Following their decision to bifurcate, negotiators went full throttle and managed to conclude the negotiation of GATT in two additional meetings held in New York and Geneva in 1947.

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The decision to bifurcate the negotiation and quickly conclude the GATT leg was supported by political economy reasons as well. Diebold (1993, p. 336) attributes to Will Clayton, a southern businessman who established a cotton brokerage firm before serving the Roosevelt administration first in the Commerce Department and then, as of 1944, in the State Department (first as assistant secretary and then undersecretary of state for economic affairs, and eventually as head of the US delegation to the Geneva talks), the following phrase: “…we need to act before the vested interests get their vests on.”53 The fear was that a delay in the negotiations might give lobbyists the necessary time to put pressure on governments to avoid trade-opening measures. Acting fast would catch domestic business interests unawares and thus reduce the number of problems that negotiators had to face. It is quite remarkable that the whole negotiation was completed in three meetings conducted over a time span of substantially less than a year. 1.1.6 The Negotiation of GATT GATT was planned as the first step in the direction of the ITO. The signature and entry into force of GATT did not mean, ipso facto, the abandonment of the ITO project. Quoting Diebold (1993) again, GATT was regarded as an “advance installment” that could be folded into the ITO later on. GATT was negotiated first in London, then in Lake Success, New York, a village in northwest Long Island, which had also been the temporary headquarters of the UN (1946–1951), and finally in Geneva, Switzerland. Following the good work done in London, negotiators met between January 20 and February 25, 1947 in Lake Success. They established an ‘Interim Drafting Committee’, which was meant to provide solutions in the areas where no agreement had been reached, complete the draft where necessary, and streamline the drafting of the provisions provisionally agreed upon in London. John Leddy, a member of the US administration who was trained in economics, was in charge. In a confidential document that Leddy addressed to the US delegation,54 he stated that the focus of the Interim Drafting Committee was on what became Part II of GATT (e.g., national treatment, customs valuation, etc.). He praised the attitude of several delegations (Australia, Canada, Cuba, India, and the UK), and was quite laudatory when discussing their contributions, while reserving criticism for others.55 To facilitate conclusion, flexibility was introduced: whereas no reservations were allowed in the final text, they were considered appropriate during the drafting stage.56 The negotiations on the GATT text were eventually complemented by negotiations on tariff reductions. Between April and October 1947, state representatives, negotiating under the institutional umbrella of the Preparatory Committee, conducted the first round of tariff negotiations at the European office of the UN in Geneva.57 Annex 10 of the London Draft58 explained the agreed tariff negotiation process:

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Negotiations should take place under strict reciprocity59 (in the sense, that countries should not be expecting one-way preferences); (a) The agreed “principal supplier rule” meant that the importing state would be negotiating the level of its import tariffs with the most important exporter for a particular commodity.

This effectively meant that the UK and the US would be omnipresent during the first tariff negotiations. The ride was far from smooth. Irwin et al. (2008) reported a cable by Clayton to his authorities stating the abrupt end of negotiations as one possible response to British intransigence. Clayton was getting exasperated with the insistence of the UK to preserve the bulk of its imperial preferences (pp. 100ff.): In a key meeting on July 12, 1947, Clayton and Cripps clashed over preferences. Clayton insisted that the time had come for Britain to eliminate imperial preferences. Cripps completely rejected this demand. They squabbled over the degree to which the United States had reduced its tariff and thereby earned a reduction in preferences. Part of the difference between them was technical: Americans assessed the value of concessions by the percentage of items on which duties were reduced or bound, whereas the British used the pre-war value of trade on which duties bound or reduced. But the British did not even pretend to make serious concessions. A U.S. cable described Cripps as “marked by complete indifference bordering on open hostility toward the objectives of the Geneva conference” (FRUS 1947, I, 965). At one point, Cripps made the amazing suggestion that a better balance might be achieved by the withdrawal or reduction of our offers. Helmore has sought an early termination of tariff negotiations and has indicated that we should be satisfied with modest results. In respect to preferences, the Commonwealth has placed us at a disadvantage in negotiations by taking the position that we must purchase every reduction or elimination of a preference twice—once from the country that receives it, and once from the country that grants it. On the basis of performance to date, it would appear that the United Kingdom will attempt to extract every concession that we will make toward easing their short-run situation without making any appreciable concessions with respect to long-run trade policy. The vested interests that have been built up under the preferential system are strong, and the United Kingdom has shown no willingness to take the political risks involved in reducing or removing the protection afforded them by the preferences which they enjoy. It appears that no concessions are made without the permission of the industry concerned. The real obstacle to effective action on preference exists, not in the Dominions, but in the United Kingdom (FRUS 1947, I, 975). The Americans were flabbergasted that Cripps would suggest that the United States should withdraw some of its offers if it believed it had not received adequate concessions. Clayton was furious over Cripps’s “callous disregard of their commitment on preferences” (FRUS 1947, I, 979). Canadian officials watched with grave concern the deterioration in the Anglo-American relationship at the conference: It is evident that temperamental differences between Clayton and Cripps have grown to the point at which they constitute a real obstacle to agreement (CDER 1947 13, 1192).

In a similar vein, here is an anecdote recounted by Zeiler (1997, p. 711): Worried about getting a deal that would satisfy Congress, Clayton began a long retreat punctuated by pleas, demands, and recrimination toward the British. He first tried to entice Britain and Canada, two nations deemed amenable to free-trade doctrine, to close sixty-five margins. Cripps merely countered with an offer to abolish preferences on frozen salmon and motor bikes, items of lesser significance than other American exports affected by Ottawa margins.

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The eventual compromise was for the US to accept a reduction (rather than an elimination) of the preference margin, and, in response, for the UK to accept in return less farreaching (than originally planned and requested) US tariff cuts. This eventually opened the door to the final agreement. Steil (2013) quoted from the October 15, 1947, New York Times: The vast project [the GATT], which makes all previous international economic accords look puny is the realization of Mr Clayton’s dream: that a group of like-minded democratic nations could deliberately reverse the historical trend toward the strangulation of world trade. It is a big step that nobody but Mr Clayton and a few of his colleagues thought would ever be taken.60

1.1.7

Entry into Force

The outcome of the Geneva tariff negotiations, together with the document negotiated in Lake Success, constituted the Geneva Final Act. This act included the Protocol of Provisional Application (PPA), under the terms of which the governments that participated in the negotiations undertook to fully apply Part I of GATT (dealing with tariff concessions and the MFN clause),61 and Part III of GATT (containing provisions dealing with administrative issues). The same governments further undertook to apply Part II of GATT (the heart of the agreement, covering national treatment, antidumping (AD), subsidies, safeguards, balance of payments (BoP), prohibition of quantitative restrictions, general exceptions to the obligations assumed, and dispute settlement) “to the fullest extent not inconsistent with existing legislation.”62 The application of Part II only to the extent consistent with existing (domestic) legislation is what became known as “grandfathering” of legislation that was inconsistent with the GATT obligations.63 It was agreed that similar inconsistencies would be tolerated on a temporary basis only, and they would be set aside when the ITO would see the light of day: “Part II of this Agreement shall be suspended on the day on which the Havana Charter comes into force.”64 GATT entered into force on January 1, 1948. Its original 23 members were the governments of the Commonwealth of Australia, the Kingdom of Belgium, the United States of Brazil, Burma, Canada, Ceylon, the Republic of Chile, the Republic of China, the Republic of Cuba, the Czechoslovak Republic, the French Republic, India, Lebanon, the Grand Duchy of Luxemburg, the Kingdom of the Netherlands, New Zealand, the Kingdom of Norway, Pakistan, Southern Rhodesia, Syria, the Union of South Africa, the United Kingdom of Great Britain and Northern Ireland, and the United States of America.65 The entry into force of GATT was provisional since it was only by virtue of the PPA. As explained in Jackson (1969), GATT could have entered into force on a permanent basis once a given number of countries representing a high percentage of international trade had agreed to do so. It was decided, nevertheless, not to proceed in this way in order to avoid

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creating discrepancies between those who had accepted GATT on a provisional basis and those who would be accepting it permanently. The adoption of the Havana Charter, which would signal the advent of the ITO, was expected to occur at a later stage, following the entry into force of GATT, and the plan was that GATT would then come under the aegis of the ITO. In the meantime, the legal relationship between GATT and the ITO was governed by Article XXIX of GATT. This provision imposed on the GATT signatories a best-endeavors obligation to behave in an ITO-consistent manner with respect to the obligations included in the chapters of the Havana Charter mentioned in Article XXIX.1 of GATT. Since the Havana Charter never came into force, GATT was provisionally applied for 47 years pending the advent of the ITO. The successful conclusion of the Uruguay round and the consequential advent of the World Trade Organization (WTO) signaled the definitive end of the ITO project. The Uruguay round is the last round of negotiations that has been successfully concluded so far. Besides the institutional innovations capped by the entry into force of the WTO, it covers both agreements on tariff reductions, as well as a series of “regulatory” agreements that we discuss in the second volume of The Regulation of International Trade (covering the WTO Agreements on Trade in Goods) hereafter abbreviated as “volume 2.” 1.1.8

Property Rights on GATT

The influence of the US and UK on the negotiation of GATT cannot be overstated. The Suggested Charter was based on negotiations between the transatlantic partners. In the account provided by Irwin et al. (2008), 75 of 89 provisions featured in the Suggested Charter found their way into the GATT text. There are still some notable provisions that were introduced by other participants, but the overall picture does not change: the US and the UK delegations exerted an immense influence on the drafting of GATT. Tellingly, Leddy’s confidential account stated (p. 4): “… in almost every case the new text is based on drafts prepared by the United States delegation in the light of the experience of the London meeting.”66 Irwin et al. (2008) included a section on the “property rights of the GATT,” in which they discussed which participant proposed which provision and confirmed that the UK and the US should be credited with most of the drafting of the original GATT. It is, of course, difficult to measure influence in a precise manner. There are good reasons, nevertheless, supporting this conclusion: 1. The negotiation was de facto a reaction to the Suggested Charter, the document that the US had prepared based on the discussions it had held with the UK. 2. There was no alternative comprehensive view of the role and function of the world trade institution that was about to be established. The UK and the US were the only

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negotiators with a view of the identity of the new trade institution. The other trading nations advocated narrower trade interests (e.g., Australia and wool). 3. As cited previously, 75 of 89 provisions included in the Suggested Charter found their way into GATT. It should also be noted at this point that these provisions constituted the crux of the GATT recipe of trade liberalization;67 4. Irwin et al. (2008) mentioned that the UK and US participated in all but one negotiating groups and committees, and the rapporteur was almost always a national of one of those two countries. 1.1.9 The People Who Made GATT Happen A handful of remarkable personalities participated directly or indirectly in the negotiation of GATT, which started in 1946. Chief among them was Cordell Hull, a genuine freetrader, whose contribution has already been discussed. Hull had the good fortune to be joined in this endeavor by some remarkable individuals who provided much-needed statesmanship, as well as intellectual rigor, at the times when it was most needed. Will Clayton and Harry Hawkins (secretary of state, then professor at the Fletcher School of Law and Diplomacy, Tufts University) led the US delegation.68 James Meade (winner of the Nobel prize in economics, 1977), Lionel Robbins (professor at the London School of Economics), and Sir Stafford Cripps (a Labour Party politician who was the chief negotiator in the later stages of the project) headed the UK team. 69 For the Canadian delegation, Norman Robertson, a well-known diplomat and close adviser to Prime Minister MacKenzie King; Hector McKinnon, one of Canada’s lead negotiators in from the 1930s through the 1950s; and Dana Wilgress, the High Commissioner to London in the post-WWII years (and first chairman of the GATT CONTRACTING PARTIES) were the key members. Alexandre Kojève, an eminent philosopher, was the leader of the French delegation. And many others were involved as well, including Leddy, who actually wrote the GATT text. (Note: “CONTRACTING PARTIES,” when used in capital letters, refers to the highest organ of GATT; when in small letters, the term refers to the GATT membership.) These statesmen produced a text dealing with highly complicated issues that has managed to withstand the test of time.70 John M. Leddy, an economist, not a lawyer, wrote a text back in 1947 that is very much relevant in today’s world. 1.2 Why GATT? 1.2.1 What Did Negotiators Have in Mind? Trade liberalization can serve different purposes. In Lewis Carroll’s oft-quoted passage from Alice in Wonderland, Alice asks, “Where do we go from here?” only to get the

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response, “It depends where you want to go.” “Where do we want to go with GATT?” is the question a wondering Alice would have asked the framers of GATT. The natural place to look for responses to this question is in the historical account of the negotiation of GATT. Where did negotiators want to go with GATT? The preparatory work of GATT is vast and has been studied and written about by countless trade scholars over the years.71 There is a plethora of accounts as well, detailing the participation and the negotiating objectives of individual trading nations. Hart (2002) offered a very comprehensive account of Canada’s priorities. His main conclusions were that Canada essentially played second fiddle to the UK and US negotiators, who monopolized the negotiations, but nevertheless it was quite happy with the introduction of MFN, which was perceived as a means to curtail the dominance of the two superpowers of that time.72 Capling (2001) discussed Australia’s participation, and concluded that it did not heavily influence the negotiated outcome. In Capling’s account, Australia was largely preoccupied with sectoral negotiations, even threatening to walk out of the negotiating room when the US initially refused to reduce its duties on wool and wool products. As expected, the overwhelming majority of historical accounts focus on the UK and US negotiating positions and the research literature is unanimous regarding the influence that the two had in shaping the original GATT. Because of the influence these two had on the shaping of GATT, it is quite appropriate to visit in more detail the scholarly works detailing their negotiating positions. Irwin (1996) and (2005) delved into the US constitutional process and aptly described the context in which US trade policy was being shaped in order to describe the goals sought by the US administration. The US was coming out of the era of the Great Depression and the Smoot–Hawley Tariff Act,73 under which high tariffs had been imposed on a wide series of products. The US had charged high tariffs a few years before the enactment of Smoot— Hawley as well, but the effects were less dramatic. By the time, for example, that the Fordney–McCumber Tariff Act of 192274 had been implemented, the US economy was growing rapidly, and European exports to the US were growing at a steady pace. By contrast, when the Smoot–Hawley Tariff Act was enacted and implemented, the US economy was contracting and European exports suffered as a result. Irwin (2011, p. 151) stated: The United States’ move to erect even higher trade barriers on top of that imposed in 1922 sharpened European resentment at American policy. With Smoot–Hawley, the United States seemed to be signaling that its economic policies would become more isolationist. For this reason, the European response to the passage of the Smoot–Hawley tariff “was disapproval-immediate, undisguised, and unanimous.” As Percy Bidwell (1932, p. 395) noted: “There was a common note in the chorus of protests, however much they may have differed in expression, namely the conviction that the new American duties constituted a serious menace to the economic progress of western Europe.”

Canada, and then the western European states, reacted and imposed retaliatory tariffs against the US. The negative impact of Smoot–Hawley did not stop here. Anti-US feelings

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rose in Cuba where, as a result, a blatantly anti-American government rose to power.75 The overall amount of international trade was spiraling down at a fast pace. The US was now facing discriminatory tariffs around the world. As a result, its income shrunk like never before. It is of course, the building of tariff walls and the ensuing reduced communication across peoples that fuelled Hull’s belief that GATT should be an instrument to abolish discriminatory treatment on trade issues, establish communication channels, and thus contribute to world peace. His ascent to government positions meant that his views were channeled to the world as the official US position. The US administration was looking for the establishment of nondiscriminatory world trade order, a reduction in the role of the state and statetrading (with the view that trade would be safer in private hands being dominant),76 and for product-by-product tariff reductions.77 The UK attitude was different as to the means, although it shared the same objective, the establishment of a world trade regime. It sought tariff reductions (essentially by the US), but also the maintenance of its imperial preferences. The UK government, largely influenced by the thinking of John Maynard Keynes (who was acting as policy adviser until his death in 1946) and James Meade (who participated in the negotiations as a member of the UK delegation), believed that it would have less to offer in terms of consideration for US across-the-board tariff reductions, if it had already unilaterally removed its imperial preferences. Keeping imperial preferences in place for as long as possible would provide the UK negotiators with an important bargaining chip: imperial preferences would be the quid pro quo for US nondiscriminatory tariff reductions.78 The difference between the two great economists was of course that Meade was eager to negotiate the imperial preferences, whereas Keynes, originally at least, was quite inflexible in this respect. The two delegations had a different approach to the issue of state trading, cartels, and quotas as well. Miller (2000) explained that, for example, the UK delegation, which favored a strong role for government in the post-WWII era, insisted on allowing quotas for the reason of maintaining BoP. In Miller’s account, the pragmatic, government-friendly attitude of the UK delegation found friends at the table, and this explains the regulation of preferences (which were not eliminated but grandfathered), quotas allowed for BoP reasons, state trading (which could legitimately persist, provided that it operated on nondiscriminatory terms), and cartels (that were not disallowed) in the final GATT text.79 Besides their differences, of course, there was a substantial overlap between their positions as well. After all, the Suggested Charter, the US text submitted to negotiators, was based on their shared belief to establish a world trade institution (the British viewing it as a means to curtail US dominance). Both governments shared the belief that trade expansion was an appropriate means to fight the unemployment that had crippled the US economy in the pre—New Deal era and was spreading throughout Europe in the aftermath of WWII,80 and, in light of this, it should come as no surprise that a specific provision in an earlier GATT draft targeted this issue.81

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Their views, however, even on this score, were not totally identical, at least not in the early stages of the discussions. Whereas the US delegates viewed the opening of trade as an antidote to persisting unemployment, the UK government had a more cautious approach to this issue since, arguably influenced by Keynes’s thinking, the UK delegates, while not denying that trade could indeed be beneficial on this score, seemed to prefer short-term, macroeconomic solutions to unemployment. In the dominant UK view, a drop in tariffs would not in and of itself help bring unemployment to an end. This was very much the Keynesian view that constituted the orthodoxy at that time.82 Because Keynes was not part of the actual negotiating process, the UK position was more influenced by the views of Meade and Robbins, who had a more favorable attitude toward trade liberalization.83 In a nutshell, the negotiating record reveals the following: 1. The UK and the US were the drivers of the negotiation. 2. They wanted to constrain each other’s behavior, not to solve domestic problems. 3. They were looking to establish an, in principle, nondiscriminatory world trade order, although both of them had to compromise on the exceptions allowed. Remaining negotiators had influence on specific provisions but offered no alternative view regarding the role of the trade institution that would result from their negotiations. The next section makes a brief detour into economic theory, including a discussion of how economists understand the rationale for trade agreements. After all, GATT pursues economic objectives, and its shaping was influenced by the ideas of eminent economists who, as argued previously, directly participated in its negotiation. 1.2.2

Economic Theory

Typically, economists, when discussing gains from trade, ask the following questions: • Are there gains from trade liberalization? • If so, why are countries not pursuing trade liberalization anyway (that is, in the absence of a written commitment or agreement to do so)? Assuming a positive response to the first question, it is the response to the second one that will allow us to understand the rationale for trade agreements. 1.2.2.1

Gains from Liberalization

One will be hard-pressed to find economists arguing that there are no gains from trade liberalization. Discussions and divergences of opinion have emerged regarding the distribution of gains from trade, but almost all observers acknowledge that there are gains from trade liberalization. Johnson (1960) goes so far as to state that “the proposition that

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freedom of trade is on the whole economically more beneficial than protection is one of the most fundamental propositions economic theory has to offer for the guidance of economic policy” (p. 327). Indeed, as explained in numerous writings from Adam Smith’s classic tome The Wealth of Nations on, all nations have an advantage in producing particular goods, and gains from trade result from specialization.84 Adam Smith had in mind “absolute advantage,” whereby a firm or a nation was better at producing a good than another firm or nation. What if, nonetheless, a nation had an absolute advantage over the production of any good over another nation? Could the two nations still be better off by trading with each other? This is where the notion of comparative advantage comes in. The modern understanding of international trade theory is, to a large extent, still based on the notion of comparative advantage (and the ensuing gains from specializing in the areas where comparative advantage exists), as developed by David Ricardo.85 Economists will compare the situation of a country living in autarky with one in which trade is liberalized. Many countries lived in autarky well into the twentieth century (that is, over a century after Ricardo completed his work), and some continued to live in autarky until well after the establishment of GATT.86 The Ricardian model shows gains from trade; that is, countries are better off (under some very realistic assumptions) when they trade with each other than when they live in autarky. Gains stem from the comparative advantage that countries have in producing goods (i.e., widgets over wheat). Comparative advantage should not be confused with absolute advantage. Even when, say, Home has an absolute advantage in producing wheat and widgets, Foreign will be better off specializing in widgets, where it arguably has a comparative advantage, than in wheat, where it does not. It is the opportunity cost of producing a good that determines comparative advantage, not the amount of resources committed to its production. Even if Home can produce widgets using fewer resources than Foreign (absolute advantage), it might be foregoing the production of many other goods by doing so, and therefore might be better off importing widgets from Foreign (which, by construction, has low opportunity cost in this field). The sources of comparative advantage could be differences in climate, in endowments, or in technology. Ever since Ricardo formulated his theory, there has been a shift in the focus of trade theory from country-, to industry-, to firm-specific analysis. Every time the level of analysis changed, economists managed to point to additional gains from trade, thus strengthening the case for trade liberalization. Economists who shared the view that countries had equal access to technology and information had a hard time understanding what determined comparative advantage: in other words, what determined that Portugal would export wine to England, and the latter cloth to the former? The Heckscher–Ohlin theorem provided a response. Even if all countries had equal access to information and technology, the relative abundance of their

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productive factors would determine trade flows. England, with its textile industry, would be exporting cloth, and Portugal, with its many vineyards, wine.87 But then, especially in the years following WWII, economists were puzzled again. England was now both importing and exporting cloth and textile products. The Heckscher– Ohlin theorem was hard to reconcile with reality, as liberalizing countries were observed to diversify their production and trade rather than specialize. The so-called new trade theory came in and focused on industry analysis, concluding on two new sources of gains (namely, the rise in efficiency resulting from increased scale of production and consumer gains from access to a wider variety of goods). The bad news was that the new trade theory opened the door to “strategic trade theory” and increased the use of subsidies (in an effort to gain competitive advantage). The “new new trade theory,” has a different focus than the “new trade theory.” It focuses on firms (and not on industrywide analysis), and has revealed an additional source of gain from trade: a rise in productivity because the least efficient firms leave the market because of increased competition and the ensuing reallocation of productive resources.88 Gains from varieties, as well as reallocation of resources, thus, are additional gains that economic theory has added to the classic Ricardian analysis. The text that follows explains in more detail the basic findings of the ‘new trade theory’ and the ‘new new trade theory’. Balassa (1966) should be credited as the first economist to take the discussion about gains from trade one step beyond the world of Ricardo and Heckhsher-Ohlin. He argued that gains from trade exist even when it is conducted between homogeneous countries. Balassa studied the European integration process and observed that reduction in tariffs across the participants in the process led to intraindustry specialization, and that in this scenario, the welfare effects of an increased exchange of consumer goods may now consist largely of improvements in the efficiency of exchange (the satisfaction of consumer wants) whereas specialization in narrower ranges of machinery and intermediate products will permit the exploitation of economies of scale through the lengthening of production runs. (Balassa 1966, p. 472)

Balassa contested the then orthodox view regarding gains from trade liberalization, arguing that tariff reductions would lead to interindustry specialization, and the ensuing gains. Thus he opened the door to subsequent research on gains from variety. The new trade theory that emerged as a result of his pioneering research has strengthened the case for trade liberalization by explaining that there are gains even when homogeneous countries open up to trade because of the inherent advantages of specialization (which allows large-scale production).89 In this vein, Krugman (1979) developed a monopolistic competition model, explaining why similar countries gain from trading with each other and why a significant part of that trade may take place within the same industries. Some producers, however, will lose, and governments might wish to protect such producers through the use of safeguards.

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Two assumptions are crucial to Krugman’s model: increasing returns to scale (economies of scale) and consumers’ love of variety.90 There is tension between the two assumptions: consumers’ love of variety favors the existence of many small firms; the organization of production in large firms is key to exploiting economies of scale. Krugman built the two opposite tensions into a single model, whereby producers have a monopoly over a variety of the product they produce and therefore can set their prices unilaterally. Because the varieties are, to some extent, substitutes for one another, each firm continues to face competition from other firms (so some disciplining of companies’ pricing policy occurs because of competition). The opening of trade means that consumers will have access to more varieties of products, but they will also become more price-sensitive. As a result, some firms will go out of business, but the gains from trade opening will outweigh such losses. There will be a “scale effect,” since companies now sell in more than one country and can thus exploit economies of scale. There will be a “variety effect” as well, since consumers now have access to more products. And there will be a “pro-competitive effect,” since consumers will now pay a lower price.91 In this paper, Krugman (1979) pointed to gains from trade liberalization resulting from trade between similar countries, building on Balassa’s work. More recently, the new new trade theory added a new dimension and pointed to yet additional gains from trade liberalization. Melitz (2003) allowed firm heterogeneity. In his model, low-productivity firms will exit the market and resources will be reallocated within the same sector to expanding (i.e., exporting) high-productivity firms. Thus, next to gains from comparative advantage (Ricardo), and from increased varieties (new trade theory), Melitz points to further gains resulting from reallocation of resources.92 1.2.2.2 No Gain without Pain: The Case for Trade Agreements In light of the previous discussion, the question that naturally arises is: If this is so, then why does trade liberalization not take place unilaterally? Why do we need GATT (and now the WTO) in order to do what we should have been doing even without GATT in light of the undisputed gains from trade liberalization? In other words, what stops nations from liberalizing trade unilaterally? According to some economists,93 GATT should not exist, so any attempt to offer an economic interpretation of the agreement is doomed to failure. In this vein, Krugman (1991) noted (pp. 25ff): There is no generally accepted label for the theoretical underpinnings of the GATT. I like to refer to it as “GATT-think”—a simple set of principles that is entirely consistent, explains most of what goes on in negotiations, but makes no sense in terms of economics … The reason why GATT-think works is, instead, that it captures some basic realities of the political process.

A few years later, Krugman (1997), stated (p. 113): If economists ruled the world, there would be no need for a World Trade Organization. The economist’s case for free trade is essentially a unilateral case: a country serves its own interests by pursuing

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free trade regardless of what other countries may do. Or, as Frederic Bastiat put it, it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbours because other countries have rocky coasts. So, if our theories really held sway, there would be no need for treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national interests.94

This view is not unanimous. Many economists see the argument for a trade agreement as necessary to reap gains from liberalization. They differ, nevertheless, on the grounds for the agreement, and their divergence is not inconsequential since it will have an impact on the eventual institutional design. Two theories have been advanced to offer a rationale for GATT: the “commitment theory” and the “terms of trade theory.” The former rests on the idea that an international agreement is necessary for trading nations that want to lock in policies in an international agreement and avoid future pressure from domestic lobbies. Their response to lobbies’ rent-seeking behavior will be, “Sorry my hands are tied.” In this view, trade agreements are a response to domestic political economy concerns. The terms of trade theory on the other hand, relies on the concept that since governments might not have any incentive to unilaterally liberalize (perhaps for good reason), an international agreement is necessary in order to internalize all externalities that stem from a unilateral definition of trade policies that might result in “protection.” In this view, trade agreements are a response to an international, not a domestic, concern—namely, cost shifting by other trading nations when they unilaterally design their trade policies. Commitment Theory The focus of commitment theory is the relationship between government and the private sector in a country. A government will choose its trade policy, and that will commit it to an international agreement signed to that effect. As a result of this commitment, it will lose its discretion with respect to the formulation of the policy committed. The gain for the government is that investment decisions will be forestalled (assuming, of course, that the commitment is credible), but it will lose contributions by the various lobbies that will be unhappy with the commitment.95 There are good arguments in support of this view. First, for a government facing unpopular choices (for at least some segments of society), the argument that “my hands are tied” 96 is an easy way out that minimizes (although probably does not eliminate) the political costs associated with similar unpopular choices.97 On this understanding, national governments will use GATT as an excuse for unpopular choices. In other words, to deter pressure from lobbies, a government might be willing to tie its policies to the GATT mast.98 Commitment theory suffers, nevertheless, from some serious weaknesses. First, one can legitimately ask whether an international agreement is required at all when it is commitment theory that explains commitments. All trading nations need is a safe where they can

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lock up their domestic policies. Naturally, though, this should be the national constitution, or something equivalent. Srinivasan (2005), thus, correctly stated that in the commitment theory, there is no need for an international agreement when the source of the distortion is domestic. The terms of trade theory, in stark contrast, requires the conclusion of an international agreement since it is the behavior of foreign sovereigns, not of domestic lobbies, that is being addressed. Second, the incentives to enforce might be totally lacking. Foreigners might be totally uninterested in enforcing commitments aimed at promoting the interests of the country making the commitment, unless in cases where nonenforcement entails negative welfare implications for them. Enforcement, in this constellation, will occur because of the cost shifting that takes place and the resulting deterioration in welfare terms of the situation for foreigners, and not because a commitment has been entered into to lock in specific behavior. This however, resembles the terms of trade story that will be explored next: foreigners will have an incentive to enforce the agreement any time costs are shifted to them. They might or might not have the incentive to enforce the agreement in order to promote an interest of their trading partner (depending on whether, as a result, costs are shifted to them).99,100 The Terms of Trade Theory The terms of trade theory differs from commitment theory in that it traces the rationale for trade agreements not in domestic distortions, but in international externalities. Critically, it is the manner in which similar externalities travel that is at the heart of this approach: through the price mechanism and the ensuing terms of trade between two goods. Bagwell (2008) traced this theory to the work of early- and mid-nineteenth-century economists such as John Stuart Mill and Robert Torrens. Harry Johnson (1953–1954) is credited with its elegant formalization, and the theory more recently found an advocate in the scholarship of Bagwell and Staiger (2002), who took the preexisting analysis a number of steps further, using it to interpret the various GATT institutions in a context of both perfect and imperfect competition.101 The starting point of this theory is that it is simply not the case that unilateral trade liberalization is the best instrument for all trading nations: countries that can influence the terms of trade of specific commodities have a strong incentive to set tariffs and influence to their advantage the terms under which they will be traded. ‘Optimal tariff theory’ suggests that governments behaving in accordance with their self-interests should not necessarily abolish tariffs unilaterally.102 Hence, tariffs can and do occur for good reasons. Unilateral setting of tariffs, however, can lead to terms of trade externalities. A country will choose its tariff rates by calculating the welfare implications of its tariff setting only

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for its domestic producers and consumers. Nevertheless, it will also be imposing an externality on foreign producers of the commodity affected by the tariffs, which (in all likelihood) will not be internalized.103 Affected nations might wish to respond and, consequently, unilateral tariff setting can spiral into a Prisoner’s Dilemma,104 where countries behave in a noncooperative manner and impose externalities on each other. Since many nations might have the power to influence terms of trade in particular markets and commodities if they all behave in this way, the result would be a suboptimal total volume of trade. It is through trade agreements that trade is expanded back to its normal level through reciprocal tariff negotiations. A trade agreement, in other words, is the means to internalize the externalities resulting from unilateral tariff setting, and accordingly, a means to escape from the Prisoner’s Dilemma. That is, through reciprocal international negotiations, trading partners will aim at bringing tariffs down to the politically optimum level (that is, to the level that governments would choose were they not motivated by the implications of their trade policies). Yet another way of saying this is that trade agreements are needed because no country that can influence the terms of trading would have the incentive to unilaterally lower its tariffs, since a unilateral decrease of tariffs from their optimal level would lead to an increase of the world price of the imported good. The importing country, therefore, would be worse off than in the opposite scenario (i.e., if it had kept its optimal tariff in place). The trade agreement leads to a coordinated reduction of optimal import tariffs by two countries. It neutralizes the adverse effects of on each country’s terms of trade—that is, each country’s price of exports relative to its price of imports. Reciprocity, a GATT principle that guides tariff negotiations (which will be discussed in more detail in chapter 3), is the institutional vehicle to achieve this result. At first, this approach was dismissed in essence because the prevailing view was that it rested on the rather weak foundation that trading nations choose their policies without thinking at all in terms of domestic political economy (i.e., disregarding lobbies’ pressure). Its appeal in recent years is largely because Bagwell and Staiger demonstrated in a series of papers that the theory holds regardless of the political motivations of governments. In their reformulation, the theory rests on only two key assumptions: • Ceteris paribus, a government preference is to maximize social welfare, which is not the case when it suffers a welfare loss because terms of trade deteriorate.105 • Assuming a country is large, an increase in an import tariff results in a terms of trade gain for the importing country106 and a terms of trade loss for the exporting country.107 Both assumptions are of course quite reasonable. Bagwell and Staiger (2002) point to the actual design of the main GATT features to make the point that their theory offers a satisfactory explanation of GATT as we know it. Using terms of trade as their workhorse, they have published a series of papers explaining key GATT institutions, such as MFN,

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renegotiation of duties, safeguards, in this prism. In the words of Staiger, one of the proponents of this theory (2011, p. 12): In light with the terms-of-trade theory of trade agreements, foreign exporters are given a “voice” in the tariff choices of their trading partners, so that through negotiations they can make their trading partners responsive to the costs that these trading partners impose on foreign exporters when making their tariff choices. And in accomplishing this, a trade agreement then naturally leads to lower tariffs and an expansion of market access to internationally efficient levels.

A number of voices have been raised against the power of this theory to explain GATT. One common criticism is that the theory provides an elegant way to explain trade agreements, but it is doubtful whether terms of trade are the motivation behind them. In other words, critics doubt that negotiators think of terms of trade when forging a trade agreement. It is almost impossible to prove or disprove this point, although intuitively, one has to concede that calculating terms of trade is a cumbersome task. Ethier (2004) took issue with the terms of trade theory, arguing that trade agreements like GATT do not in fact prevent countries from influencing the terms of trade. For one thing, GATT does not include disciplines on export taxes (duties), an instrument that affects terms of trade in the same way as import duties do. Additionally, the terms of trade theory does not explain why small countries, which cannot affect the terms of trade, participate in trade agreements. Ethier based his first point on the fact that GATT does not include a provision as elaborate as Article II that would be applicable to export taxes. This does not mean, however, that export taxes cannot be negotiated and bound. In fact, GATT treats import and export duties symmetrically, in that they are not disallowed but can be disciplined.108 The presumption behind Ethier’s second point is that developing countries cannot affect the terms of trade at all.109 The work of Broda et al. (2008) is quite relevant here. The authors demonstrated that, absent the WTO framework, countries of different size and bargaining power do impose higher tariffs to the extent that they can affect the price of commodities in specific geographic markets. Their analysis is not direct support for the theory, but it is consistent with it. The wider point, though, is worth reflecting about. The fact that there are positive external effects for smaller players from negotiations based on terms of trade does not necessarily disprove the idea that the negotiation was not based on terms of trade at all. It is probably the case that disregarding similar effects marks the influence that Cordell Hull had on the shaping of GATT—that is, negotiate fiercely with the UK (in a scenario similar to terms of trade), but to allow those with lesser bargaining power to benefit from negotiation. Regan (2006) offered a different critique, arguing that terms of trade manipulation does not happen simply because there is market power. In his view, manipulation of terms of trade is a sophisticated policy that should not be assumed lightly. The models that

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economists use are two countries—two goods-models. And, indeed, there is nothing that makes it mathematically impossible to extrapolate the results to a world with many countries and many goods. The issue, nonetheless, is whether trade delegates as we know them can perform very complicated analyses and be clear about the terms of trade of all their countries’ exports and imports and do the same for each WTO participant. This sounds too demanding, and one has to concede that the author offers valid criticism in this respect. At the same time, however, having a rough idea about terms of trade is probably all that is realistically required.110 Regan (2014) explained in clearer and more comprehensive manner his understanding of what drives trade agreements. He argued that terms of trade is of no concern to policy makers—rather, it is protectionism they are after, which he defines as “unilateral trade policy that restricts imports in order to get political support for the government from import-competing producers.” In doing that, he de facto sided with many economists who proposed rent-seeking explanations for trade agreements. Trade agreements are primarily about restraining politically motivated protectionism. In his view, the models employed by Bagwell and Staiger (2002), and even Grossman and Helpman (1995), would entail that trade agreements never reduce protectionism since the sole function of trade agreements in these models is to eliminate terms-of-trade manipulation. Terms-of-trade manipulation is a completely distinct phenomenon from protectionism, reflecting a different government motivation. Protectionism, as Regan (2014) defined it, aims to affect domestic relative prices in response to special interest politics. Terms-of-trade manipulation aims to affect world prices, and to increase national income. Regan (2014) cared about domestic prices, not world prices as terms-of-trade theorists do.111 Small countries, his argument implies, are more effective at raising domestic prices than large ones (since no one will ask them to bind their tariffs, precisely because they will not affect terms of trade because of their size). There is a lot of empirical support for this observation, which will be detailed in chapter 3. Terms-of-trade theorists would respond, of course, that smaller countries have more political pressure to use high tariffs. Regan’s main point is that welfare effects of tariffs on outside countries travel through terms of trade, but governments impose tariffs to raise domestic prices (i.e., they ignore terms-of-trade effects of their policies). If this interpretation is correct, then his model and the terms of trade model coincide for the small-country case but have different implications for the large-country case. The difficulty for economists would be to understand why rational governments would not account for terms-of-trade effects while choosing tariffs. One potential answer is that terms-of-trade rents go to one wing of the government, while tariffs are set by another branch. This is probably true to some extent. Regardless of their differences, Regan (2014) and terms-of-trade theorists share one common feature: they understand the role of trade agreements to be the means that will

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address international cost shifting. True, they disagree with respect to the manner in which externalities will travel, but it is highly debatable whether this difference has any bearing on the understanding of the basic legal institutions. Take, for example, a case where Home imposes a higher sales tax on domestic drinks than on imported ones. In Regan’s view, this would be outright protectionism, and Home would be found to violate its obligations under Article III of GATT (chapter 7 discusses this issue in more detail). In the Bagwell-Staiger framework, if the foreign country’s trade policy is not set at its politically optimal level, then it is no longer indifferent to small changes in its local price. For this situation, if Home were to raise its sales tax, then international externalities would travel through the terms of trade and the foreign local price (which would be altered due to the underlying change in the terms of trade). In this case, a small hike in Home’s sales tax, even if hypothetically motivated only by local price considerations, could harm the foreign government and reduce joint efficiency as well. The ultimate result is a similar understanding of the national treatment obligation, which is embedded in Article III of GATT. A prima facie weakness of the terms-of trade theory is its assumption that a world market exists. Trading nations will not negotiate with any entity that cannot affect terms of trade. What about their exporters, though, who have been investing in distribution networks in similar markets? The notion of a world market is probably an illusion since it underestimates switching costs from one market to another. Terms-of-trade theorists could respond that, ex post, negotiations with similar markets might indeed occur since terms of trade will be affected because of similar costs. Others have argued that the terms-of-trade theory does not explain important legal institutions like AD. This, it should be noted, was never the intention of the theory: its purpose was to explain the core issues, the heart of GATT. Indeed, GATT could have existed without AD.112 The terms-of-trade theory aims to explain the original GATT, which was largely a tariff negotiation where disciplines on nontariff barriers (NTBs) were some kind of “supporting cast,” in the sense that they were contracted in a manner that would serve (e.g., avoid the circumvention or evisceration of the tariff negotiation.113 It encroaches on difficulties when it comes to explaining negotiations on regulatory (as opposed to tariff) barriers. A good illustration in this vein is offered by the Uruguay round Agreement on Agriculture (see chapter 8 of volume 2), in which negotiators agreed to “tariffy” (i.e., express in tariff terms) existing protection of regulatory nature, obviously because they had found it hard to agree on reciprocal concessions by exchanging the protection of regulatory nature. Moreover, they also had to agree on the types of measures (regulations) that they would tolerate, and to further agree that their disagreements concerning classification of measures (which measure should be classified as tolerable or intolerable) would be submitted to adjudication.

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This is not to suggest that terms of trade cannot be affected through NTBs. There are even specific models that explain how this happens, and these will be discussed further in chapter 7. There is, however, a key difference between tariffs and NTBs. Tariffs, at least historically, were unidimensional (and now are at such low levels that they do not matter anymore): those who could exercise market power would do so and extract the associated benefits. Quantification, the difficulty of measurement notwithstanding, could lead to a rough idea as to what their impact would be in specific markets by specific players. In turn, reciprocal negotiations aiming at the reduction of tariff levels take place. NTBs usually are not unidimensional, though. Consider safety standards where a standard might be affecting terms of trade, but there is also a policy rationale behind it, which could be unrelated to terms-of-trade effects. As a result, it is problematic to see how reciprocal negotiations can take place on this basis.114 Blanchard (2010, 2013) cast some doubt on the terms-of-trade theory, arguing that overseas investment holdings, under assumptions, would offset the beggar-thy-neighbor externality. In case of ownership (e.g., investment by important lobby in a foreign country), governments might be incentivized not to shift costs to the foreign country hosting this investment, since they will be inflicting a cost on a “national” agent.115 This is, of course, a limitation of the theory, not a negation.116 The terms-of-trade theory presupposes reciprocal negotiations. As chapter 3 will describe, reciprocity holds the key to tariff reductions. The manner in which tariff negotiations are being conducted affect the degree of relevance of reciprocity, though. During the GATT negotiations, the “request and offer” approach was adopted: that is, a pair of negotiating partners negotiated the level of tariffs in specific commodities of their interest. This scenario offers fertile ground for a terms-of-trade negotiation. In subsequent rounds, tariff reductions were agreed following certain formulas, such as, for example, a reduction of 25 percent being agreed on in exchange for higher tariffs, and a reduction of 10 percent for lower tariffs. In this scenario, it is difficult (prima facie at least) to see how terms of trade can explain the negotiation. This point concerns more the continued relevance of terms-of-trade theory to explain GATT, and less its power to explain the original negotiation. The US “peril point” provision also seems to cast doubt on the validity of the theory. According to this provision, the then United States Tariff Commission (USTC) was required to evaluate the effects of tariff reductions on US economy. It was further required to determine a point to which tariff reductions could be agreed that would not hurt US producers. This is, of course, a unilateral determination, which is at odds with the very essence of terms of trade. Although the peril point provision has been around since 1948, one would need to know in which negotiations it was used in order to conclude on the relevance of terms of trade. Baldwin (2009), and Hornbeck (2013) offer succinct accounts of this provision.

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The terms-of-trade theory, its limitations notwithstanding, has the correct focus, in that it traces the rationale for GATT to the desire to curb foreign behavior that can have negative external effects beyond national borders. In a world which, in Friedman’s (2005) inimitable expression, becomes increasingly “flat,” the need to constrain unilateral behavior increases as well.117 This theory asks the right question: it is international, and not domestic, problems that a trade agreement like GATT aims to solve. Regan (2014) shares this basic view. Finally, there are those who believe that adherence to GATT/WTO does not matter at all. Rose (2004) is one of these scholars; he argues that there is not much evidence that GATT and WTO have contributed to trade liberalization. In his view, nations would have behaved more or less in the same way even in the absence of such an institutional framework. A series of papers have responded persuasively. First, Subramanian and Wei (2007) showed that there are sizeable effects for developed countries’ trade, but maybe the same is not the case for developing countries’ trade, but this is so because the latter either have not liberalized at all or did so to only a limited extent. By their calculations, GATT/WTO have had a strong positive impact on trade, amounting to 120 percent additional world trade (or $8 trillion in 2000 alone).118 Second, as stated previously, Broda et al. (2008) found evidence of optimal tariffs when checking tariffs of WTO members before accession to the WTO. The larger the market, the higher the tariff in specific goods. Finally, Bagwell and Staiger (2011a) checked the tariff concessions made by countries that have acceded to the WTO and found that small countries make few concessions, whereas big countries make meaningful concessions; concessions are greater where prenegotiation import volumes are greater, as the theory predicts. They also found strong and robust support for the central predictions of the terms-of-trade theory in the observed pattern of negotiated tariff cuts. In short, GATT and WTO do matter.119 1.2.3

Economics Meets the Negotiating Record

There is hardly any historic support in favor of the commitment theory. There is, on the other hand, support for the view that international externalities, not domestic problems, should be addressed in a trade agreement. This does not necessarily mean that the negotiating record supports the view that the negotiation of the GATT was about terms of trade. Only knowledge about the identity of the negotiating partners (i.e., who negotiated with whom the tariff treatment of particular commodities), the level of agreed tariff cuts, and the change in trade volumes provide definitive confirmation that it was all about terms of trade. The negotiating history of GATT is only partly accessible to the public. Unfortunately, the inaccessible part covers the negotiation of the first tariff bargain, the negotiation in Geneva from April to July 1947. We remain in the dark on this score.

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There is ample evidence suggesting that negotiators were indeed addressing international cost shifting, irrespective of whether it drives through the price mechanism (as terms of trade theorists would want it to) or not. Several GATT institutions support this view. It is principal suppliers who negotiated the level of tariffs, and the negotiation of tariff levels was based on reciprocal concessions. Actually, during the original GATT sessions, there was a legally binding obligation to negotiate for all nations to which a request to this effect had been addressed.120 This feature of the negotiation points toward an arrangement focused on unraveling the damage done to the volume of trade by noncooperative tariffs. The renegotiation of schedules lends extra support to this thesis since this instrument addresses the need to rebalance concessions following a deviation from the originally agreed-upon level. These instruments support the view that it was the constraint of each other’s behavior that negotiators were seeking through negotiating GATT. The voices of protagonists point in this direction as well. In the following statement, Clayton aimed to capture that it is reciprocal concessions that drive the GATT: The world will be a better place to live in if nations, instead of taking unilateral actions, without regard to the interests of others, will adopt and follow common principles and enter into consultation when interests come into conflict. And this, throughout the entire range of trade relationships, is what the signatories of the Charter will agree to do. Each will surrender some part of its freedom to take action that might prove harmful to others and each will thus gain the assurance that others will not take action harmful to it.121

Analysts have provided evidence to this effect. Drache (2003), for example, reports that, at their 1941 meeting in Newfoundland, Churchill and Roosevelt held the view that international beggar-thy-neighbor policies must be addressed in the post-WWII era within the framework of a trade institution. All this evidence supports the view that the rationale for GATT was the disciplining of the behavior of trading partners and not the domestication of lobbies at home. GATT was conceived as an agreement aimed at curbing unilateralism.122 Finally, let’s entertain the reason for opting for a formal agreement. If GATT, thus explained, represents an equilibrium from which deviations are suboptimal, why put it down on paper? The case for a formal written agreement is supported by the sheer amount of information that went into the GATT contract. The complexity of the subject matter does not facilitate collusive behavior through tacit cooperation.123 GATT is magnificent in its simplicity, yet it covers a lot of ground, and one should not rationally expect that all trading nations would have always conformed to GATT, even in the absence of a document that they can use as a compass. The agreement is also needed in order to explain to economic operators what their governments have agreed to do and what not to do. The need for formalism has intensified over the years as new agreements were added to the old ones, and as the membership grew from the original 23 to the current 161.

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1.3 The (Trans-)Formative Years: GATT in the GATT Era 1.3.1

Flexibility Required: Grandfathering and the Existing Legislation Clause

Earlier in this chapter, the fact that the MFN, the cornerstone of GATT, was not agreed upon as a rule, without exceptions, was mentioned. Starting with the UK, a number of nations introduced margins of preference in favor of specific beneficiaries that they grandfathered. The grandfathering of margins of preference was intended to provide trading nations that used to live in safe havens insulated from the rest of the world with the breathing space necessary to adjust to the new reality of nondiscriminatory trade. The grandfathered margins of preference will be discussed exhaustively in chapter 4. For the time being, though, it can be simply stated that they have all but lost their relevance nowadays. There was another important flexibility that was agreed on at the signing of GATT, to which we also briefly alluded to previously. The GATT contracting parties agreed to apply Part II of GATT (that is, the core of GATT comprising key obligations like the national treatment) “to the fullest extent not inconsistent with existing legislation.”124 This became known as the “existing legislation clause” (i.e., Article 1(b) of the PPA). The clause was deemed necessary in order to allow trading nations to accept GATT right away and avoid the risk that delayed acceptances might comport. The risk of no eventual agreement was too much of a risk for anyone to take, and the framers opted for a suboptimal agreement instead. In the real world, the concession made through the existing legislation clause proved to be innocuous. There are various contributing factors to this. Essentially, GATT contracting parties did not abuse this privilege. Litigation on this score was rare, and when it did occur, the adjudicating panels interpreted this clause in a restrictive manner. In US–Manufacturing Clause, a GATT panel dealt with a US prohibition to import copyrighted work. The prohibition applied to cases where the author lived in the US, unless portions of the work had been produced in the US or Canada. Following a complaint, the panel established a test that essentially made recourse for violations of this provision quite onerous, if not almost impossible. In its view, GATT contracting parties could decrease the amount of inconsistency between national legislation and GATT using the state of domestic legislation on October 30, 1947, as the benchmark (§ 36). Once they had done so, they could not increase it again, not even to the level that had been in place before October 30, 1947 (§ 39). In other words, they could not go back to the pre–October 30, 1947, level. The same report explained that the existing legislation clause covered only legislation that was mandatory either by its terms or because of the expressed intent. Subsequent panels repeated these findings almost verbatim, constructing the existing legislation clause as a “one-way street” (i.e., only decreases in the inconsistency were allowed), not a “two-way street” (since, following any decrease, there was no way to reverse it).125

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One can easily see why this construction of the clause was so effective. Many trading nations subsequent to the entry into force of GATT had adopted GATT-consistent legislation and undid prior GATT-inconsistent laws. Once they had done this, however, there was no way back, and at best, they would be allowed to keep the new, less inconsistent measures in place. The PPA was eventually rescinded at the end of the Uruguay round. On December 8, 1994, at their Sixth Special Session, the contracting parties adopted a decision on “Transitional Co-existence of the GATT 1947 and the WTO Agreement,” which provided inter alia that: The legal instruments through which the contracting parties apply the GATT 1947 are herewith terminated one year after the date of entry into force of the WTO Agreement. In the light of unforeseen circumstances, the CONTRACTING PARTIES may decide to postpone the date of termination by no more than one year.126

1.3.2 The GATT Recipe for Trade Liberalization The GATT recipe for trade liberalization can be summarized as follows. Instruments affecting trade can be usefully divided into two categories, depending on whether they are imposed only on imports (“border-” or “trade instruments,” in economic jargon), or on both domestic and imported goods (“domestic-” or “behind-the-border instruments”). Since trade instruments can be decomposed into domestic instruments,127 the disciplining of both sets of instruments was necessary. Otherwise, if obligations were imposed solely on trade instruments, trading nations could easily circumvent them by adopting discriminatory domestic policies (e.g., a high consumption tax on imported cars, and a low consumption tax on domestic cars). Once the coverage of the GATT has been addressed this way, the next question is: What kind of (legal) disciplines should trading nations impose on instruments affecting trade? There are only two trade instruments: namely, tariffs and quotas.128 In principle, there is no need to use both of them since, for example, a very high tariff can amount to an import embargo. It was unrealistic to expect that trading nations would agree to move immediately to a free trade equilibrium. They needed to do that at a certain pace, and in an incremental manner. So the question became: What would be the form of transitional protection? For good economic reasons129 (detailed in chapter 2), GATT signatories decided to privilege the use of tariffs over quotas. As a result, upon accession to the GATT, trading nations would not be allowed to apply import and/or export quotas at all (by the terms of Article XI of GATT), whereas recourse to tariffs would be permissible. Tariffs, nevertheless, would be consolidated and then gradually reduced in the context of multilateral tariff negotiations convened to this effect. Consolidation was deemed necessary in order to provide security regarding transaction costs. Otherwise, because the level of tariffs could vary substantially from one day to the

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next, traders might have had little incentive to trade in the first place. The level of tariffs to be imposed on imported products would be a matter for negotiation. Ceilings (or “bindings,” in GATT-speak) would be agreed on through reciprocal concessions, and GATT signatories would no longer be in a position to impose tariffs that were higher than the agreed ceiling (according to Article II of GATT). Through bindings, tariff volatility beyond the agreed cap would become impossible; thus, unpredictability regarding transaction costs would be severely constrained. The binding of tariffs eliminated any uncertainty regarding transaction costs for goods shipped to foreign markets. GATT signatories would be allowed to increase their duties above the ceiling, only following a multilaterally agreed process (as per Article XXVIII of GATT). Furthermore, regardless of whether tariffs had been bound, GATT signatories were required to apply them in a nondiscriminatory manner (Article I of GATT). This is the very essence of the MFN clause that epitomizes the Hullian view of trade liberalization. Importantly, GATT signatories could not treat non-GATT signatories better than their fellow signatories. MFN emerged, thus, as the carrot that would induce outsiders to join the agreement. Acceding countries knew that, in principle at least, their products would receive the best possible treatment in the markets of GATT contracting parties.130 MFN was also the “insurance policy” against concession erosion. GATT signatories should extend the best treatment they offered to anyone to all other GATT signatories. Thus, the incentive to continue making reciprocal tariff concessions would be intact, since the value of tariff concessions was safeguarded by the MFN clause. All exceptions to MFN were included in GATT. For example, members of a preferential trade agreement (PTA)— that is, a customs union (CU) or a free trade area (FTA)—could have recourse to preferential rates (Article XXIV of GATT). However, GATT signatories could not lawfully evade MFN by invoking grounds that had not been contracted into the GATT. MFN was necessary, but not sufficient “insurance” to safeguard the value of negotiated tariff ceilings. Trading nations bought more forms of insurance. First, GATT signatories incurred a nondiscrimination obligation with respect to all domestic policies that they would unilaterally adopt. They accepted to treat imported goods that had paid their ticket to entry (in the form of an import duty) into their national market as if they were domestic goods (Article III of GATT). This provision aimed to ensure that no protection would be afforded to domestic goods beyond the tariff protection that had been negotiated.131 The GATT signatories went one step further in their quest for insurance for tariff concessions, and this is what brings us to our second point: those who saw the value of tariff ceilings negatively affected by even legal (e.g., nondiscriminatory) measures could raise a nonviolation complaint (NVC) and request compensation for damages suffered. To accomplish this, they would have to show that the damages suffered were a result of actions that they could not legitimately anticipate at the moment they had negotiated the tariff ceiling.132 NVC, thus, underscores the importance that negotiators attached to the value of the tariff promise by obliging trading nations to take account of their actions on their

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trading partners even when adopting nondiscriminatory measures following an exchange of tariff promises. It is probably not accidental at all that the majority of NVCs in GATT years were raised against subsidies. The typical scenario would be that where the complainant would claim that a subsidy granted after a tariff concession had been negotiated reduced the value of the tariff concession itself, since the exporter ended up exporting less than anticipated.133 Subsidies were explicitly contracted in Article XVI of GATT, but the discipline on domestic subsidies was ‘incomplete’. In any case in which it is determined that serious prejudice to the interests of any other contracting party had been caused or threatened by subsidization, the contracting party granting the subsidy had to, upon request, discuss with the other contracting party or parties concerned, or with the contracting parties, the possibility of limiting the subsidization. Thus, there was, in principle, no obligation to remove the subsidy (property rules), or even to pay compensation for damage done while keeping the subsidy in place (liability rules, some sort of efficient breach of contract). Subsidizers could simply disregard the plea for limiting the subsidization, and NVCs was the only means to make them change their attitude in this respect. National treatment and NVCs were a kind of ‘market preservation’ rule, in the terminology of Staiger and Sykes (2013), which was aimed to guarantee that the value of tariff concessions would not be undermined through subsequent unilateral actions.134 Finally, a flexibility clause in the form of safeguards was agreed upon. GATT signatories could legitimately raise their duties if, as a result of unforeseen developments, increased imports was damaging their domestic industry. The necessity for a flexibility clause in a trade agreement cannot be overstated. For now, it is enough to state that trading nations have more of an incentive to make meaningful tariff concessions when a flexibility clause has been inserted in the contract allowing them to move to higher tariffs subsequently, assuming certain agreed-upon conditions have been met. This issue will be discussed further in volume 2, chapter 4. Some important policy consequences stem from the points discussed here: • Assuming a reasonable understanding of the term “protection,” GATT allows its signatories to protect their domestic producers only through import tariffs. Tariffs are negotiable, so protection, a rather elusive and hard-to-define concept, becomes a negotiable commodity in itself. • Because of insurance bought with respect to instruments that can affect the value of tariff concessions (in the form of nondiscrimination and NVCs), trading nations continue to have an incentive to negotiate tariff reductions in the future as well. • This discussion also reveals that GATT is a “negative integration” contract: that is, its signatories were left essentially free to unilaterally define their domestic policies and were under no constraint at all to follow a particular antitrust, environmental, labor, or other

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kind of policy. All they promised by acceding to GATT was that, once they had decided on similar policies (if they did so at all), they would apply them in a nondiscriminatory manner to both domestic and imported goods that came under their purview. 1.3.2.1 Tariffs and … Supporting Act The GATT framers can be credited with crafting a remarkable document that has withstood the test of time. Their success is even more formidable considering the enormity of their task: to bring about the first multilateral trade order. The GATT negotiators of the 1940s managed to rise to the challenge and produce a short, concise text that generated remarkable trade over the years, while serving as a template for dozens other trade agreements as well. So far, this chapter has described GATT as an agreement that focuses on tariff negotiation. Why focus on tariffs?135 In equilibrium, any government intervention can affect trade, even if only indirectly or potentially. Consequently, an agreement aiming at liberalizing trade should discipline all government actions. Moreover, countries do not have symmetric preferences, and policies change over time as a result of social preferences. To achieve trade liberalization, thus, trading nations would have to be in a permanent stage of negotiation aiming at disciplining each and every one of these instruments. And yet the GATT framers managed to produce a text that dealt with those issues after only a few months of intense negotiation. How did they do that? They conducted for all practical purposes a tariff negotiation, dealing only to the extent necessary with the dozens (or even hundreds) of other instruments that can affect trade. It is striking that whereas four provisions (Articles I, II, XXVIII, and XXVIII bis of GATT) deal in a detailed manner with tariffs, only one (Article III of GATT) deals with all domestic instruments (policies) ranging from taxation to public health to food safety. In one provision as well (Article XI of GATT), the framers of the GATT banned the use of export and import quotas. Baldwin (1970) provided the most persuasive explanation of the structure of GATT, arguing that negotiators rationally focused on tariff barriers, which constituted the main market access impediment at the time and, because of their sheer size (e.g., Smoot–Hawley), were hiding the relevance of NTBs.136 Disciplining tariffs and import quotas first, and then reducing their bite, would allow trade negotiators to better appreciate the bite of behind-the-border policies (i.e., NTBs): Baldwin aptly called this a “draining of the swamp” effect; in his words (1970, p. 2): “The lowering of tariffs has, in effect, been like draining a swamp. The lower water level has revealed all the snags and stumps of nontariff barriers that still have to be cleared away.” This is why they focused on tariff negotiations. The GATT was thus conceived as the means to curb unilateralism and the resulting uncertainty regarding transaction costs by prioritizing the most egregious trade barriers, tariffs, and quotas. By imposing a nondiscrimination obligation on NTBs, they managed to kill two birds with one stone: they

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safeguarded the value of tariff concessions and they avoided convening a permanent forum for negotiations. NTBs are not reciprocally negotiated; in fact, they are not negotiated at all. GATT contracting parties are free to adopt new policies and modify or abandon existing ones, so long as they do not discriminate between domestic and imported goods when applying them. The solution presupposes, of course, some agreed understanding of discrimination, which will be discussed further in chapter 7, and in volume 2, when we discuss the “new generation” agreements. GATT is all about “shallow” integration. It may be shallow, but it is integration nevertheless. GATT was the first step—a very meaningful first step toward trade integration. 1.3.2.2 Embedded Liberalism We briefly alluded to the negative integration-character of GATT earlier in this chapter. This statement should be taken with a grain of salt. Yes, participants would be free to create the policy mixture that they deemed warranted at home, and GATT would not prejudge the extent of their public health, environmental, or competition policies. The underlying assumption, though, was that participants would be market economies pursuing free trade policies—negative integration, but within limits. For example, the Suggested Charter in Article 28 made this assumption explicit, allowing for an exception for countries establishing or maintaining a complete or substantially complete monopoly of import trade to negotiate accession and eventually participate in the ITO. The fact that Western democracies participated in the negotiation, and only a special provision had been made to accommodate the USSR, is ample testimony to this. GATT was thus built on the implicit understanding that liberal policies would be pursued at home, and free trade would govern the interstate relations (a sort of ‘embedded liberalism’, in other words).137 Over the years, this unwritten foundation of GATT has not changed. Trading nations have made explicit concessions to accommodate instances of illiberal policies, such as Article XVII of GATT (state trading).138 In a similar vein, there is a provision on NMEs in the Interpretative Note in Article XVI of GATT. It is also true that some NMEs that had joined the GATT much before they espoused free market liberalism did not fully implement their GATT obligations. Poland, for example, joined GATT much before the fall of the Berlin Wall and the ensuing events. It applied GATT through a protocol, which guaranteed a certain level of imports from GATT markets that would increase over the years in exchange for MFN access to the markets of GATT contracting parties. This led Hudec (1972, pp. 1369ff) to call Poland’s participation in GATT a “muli-purchase commitment,” or even a “de jure participation,”since de facto a lot of the GATT obligations were never implemented by Poland. More recently, WTO members inserted a series of obligations in addition to those reflected in the WTO contract in the Protocols of Accession of new members that used to be NMEs (e.g., China). Similar adjustments were deemed compulsory in order to ensure

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a smooth implementation of WTO obligations. This point will be discussed in more detail later in this chapter. 1.3.3

Becoming an Institution

1.3.3.1 Goodbye, ITO On December 6, 1950, it became clear to all that the ITO Charter would not be formally presented to the US Congress for ratification.139 Various reasons led to this decision, and it is probably unfair to blame the US alone for the nonadvent of the ITO. Diebold (1993) sums it up fairly when he states: “The efforts to go beyond traditional areas of agreement led to what I regard as a fairly promising chapter about international commodity agreements, a weak one on private business practices, and what turned out to be disastrous provisions about economic development and private investment.”140 It is true that in the US, the mood was not favorable to the ITO. There was dissatisfaction in US business circles with the negotiations. The prevailing feeling in the US was that modernized versions of FCN treaties, bilateral agreements that the US used to sign with a host of interested states, would better correspond to the aspirations of US business than a chapter on investment in the ITO.141 The chapter on employment policies was also perceived as an intrusion into domestic policies that would be better left to national discretion. Two other factors contributed to the demise of the ITO: first, the absence of ITO champions in the administration of President Harry Truman after 1949, and second, the realization how much could be achieved already, solely through the implementation of GATT.142 Those who would have defended the ITO in the Truman administration had left office by 1949–1950. Diebold (1993, p. 341) described the situation as follows: Clayton had gone, as had Wilcox. Nitze was doing other things. Acheson was back but he never put a high priority on trade matters except as part of larger issues. I think he regarded trade liberalization as a kind of hobby of Cordell Hull’s and he did not have a lot of respect for Mr. Hull’s political judgment—at least on international matters. Raymond Vernon has put forward the idea of “policy entrepreneurs” and I wonder whether the absence of one may not have contributed to the Truman administration’s dropping of the ITO.

Odell and Eichengreen (1998) invoked “principal-agent slack.” They compared the ITO with the WTO negotiations and note that in the latter, “principals instructed their negotiating agents earlier, more often, and more precisely.”143 As a result, the final outcome of the WTO negotiations was closer to the Congress’s preferences than the ITO had ever been. The Truman administration lost not only its ITO champions, but it was not fully aware of the implications of the ITO negotiations and was quite reluctant to invest substantial political capital to salvage a process that it had not fully understood. In the meantime, GATT was beginning to show that, its birth defects (as a result of the nonadvent of the ITO simultaneously with it) notwithstanding, it was quite capable of

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accomplishing its assigned mission. By 1950, it had already wrapped up three rounds of tariff negotiations (at Geneva, Annecy, and Torquay). Things looked quite rosy on the trade front. Moreover, the success of GATT had a positive influence on the other grand enterprise that the US had embarked upon: the financing of Europe’s development. Will Clayton, in a preface to the 1949 book by Clair Wilcox, explains that the US had embarked on a dual interlinked process aimed at leading to recovery on the European continent, as well as worldwide: “The program that is embodied in the Charter provides a necessary sequel to the program for European recovery on which the United States is now embarked. The two are interdependent; neither can be wholly successful without the other; both are parts of a common policy.”144 European recovery, of course, would be largely achieved through the Marshall Plan. There was an increasing conviction that the second part (the Charter’s program) could be largely achieved through GATT as it stood. What would the ITO add then in a meaningful manner? Still, there were some voices that tried in vain to persuade the US to endorse the project. Clair Wilcox, one of the chief US negotiators, went as far as to state that, “There is no hope that a multilateral trading system can be maintained in the face of widespread and protracted unemployment. Where the objectives of domestic stability and international freedom come into conflict, the former will be given priority.”145 Similar efforts fell on deaf ears. It is noteworthy, though, that the ITO was never formally abolished. In fact, Article XXIX of GATT kept some of its provisions legally relevant, albeit to a limited extent.146 The advent of the WTO (January 1, 1995) signaled the end of the ITO. 1.3.3.2 Functional Institutionalism à la GATT GATT, which in the meantime had entered into force on January 1, 1948, was left to operate in an institutional vacuum. It was conceived as an agreement under the aegis of the ITO, the world trade institution; and for this reason, it did not contain any institutional architecture other than a few scattered provisions. The best testimony to this is provided by the terminology used throughout GATT: its “members” were “contracting parties,” and the decisive organ of GATT was the CONTRACTING PARTIES. References to important institutions, like the GATT Council, were totally missing from the original text. In fact, Article XXV of GATT explicitly acknowledged the institutional vacuum and the need to fill in order to honor the GATT mandate, when stating that: “… representatives of contracting parties shall meet from time to time for the purposes of giving effect to those provisions of the Agreement which involve joint action and, generally, with a view to facilitating the operation and furthering the objectives of the Agreement.” GATT had to slowly evolve into an international institution in an attempt to fill the gap that had been left by the nonestablishment of the ITO.147 Its institutional development both

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benefited and suffered from its various birth defects. The countries participating in GATT did not plan very far ahead. Institutional innovations were more a practical response to observed needs than a springboard to accommodate future challenges. This “functional institutionalism” à la GATT gained in legitimacy precisely because the edifice was built on perceived and not imaginary needs. The use of GATT panels to forge dispute settlements is probably the most successful example of an organ that was not foreseen in the original GATT, but such panels were subsequently created in order to ensure the smooth functioning of the emerging institution. However, there were also some failures with this approach: the Consultative Group of Eighteen (CG18) was created with the aim to provide some sort of a directory or executive office for GATT, but it never managed to honor a similar mandate. It never managed to become a genuine executive office. But its story supports another advantage of functional institutionalism: when it became obvious that it had not responded to the expectations, the use of CG18 came to an end. It is, of course, much easier to do that with a nonstatutory entity than with a body that has been foreseen and dictated in an international agreement. Before we move to discussing the two institutions, though, it is worth underscoring that all decisions in the GATT years, like the ones described previously, were taken by consensus. Consensus voting added to the legitimacy of the endeavor. Tacit acquiescence sufficed to adopt a decision, and only formal opposition would block consensus. There is a trade-off between consensus voting, and efficiency, of course, since any one GATT signatory could block a decision and thus slow down the decision-making process. The GATT signatories preferred to err on the side of efficiency and sacrificed speed of their integration process to the altar of making consensual decisions at each and every step of their common way. CG18 The CG18 was established by a GATT Council decision taken on July 11, 1975: The task of the Group is to facilitate the carrying out, by the CONTRACTING PARTIES, of their responsibilities, particularly with respect to: following international trade developments with a view to the pursuit and maintenance of trade policies consistent with the objectives and principles of the General Agreement; the forestalling, whenever possible, of sudden disturbances that could represent a threat to the multilateral trading system and to international trade relations generally; and action to deal with such disturbances if they in fact occur; the international adjustment process and the co-ordination, in this context, between the GATT and the IMF. In the pursuit of its task, the Group shall take into account the special characteristics and requirements of the economies of the developing countries and their problems. The Group shall not impinge upon the competence or authority of the CONTRACTING PARTIES148 or of the Council and shall not assume, or detract from, any of the decision-making responsibilities of these two bodies or of the permanent GATT Committees. Neither shall it interfere with the activities and competence of the Trade Negotiations Committee. The Group’s membership shall be balanced and broadly representative due regard being had to rotation of membership as appropriate. Initially the composition of the Group shall be as follows:

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Chairman: To be designated by members of the Group.149 Membership: Argentina

India

Peru

Australia Brazil Canada Egypt EU150

Japan Malaysia Nigeria Nordic country Pakistan

Poland Spain Switzerland United States Zaire

The attendance of alternates shall be provided for. In developing its procedures, the Group shall ensure that, when a matter of particular importance to any contracting party is under discussion, that contracting party shall have the opportunity fully to present its views to the Group. The Group may invite observers to attend during the discussion of an item on the agenda of a meeting. The Group shall meet periodically as necessary. The Group shall report periodically to the Council. It shall submit once a year a comprehensive account of its activities. The Group is established provisionally for a period of one year, its task, composition, and terms of reference being subject to review by the Council at the end of that year.151

Prior to the establishment of the CG18, there was no comparable attempt to bring senior officials from their world capitals to Geneva on a regular basis. Following an initiative by Director-General (DG) Olivier Long,152 discussions on the establishment of the group were initiated. In Long’s mind, the idea was to bring in an “Executive Committee for the GATT,” the membership of which was fast increasing. An organ with limited membership but quite representative of all GATT contracting parties was deemed necessary in order to ensure that expanding membership would not prove an impediment to swift decision making. What he had in mind was a structure akin to the Committee of Twenty (C-20) of the IMF, which had been studying the reform of the international monetary system. This restricted group of high-level representatives, which would not impinge upon the competence or authority of the CONTRACTING PARTIES, the Council, or other permanent GATT bodies, would be able to discuss international trade matters within the political context and on the basis of the personal knowledge and authority of the group’s members. Following consultations about the composition of the group, Long made a further submission to the Council in July 1975, where he set out the terms of reference for the group as was just described, which were approved by the Council without amendment.153 In addition, provision was made for nine alternate members, to be approved each year (along with the permanent groups) by the CONTRACTING PARTIES. In the first year, these were Austria, Côte d’Ivoire, Hungary, Israel, Jamaica, Korea, New Zealand, Norway, and Yugoslavia, followed by a rotation of countries within geographic regions. Alternate members could participate fully in the group’s discussions. The difference between full members and alternate members was that the former were provided with two seats, one to be used by an adviser, while alternate members had only one.

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The first meeting of the group was held in November 1975. The change in its name from “Management Group,” as originally proposed, to “Consultative Group” reflected the intention that this should not be a decision-making body. The group’s function was essentially consultative, and on a number of occasions, it made recommendations or suggestions to the GATT Council on matters of importance. Thus, in July 1981, it recommended that the CONTRACTING PARTIES should envisage convening a Ministerial Meeting in 1982, which eventually led to the launch of the Uruguay round. At the session of CONTRACTING PARTIES in November 1985, it was decided that in 1986, the membership of the group should be somewhat enlarged (to twenty-two full members), while the number of alternate members remained nine. This group became the forum for numerous discussions on the GATT mandate, its eventual expansion to other areas, and other topics. It fell short of deciding anything that meaningfully affected the life and evolution of the GATT institution, however, and eventually it fell into desuetude. Dispute Settlement Two GATT provisions explicitly refer to the settlement of disputes (namely, Articles XXII and XXIII), but they do not contain specific procedures for this purpose. The GATT procedural rules were very limited, largely because it was anticipated that the ITO rules would soon come into force. The ITO Charter contained detailed dispute settlement rules that included a provision for the referral of questions to the International Court of Justice (ICJ). The history of dispute settlement in GATT begins with a complaint submitted in the summer of 1948 by the Netherlands against Cuba, where the issue was whether the MFN obligation (Article I of GATT) also applied to consular taxes.154 The matter was referred to the chairman, who ruled that Article I of GATT effectively applied to consular taxes. Rulings by the chairman were subsequently substituted by a Working Party, whereby the complaining party, the defendant, and any other contracting party that might have an interest in the dispute would participate. We thus moved from chairman rulings to Working Parties, and then, eventually to “Panels.” In 1952, the “Panels on Complaints” took over de facto from where the Working Parties had left off, adjudicating nineteen complaints in total between 1952 and 1963. Three or five neutral panelists would prepare a report that would eventually be submitted to the CONTRACTING PARTIES for their consideration and adoption.155 All this started with a complaint by Norway against Germany. Norway had complained that its exports of sardines to Germany were accorded treatment less favorable than that Germany accorded to sardines originating elsewhere.156 The complaint was supposed to go be submitted to a Working Party. It is then that Eric Wyndham White, the DG of the GATT, “hijacked” the process, proposing that the dispute be referred to a single working party, the terms of which would be decided later.157 A few days later, Greece requested that its dispute with the US regarding the treatment of its exports of dried figs be resolved through the multilateral procedures. The chairman

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recalled the agreement in principle to refer similar disputes to a single panel that should be composed of delegates from Australia, Canada, Ceylon, Cuba, Finland, and the Netherlands. Its terms of reference were stated as follows: To consider, in consultation with representatives of the countries directly concerned and of other interested countries, complaints referred to the CONTRACTING PARTIES under Article XXIII, and such other complaints as the CONTRACTING PARTIES may expressly refer to the Panel, and to submit findings and recommendations to the CONTRACTING PARTIES.158

Denmark then tabled an official proposal aiming to making the move to panels permanent.159 The proposal was not adopted, but panels eventually became a permanent feature of GATT anyway. Still, the absence of formalism did not lead to a total breakdown of GATT dispute settlement. Hudec (1998b, p. 107) explained why, the absence of elaborate procedures notwithstanding, GATT had some early success adjudicating disputes: The first few legal rulings overcame both the time pressure and the neutrality problem by the device of a ruling from the chair, which became a ruling of the entire membership when it was tacitly approved by silence. This device was accepted as sufficiently neutral for two rather special reasons. First, the Chairman of the Contracting Parties during the first four sessions was L. Dana Wilgress, a senior Canadian diplomat who had also been Chairman of the 1946–48 GATT/ITO negotiations. Wilgress’ key role in those negotiations lent an unusual degree of authority to his rulings, both because of his expertise as to the meaning of the agreement and because of the reputation for fairness he had earned in his work as chairman of the ITO negotiations. Second, and perhaps more important, in these early years most of the delegates to GATT meetings were also veterans of the GATT/ITO negotiations themselves. As such, they all felt they knew exactly what was meant by all of the provisions in the agreement they had drafted, and consequently saw nothing amiss in voting on authoritative legal interpretations. There was no problem of neutrality, they thought, when everyone in the room very well knew the right answer.160

In its early stages, thus, dispute settlement in GATT reflected its diplomatic roots: the majority of panelists were diplomats. No formal requirement to have legal training, let alone GATT-related legal training, was imposed. Both Hudec (1993b) and Davey (1987) have observed that the goal of the process was to end up with a mutually acceptable solution rather than to judge on the legal merits of the case, and as a result, the overall tenor of the process was highly conciliatory. The emphasis was on removing cases from the docket. Between 1964 and 1970, dispute adjudication came to an abrupt halt. Hudec (1998b) identifies two reasons for the halt.161 First, the EU had adopted an antilegalist bias requesting from its trading partners a flexible attitude toward its common agricultural policy (CAP), and its PTAs that it had signed with former colonies since, by challenging their consistency with the GATT rules, they would be questioning the EU integration process as such. Second, Wyndham White, the head of GATT at that time, had acceded to the pragmatic approach advocated by the EU. Hudec (1998b, p. 111) mentions that he went so far as to state that GATT could not offer position to lawyers.

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Things changed in the 1970s. The rise of NTBs, and the “drainage of the swamp,” in Baldwin’s (1970) inimitable expression, which fostered a better understanding of the “cost” of NTBs, were the main reason why the US pushed for a new round that would shift its focus from negotiation of tariffs to negotiation of NTBs. In this vein, in Hudec’s (1998b) account, the US Congress made it clear that it would support similar efforts, provided that enforcement of agreed obligations would be strengthened. The US, while negotiating the Tokyo round of agreements, one of the rounds of multilateral trade negotiations that we detail further on, submitted a series of disputes (against the EU) challenging aspects of its CAP. Other countries followed. The challenges pertained to complicated legal issues, and this changing attitude of the trading nations toward the CAP called for reinforcement of the legal expertise embedded in GATT. GATT had to adapt to the new reality and to the many requests for more “legalism.” It responded by formalizing panel procedures by crystallizing prior practices into formal decisions and hiring trade lawyers to staff its services.162 The “Understanding on Notification, Consultation, Dispute Settlement, and Surveillance of 28 November 1979” (in GATT-speak, the “1979 Understanding”) was formally adopted by the GATT CONTRACTING PARTIES at the conclusion of the Tokyo round. This was the first attempt to formalize prior practices. It included an Annex that set out an “Agreed Description of the Customary Practice of the GATT in the Field of Dispute Settlement,” specifying the way in which dispute settlement procedures had evolved since the inception of GATT: Panels set up their own working procedures. The practice for the panels has been to hold two or three formal meetings with the parties concerned. The panel invited the parties to present their views either in writing and/or orally in the presence of each other. The panel can question both parties on any matter which it considers relevant to the dispute. Panels have also heard the views of any contracting party having a substantial interest in the matter, which is not directly party to the dispute, but which has expressed in the Council a desire to present its views. Written memoranda submitted to the panel have been considered confidential, but are made available to the parties to the dispute. Panels often consult with and seek information from any relevant source they deem appropriate and they sometimes consult experts to obtain their technical opinion on certain aspects of the matter. Panels may seek advice or assistance from the secretariat in its capacity as guardian of the General Agreement, especially on historical or procedural aspects. The secretariat provides the secretary and technical services for panels.163

Panels thus formally came into being through this agreement. Three years later, at the 1982 Ministerial Conference,164 the CONTRACTING PARTIES reaffirmed the 1979 Understanding and added more institutional detail to dispute adjudication, including the following requirement: “The contracting party to which such a recommendation [i.e., to bring a challenged measure into conformity with GATT] has been addressed, shall report within a reasonable specified period on action taken or on its reasons for not implementing the recommendation or ruling by the CONTRACTING PARTIES.”165

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Further steps were taken with the Decision on Dispute Settlement Procedures adopted on November 30, 1984.166 Eventually, the Montreal Rules were agreed upon167 during the Uruguay round, and the Panel process began to take its current form. In the meantime, in 1981 Arthur Dunkel (the then-DG of GATT) had appointed as Director of Legal Affairs Hielke van Tuinen, a very respected member of the GATT secretariat, for an experimental two year-term. The 1982 Ministerial Declaration acknowledged the role of the secretariat in assisting panels by stating the following: “(iv) The secretariat of GATT has the responsibility of assisting the panel, especially on the legal, historical, and procedural aspects of the matters dealt with.” In 1983, the Legal Affairs Division was established, and DG Dunkel asked another experienced member of the secretariat, Åke Sten-Oscar Lindén, to head it. The Legal Affairs Division was staffed with additional lawyers and began servicing panels acting as clerks for panelists. The decisive step toward providing panels with professional legal advice was taken there and then.168 Over the years, GATT developed an institutional infrastructure that would adequately cope with its ever-increasing needs. Although the participants in the GATT process continued to be formally called “contracting parties” until the final days of GATT, they behaved de facto as members of an institution, operating under a vague institutional umbrella. 1.3.4 The GATT Rounds of Trade Liberalization 1.3.4.1 Bringing Tariffs Down The GATT mandate calls for progressive tariff liberalization, not for immediate tariff elimination (Article XXVIIIbis). During the GATT years, the contracting parties conducted eight rounds of multilateral negotiations (previously called “Tariff Conferences”) aimed at reducing tariffs (see table 1.1). The Doha round, which was launched in that Middle Eastern city in the autumn of 2001, was the ninth trade round since the inception of GATT, and the first since the advent of the WTO. Table 1.1 Negotiating rounds Name of the Round

Chronology

Number of Participants

Geneva Annecy Torquay Geneva Dillon Kennedy Tokyo Uruguay

1947 1949 1950 1956 1960–1961 1962–1967 1973–1979 1986–1994

23 13 38 26 26 62 102 123

Source: Understanding the WTO, The WTO: Geneva (2015), p. 16; https://www.wto.org/english/thewto_e/ whatis_e/tif_e/understanding_e.pdf.

50

Chapter 1

The Dillon round was “… the last of the traditional GATT tariff negotiations, which provided a multilateral framework for a collection of bilateral item-by-item tariff negotiations.”169 It was meant to address two issues: general tariff concessions as discussed earlier, and provide the: “… first opportunity for negotiating reductions in the common external tariff of the Community.”170 The focus of the negotiators, up to and including this round [which signaled the first participation of the European Economic Community (EEC) as an entity in the negotiations], had been exclusively on dismantling tariff protection since, as of the Kennedy round, negotiations on developing the legal arsenal of GATT were initiated as well. Tariff reduction represents an area where GATT has enjoyed remarkable success. Irwin (1996 and 1998a) states that average duties across all goods calculated on dutiable imports stood at 19.34 percent in 1947 and 13.87 percent in 1948.171 However, if duty-free trade was included, the ratio of duties collected to total imports amounted to 7.55 percent in 1947 and 5.71 percent in 1948. The average tariffs on dutiable imports weighted with the 1939 trade values was 32.2 percent in 1947, and 25.4 percent in 1948. As 60 percent of US imports were duty-free in 1947, the average tariff for total imports was much lower. In addition, were tariff averages weighted with the 1947 trade weights and prices (and not with 1939 values), then the post-Geneva average tariff on dutiable imports drops from 25.4 percent to 15 percent. Including duty-free imports, the pre-Annecy (GATT 1948) tariff average of all US imports was estimated by the US Tariff Commission to amount to 5.9 percent. This number fits unusually well with the ratio of duties to total imports (free and dutiable) of 5.97 percent in 1950. Today’s duties, with few exceptions, are almost immaterial, as the tables in this chapter show. Bringing down tariff protection to today’s level is quite a remarkable achievement,172 but there are caveats. Reductions have not been symmetric across products or across countries. Farm and textile products essentially lived outside the core disciplines of GATT: the former because of Articles XI.2 and XVI of GATT (which allowed some import restrictions and subsidization, respectively); the latter because of the Multifiber Arrangement (MFA), which established a global quota for textile products. Developing countries, on the other hand, did not make tariff cuts comparable to those made by developed countries, as various tables in the WTO World Trade Report of 2007173 clearly demonstrate. Still, they managed to reduce their tariffs in general—on occasion, quite drastically. The term “developing countries” represents, of course, a very heterogeneous group of countries. Therefore, it is appropriate to operate subdivisions between them. The big developing countries did make a serious effort to reduce tariff levels. Bhagwati, Krishna, and Panagariya (2015) have calculated that the aggregate level of tariffs across goods prevailing in India during the Doha round was around 10 percent ad valorem, while the corresponding level in China was around 8.7 percent, and across Latin American countries at just below 15 percent. Smaller developing countries typically agreed to humbler tariff reductions.174 Still, very few developing countries, in their estimation, exhibit aggregate levels above the 15 percent

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threshold, and this is routinely the case for least developed countries (LDCs)—that is, the “poorest” among developing countries—while south-south cooperation (between developing countries at large) has doubled since 1995; e.g., at the end of the last successful GATT round (Uruguay round), where meaningful tariff reductions were agreed upon. During the Uruguay round, LDCs agreed for the first time to bind many of their duties.175 Tariff reductions should not be attributed solely to GATT. Investment liberalization, for example, has contributed as well. When a constituency holds an economic interest in a foreign market (say, through foreign direct investment), its home government has less incentive to impose tariffs.176 Common sense has contributed as well, since some small countries must have realized that the only effect that their tariffs have had was to deprive its citizens of commodities. To conclude, the dismantlement of tariffs has been the main GATT success story. Ossa (2014) provides a very comprehensive evaluation of potential gains from tariff reductions from now on. His conclusion is that potential gains are modest. The candle is not worth the flame, and the multilateral trading system should focus on regulatory barriers instead. Tables 1.2 and 1.3 show the tariff cuts by developed GATT contracting parties on industrial goods over the years, whereas table 1.4 reflects tariff cuts by countries acceding to the WTO after January 1, 1995. Table 1.2 Tariff cuts by developed countries in industrial goods Implementation Period

Round Covered

Weighted Tariff Reduction

1948 1950 1952 1956–1958 1962–1964 1968–1972 1980–1987 1995–1999

Geneva (1947) Annecy (1949) Torquay (1950–1951) Geneva (1955–1956) Dillon (1961–1962) Kennedy (1964–1947) Tokyo (1973–1979) Uruguay (1986–1994)

–26 (1939) –3 (1947) –4 (1949) –3 (1954) –4 (1960) –38 (1964) –33 (1977 or 1976) –38 (1988 or 1989)

Notes: The last column represents the year during which the MFN import weights were based. Source: The World Trade Report, 2007, p. 207.

Table 1.3 Tariff cuts on industrial goods during the Uruguay round PreTrader

Uruguay Round

United States Japan EU-12 Total

5.4 3.9 5.7 5.2

Post-

3.5 1.7 3.6 3.1

Reduction

Imports (MFN)

rate (%)

Billion $(1988)

–35 –56 –37 –39

297 133 197 627

Source: The World Trade Report, 2007, The GATT: Geneva at p. 209.

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Chapter 1

Table 1.4 Tariff cuts by countries acceding at or after the Uruguay round Agricultural Products

Albania (a) Republic of Armenia Bulgaria Cambodia (c) China Croatia (c) Ecuador Estonia (b) FYR Macedonia Georgia Jordan Kyrgyz Republic (c) Latvia (a) Lithuania (b) Moldova (a) Mongolia (c) Nepal (c) Oman (a) Panama (b) Saudi Arabia (d) Chinese Taipei (c)

Industrial Products

Bound

Applied

Bound

Applied

9.4 14.7 35.6 28.1 15.8 9.4 25.5 17.5 11.3 11.7 23.7 12.3 34.6 15.2 12.2 18.9 41.4 28.0 27.7 22.4 15.3

9.0 6.6 18.4 19.5 16.2 9.3 14.7 12.2 12.7 11.7 19.6 7.0 11.8 9.7 10.2 5.1 13.5 10.2 14.8 7.8 16.3

6.6 7.5 23.0 17.7 9.1 5.5 21.1 7.3 6.2 6.5 15.2 6.7 9.4 8.4 6.0 17.3 23.7 11.6 22.9 10.5 4.8

7.2 2.3 8.8 15.9 9.5 4.1 11.5 0.1 8.7 6.9 12.1 4.3 2.2 2.4 4.1 4.9 13.7 5.0 7.4 4.8 5.5

Note: 2004 is the year of applied duties by default unless otherwise indicated: (a) refers to 2001, (b) to 2002, (c) to 2003, and (d) to 2006. It may seem perplexing for the bound duty to be higher than the applied duty, but it actually makes sense: duties have to be reduced to the bound level by the end of an agreed “staging period,” and it may be the case that the information included in this table was collected before the end of this period. For example, the Marrakesh Protocol to GATT 1994 explains in its §2 that agreed tariff reductions should be implemented in five equal rate reductions, and it provides the time period within which all five reductions should take place. Source: The World Trade Report, 2007, The GATT: Geneva at p. 209.

1.3.4.2 Adding to the Legislative Framework During the Kennedy round, the focus shifted for the first time toward examining the role that NTBs play in restricting trade in goods. Originally, negotiations on NTBs focused on barriers imposed for economic reasons, such as AD, countervailing, and safeguards. Eventually, however—first through the negotiation of the Agreement on Technical Barriers to Trade (TBT) during the Tokyo round, and then through the renegotiation of the TBT, as well as the negotiation of the Agreement on the Application of Sanitary and Phyto-sanitary Measures (SPS) during the Uruguay round—trading nations began to negotiate NTBs adopted ostensibly for public policy reasons, such as the protection of human health. The agreements concluded during the Tokyo round dealing with NTBs were the following:177 • Agreement on Implementation of Article VI of the General Agreement on Tariffs and Trade (AD)

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• Agreement on Interpretation and Application of Articles VI, XVI, and XXIII of the General Agreement on Tariffs and Trade (SCM) • Agreement on Import Licensing Procedures (ILA) • Agreement on Technical Barriers to Trade (TBT) • Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade and Protocol to the Agreement (CV) • Agreement on Government Procurement (GPA) • Agreement on Trade in Civil Aircraft (CA) • International Dairy Arrangement (IDA) • International Arrangement Regarding Bovine Meat (IBM) The approach followed during the Tokyo round became known as “GATT à la carte,” as GATT contracting parties were given the option to decide whether to accede to the various codes. The list of the signatories to the various Tokyo round agreements is reproduced in table 1.5:178 Under the single-undertaking approach that was adopted during the Uruguay round, trading nations were requested to adhere, with very few exceptions, to all agreements reached, departing thus from the practice during the Tokyo round. The Uruguay round, however, introduced a new distinction between multilateral agreements (where participation was automatic upon accession to the WTO), and plurilateral agreements (where participation was optional). The Tokyo round agreements were “plurilateral,” in today’s terminology. The bulk of the Uruguay round agreements were multilateral: in essence, almost all Tokyo round agreements (codes) were “multilateralized,” and a new multilateral agreement (SPS) was added as well. Four plurilateral agreements were concluded during the Uruguay round: namely, the Dairy Arrangement and the Arrangement Regarding Bovine Meat (both of which have since expired), and the Government Procurement Agreement (GPA) and the Agreement on CA (both of which are still in force). The signing of agreements during the rounds does not exhaust the legislative activity in GATT, since various decisions and recommendations were (and still are) being routinely adopted at the committee level between rounds.179 The increase in the number of participants, as well as the increase of negotiated items, unavoidably took their toll on the duration of rounds. Negotiations gradually took longer to complete (four years for the Kennedy round, six years for the Tokyo round, eight years for the Uruguay round, and the Doha round has been going on for thirteen years).180 The changing subject matter also must have had decisive influence here, since it is easier to negotiate tariffs on reciprocity grounds, while it is harder to create a legal document that aims to provide a test that will distinguish between measures that genuinely pursue a goal such as protection of public health, and measures that do not do so. For these reasons, and

A*

A A A

A A* A A A

O S

A A A A O

O

O

O A*

A A A

O

O

A O

O O A A

O

O

O A* A*

O

A O

A

A

O A

A

A

O A* A O

Subsid. Countervailing

O

A O

O

Gov’t Procur.

A

A

A

A

A

A

A

S O A O

Tech. Barriers

A

Suppl. 1979 Protocol A A

A

Argentina Australia Austria Bangladesh Barbados Belgium Belize Benin Brazil Burma Burundi Cameroon Canada Central African Republic Chad Chile Colombia Congo Cuba Cyprus Czechoslovakia Denmark Dominican Republic Egypt EEC Finland France Gabon Gambia Germany Ghana Greece Guyana

AR AU AT BD BB BE BZ BJ BR BU BI_ CM CA CF TD CL CO CO CU CY CS DK DO EG CE FI FR GA GM DE GH GR GY

Geneva 1979 Protocol

Countries CONTRACTING PARTIES

Table 1.5 Participation in the Tokyo round agreements

O

A A A

O

A

A

A

Prov.

A A A234 O

Bovine Meat

O

S A A

O

O

O

O O

A A A O

Dairy

O A A

A

O

O O

A*

A*

S* A A O

Customs Val.233

O

O

A A A

A

O

A O

A

O

S A A O

Import Lic.

A* O S

A O

S A

O A*

O A

O

A

A O

O

Civil Aircraft

O

A A A

A

O

O O

A

A

O

O A

AD

54 Chapter 1

Haiti Hungary Iceland India Indonesia Ireland Israel Italy Ivory Coast Jamaica Japan Kenya Korea Kuwait Luxembourg Madagascar Malawi Malaysia Maldives Malta Mauritania Mauritius Netherlands New Zealand Nicaragua Niger Nigeria Norway Pakistan Peru Philippines Poland Portugal Romania Rwanda Senegal Sierra Leone Singapore South Africa

Countries CONTRACTING PARTIES HT HU IS IN ID IE IL IT CI JM JP KE KR KW LU MG MW MY MV MT MR MU NL NZ NI NE NG NO PK PA PH PL PT RO RW SN SL SG ZA A

A

A

A

A A

—

A

A A*

A S A

A A

Geneva 1979 Protocol

A

A A

— A

A

A

A

A A

A

Suppl. 1979 Protocol

A

O A A O A O O A S O A O

O O

O O

O A

O O

O

O A A O

O

O O A O O

A

O O

. O

Gov’t Procur.

O

A

A

A

A O A O A O

A*

Tech. Barriers

O

O

O A A O A* O A* O

A O

O

O

A

O O A

O

A A*

O O

Subsid. Countervailing

A

A O A

O A

A O

O

O

A O

O

O

O A

Bovine Meat

A

A O A

O A

A O

O

O O A

O

O

A

Dairy

O A

O A O O O O O A

A* O

A* O

A*

A

O

O

A* O

A

Customs Val.233

A A

O

O A A O A* O O A

A

O

O

O

O O A

O

A O

A

Import Lic.

O

O O A

O A

O A

O

A

A

O O A O A

A O

O

O A A O O A O A

O O

O

O

O

A

O

O

A O

A

AD

(continued)

Civil Aircraft

From GATT to the WTO 55

A

A

A

Suppl. 1979 Protocol

O O O

A

O

O O

O O

O

A S O

A* A

A O

A A O O

A O

Subsid. Countervailing

O

A O

A* A

O O

O O A* A

O

A A

O

Gov’t Procur.

A A O O

A O

Tech. Barriers

A* O O Prov. A

A O

A A O

A* A

O O

O

A A

O

Bovine Meat

O

O O

A

A O

O O

A A

O

Dairy

O

A* O

A O

A* A

O O

O

A A

A* O

Customs Val.233

O O

O

O

O

A O

A* A

O O

A A O O

O O

Import Lic.

O

O

A* A

O O

A A

O O

Civil Aircraft

Notes: A Accepted; B Signed (acceptance pending); O Observer; * Reservation, condition, and/or declaration; ** Provisional accession to GATT

BW BG CR EC GT MX PA PY TN VE

A

A A

A A

A

Spain Sri Lanka Suriname Sweden Switzerland Tanzania Thailand Togo Trinidad and Tobago Turkey Uganda United Kingdom United States Upper Volta Uruguay Yugoslavia Zaire Zambia Zimbabwe Other Countries Botswana Bulgaria Costa Rica Ecuador Guatemala Mexico Panama Paraguay Tunisia Venezuela

ES LK SR SE CH TZ TH TG TT TR UG GB US HV UY YU ZR ZM ZW

Geneva 1979 Protocol

Countries CONTRACTING PARTIES

Table 1.5 (continued)

AD

O

O

O

O

O A O

A* A

O O

A A O O

A O

56 Chapter 1

From GATT to the WTO

57

probably many more, six rounds were successfully concluded in the first twenty years of GATT, as opposed to two in the next fifty years, one of which (the Doha round) is still going on.181 1.3.5 The Transformations of GATT The original GATT underwent a series of changes over the years. In 1948, during the Havana Conference, only minor changes were made to the GATT text, the most important being the expansion of Article XXIV GATT to FTAs. In 1955, the GATT Review Session took place, which amounted to a comprehensive reevaluation of GATT. The provisions on BoP and renegotiation of duties were heavily redrafted at that time. In 1965, Part IV was added to GATT. It was the institutional acknowledgment that MFN was not working to the benefit of developing countries, and it opened the door first to a request for a “waiver” that was granted in 1971 and allowed temporary deviations from MFN in favor of goods originating in developing countries, and then to a decision allowing permanent deviations (Enabling Clause, 1979). This decision enabled GATT contracting parties (developed countries) to provide, through national Generalized System of Preferences (GSP) schemes, a tariff treatment of imports originating in developing countries that was better than that of imports of the same goods originating in developed countries, without developing countries being obligated to pay consideration in return. The ultimate transformation of GATT came in 1995, at the end of the Uruguay round, when, as a result of its successful conclusion, GATT reverted to its original function: an agreement coming under the institutional umbrella of a trade organization. This would no longer be the ITO, but the WTO. 1.3.6 A Brief Appraisal of the GATT Record GATT dismantled tariff protection and added an impressive legislative arsenal regulating trade in goods. Matters were not always always smooth, however. GATT faced numerous challenges, criticism, and doubt as it made its way throughout the years. Its system of monitoring preferential trade agreements failed, and was severely criticized, as we will discuss in chapter 6. The manner in which it dealt with the US decision to delink the dollar from gold in 1971 was less than fortunate, and we will discuss this issue in chapter 2. And the debate was not confined to internal discussions among institutional players. Noted scholars stepped in, and offered their views on the overall character of commitments made under the aegis of the GATT. This debate has been portrayed as a divide between pragmatists and legalists, although, as Hudec (1972) correctly explains nuances, are warranted. After all, it was Hudec who provided the impetus for additional support in favor of a pragmatic approach by virtue of his 1972 paper aptly titled “GATT or GABB” (GABB standing for General Agreement for Better Bargaining).

58

Chapter 1

Dam (1970) was uneasy with the legalistic turn of GATT. He argued forcefully that the overall purpose of GATT would be better served through an agreement on procedures rather than on strict legal obligations. The limits of human foresight were, in his view, particulary dangerous in a contractual arrangement regarding trade liberalization, where events surpass human imagination and are surpassed themselves by new facts that could not have been adequately described in the original contract. Jackson (1969) took a different view. He believed that binding legal obligations served a purpose in that they imposed a clear discipline on the addressees that would be called to implement it. His concession to pragmatism was that he saw room for what he termed “norms” (pp. 780ff.), e.g., a set of rules that would be agreed on multilaterally but would not have any force unless if implemented voluntarily by national governments. Hudec (1972) was definitely a pragmatist. In fact, he thought nothing of substance would be lost if instead of contracting specific obligations, the whole GATT was about an agreement for third party adjudication any time benefits had been nullified and/or impaired. This was not an intellectual battle for winners and losers. It was a thoughtful analysis of GATT by scholars who had realized that a lot more than trade liberalization was at stake if GATT endeavor failed. Trade was one of the few areas in international relations where a spirit of cooperation had been established, and the hope was that this spirit could be mimicked in other fora as well. GATT was a mix of legalism and pragmatism. Strict legal obligations were enforced with reasonableness; decisions were always made by consensus; and institutional improvements corresponded to actual needs and not to a future mega-design. The GATT was thus a pragmatic implementation of legal obligations. Pragmatism understood in this way served the GATT well—consolidating its existence, and allowing it to take a place among international institutions that promoted cooperation. Equally, if not more importantly, GATT contributed through its pragmatism in bringing about the only genuine compulsory third-party adjudication system, an oddity in international relations, where courts typically will be established to adjudicate disputes between nations only following an agreement between the interested parties to this effect. In Hudec’s (1993b) account, there is only one case where the defendant, although legally entitled to do so, refused to establish a panel: the case concerned the first dispute concerning trade of hormone-treated beef between the EU and the US, and ultimately a panel was not established due to a disagreement between the two parties regarding its composition (one party wanted a scientists-only panel, whereas the other preferred a panel composed of trade experts and, if warranted, scientists as well).182 Hudec’s study showed that between 1947 and 1992, 207 panels were established, and the losing party eventually accepted the results of an adverse panel report in approximately 80 percent of cases.183 The percentage would have been even higher (close to 90 percent) had it not been for panel practice in the 1980s, when blocking adoption occurred with increasing frequency, probably because trading partners moved to the adjudicating table

From GATT to the WTO

59

issues that they could not agree upon while negotiating. A number of panels during this period dealt with farm policy, a contentious issue during the Uruguay round, especially between the two transatlantic partners (EU and US).184 Hudec’s study also revealed that the only time that a GATT contracting party, facing noncompliance by the defendant, requested authorization to impose countermeasures and had its wish granted.185 The thrust of Hudec’s argument is that the passage to negative consensus186 through the Montreal Rules, and its subsequent extension, should not come as a surprise. The trading partners were living in a de facto world of compulsory third-party adjudication. The GATT panel system earned its reputation through a mix of increasing legal rigor (essentially through the establishment of the GATT Legal Affairs Division back in 1982), careful intrusiveness in some sensitive areas of sovereignty (e.g., joint selection of judges; freedom as to the choice of implementing measures), and legitimacy (since the losing party would agree that it had been wrong by adhering to the consensus). By any reasonable account, the system functioned to the satisfaction of its “clients,” the trading nations, and this is probably what prompted them to move to compulsory thirdparty adjudication, thus giving up precious sovereignty. GATT thus promoted a spirit (indeed, a culture) of cooperation, both at the negotiation (tariffs, legislation) and adjudication levels. The best proof that GATT has been a success is probably the fact that its membership has grown steadily over time: 23 nations signed the original text back in the summer of 1947 in Geneva, whereas 120 signed on the dotted line for the Marrakesh Agreement that closed the GATT chapter and opened that of the WTO. That number has risen to 161 since. 1.3.7 A Few Good Men One of the not-so-often told stories of GATT is that the remarkable record that has been discussed in this chapter was the work of a few good men picking up from where the framers of the edifice left off. The GATT secretariat originally consisted of a handful of people routinely working overtime trying to serve trade delegates that were frantically negotiating one trade round after the other in the early 1950s. Not only that, but that legion of workers had to be kept to the bare minimum because of extreme budgetary constraints. Aptly named the ICITO Secretariat (with ICITO standing for “Interim Commission for the International Trade Organization”)187 in an effort to keep the link to the ITO intact, the GATT secretariat was briefly reduced to “five officers, an administrative assistant, and 3 or 4 stenographers.”188 Williams (2014), one of the early GATT officials himself, with a long career at the institution, recalled how GATT was originally composed by former negotiators, such as Jean Royer, a member of the French delegation that had negotiated the original agreement. The link between the administration of the agreement and the negotiating intent thus was kept intact, a link that alas has loosened over the years.189

60

Chapter 1

At the helm of GATT, as noted previously, was Eric Wyndham White, a man of rare intelligence, who in the face of adversity managed to guide GATT to the completion of trade rounds, provide it with institutional infrastructure, and, most important, inspire the confidence of trading nations in the institution he was heading.190 In his obituary for Wyndham White in 1980, John M. Leddy wrote: “As Sir Eric used to point out, the GATT was the Cinderella of international institutions. That it held together at all was due as much as anything to the initiative, persuasive talents and sheer force of will of Sir Eric, who was responsible for converting, often by stratagems bordering on the Byzantine, a simple trade agreement into a vital international institution.”191 1.3.8 A Gentlemen’s Club Economists often describe GATT as a “relational contract,” with like-minded countries brought in by invitation only, and they managed to proceed with consensus decisions. There are dozens of anecdotes that support this view. In 1962, France had imposed import restrictions. The US complained, and the France, to its credit, acknowledged before the panel that its measures were illegal. The natural consequence of this admission would be for the panel to pave the way toward adoption of countermeasures. And yet, in a remarkable passage in its report on France import restrictions, the GATT panel explicitly asked the US to stop short of requesting authorization to impose countermeasures and give France the necessary breathing space to bring its measures into conformity with its obligations (§ 7). The US was probably comforted by the fact that it would be the recipient of similar treatment whenever warranted. An even more persuasive illustration is that the GATT Panel on Germany Starch Duties acknowledged in 1955 that an agreement during the negotiations, to the effect that duties would be set at a certain level that had not been transposed in a schedule of concessions, was an integral part of the balance of concessions agreed during the Torquay round. The word of negotiators sufficed, by and large (§§ 23ff.). 1.4

Regulation of Trade in Goods in the WTO Era

The WTO192 took over from GATT and provided the institutional coverage for a number of agreements, including GATT. The WTO is a “universal” institution, with 161 members, and over 20 more countries waiting to accede to it. The Agreement Establishing the World Trade Organization contains four annexes: • Annex 1 is subdivided into 1A, which covers multilateral agreements on trade in goods; 1B, on trade in services; and 1C, dealing with the TRIPs agreement. • Annex 2 deals with the administration of disputes in the WTO, and the relevant source of law for this purpose is the Dispute Settlement Understanding (DSU).

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• Annex 3 includes the Trade Policy Review Mechanism (TPRM). • Annex 4 reflects the plurilateral agreements. When a country (or separate customs territory possessing full autonomy in the conduct of its external commercial relations, as per Article XII.1 of the Agreement Establishing the WTO) accedes to the WTO, it will accept a third (besides accession to multilateral and, possibly, plurilateral agreements) layer of obligations, those assumed through its Protocol of Accession. 1.4.1 The “Old” and the “New” GATT: GATT 1947, GATT 1994 Article II of the Agreement Establishing the WTO explicitly refers to “GATT 1994,” one of the agreements coming under the aegis of the WTO, and adds that it is a legally distinct document from the original GATT (referred to as “GATT 1947”): The General Agreement on Tariffs and Trade 1994 (“GATT 1994”) shall consist of: the provisions in the General Agreement on Tariffs and Trade, dated 30 October 1947, annexed to the Final Act Adopted at the Conclusion of the Second Session of the Preparatory Committee of the United Nations Conference on Trade and Employment (excluding the Protocol of Provisional Application), as rectified, amended, or modified by the terms of legal instruments which have entered into force before the date of entry into force of the WTO Agreement; the provisions of the legal instruments set forth below that have entered into force under the GATT 1947 before the date of entry into force of the WTO Agreement: protocols and certifications relating to tariff concessions; protocols of accession (excluding the provisions (a) concerning provisional application and withdrawal of provisional application and (b) providing that Part II of GATT 1947 shall be applied provisionally to the fullest extent not inconsistent with legislation existing on the date of the Protocol); decisions on waivers granted under Article XXV of GATT 1947 and still in force on the date of entry into force of the WTO Agreement;193 other decisions of the CONTRACTING PARTIES to GATT 1947; the Understandings set forth below: Understanding on the Interpretation of Article II:1(b) of the General Agreement on Tariffs and Trade 1994; Understanding on the Interpretation of Article XVII of the General Agreement on Tariffs and Trade 1994; Understanding on Balance-of-Payments Provisions of the General Agreement on Tariffs and Trade 1994; Understanding on the Interpretation of Article XXIV of the General Agreement on Tariffs and Trade 1994; Understanding in Respect of Waivers of Obligations under the General Agreement on Tariffs and Trade 1994; Understanding on the Interpretation of Article XXVIII of the General Agreement on Tariffs and Trade 1994; and the Marrakesh Protocol to GATT 1994.

There is no ambiguity regarding the identity and the legal value of “Understandings,” “Protocols of Accession,” “Protocols of Certification,” and “Decisions on Waivers,” which are international agreements binding on their signatories, and have been included one by one in the various Annexes to the Agreement Establishing the WTO. Understandings are treated in WTO practice for all practical purposes as agreements. The Appellate Body (AB), for example, in its report on Turkey—Textiles, followed the definition of the term “general incidence of duties” that had been included in the Understanding on Article XXIV

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of GATT, and applied it without any further discussion (§ 53 of the AB report). There is no ambiguity regarding waivers either, as these are identifiable instruments. This point will be discussed further in chapter 9. However, there is ambiguity as to the coverage of the term “other decisions.” The reason for this is that, during the GATT years, there was nothing even resembling a provision discussing in sufficient detail the various legal acts that the CONTRACTING PARTIES could adopt, or their legal consequences. This was the case, because, as covered earlier, GATT was only an agreement designed to come under the aegis of the ITO. It was in the Havana Charter that the framers of the ITO had included institutional provisions. The GATT CONTRACTING PARTIES, though, adopted a series of acts aiming to further the objectives pursued through GATT. They employed a highly varied terminology in order to achieve essentially the same outcome. For example, the terms “decision” and “recommendation” were often used to refer to essentially the same concept. The problem with respect to similar acts should not be overstated, since many decisions, recommendations, and other acts adopted during the GATT-era have found their way into subsequent agreements. The question has also been raised in case law whether the term “other decisions” covers panel reports as well. The panel, in its report on Japan–Alcoholic Beverages II, was the first that was called upon to address this issue. The panel took the view that adopted panel reports enjoyed the status of “other decisions” (§ 6.10). The AB194 disagreed with the panel, though, holding that the decision to adopt a panel report is not a “decision” within the meaning of Article 1(b)(iv) of GATT 1994, although it did acknowledge that adopted reports are “an important part of the GATT acquis” (p. 15 of the AB report on Japan–Alcogholic Beverages II). The term “GATT acquis” is a creation of the AB, and its meaning was clarified in a subsequent report. In US–Shrimp (Article 21.5–Malaysia), the AB held that this term covered the legitimate expectations of WTO members to see that relevant prior case law, even in the absence of stare decisis195 in the WTO legal order, will be duly taken into account in future disputes—to the extent, of course, that it is relevant (§§ 108–109). This issue arose again in US–FSC. This time, the panel found that, instead of understanding decisions to adopt panel reports as “other decisions” in the sense of GATT 1994, it was more appropriate to subject them to Article XVI of the Agreement Establishing the WTO. This provision reads as follows: “… the WTO shall be guided by the decisions, procedures, and customary practices followed by the CONTRACTING PARTIES to GATT 1947.” The panel held as much, a construction that came very close to the substantive content of GATT acquis that had already been endorsed by the AB, and the AB explicitly approved this finding (§§ 108–115), holding that adopted GATT reports provide guidance to future panels dealing with the same issue. It is unclear what “guidance” actually entails, although it cannot amount to stare decisis. Guidance can be provided not only by adopted panel reports, but by unadopted ones as well. Panels in the WTO era have, on occasion, cited and followed the reasoning of unadopted GATT reports to the extent that they found it

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persuasive in a particular dispute. The AB, in its report on Japan–Alcoholic Beverages II, held that (p. 16) “a panel could nevertheless find useful guidance in the reasoning of an un-adopted panel report that it considered to be relevant.”196 1.4.2 The Relationship between GATT and the Other Annex 1A Agreements Annex 1A to the WTO Agreement includes GATT 1994; twelve agreements [Antidumping (AD), Agriculture (AG); Textiles and Clothing (ATC); Customs Valuation (CV); Import Licensing (ILA); Preshipment Inspection (PSI); Rules of Origin (ROO); Subsidies and Countervailing Measures (SCM); Safeguards (SG); Sanitary and Phyto-Sanitary Measures (SPS); Technical Barriers to Trade (TBT); and Trade-related Investment Measures (TRIMs)]; six Understandings [on Article II.1(b) GATT; on Article XVII GATT; on Balance of Payments (BoP); on Article XXIV GATT; on Waivers; and on Article XXVIII GATT]; and the Marrakesh Protocol to the GATT 1994 concerning implementation of agreed tariff reductions. A thirteenth Agreement was concluded in the Bali Ministerial Conference, the Agreement on Trade Facilitation (TF).197 The General Interpretative Note to Annex 1A establishes the legal relationship between GATT on the one hand and Annex 1A Agreements on the other, in the following sense: In the event of conflict between a provision of the General Agreement on Tariffs and Trade 1994 and a provision of another agreement in Annex 1A to the Agreement Establishing the World Trade Organization (referred to in the agreements in Annex 1A as the “WTO Agreement”), the provision of the other agreement shall prevail to the extent of the conflict.

The term “conflict” emerges as key to understanding the relationship between GATT and the other Annex 1A Agreements. Earlier case law suggests that this term should be interpreted narrowly: in the absence of genuine conflict (in the sense that there is a legal impossibility to respect two provisions simultaneously—that is, a provision of GATT and a provision of another Annex 1A Agreement), a WTO adjudicating body could start its analysis from the review of GATT instead of the provisions of the specialized agreements. An appropriate illustration of this case law is offered by the panel report on EC–Bananas III (§§ 7.158–7.163). Subsequent case law construes the term “conflict” more in line with the lex specialis principle. This principle is not explicitly included in the Vienna Convention on the Law of Treaties (VCLT).198 Rather, to some extent, it reflects the spirit of “ut regis valeat quam pereat,” the principle of effective treaty interpretation, the cornerstone of the VCLT edifice, which requires that the interpreter avoid interpreting terms to redundancy. Assuming that two provisions regulate the same transaction, privileging recourse to the relatively more general one would reduce the more specific provision to redundancy. In this understanding, an interpreter should always start the interpretative exercise from the agreement that more specifically deals with a particular issue, reverting to the more general provision only when necessary.

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The relationship between TBT/SPS, on the one hand, and GATT, on the other, is the area that provoked most of the discussion on this score. In § 77 of its report on EC– Asbestos, the AB concluded that a measure revealing that characteristics of a technical regulation that simultaneously fell under both the TBT and GATT should have been examined under the TBT rather than under GATT. In holding this proposition, the AB distanced itself from the panel’s findings. The panel had opted for a review of the measure under GATT in the absence of a genuine conflict between GATT and the TBT disciplines. The subsequent panel on EC–Sardines went the extra mile, so to speak, and provided the rationale for its preference to examine claims under the TBT Agreement before examining them under GATT. It explicitly stated that, in its view, the TBT disciplines deal more specifically with the disputed transaction, and for this reason, it provided the priority forum to entertain legal claims (§§ 7.14–16). On appeal, the panel’s approach was upheld by the AB (§ 195). The relationship between two multilateral Annex 1A agreements is sometimes prescribed by legislative means (see, e.g., Article 1.5 of the TBT, which clarifies the relationship between the TBT and the SPS Agreements). Otherwise, it is left to the discretion of the WTO adjudicating bodies. The other chapters of this book and in the next volume will refer to case law in this area.199 1.4.3 The Plurilateral Agreements Earlier in this chapter, we mention that, as a reaction to the GATT à la carte approach followed in the Tokyo round, which resulted in different contractual relations between different GATT contracting parties,200 the WTO was negotiated following the singleundertaking approach. All WTO members should be signatories to all agreements negotiated under the auspices of the Uruguay round. The decision to adopt “single-undertaking” was not made overnight. The Ministerial Declaration of 1982 included a provision mandating a review of the operation of the Tokyo-round “Codes.”201 A bridge was then established between reviews by the various committees administering the Codes and the negotiation of the Uruguay round (as of 1986). The concern for unity and consistency of the GATT system started gaining speed. Two ideas were advanced: either incorporate the Codes as such into the GATT system (the ambitious proposal), or take the appropriate measures to ensure that as many GATT contracting parties as possible joined the Codes (the realistic proposal).202 It was decided that a Working Party would be assigned to discuss this issue in more detail. It is in the context of these discussions that the ambitious proposal won the argument, almost without exception.203 Plurilateral agreements are the only exception to this rule. Initially, there were four plurilateral agreements: the CA, the GPA, the IDA, and the IBM. The terms for participation

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in the Annex 4 Agreements are spelled out in each of the four agreements (Article XII.3 of the Agreement Establishing the WTO).204 These four agreements are only open for accession to WTO members (Article II.3 of the Agreement Establishing the WTO). WTO members (Article X.9 of the Agreement Establishing the WTO) can, through consensus voting, add new agreements to the existing list of plurilateral agreements. WTO members enjoy the right to terminate the plurilateral agreements. They decided to terminate the IBM and IDA agreements by decisions of the General Council adopted on December 31, 1997, and December 17, 1997, respectively. As a result, there are only two plurilateral agreements now in place: the GPA, which entered into force on January 1, 1996;205 and the CA, which entered into force on January 1, 1995. Note that they were both negotiated and signed for the first time during the Tokyo round. The original GPA and CA were Tokyo round Codes, and they entered into force on January 1, 1980.206 1.4.4

Single Undertaking Versus “Clubs”

Following the Uruguay round of negotiations, the single-undertaking approach was supposed to be followed in the Doha round as well. §47 of the Doha Ministerial Declaration stated: With the exception of the improvements and clarifications of the Dispute Settlement Understanding, the conduct, conclusion, and entry into force of the outcome of the negotiations shall be treated as parts of a single undertaking. However, agreements reached at an early stage may be implemented on a provisional or a definitive basis. Early agreements shall be taken into account in assessing the overall balance of the negotiations.207

This paragraph is a bit of mystery, though. On the one hand it endorses “single undertaking,” but on the other it does not reject “early harvesting”; that is, it allows for agreements that have been concluded earlier than others to enter into force, even though there is uncertainty looming regarding the conclusion of the remaining agreements. And early harvesting has indeed occurred in the face of the “Aid for Trade” package and the successful conclusion of the meeting in Indonesia (December 2013), the so-called Bali package. The entry into force of these agreements was not conditional on the successful conclusion of the remaining issues. §1.11 of the “Bali Ministerial Declaration” stated: to further demonstrate this commitment, we instruct the Trade Negotiations Committee to prepare within the next 12 months a clearly defined work program on the remaining Doha Development Agenda issues.208

And yet, the Agreement on Trade Facilitation should have entered into force already by July 31, 2014, as per §3 of the decision announcing the agreement on this issue (WTO

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Document WT/MIN(13)/W/8 of December 6, 2013). Its definitive entry into force was delayed, as is recounted in chapter 1, volume 2 of this work. Nothing, for example, in the decision adopting the Agreement on Trade Facilitation links its adoption to the adoption of the remaining Doha agenda. Hence, one can safely conclude that single undertaking was de facto not observed in the Doha talks, as it was not in the Tokyo round, where the “codes” approach had been followed.209 Practice, thus, shows a back-and-forth between single undertaking and deals between club members. The Tokyo round was full of similar deals, and four of them survived the Uruguay round. Where does research literature stand on this issue? It is a commonplace argument that there is a greater scope for deals as possibilities abound (through offering a large set of agreements).210 Single undertaking offers negotiators more to bargain for, but maybe it also offers much more than they can handle. It is the inflexibility that has been associated with the fact that single undertaking requires trading nations to form an integral part of all agreements that has been criticized. Hufbauer and Schott (2013), when discussing the Doha round, explained how the single-undertaking approach has impeded the attainment of several deals that could have come to fruition had their fate not been linked to that of the round. Lawrence (2006) added his voice to similar claims, arguing for a “clubs” approach as a result of the increasing participation in the WTO of nations with highly uneven development levels. As new issues arise as a result of dialogue within societies, it is not to be expected that all WTO members will be ready to discuss them in the multilateral forum. Hoekman and Mavroidis (2015) have argued that clubs are inevitable. Integration of domestic policies requires instruments beyond nondiscrimination, which cannot guarantee market access.211 Those interested in doing so employ other instruments such as recognition or harmonization. Similar arrangements are common across relatively homogeneous states (i.e., across clubs).212 Note that there is nothing legally wrong with proceeding this way, so long as the outcomes of similar exercises will be mutlilateralized to those who can meet the contracted standards. Indeed, this is what MFN is all about. Integration of domestic policies, therefore, will inevitably occur within clubs, and it is in the WTO’s interest to keep bridges to them. These authors also point to a second, independent reason why bridges to clubs must be a priority for the WTO. Clubs could emerge as the “hothouse” for the future multilateral agenda. A look at the regulatory agenda in the Trans-Atlantic Trade and Investment Partnership (TTIP), for example, is quite revealing regarding the issues that the EU and the US view as the modern trade agenda. In TTIP, the EU and the US have embarked on a comprehensive negotiation of regulatory barriers to trade. Some of the negotiating items in the area of standards could eventually be mutlilateralized, or, at the very least, provide some food for thought regarding the approach that should be taken at the multilateral level to address some issues. And the institutional design of clubs is in and of itself of interest

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to the WTO, since maybe some of their features that make them attractive to trading nations could be reproduced at the multilateral level. As things stand, nevertheless, WTO members have made very little use of plurilaterals. The Civil Aviation agreement could only be plurilateral since there are not many producers of aircraft anyway, and there is nothing like a world competition law to address consumer concerns. The GPA stayed plurilateral, probably because the agreement was a remnant of the Tokyo round, and others were not interested in joining in. On July 8, 2014, fourteen WTO members initiated negotiations with the aim of adding a third plurilateral agreement to the WTO arsenal, this time on environmental goods. On the other hand, over 500 PTAs have been concluded. It is PTAs that are the “club” par excellence, and this will be covered in more detail in chapter 6. 1.4.5 The Protocols of Accession A Protocol of Accession reflects the terms under which a country (or customs territory) accedes to GATT/WTO. For years, similar documents would reflect the level of agreed tariff bindings, and rarely, they extend to cover commitments of a different nature. Their legal relevance thus would be largely limited to providing information regarding the level of duties that the new contracting party had agreed to apply following its accession to GATT. Following the successful conclusion of the Uruguay round, a flurry of countries joined the WTO, and many of them had one thing in common: they were NMEs (nonmarket economies). Now what exactly constitutes an NME is not an exact science. The Interpretative Note of Article VI of GATT includes the only statutory definition: It is recognized that, in the case of imports from a country which has a complete or substantially complete monopoly of its trade and where all domestic prices are fixed by the State, special difficulties may exist in determining price comparability for the purposes of paragraph 1, and in such cases importing contracting parties may find it necessary to take into account the possibility that a strict comparison with domestic prices in such a country may not always be appropriate.

It might seem odd that the only reference to NMEs appears in the context of Article VI of GATT, which deals with the conditions under which AD duties can be imposed.213 One should not neglect the fact that in the context of AD duties or countervailing duties (CVDs), the pricing mechanism in the exporting country is of particular relevance, and NMEs are relevant for this reason as well. Decisions affecting trade, though, can be affected across the board, and it is remarkable that recognition of NME status becomes legally relevant only in the context of contingent protection.214 On paper, an NME must have a complete (or substantially complete) monopoly of trade, and all its domestic prices must be centrally fixed. Surely many centrally planned economies would fail the second condition, and since the two conditions must be cumulatively met, one would expect scarce practice on this score. Practice, however, demonstrates that

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only non–“Western bloc” states have often been treated as NMEs by market economies in the context of AD investigations. WTO adjudicating bodies have not disturbed this practice either. An appropriate illustration is offered by the recent panel on EC—Fasteners (China), which satisfied itself with the observation that China is treated by many as an NME without going any further (§§ 7.68ff). NMEs have been asked to pay a price that WTO incumbents had not paid upon their accession to the world trading system. The Protocols of Accession post-1995 are akin to inventories of obligations that go much further than whatever WTO incumbents had agreed to observe. For example, during the negotiations leading up to the accession of the People’s Republic of China to the WTO, a special safeguard mechanism was concluded which, contrary to the terms of the WTO Safeguards Agreement, allows WTO members the possibility to impose discriminatory (i.e., country-specific) safeguards against China.215 In a similar vein, China was requested to accept a legal obligation to join the GPA, although, as mentioned previously, accession to plurilaterals is an option for WTO members.216 With respect to trading rights, China accepted for all practical purposes to partially give up its rights under Article XVII of GATT: Without prejudice to China’s right to regulate trade in a manner consistent with the WTO Agreement, China shall progressively liberalize the availability and scope of the right to trade, so that, within three years after accession, all enterprises in China shall have the right to trade in all goods throughout the customs territory of China, except for those goods listed in Annex 2A which continue to be subject to state trading in accordance with this Protocol. Such right to trade shall be the right to import and export goods. (emphasis added)217

By the same token, when Saudi Arabia joined the WTO, it promised, following requests by its partners, that when transforming the Gulf Cooperation Council (GCC) into a FTA, it would respect the conditions of Article XXIV of GATT, and Article V of GATS (the General Agreement on Trade in Services that was agreed on in 1995 and has come under the aegis of the WTO), thus waiving the possibility to notify the preferential scheme under the Enabling Clause, which contains less stringent obligations.218 Notification under the Enabling Clause is a privilege that all developing countries enjoy, and the qualification of a WTO member as developing is the exclusive privilege of the individual member (the lack of merits of this approach notwithstanding). More generally, similar stipulations can represent either additional obligations to those assumed by the WTO membership (“WTO plus” or “WTO+,” like the obligation accepted by China), or even, on occasion, a lessening of these obligations (“WTO minus” or “WTO−”):219 for instance, Lithuania acceded to the WTO on May 31, 2001, but it was given until December 31, 2005, to bring its excise taxes on beer and mead into conformity with Article III of GATT.220 WTO− obligations, hence, have a function akin to the grandfathering of obligations that some of the original GATT signatories practiced.

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During the early GATT years, before the Tokyo round Codes were negotiated, accession to GATT was symmetric across incumbents and newly acceding countries. Article XXVI.4 of GATT read to this effect: “Each government accepting this Agreement shall deposit an instrument of acceptance with…” (emphasis added). Arguably, nowadays there is more leeway to negotiate conditions above and beyond the multilateral framework. Article XII of the Agreement Establishing the WTO reads: Any State or separate customs territory possessing full autonomy in the conduct of its external commercial relations and of the other matters provided for in this Agreement and Multilateral Trade Agreements may accede to this Agreement, on terms to be agreed between it and the WTO. (emphasis added)

This provision does implicitly impose a limit: the Protocol of Accession cannot extend beyond issues not covered by the current mandate of the WTO. In this vein, imposing obligations on a particular environmental or competition policy would go beyond the current WTO mandate, what Horn, Mavroidis, and Sapir (2010) have termed “WTO extra,” or “WTOx” obligations. This issue will not be discussed further in this volume. Suffice to say that those interested in an overview of the obligations of those WTO members that acceded to the organization after 1995 should be studying not only the multilateral and plurilateral agreements, but their Protocols of Accession as well.221 1.4.6 The WTO Organs Administering Agreements on Trade in Goods The highest organ in the WTO institutional architecture is the Ministerial Conference. This organ meets every two years (at a minimum by law, but in practice, exactly every two years) and can adopt decisions regarding all matters, such as decisions regarding trade in goods (Article IV.1 of the Agreement Establishing the WTO).222 The General Council will meet in between the meetings of the Ministerial Conference, and assume all competences entrusted to the Ministerial Conference (Article IV.2 of the Agreement Establishing the WTO). The Council for Trade in Goods (CTG), which comes under the aegis of the General Council, oversees the functioning of the Multilateral Trade Agreements in Annex 1A (to the Agreement Establishing the WTO); that is, the agreements dealing with trade in goods (Article IV.5 of the Agreement Establishing the WTO). A series of committees with well-delineated competence have been established and deal with the day-to-day operations of the agreements included in Annex 1A. Some committees have been established through provisions of the Annex 1A Agreements, or through decisions of the WTO membership.223 The Agreement Establishing the WTO provides for the advent of two committees: namely, the Committee on Trade and Development (CTD), and the Committee on Balance of Payments (Article IV.7 of the Agreement Establishing the WTO).

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All committees are serviced by the WTO secretariat. The secretariat is appointed by the DG of the WTO (Article VI.2 of the Agreement Establishing the WTO); §§ 3 and 4 of Article VI of the Agreement Establishing the WTO read: 3. The Director-General shall appoint the members of the staff of the Secretariat and determine their duties and conditions of service in accordance with regulations adopted by the Ministerial Conference. 4. The responsibilities of the Director-General and of the staff of the Secretariat shall be exclusively international in character. In the discharge of their duties, the Director-General and the staff of the Secretariat shall not seek or accept instructions from any government or any other authority external to the WTO. They shall refrain from any action which might adversely reflect on their position as international officials. The Members of the WTO shall respect the international character of the responsibilities of the Director-General and of the staff of the Secretariat and shall not seek to influence them in the discharge of their duties.

The term “Secretariat” denotes the will of the GATT framers to reduce the international officials appointed to clerk-like functions only. The Secretariat has nonetheless, on occasion, assumed some important initiatives. Preeg (1995) refers to the package deal prepared by Wyndham-White in 1967 in the context of the Kennedy round (p. 139). More to the point, Arthur Dunkel prepared the “Dunkel draft” (aspects of which we discuss in chapter 8 of volume 2), a very comprehensive attempt to get over the deadlock reached during the Uruguay round. Preeg (1995) notes to this effect (p. 139): “As director-general of the GATT, Arthur Dunkel was a creature of the GATT membership with no designated authority to act as a mediator. Such a role of the head of an international secretariat is not uncommon, however, and the crucial factor is the judgment as to when and how to act.” Dunkel paid for his audacity as, a few weeks after presenting his draft, he left the Secretariat.224 Four deputy director generals are entrusted with the supervision of the various WTO divisions. The committees dealing with trade in goods are as follows: the Market Access Committee, which deals with tariff and nontariff concessions not dealt with by any other committee, and with keeping all schedules of concessions updated, including the introduction of changes introduced to the Harmonized System.225 The Customs Valuation Committee, the Committee on Rules of Origin, the Import Licensing Committee, and the Committee on Trade Facilitation focus on the administration of the four WTO Agreements that established them (CV, ROO, ILA, TF). The Customs Valuation Committee also manages the Agreement on Preshipment Inspection, whereas the Committee on Rules of Origin, together with the WCO226 Technical Committee on Rules of Origin (TCRO), carry out the main work of harmonizing nonpreferential rules of origin. The Agriculture Committee administers the implementation of the Agreement on Agriculture. The Technical Barriers to Trade Committee and the Sanitary and Phyto-sanitary Measures Committee deal with the day-to-day administration of the respective agreements (TBT, SPS), and provide a

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forum for raising and debating “specific trade concerns,” an informal mechanism for settling disputes that we discuss in detail in chapter 5 of volume 2. The Trade-Related Investment Measures (TRIMs) Committee monitors the implementation and operation of the TRIMs Agreement. The Antidumping Practices Committee, the Subsidies and Countervailing Measures Committee, and the Safeguards Committee provide WTO members with a forum to discuss all matters arising from the operation of the three agreements (AD, SCM, SG). The Working Party on State Trading Enterprises reviews notifications by WTO members on their state trading activities; the ITA Committee (or, more formally, the Committee of the Participants on the Expansion of Trade in Information Technology Products) oversees issues concerning the operation of the ITA Agreement.227 Then there are two committees established under the auspices of the two plurilateral agreements still in force: the Committee on Civil Aircraft, and the Committee on Government Procurement, dealing with the operation of the two corresponding agreements. The Market Access Committee, the Customs Valuation Committee, the Rules of Origin Committee, the Import Licensing Committee, and the ITA Committee are serviced by the Market Access Division. The Agriculture Committee is serviced by the Agriculture and Commodities Division; the Technical Barriers to Trade Committee, as well as the Sanitary and Phyto-sanitary Measures Committee, are serviced by the Trade and Environment Division. The Trade-Related Investment Measures Committee, the Antidumping Practices Committee, the Subsidies and Countervailing Measures Committee, the Safeguards Committee, the Committee on Civil Aviation, and the Working Party on State Trading Enterprises228 are all serviced by the Rules Division. Finally, the Committee on Government Procurement is serviced by the Intellectual Property Division of the WTO. The WTO committees, with few exceptions that will be discussed later, spend their time dealing with day-to-day issues, and, typically, abstain from entertaining discussions regarding the future of the world trading system. Partly, this is because the WTO secretariat, the common agent that could be entrusted with similar functions, is kept at a bare minimum number-wise and is not trusted with a mandate to this effect. It includes only a handful of researchers (unlike, for example, the WB and the IMF). Even The World Trade Report, the closest thing there is to research at the WTO, which is issued on yearly basis by the WTO Research Division, reflects a survey of economics literature on a given topic, and nothing beyond that. There are some unwanted consequences stemming from the WTO corporate governance, as has been described here. The trade agenda is shaped by those who are researching the area and trying to match the needs of the private sector with the appropriate institutional design. This exercise is, for this and other reasons, easier accomplished within clubs (and, most notably, PTAs), than in the WTO. This issue will be explored further in chapter 6. The previous discussion on committees referred to exceptions, and the TBT Committee is one of them. It spends time and effort discussing issues of daily concern, as it does debating on the future shape of the Agreement. It is not that it has a different mandate

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than other committees, since they are all entrusted with the task to review the operation of the WTO Agreement they serve. It might have to do with the composition of the committee, since typically it is not trade negotiators that participate therein, but technical experts interesting in addressing the necessity of regulatory interventions. This is an area where research is making its first steps, and additional work is required.229 Two WTO divisions are important for the discussions in this volume: the Legal Affairs Division and the Appellate Body Division service the panels and the AB, respectively; e.g., the adjudicatory organs entrusted with the exclusive competence to interpret the agreements regulating trade in goods. All this is, of course, relevant to the internal organization of the WTO. The WTO has a legal personality (Article VIII of the Agreement Establishing the WTO) and can conclude international agreements with other organizations, thus establishing the links necessary for it to carry out its functions (Article V of the Agreement Establishing the WTO). For example, more intense cooperation between the WTO, on the one hand, and the IMF and the WB, on the other, has become necessary in order for the WTO to discuss and administer issues relating to currency and trade, trade and development, or both. To this effect, the WTO has signed agreements of cooperation with the institutions on both sides of 18th Street in Washington, DC, that is, the World Bank and the International Monetary Fund. In the WTO era, it began with the “Declaration on the Contribution of the WTO to Achieving Greater Coherence in Global Economic Policymaking” (§ 5 of the Declaration), which was adopted at the end of the Uruguay round. It reflected an invitation to the WB and IMF delegates to brainstorm on ways and means to render the policies adopted by the three institutions mutually supportive. Picking up on ideas that have been floating around since the birth of GATT,230 the WTO eventually signed formal agreements with both the WB231 and the IMF.232 The overarching principle guiding these agreements is “global coherence”; e.g., to ensure that the three institutions will not impose conflicting obligations. Additionally, there are provisions that guarantee that distribution of labor between the three institutions will correspond to the comparative advantage of each of them. Chapter 2, for example, will explain how IMF expertise is taken into account in the context of dispute settlement when issues relating to exchange and BoP restrictions arise.

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Quantitative Restrictions

2.1 The Legal Discipline and Its Rationale 2.1.1 The Legal Discipline Import and export quantitative restrictions (QRs) are illegal by virtue of Article XI.1 of GATT. Members of the WTO can still justify an import- or export QR that they have imposed if they successfully carry the burden of proof associated with one of the exceptions included in the GATT. They can invoke, to this effect, economic (e.g., balance of payments or BoP) or noneconomic (e.g., environmental or public health protection) motives in order to justify violations of the obligation that they assumed under Article XI.1 of GATT. 2.1.2 The Rationale for the Legal Discipline Any agreement aiming to liberalize trade, of course, should discipline QRs since similar instruments segment markets. The questions that occupied the mind of the GATT framers during negotiations were whether the rationale for QRs should matter, and, if so, what should the obligations be in case recourse to QRs was justified. An in principle ban on QRs was consonant with the preference of the framers to allow for only one border instrument that could lawfully segment markets—namely, tariffs. Should one nevertheless, put all QRs in one basket? QRs are imposed for various reasons, ranging from simply protecting domestic producers’ income to addressing a health hazard. Sometimes a justification has been offered for imposing a QR, and sometimes not. Negotiators felt that QRs imposed for nonprotectionist reasons should not be treated in the same manner as naked attempts to favor domestic producers. 2.1.3

Discussion

2.1.3.1 Negotiating History Article 25 of the “London Draft” (the progenitor of Article XI.1 of GATT) excluded from its coverage measures that dealt with postwar shortages or surpluses of foodstuffs and

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other farm goods. These were the two areas that were mentioned as examples of “permissible” QRs. Postwar anxieties regarding food security provided the rationale for this caveat. Negotiations during the New York Conference did not produce any major change to this provisional agreement, and these two areas eventually found their way into Article XI.2 GATT.1 The list of Article XI.2 of GATT was probably not meant as an exception to the prohibition established in Article XI.1 of GATT, but as a limit to the coverage of the in principle ban on QRs. If this understanding is correct, then in the case of disputes on whether, for example, a QR was meant to address a critical shortage, the complainant would carry the burden of proof and have to provide prima facie evidence that this was not the case. However, this is not how case law understood the allocation of burden of proof under Article XI.2 of GATT, as we will see later in this chapter. Regardless of the allocation of the burden of proof, Article XI.2 of GATT had to be drafted in a way that it would not become a self-fulfilling prophecy. 7 Disagreements, however, continued to persist regarding the extent of the carve-out— that is, what else should be included in the provision that “carved out” subject matter from the discipline to abolish QRs in principle. Norway for example, insisted that only farm products should be covered. Chile, on the other hand, pressed in the opposite direction— that is, it proposed more extended coverage.2 The majority of negotiators sided with Norway, but developing countries stood behind the Chilean proposal. The Geneva Draft3 followed the New York Draft, and the disagreement between Norway and Chile ended provisionally in victory for the former.4 Eventually, the words “or other products” were added, as the current text of Article XI.2 of GATT suggests. Chile could claim victory. Furthermore, developing countries introduced exceptions not in the body of Article XI, but in the body of (what became) Article XVIII(c) of GATT; that is, the provision allowing for deviations from obligations assumed in order to protect “infant industry.”5 And, echoing the UK/Keynesian belief that short-term macroeconomic solutions were appropriate and a flat-out prohibition of QRs would have made it impossible to have recourse to similar instruments, exceptions to preserve BoP were agreed on as well. Article XI of GATT was not modified any further during the subsequent Havana Conference.6 And of course, the list of general exceptions was also agreed at a later stage (Article XX of GATT). It is probably fair to state that the negotiation of this provision focused more on the extent of the carve out rather than on the negotiation of the in principle ban on QRs. Note, finally, that during the negotiations leading to the signature of the original GATT, a separate provision dealing exclusively with boycotts was also discussed. In essence, this provision would have requested from trading nations to avoid participating actively in campaigns that aimed to discourage consumption of imported goods (Article 23 of the London Draft). But it was not included in the final GATT text. Negotiators found it impossible to agree on the formulation of the provision during the London Conference. A consensus emerged to distinguish between boycotts and “Buy National” policies, and that subsequent rounds of discussions would differentiate between the treatments of the two policies.8

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This distinction was retained in the New York Draft (in Article 23). It was during that meeting that the US delegate suggested that the initial rationale for boycotts was to preclude “Buy National” policies, but since no agreement on this score could be achieved, the provision should be scrapped altogether, and so it happened.9 This provision was omitted from the GATT text and was not reintroduced in the Review Session of 1955. 2.1.3.2 The Economics of QRs QRs create deadweight losses since a number of beneficial trades will not take place, and also because resources in the country imposing the quota will be misallocated as a result of their imposition. That is, domestic (inefficient) producers will move in and produce the good where the quota is imposed, even if they price their produce above the world price. QRs can, of course, also be imposed for public policy reasons, and then the question is to what extent the QR is the best instrument to serve the stated public purpose. For example, an embargo could be called in order to shun imports of beef contaminated with mad cow disease. Chapter 9 will discuss this type of intervention. Economists have delved into the question of whether the GATT framers got it right when deciding to treat QRs and tariffs differently. Both QRs and tariffs are instruments that segment markets; yet, whereas import- and export QRs are prohibited outright, tariffs (as the next chapter will explore in more detail) are not. They can be capped and reduced through negotiation. Consequently, unlike import and export QRs, tariffs are not in principle illegal. Is there any reason for this differential treatment, especially since, in a perfect competition model, tariffs have a QR-equivalent (e.g., they can lead to the same result)? Economic theory has advanced good arguments in favor of the differentiated treatment of the two instruments. Recall from chapter 1 that the GATT framers wanted to establish a nondiscriminatory (most-favored-nation, or MFN) world trade order. MFN is easily applicable in a tariffs-only context, while it is quite onerous when applied to QRs. In the former case, all a WTO Member has to do is impose the same customs duty on an import— for example, wheat—irrespective of its origin. How is MFN served when 1,000 tons of wheat are allowed in a market? Should it be first come, first served? Does MFN require in this scenario adjustments to ensure that those who are not in geographic proximity will not be disadvantaged? These are questions to which there are no easy answers. Negotiators also felt that trade negotiations are substantially facilitated when they focus on one measure (tariff) rather than two (tariff, quota). In this vein, Krueger (1964) researched the negative external effects associated with the administration of QRs. Her work shows that there are substantial costs associated with the administration of quotas. There is a need, for example, to monitor whether QRs have been filled; whether they have been filled in a nondiscriminatory manner; eventually, if (import or export) licenses have been issued; and, if so, whether they have been issued in a nondiscriminatory manner.10 The administration of a tariff-based import system, on the other hand, does not raise similar issues. In other words, MFN trade works better when tariff

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promises are being exchanged, and considerably worse when QR promises become the vehicle for trade liberalization. Bhagwati (1965) provided additional support for the argument that QRs must be treated differently than tariffs. He shows that, in a perfect-competition model, tariffs have a QRequivalent, but he also shows that this is not necessarily the case in imperfect competition (i.e., in a more realistic setting). For example, a monopolist in a market where a QR has been imposed will capture all residual demand—that is, demand after the QR has been exhausted. If, instead, a tariff (in lieu of a QR) has been introduced, some competitive pressure will always be exercised on the monopolist, who may not be in position to profit as much as if a QR (in lieu of a tariff) had been in place. This point becomes even more persuasive were one to take into account the nature of tariffs imposed. Ad valorem duties are expressed as a percentage imposed on the import price. As prices fall, the “bite” of tariffs is gradually diminished. This is not the case with QRs, which are immune to price variation. Economists have also studied the effects of QRs in the domestic economy. A QR—just like a customs duty (the treatment of which under GATT we examine in the next chapter)—effectively redistributes income between segments of the society. Producers will enjoy additional profits thanks to the limited competition from abroad, whereas consumers will have to switch from cheaper imported goods to more expensive domestic products. The economic rationality of redistribution of income through trade instruments is highly questionable. Dixit (1985) has pointed to the negative external effects resulting from similar initiatives. Rodrik (1995) put it very aptly and in colorful terms when stating “… saying that trade policy exists because it serves to transfer income to favored groups is a bit like saying Sir Edmund Hillary climbed Mount Everest because he wanted to get some mountain air.” Just as the famous New Zealander could have taken a stroll on a hill, states could simply use taxation instead of QRs for the purposes of redistributing income. Political economy serves to explain similar actions. There are many definitions of “political economy” that could be usefully summed up as the study into the reasons explaining the divergence between the socially optimal outcome and whatever we observe in practice. Rodrik (1995) underlines the exaggerations that we often observe in the realm of trade policy in the following manner (p. 1457): “Perhaps no other area of economics displays such a gap between what policy makers practice and what economists preach as does international trade.” 2.2 2.2.1

Coverage of the Legal Discipline General Elimination of Quantitative Restrictions

The title of Article XI of GATT is: “General Elimination of Quantitative Restrictions.” Article XI.1 of GATT specifies what the legal discipline actually consists of:

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No prohibitions or restrictions other than duties, taxes or other charges, whether made effective through quotas, import or export licences or other measures, shall be instituted or maintained by any contracting party on the importation of any product of the territory of any other contracting party or on the exportation or sale for export of any product destined for the territory of any other contracting party.

The term “quantitative restrictions” does not appear in the body of Article XI.1 of GATT—only in the title of this provision. It is replaced by the terms “prohibitions” and “restrictions.” Both terms point to a restrictive effect, and complainants have often referred to both in tandem when requesting consultations and the establishment of a panel. Panels have understood that the collective scope of these two terms obliges them, in principle, to punish all measures restricting international trade, other than those explicitly exempted from the coverage of this provision. In Colombia–Ports of Entry, the panel revisited prior case law and provided its understanding of the wide coverage of this provision. In its words (§ 7.240): Thus, as evidenced above, a number of GATT and WTO panels have recognized the applicability of Article XI:1 to measures which create uncertainties and affect investment plans, restrict market access for imports or make importation prohibitively costly, all of which have implications on the competitive situation of an importer. Moreover, it appears that findings in each of these cases were based on the design of the measure and its potential to adversely affect importation, as opposed to a standalone analysis of the actual impact of the measure on trade flows.

In similar vein, the Appellate Body (AB) provided its understanding of the terms “prohibition” and “restriction” in its report on Argentina–Import Measures (§ 5.217): In China–Raw Materials, the Appellate Body observed that the term “prohibition” is defined as a “legal ban on the trade or importation of a specified commodity.” In that dispute, the Appellate Body also referred to the term “restriction” as “[a] thing which restricts someone or something, a limitation on action, a limiting condition or regulation” and, thus, generally, as something that has a limiting effect. The use of the word “quantitative” in the title of Article XI of the GATT 1994 informs the interpretation of the words “restriction” and “prohibition” in Article XI:1, suggesting that the coverage of Article XI includes those prohibitions and restrictions that limit the quantity or amount of a product being imported or exported. This provision, however, does not cover simply any restriction or prohibition. Rather, Article XI:1 refers to prohibitions or restrictions “on the importation … or on the exportation or sale for export.” Thus, in our view, not every condition or burden placed on importation or exportation will be inconsistent with Article XI, but only those that are limiting, that is, those that limit the importation or exportation of products. Moreover, this limitation need not be demonstrated by quantifying the effects of the measure at issue; rather, such limiting effects can be demonstrated through the design, architecture, and revealing structure of the measure at issue considered in its relevant context. (italics in the original)

The excerpts cited above support the conclusions that a wide understanding of the terms “prohibition” and “restriction” is appropriate. Panels do not need to quantify the effect of challenged measures to decide whether Article XI.1 of GATT has been violated. It suffices that they look into the design, architecture, and revealing structure of the measure—a

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rather open-ended test—to form an opinion on whether Article XI.1 of GATT has been violated or not. Finally, the measures captured by Article XI.1 of GATT are measures imposed on importation and/or exportation of goods, and not any measures that might affect the volume of imports and/or exports. We will discuss all these points in detail later in this chapter. “Quantitative restrictions” can take three forms: • Quotas • Import or export licenses • Other measures Therefore, “quotas” and “QRs” are not synonymous. The former only partially overlaps with the latter. A quota, as we detail later in this chapter, is a measure imposing a numerical target, such as 5 tons or 1,000 liters. Import or export licenses condition trade upon the prior granting of a license. Problems arise with respect to the understanding of the all-encompassing term “other measures,” prima facie at least. Recall that only “other measures” that have been “instituted or maintained on importation … or exportation” are covered by Article XI.1 of GATT. These words should suffice to exclude measures of a purely domestic nature (e.g., production quotas) from the coverage of the discipline, a point to which we will return later and explain in more detail why this should be the case. The text of Article XI of GATT explicitly prohibits measures other than “duties, taxes, or other charges,” which are thus excluded from the coverage of Article XI of GATT. This, of course, is normal since otherwise, GATT would be imposing two diametrically opposed disciplines on import duties: they would be allowed under Article II of GATT and prohibited under Article XI of GATT. The same is true with respect to the other terms appearing in this carve-out (“taxes,” “other charges”).11 Furthermore, through Article XI.2 of GATT, some farm quotas were explicitly excluded from the coverage of this provision as well. We discuss this in more detail later in this chapter. 2.2.2

Quotas

The commonplace definition of a “quota” requires the presence of a numerical target. A quota, for example, would be a measure limiting imports to 1,000 tons of wheat, 5,000 liters of beer, or 5,000 passenger vehicles. The GATT Panel on France-Import Restrictions (discussed in chapter 1) is a typical case of an import quota. Export quotas also have been found to be GATT-inconsistent. In China–Raw Materials, the complainants claimed that China, through its “Export Quota Administrative Measures,” was in violation of its obligations under Article XI of GATT. Under this regime, the Chinese Ministry of Commerce (MOFCOM) had been entrusted with the administration of exports of a series of commodities (i.e., bauxite, coke, and zinc). MOFCOM would publish an annual export quota, a numerical target that exporters could not exceed, and if they did so, they would

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be liable to paying penalties. The panel found that export quotas constituted a clear violation of Article XI.1 of GATT. It further found that, since China admitted that the absence of mention of an export quota for a particular commodity (zinc) amounted to impossibility to export at all, an export embargo (that is, omission from the published lists) amounted to an export quota and thus constituted violation of Article XI.1 of GATT (§§ 7.214ff.). A de facto import/export quota—that is, a measure that does not include a numerical target—could still be considered to be an “other measure,” and thus would be prohibited by Article XI.1 of GATT. This would be the case, for example, when the Home nation imposes a “trade balancing” condition, in which imports will be allowed only when a certain amount of exports have been realized. We discuss the case law on the understanding of the term “other measures” later in this chapter. 2.2.3

Import and Export Licenses

Import and export licensing are not subject to the same rules. They both come under Article XI of GATT—that much is clear. In 1979, nevertheless, the Tokyo-round ILA, the first agreement in this area, was enacted. It has since been replaced by the Uruguay round agreement on this score. There is no WTO agreement on export licensing. As a result, whereas it is the various provisions embedded in ILA that constitute the legal benchmark to evaluate whether the various import licensing schemes are WTO-consistent,12 the consistency of export licensing schemes with GATT will be reviewed by referring to the discipline embedded in Article XI of GATT. 2.2.3.1 Import Licensing Article XI of GATT was enacted in 1947, when the first ILA was not even contemplated. The question arises about whether an instrument that qualifies as import licensing should be checked for its consistency with the multilateral rules under Article XI.1 of GATT, or under the disciplines included in the ILA. There was, of course, no issue until January 1, 1980, when the Tokyo-round ILA (the first ILA) entered into force. Up to that time, Article XI.1 of GATT was the only forum to perform similar inquiries. The question would be whether it sufficed that a scheme qualified as import licensing for its inconsistency with Article XI.1 of GATT to be ipso facto proclaimed, or whether something more needed to be demonstrated to this effect. The wording of Article XI.1 of GATT might legitimately lead to the conclusion that import and export licensing were per se illegal. Although this is now a moot point (since ILA provides—or at least should provide—the benchmark for evaluating the consistency of import licensing schemes), a GATT panel did not adhere to this view. It refused to treat import licensing as a per se violation of Article XI of GATT. It inquired into whether the challenged measure, an import-licensing measure, constituted a prohibition or restriction. Only in the case of an affirmative response to this question would it be prepared to establish a violation of Article XI.1 of GATT.

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In EEC–Minimum Import Prices, a GATT panel was facing a European Union (EU) regime that conditioned imports of tomatoes and other products upon the prior granting of an import certificate (license). The panel described the regime in the following terms (§ 4.1): “… lodging of security to guarantee the undertaking to effect certain imports for as long as the certificate is valid.” The panel issued its report in 1978, a few months before the conclusion of the Tokyo round and the advent of the first ILA. It found that the EU regime was properly characterized as “automatic licensing,” and it was thus not inconsistent with Article XI.1 of GATT since all interested parties would be granted an import certificate upon payment of the security (§ 4.1). No prohibition or restriction thus existed in the eyes of the panel. What if the security was not of nominal value? Would the fact that the challenged measure qualified as “automatic licensing” in and of itself have sufficed to shield the challenged measure from claims that it was in violation of Article XI.1 of GATT? The opportunity to respond to these questions arose during the litigation in Argentina–Import Measures. There, the panel and the AB dealt with the consistency of an Argentine measure, the DJAI (“Declaración Jurada Anticipada de Importación,” translated in English as “Advanced Sworn Import Declaration”), with Articles VIII and XI.1 of GATT and the ILA. DJAI was a procedure aiming to provide Argentine authorities with information about importers of various commodities. Importers would not be allowed to proceed with imports unless they first demonstrated that they had satisfied a series of criteria, including the achievement of “trade balance” and “export surplus.” The question arose whether the panel should start its analysis from Article XI.1 of GATT or from the ILA. The relationship between Article XI.1 of GATT and Article VIII of GATT was less of an issue (as discussed later in this chapter). The panel reviewed the consistency of the measure under Article XI.1 of GATT, and, having found that the Argentine measure was in violation of this provision, did not proceed to examine whether it was in violation of the ILA as well. Argentina appealed the panel report, but not this finding. In an obiter dictum, the AB held (§ 5.253): That the Panel took such an approach did not, in our view, contribute either to the clarity of its reasoning, or to a clear understanding of the relationship between different obligations under the GATT 1994 and the Import Licensing Agreement. [footnote 666 in the report appeared here] Nevertheless, no party has challenged the Panel’s approach on appeal.

In footnote 666, the AB added: Similarly to these disputes, the complainants in EC–Bananas made claims under provisions of the GATT 1994 and the Import Licensing Agreement. In that case, the Appellate Body considered that a panel should apply first the agreement that “deals specifically, and in detail,” with the matter at issue. (Appellate Body Report, EC–Bananas III, para. 204) As the Panel’s decision to start its examination with the claims under Article XI:1 is not appealed, we neither endorse nor reject the Panel’s approach in this regard. (See Panel Reports, paras. 6.358–6.361 and 6.448) In addition, we recall that the Panel examined the consistency of the DJAI procedure with Article XI:1 of the GATT 1994, irrespective of whether the DJAI procedure constitutes an import licensing procedure, and

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subsequently refrained from making any findings under the Import Licensing Agreement. (Ibid., paras. 6.479, 6.505, 6.511, 6.517, 6.523, 6.529, 6.535, 6.540, and 6.543) As the Panel’s approach, in this regard, is not appealed, we neither endorse nor reject it. Moreover, since the Panel made no finding as to the consistency of the DJAI procedure with the Import Licensing Agreement, we do not opine on the general relationship between the GATT 1994 and the Import Licensing Agreement.

The AB, thus, did not reverse the panel findings in this respect because it did not have the mandate to do so. It did note, however, that panels should start their analysis from the agreement dealing more specifically with the issue (that is, the ILA), as indeed the AB itself had done when facing similar issues in EC–Bananas III. Chapter 1 of volume 2 will discuss in detail the current statutory requirements for complying with the ILA. What do we conclude from the discussion here? Panels should from now on, when facing challenges against import licensing regimes, examine the consistency of the challenged measures with the ILA, and not with Article XI.1 of GATT anymore. The purpose of the disciplines embedded in the ILA is to ensure that no restrictions should be imposed through these measures additional to whatever is required to establish a functioning licensing regime. Failure to meet the statutory requirements of the ILA would thus, amount to an imposition of an impermissible quantitative restriction. Under the circumstances, there will be no need to find that a measure that violates the ILA also violates Article XI.1 of GATT as well. 2.2.3.2 Export Licensing There has not been much litigation practice in the context of export licensing. In China– Raw Materials, the panel faced a claim to the effect that China had in place a system of export licensing that amounted to a violation of Article XI.1 of GATT. The Chinese Chamber of Commerce of Metals, Minerals, and Chemicals Importers and Exporters (CCCMC) had in place a system whereby it would deliver export licenses upon submission of a series of documents. Export licenses would cover various commodities, such as bauxite, coke, and zinc. Three facts stand out in this case: 1. Some licenses were delivered automatically, whereas others were not. 2. Some documents had been specifically mentioned and made publicly available, and thus potential exporters were well aware of the procedure to obtain a license, whereas other documents were not mentioned or made publicly available. 3. For some goods, a justification for the restrictive regime was provided. The panel held that to the extent that export licenses were granted automatically, or measures implementing restrictions were justified by Article XI.2, XII, XVIII, XIX, XX, or XXI of GATT, no violation of GATT was established (§ 7.957). To the extent, however, that CCCMC retained discretion because some of the documents necessary to obtain an export license had not been clearly spelled out in the relevant legislation, the measure

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amounted to an additional restriction and was thus in violation of Article XI.1 of GATT (§ 7.959). It is, therefore, the exercise of discretion and the resulting uncertainty regarding the export transaction that provide the decisive criterion when it comes to distinguishing lawful from unlawful export licensing. In the presence of discretion to decide on granting an export license, the challenged scheme will be judged GATT-inconsistent, unless successful recourse could be made to one of the aforementioned justifying grounds. The opposite will be the case if export licenses are granted automatically. 2.2.4

Other Measures

The definition of the term “other measures” has been the subject matter of various panel reports. Recapping prior case law, the panel on Argentina–Import Measures ruled: Concerning the term “other measures,” the panel in Argentina–Hides and Leather interpreted this term as a “broad residual category.” A broad interpretation of the term “other measures” is also supported by a GATT panel in Japan–Semi-Conductors, in which “[t]he Panel noted that this wording was comprehensive: it applied to all measures instituted or maintained by a contracting party prohibiting or restricting the importation, exportation or sale for export of products other than measures that take the form of duties, taxes or other charges.” [italics in the original]

The next sections discuss this “broad residual category”; that is, the various measures that panels have subjected to the coverage of the term “other measures.”13 2.2.4.1 De Facto Export Quotas The leading case regarding de facto export quotas is Japan–Semiconductors. A GATT panel was called to address a situation in which the government of Japan, when implementing an agreement that it had reached with the United States (US) known as the “US–Japan Semiconductor Pact,” adopted a series of measures that induced Japanese companies producing semiconductors to raise their export prices to approximate the prices charged by their US competitors.14 As a result of the increase in price, the EU suffered a net welfare loss. The EU was a consumer (and no producer) of semiconductors at that time, and US semiconductors were the only competition to Japanese semiconductors sold in the EU market. The EU challenged the consistency of the Japanese measure with Article XI of GATT, arguing that the volume of Japanese exports to the EU had been substantially reduced as a result of the adoption of this measure. The measure, in the EU’s view, was a government measure since Japanese producers would not have raised their export prices in the absence of the incentive mechanism provided by the Japanese government. The issue of attribution of the challenged practice to the Japanese government will be discussed later in this chapter. For now, we concentrate on whether the Japanese measure could qualify as an “other measure” outlawed by the discipline in Article XI.1 of GATT. The panel first described in detail the measures that Japanese operators adopted in order to implement the Semiconductor Pact. The report mentions that, to avoid below-cost sales

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in export markets (§ 112), Japan had put in place a system (“administrative guidance”) whereby producers and exporters were requested to submit detailed information of costs and export rates on a regular basis (§ 113). Fines were imposed for failing to notify practiced prices, but not for failing to follow suggested prices (§ 113). Japan, in a nutshell, using administrative guidance, aimed at eliminating pricing of semiconductors below cost, but had not put a numerical target limiting its exports of semiconductors. In principle, the same and even a larger volume of sales could occur, so long as the asking price sufficed to recoup the costs incurred. The panel found that the Japanese measure was in violation of Article XI.1 of GATT since it could de facto lead to fewer exports, the counterfactual being the volume of exports realized before the adoption of the measure. The rise in export price that would result from the obligation to notify the Japanese authorities of prices practiced, as well as the obligation to avoid dumping, were reason enough for the panel to decide this way since they both could lead to a lower volume of exports. The panel did not check whether fewer semiconductors had actually been exported. The potential for fewer exports sufficed for its finding of violation (§§ 109ff). This outcome, which is not necessarily correct, was the outcome of the standard of review practiced by this panel, an issue that will be covered further later in this chapter. 2.2.4.2 Minimum Import Prices The Panel on EEC–Minimum Import Prices found that the requirement that importers of tomato concentrates provide additional “security” to guarantee that the price charged at the moment of import clearance of goods at the EU frontier plus the customs duty payable would equal or exceed a predetermined minimum import price was in violation of Article XI.1 of GATT (§ 4.9).15 The rationale for this finding is obvious: a minimum import price restricts entry, since all goods priced below the statutory minimum price will not access the market.16 One might respond that customs duties are essentially “minimum import prices.” In that case, why allow customs duties but not minimum import prices? What is good for the goose is good for the gander, as the popular saying goes. First, customs duties and minimum import prices are not necessarily substitutes, as they could be complements. Minimum import prices could be imposed above and beyond customs duties if necessary, in order to ensure that the price of imports equals that of domestic goods. Second, minimum import prices are not formally customs duties, and, as such, they do not have to respect the discipline imposed in Article II of GATT. Minimum import prices are not fixed by reference to the price of the imported good only, but rather by looking into the difference between the price of the domestic good and the price of the imported one. Typically, they represent the difference between the two prices. The only provision that can put a halt to similar practices is Article XI.1 of GATT. Finally, whereas customs duties are “negotiable,” as trading nations can determine their level through exchange of concessions, the level of minimum import prices is unilaterally by importers.

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Consequently, by banning the use of minimum import prices, case law has essentially ensured that no circumvention of Article II of GATT will occur. Protection of domestic producers can occur only through customs duties, not through any other form. 2.2.4.3 Minimum Export Prices In Japan–Semiconductors, the panel effectively outlawed a scheme that prohibited exports below a certain price level. Recall that Japanese producers had to report their prices and, as we will see later in this chapter in more detail, were requested to avoid one form of dumping when asked to price their exports above cost. The panel referred directly to the rationale for outlawing the EU scheme applied by the Panel on EEC–Minimum Import Prices, stating that it was good law in the context of export prices as well, since both import and export QRs were in violation of Article XI.1 of GATT (§ 106). In a similar vein, in China–Raw Materials, the panel found that a system of coordinating minimum export prices imposed by China violated this provision. The panel held that the scheme was in violation of Article XI.1 of GATT since it restricted exports: the minimum price imposed ensured that more of the domestic production would be sold in the domestic market instead (§ 7.181). Minimum export prices have economic effects similar to export duties (taxes), of course, as both restrict exports. There is a difference, though: unlike export taxes (duties), it is probably producers who will capture “monopoly rents” when minimum export prices are practiced. Minimum export prices are similar to export cartels as well. The difference, however, is that in the case of minimum export prices, it is the government that mandates the export cartel, whereas export cartels are usually formed without government involvement. This issue will be explored further later in this chapter. 2.2.4.4 Trade Balancing Condition In India–Autos, the panel addressed the Indian “trade balancing condition”: the Indian government would establish a threshold on the amount of exports that each manufacturer should make, which in turn would determine the amount of imports that they could make. This measure, in the panel’s view, amounted to an import restriction. The panel examined the function of the trade balancing condition and held that, absent this measure, the quantity of imports could have been larger. In light of the standard of review practiced, the panel found that the Indian measure was in violation of Article XI.1 of GATT (see §§ 7.254, 7.257–7.260, 7.264, 7.268, 7.270–7.272, and 7.276–7.277). In a similar vein, the Panel on Argentina–Import Measures outlawed an Argentine “limiting condition,” whereby imports would be allowed only if prior export targets had been reached (§§ 6.256–6.257).17 2.2.4.5 Local Content Local content requirements are inconsistent with Article III of GATT, as will be discussed in chapter 7. In Argentina–Import Measures, the panel explained in pertinent terms why they also violate Article XI.1 of GATT (§ 6.258):

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The required increase of local content, either by purchasing from domestic producers or by developing local manufacture, has a direct limiting effect on imports, because the measure is designed to force the substitution of imports in line with policies set by Argentina in the PEI 2020. Economic operators in the motorcycle or the agricultural machinery sectors have been required to replace a specified amount of imports with domestic products in order to continue importing.

Since, because of local content, imports can be displaced, Article XI.1 of GATT is violated. 2.2.4.6 Irrevocable Capital Contribution (Investment) In Argentina–Import Restrictions, the panel faced a measure whereby economic operators were required to invest in Argentina. The right to import was linked to prior demonstration that an investment had been made. In the panel’s view, economic operators unwilling to invest in the Argentine market thus would be barred from importing goods, and, consequently, were obliged to use domestic goods instead. It is for this reason that the panel found that this requirement acted as a prohibition to import because otherwise (e.g., if no obligation to invest was present), economic operators might have imported more (§ 6.259). The standard of review matters here as well, since the panel saw no need in examining whether fewer imports had actually occurred. 2.2.4.7 Prohibition to Repatriate Profits Argentina had imposed on foreign economic operators an obligation to not repatriate profits. Unless they had met this requirement, economic operators would be in no position to import goods. As with the “irrevocable capital contribution” and the local content requirements, this was a measure designed to address the onerous financial situation that Argentina was in following the 2008 financial crisis. In Argentina–Import Restrictions, the panel held that, since the right to import was linked to prior demonstration of no repatriation of profits, this latter requirement acted as a prohibition to import because otherwise (e.g., if no similar obligation existed), economic operators might have imported more (§ 6.259). Once again, the standard of review holds the key to understanding the panel’s finding. This point will be detailed later in this chapter. 2.2.4.8 Trading Rights in China When China acceded to the WTO, it adopted a number of obligations (in addition to those that the rest of the WTO membership had to observe) that were included in its Protocol of Accession. Some of them concerned trading rights for companies (Chinese as well as foreign). The term “trading rights” roughly means the right of traders to import into and export goods out of China. China had agreed to eliminate them within a specified time period. It did not do so, and this provoked a complaint before the WTO. In China–Raw Materials, the panel outlawed a practice by China whereby exports were conditioned on prior performance, a measure that closely resembles the trade balancing condition discussed previously. The panel also outlawed “minimum capital requirements”

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that applicants to export commodities from China had to satisfy in order to be eligible to export in the first place. In its view, both these requirements amounted to trading rights that had to be abolished since they could restrict trade from China to the world (§§ 7.224ff.). 2.2.5

Measures Not Covered

The following section examines exhaustively the various exemptions from the discipline imposed in Article XI.1 of GATT. “Exemptions” should not be confused with “exceptions”: the former term covers transactions that do not come at all under the ambit of the relevant legal discipline, the consequence being that parties remain free to act on their own volition (unless, of course, if they are bound by another legal discipline). For example, WTO members do not have to abolish their customs duties by virtue of the ban on QRs. They do not even have to justify their existence, since customs duties constitute an exemption from, not an exception to, this provision. Customs duties, in other words, do not constitute an agreed deviation from the discipline imposed through Article XI of GATT. They are alien to this discipline. Conversely, an exception is an agreed deviation from an established discipline and signals a shift in the allocation of burden of proof if a WTO member wants to avail itself of this possibility. For instance, a WTO member that imposes a ban on imports of contaminated bovine meat that represents a risk to human health can do so only if it successfully meets the requirements of Article XX(b) of GATT. If not, it will be violating Article XI.1 of GATT. One would expect that the allocation of burden of proof would not be identical with respect to both exceptions and exemptions: indeed, exemptions could in principle, be left out not only from the coverage of Article XI.1 GATT, but from the coverage of GATT altogether. If they have to respect a different discipline, then it should be the complainant that would be asked to demonstrate why that discipline had been violated. In practice, this is indeed the case for customs duties, since it is complainants that must show that Article II of GATT has been violated when customs duties have been imposed. This is not the case with respect to some other exemptions from the coverage of Article XI.1 of GATT, those included in Article XI.2 of GATT.18 And yet, the wording of this provision is unambiguous, as it states that: “The provisions of paragraph 1 of this Article shall not extend to the following” (italic added). This would suggest that the complainant would have to show that a measure is a QR, in the sense of Article XI.1 of GATT, and is not a measure featured in Article XI.2 of GATT. This is not what has happened in practice, as we explain in what immediately follows. It seems that panels have adopted two different solutions with respect to exemptions simply because some of them are disciplined in the body of Article XI of GATT (food shortages), whereas, some others in a different provision, namely in Article II of GATT (customs duties). Case law has been treating the exemptions embedded in Article XI.2 of

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GATT as if they were exceptions. “Animal health,” for example, does not feature in Article XI of GATT. It features in Article XX of GATT, entitled ‘General Exceptions’. QRs aimed to protect “animal health” are consequently not “exempted” from the coverage of the discipline embedded in Article XI.1 of GATT. Measures for the protection of “animal health” can be lawfully taken only if the requirements embedded in Article XX(b) of GATT have been met (as explored further in chapter 9). In this case, it will be the party taking measures to protect animal health that will carry the associated burden of proof. The distinction thus, of “exemption” from and “exception” to Article XI.1 of GATT has been blurred in case law. Here is how it happened. 2.2.5.1 Customs Duties and Charges Article XI.1 of GATT explicitly exempts from its coverage “duties, taxes, or other charges” (duties fall under Article II; taxes, under Article III; other charges, under Article VIII of GATT). Standing case law suggests that the burden of proof to show violation of any of the aforementioned three provisions rests with the complainant. 2.2.5.2 Export Taxes The question arises whether the term “duties, taxes, and other charges” should cover only import duties or extend to cover export duties (taxes) as well? A positive response seems warranted. Prima facie, there seems to be an imbalance in GATT. Whereas Article II of GATT refers to schedules of concessions for import duties only, there is no corresponding provision regarding export duties.19 There should be no doubt, nevertheless, that export duties are treated symmetrically with import duties in the GATT-system. Article XXVIIIbis supports this approach, calling for negotiations “directed to the substantial reduction of the general level of tariffs and other charges on imports and exports. …” If export taxes were covered by the prohibition included in Article XI.1 of GATT, there would be no need for negotiations, right? A Note prepared by the GATT Secretariat20 during the Uruguay round confirms the view that, absent specific commitment to this effect, WTO members are free to impose export taxes. It states in clear language that GATT “permits the imposition of charges on exports” and explains that, if imposed, export taxes must respect the MFN principle. The perceived imbalance mentioned previously should thus be given no weight at all when it comes to understanding the type of customs duties exempted from the coverage of Article XI.1 of GATT: both import and export customs duties are exempted. In fact, the negotiating history is quite illuminating in this respect and largely explains the observed imbalance regarding the treatment of import and export duties. Originally, a US report prepared by the “Special Committee on Relaxation of Trade Barriers,” a body comprising government officials, recommended that a provision should be made in the context of a trade agreement to abolish all “objectionable” export taxes. Why would the US want to outlaw export taxes?

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A production tax reduces a firm’s incentive to supply goods. An export tax reduces a firm’s incentive to supply an export market. It creates an incentive to supply the domestic market. The reduction in export supply drives prices up in the export market. The diversion of supplies to the domestic market resulting from the imposition of the export tax drives prices down in the domestic market. As a result, domestic producers of, say, a downstream good will profit from cheaper prices of inputs in the domestic market, whereas their foreign competitors will be disadvantaged. So there are good reasons to view export taxes with suspicion. The distinction between objectionable and nonobjectionable export duties, though, was not watertight by any reasonable benchmark. The US report provided for a list of nonobjectionable export taxes: • Taxes imposed for revenue purposes • Taxes enforced pursuant to international agreements • Taxes imposed under the conditions of famine or severe domestic shortage in the exporting country • Taxes designed to regulate the trade in military supplies under specified conditions21 The same report recognized that there was lack of significant practice in the field of export taxes. This is probably the single most important reason explaining why GATT framers did not spend time and effort designing a mechanism for negotiation of export tariffs à la Article II of GATT. For example, the report states:22 Except during wartime, governmentally-imposed export duties, and prohibitions and quantitative restrictions on exports have had relatively little influence in limiting the overall movement of commodities in world trade, although they have seriously affected the movement of specific products. Export taxes and quantitative restrictions on exports have been instituted for a variety of reasons. Some, such as export taxes on coffee in certain Latin American countries, have been imposed for revenue purposes. Some have been imposed for indirect protective reasons: for example, the United States prohibition on commercial exports of tobacco seed for the purpose of preventing the cultivation abroad of American types of tobacco. In a different category are the Mexican export taxes, which are used for revenue purposes and, in combination with an export tax-rebate system to enforce membership in export cooperatives. Some, such as the United States control of helium exports, have been imposed for security reasons. Some have been imposed pursuant to international agreements; for example, the undertaking by Cuba, in connection with the trade agreement with the United States, to prohibit the exportation of avocados to the United States except during the months of July through September …

Political economy considerations could of course, also contribute to this outcome, that is, to avoid a detailed discussion on export taxes. Exporters would not be necessarily interested in seeing their revenue divided between them and their government (that would pocket the export tax), unless if there were perks for them because of this division. Assuming that their lobby power matters to the government, one would thus expect few export taxes. The producers’ interests are, of course, the exact opposite when it comes to import

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tariffs. This largely explains the proliferation of import duties and the almost total absence (initially, at least, when GATT was being negotiated) of export duties. Producers, if interested, could achieve the same outcome as export taxes through other mechanisms such as export cartels. Unlike what is the case with respect to export taxes, in an export cartel scenario, it is members of the cartel (not the government) that would be pocketing monopoly rents.23 This will be covered in more detail later in this chapter. The previous discussion explains the perceived imbalance and further explains that, the imbalance notwithstanding, one would be ill advised to rush to the conclusion that export taxes are illegal because they share characteristics with export quotas. There is no better argument than practice itself to put this claim to rest. WTO members have, on occasion, negotiated export concessions.24 For example, WTO members negotiated with China a specific clause that was inserted into its Protocol of Accession, whereby “China shall eliminate all taxes and charges applied to exports unless specifically provided for in Annex 6 of this Protocol or applied in conformity with the provisions of Article VIII of the GATT 1994.”25 Annex 6 of the Protocol of Accession contains the maximum export duties applicable on 84 products. China cannot levy export taxes on goods not included in the agreed list featured in Annex 6. In this vein, the Panel on China–Raw Materials Exports found that export taxes on a series of goods not included in the agreed list (bauxite, coke, etc.) were in violation of China’s commitments under its Protocol of Accession, and inconsistent with its obligations under the WTO for this reason (§ 7.105). During the negotiations that led to the accession of Russia to the WTO, a fifth part was added to the WTO Protocol of Accession. The level of various agreed export taxes was reflected therein, and it was also agreed that a violation (of the agreed level) would ipso facto entail a violation of Article II.1(a) of GATT. Unless a concession has been entered, export taxes (like unbound import duties) can lawfully be enacted. In this case, they will have to respect Article I of GATT. In chapter 4 we will return to this issue. 2.2.5.3 Production Quotas Production quotas are not explicitly discussed in GATT.26 Their function might resemble that of export quotas. The wording of Article XI.1 of GATT, though, suggests a restrictive understanding of its coverage and does not condone the view that production quotas come under its purview. It refers to restrictions on importation/exportation, and not, for example, “in connexion” with importation/exportation, as is the case with Article I of GATT. If the intention of the parties was to allow for any QR to come under the purview of Article XI.1 of GATT, they could have chosen a more appropriate wording to this effect. A literal interpretation of this provision would suggest that domestic (e.g., production) quotas are GATT-consistent, since similar quotas are not imposed on the exportation (or on the sale for exportation).

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A reduction in the quantity produced would, other things being equal, lead to fewer exports as well. Unlike export quotas, the presumption that production quotas necessarily favor the domestic market is weaker. All in-quota production could be exported in principle, if the price offered by foreigners is higher than that offered by domestic buyers (for example). This is why they should not be considered to necessarily run afoul of Article XI.1 of GATT. Practice provides additional support to this view. Production quotas practiced by members of the Organisation of the Petroleum Exporting Countries (OPEC) is particularly relevant here. While some of the OPEC members are not WTO members (i.e., Algeria, Iran, Iraq, and Libya), the majority of them are (i.e., Angola, Ecuador, Kuwait, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela). When Saudi Arabia, the OPEC member that most recently joined the WTO, negotiated its terms of accession, trade in energy products was quite high on any incumbent WTO member’s agenda. Still, the Working Party Report on its accession reflects a rather benign discussion of petroleum production quotas. Under the circumstances, it seems safe to conclude that production quotas should not be considered GATT-inconsistent.27 Finally, even if all arguments mentioned so far were to be judged GATT-inconsistent and thus were rejected by a panel, production quotas can still be justified through recourse to various paragraphs of Article XX of GATT:28 • Article XX(g) allows for measures relating to the conservation of exhaustible natural resources, if such measures are made effective in conjunction with restrictions on domestic production or consumption. • Article XX(i) allows for measures involving restrictions on exports of domestic materials, if such measures are part of a stabilization plan and do not operate to increase the exports of or the protection afforded to the domestic industry. • Article XX(j) allows for measures essential to the acquisition of products in general or local short supply, provided that all contracting parties are entitled to an equitable share of the international supply of that product. 2.2.5.4 Tariff Quotas A tariff quota (TRQ) is an import measure, whereby a lower tariff will be applied for a certain volume of imports (in-quota tariff), and a higher tariff will be applied to imports above and beyond the set quota (out-of-quota tariff). For example, a 5 percent ad valorem duty will be imposed for the first 10,000 cars, and a 50 percent ad valorem duty for any additional entry. The context of Article XI of GATT makes it clear that there should be no doubts as to the overall consistency of TRQs with GATT, even though on their face, they seem to function as a QR.29 Article XIII.5 of GATT (Non-Discriminatory Administration of Quantitative Restrictions), for example, calls for application of this provision to TRQs. By the

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same token, § 6 of the “Understanding on the Interpretation of Article XXVIII of the GATT 1994” states that a TRQ can lawfully replace an unlimited tariff concession, provided that the conditions (payment of compensation) embedded in this paragraph have been met. TRQs, thus, can lawfully be contracted between WTO members. In practice, most TRQs concern farm products. Australia, for example, has TRQs in place, inter alia, for fresh cheese (HS 0406.10.00) and grated or powdered cheese (HS 0406.20.00), but also for tobacco for use in the manufacture of cigarettes (HS 2401.1012) and tobacco refuse (HS 2401.30.00). By the same token, Indonesia has TRQs in place for milk and cream of fat and its products (HS 0402 Ex) and rice (HS 1006 Ex). In 2006, 45 members had in place 1,434 individual TRQs.30 The administration of TRQs is considered a form of licensing, as is explained in chapter 1 of volume 2. 2.2.5.5 Trade in Textiles Before the entry into force of the Uruguay round agreements, trade in textile products was regulated in the Multifibre Agreement (MFA).31 This agreement was signed in 1974 between 8 developed and 31 developing countries and essentially imposed a worldwide system of bilateral quotas between exporters (usually in the Southern Hemisphere) and importers (in the Northern Hemisphere). The relationship of the MFA with GATT (and Article XI) was not clarified by law. On the one hand, Article 1.6 MFA states that this agreement will not affect the rights and obligations of contracting parties under GATT. On the other, Article 2 MFA makes it clear that QRs notified under the MFA will be deemed GATT-consistent if they conform to the many requirements embedded therein. Practice confirms that Article 1.6 of the MFA has cosmetic value. It aimed to reaffirm the commitment of trading nations’ signatories of the MFA to the multilateral system when the MFA itself violated the quintessential elements of GATT. This should not come as a surprise since the whole idea of the MFA was to establish a system of administered bilateral quotas.32 Practice also confirms that the MFA was not challenged per se for being inconsistent with GATT. A legislative solution was privileged instead. The Agreement on Textiles and Clothing (ATC) was signed along with the other Uruguay round agreements and replaced the MFA, bringing textiles into the realm of the GATT disciplines after 2005. This topic is discussed in more detail in chapter 9 of volume 2. 2.2.6 Attributing QRs to WTO Members 2.2.6.1 No Need to Coerce GATT disciplines government behavior only; it does not constrain the behavior of private parties. Sometimes it is clear who the agent of behavior is; sometimes it is less so. The former could be the case when, for example, it is a government agent that adopts a particular measure (such as allegedly violating Article XI.1 of GATT). What is the answer,

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though, if a government uses a private party as a conduit? Or, to go even further, what if the government adopts measures that incentivize private parties to act in particular way? The GATT Panel on Japan–Semiconductors stands for the proposition that providing incentives to private parties to act in a particular manner suffices for a measure to be attributed to a government (§§ 109ff.). In §117 of its report, it held: The Panel considered that the complex of measures exhibited the rationale as well as the essential elements of a formal system of export control. The only distinction in this case was the absence of formal legally binding obligations in respect of exportation or sale for export of semi-conductors. However, the Panel concluded that this amounted to a difference in form rather than substance because the measures were operated in a manner equivalent to mandatory requirements. The Panel concluded that the complex of measures constituted a coherent system restricting the sale for export of monitored semi-conductors at prices below company-specific costs to markets other than the United States, inconsistent with Article XI:1.

Subsequent GATT and WTO case law has consistently referred to this ruling when deciding whether a particular measure should be attributed to a government. Hence, it is not only government actions that can be challenged before a panel, but also private actions, to the extent that they are attributable to a government. To decide on attributability, WTO panels will be using the incentives test described previously as the criterion. This test could be phrased as a “but-for” test: the question will be whether, but for the incentives provided by the government, a private party would have adopted the behavior that is being challenged for being GATT-inconsistent before a panel. Providing agents with incentives to act in a particular way is the lowest intensity involvement of governments for their measures to be challengeable before GATT. If governments incentivize private agents to act in a particular way, then private actions are attributed to government. It goes without saying that, to the extent government involvement is more intense, then actions are of course attributed to governments. Case law reveals many instances where governments had more intensive involvement in ensuring that the addressees of their actions would adopt a certain conduct. In Japan–Film,33 a measure endorsed (but not performed) by government was attributed to it (§ 10.45). In China– Raw Materials, the panel satisfied itself that a measure was attributable to the Chinese government because it had delegated authority to CCCMC, the organization that had introduced the measures that were being challenged (§§ 7.1004–1005). In US–Corrosion Resistant Steel Sunset Reviews, the AB held that omissions to enforce law also can be challenged before a WTO panel (§ 81). It follows that case law so far stands for the proposition that, besides actions undertaken directly by government agents, actions will be attributed to a government if it has done any of the following: • Endorsed them • Acquiesced by omitting enforcement against them

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• Delegated authority to an entity to act on its behalf • Provided incentives that made the challenged behavior happen34 2.2.6.2 Export Cartels There are still some gray areas that have provoked a lot of discussion, both in WTO practice and in the literature. The consistency of export cartels with the GATT rules is one of them, and their consistency with the multilateral rules has been debated not only in the literature, but also in WTO committees. Antitrust authorities have little, if any, interest in regulating the activities of their national export cartels, of course, since the domestic market will not be immediately affected by such activities. An argument could even be made that national markets might be positively affected since high export prices could be used to subsidize domestic sales and lead to more intense competition in the home market.35 As a result, some nations have gone so far as to exempt export cartels from national prosecution. The US Webb-Pomerene Act of 1918, for example, partially exempts export cartels from antitrust prosecution. US economic operators, as a result, can decide to cartelize export markets in the safe knowledge that the US authorities will not prosecute them for doing so. They can thus engage in practices that are illegal under US law, such as price agreements, when they target export markets. In light of the previous discussion, the question arises whether the US law is in violation of Article XI.1 of GATT. Recall that, following Japan–Semiconductors, WTO members cannot provide incentives to private traders to restrict commerce. In Japan–Semiconductors, the Japanese government put in place for all practical purposes an export cartel. Although the panel stopped short of explicitly referring to the presence of an export cartel, it did find, as described previously, that Japan was in violation of its obligations under Article XI.1 of GATT. Although Japanese and US producers did not align the prices they charged when exporting to the EU market, there should be no doubt that the measure was intended and practiced so as to reduce/ eliminate competition between US and Japanese producers. US producers could do so in the safe knowledge that, because of the Webb-Pomerene Act, they would not be charged with violating US antitrust laws in deciding on prices they charged when exporting to the EU market. Then, is the US government providing, through Webb-Pomerene, incentives to its economic operators to cartelize the world market by partially exempting them from antitrust prosecution?36 A negative response seems appropriate. There is a notable difference between WebbPomerene and Japan–Semiconductors. What does the US do? It promises that it will not act against companies if they cartelize export markets. Is this enough of an incentive to export cartels (and thus, restrict exports)? The ultimate decision to cartelize a foreign market lies with the economic operators themselves since the US government is not imposing cartelization. Economic operators know that they may have to face a foreign antitrust authority anyway, should they decide

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to cartelize. The severity of the sanctions that they might be facing in export markets, as well as the likelihood that they will be punished (which is considerable because of the increasing sophistication of antitrust authorities around the world, and because they can now rely on legal assistance treaties and other legal devices), the level of remedies imposed (usually a multiplier of profits made through export cartelization) and the worldwide acceptance of the “effects doctrine” (which guarantees prosecution abroad in case of detection) will definitely be a factor in the calculation and the ultimate decision of whether to cartelize. It seems that the lack of legal pursuit in the US market is an ancillary consideration, if it is considered at all. Economic operators will decide on the course of action, taking into account the gains from cartelization on the one hand, and the consequences if they are successfully prosecuted in a foreign jurisdiction on the other. This argument casts doubt on the legitimacy of the approach taken by the panel on Japan–Semiconductors. Indeed, whereas the panel applied inducement as a criterion to decide whether private behavior had been affected, it did so in a clumsy way. It asked only the question whether Japanese producers had been induced by the measures adopted by their own government. It did not ask the question whether they had also been induced by the potential threat of antitrust prosecution in the EU. What if, for example, fines for antitrust violations were much higher than penalties paid in Japan for inadequate notification of prices? There is, of course, one key difference between the discussion here and the facts in Japan–Semiconductors: the Japanese government essentially de facto established an export cartel. Contrary to the Webb-Pomerene Act, therefore, the Japanese government did not merely allow the establishment of an export cartel (leaving the eventual decision whether to export cartelize world markets to private operators); it de facto mandated it by reducing the potential for price competition across its producers. Still, any rational Japanese agent would have factored in the possibility of being prosecuted by the EU antitrust authority and whatever antitrust prosecution might entail. It seems that the panel adopted a very generous understanding of the term “incentives” in this case. In short, it asked the right question but responded to it only by half measures. 2.2.7

Standard of Review

2.2.7.1 The Issue The question being asked here is whether panels (and the AB) should adopt the same standard of review, regardless whether they are dealing with a quota or an “other measure.” When a numerical target is set (quota), it is clear that the imposition of the target in and of itself leads to a QR effect. It is less than clear, though, if (and if so, to what extent) the same is true when another measure has been introduced. For example, what evidence supports the finding that the Japanese exported fewer semiconductors to the EU market because of the administrative guidance that the government had put in place in order to

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implement its agreement with the US? How did the Panel on Japan–Semiconductors establish that the QR effect was the result of incentives to act in a particular manner? The short answer is that it did not. It did not even check if the volume of exports had been reduced, never mind providing a causal link between reduced exports and the Japanese measures. In the name of the “no-effects-cum-no-intent” test that it had borrowed from prior case law,37 it satisfied itself that Japan was in violation of its GATT obligations by the mere fact that it had provided incentives that could (but did not necessarily) affect the behavior of private parties. Indeed, for all we know, it could very well be the case that Japanese private operators, when they realized that they were not facing serious competition from US producers, changed their pricing policies (or cut back on their production).38 Ideally, it would be good to see some discussion of the competitive conditions in the EU market—some analysis that would explain, at the very least, why the incentives were necessary in this particular case for the Japanese to behave in this particular way. 2.2.7.2 The Origin of the Problem Where does the “no-effects-cum-no-intent” test, on which the Panel on Japan–Semiconductors relied so heavily, come from? The panel on Japan–Leather II (US), a GATT panel, dealt with a challenge against a quota. Japan had in place a quota on leather and other products. That much was not disputed. Japan however, argued before the panel that no violation of Article XI.1 of GATT had been committed, since the quota had not been filled. This panel rejected the view that a quota should not be considered as restraining trade simply because the quota had not been fully utilized and thus could not have negatively affected trade volumes. The panel explained that nullification or impairment arises from prohibited QRs, not only because of the effects on trade volumes but also because importers investment plans would be affected negatively and transaction costs would increase (§ 55): [T]the existence of a quantitative restriction should be presumed to cause nullification or impairment not only because of any effect it had had on the volume of trade but also for other reasons, e.g., it would lead to increased transaction costs and would create uncertainties which could affect investment plans.

The Panel on US–Superfund extended this approach to the case law under Article III of GATT as well. It stands for the proposition that Article III of GATT (just like Article XI.1 of GATT) protects expectations regarding competitive conditions in national markets. In this particular case, the complainants argued that a US internal tax, which granted domestic (petroleum) products slightly better treatment than the imported similar products, was inconsistent with Article III of GATT. The tax differential between domestic and imported goods was close to any reasonable definition of de minimis. The complainants argued, however, that there was no requirement to demonstrate trade effects.

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The US defended itself before the panel by arguing that the tax differential was not substantial, so it could not have had any bearing on the volume of goods traded. The US, thus, effectively argued that effects mattered and that, since no trade effects could be shown in light of the minimal difference in tax treatment across the two categories of goods, no violation of GATT could have been established. The panel disagreed with the US (§ 5.2.2): The general prohibition of quantitative restrictions under Article XI, which the Panel on Japanese Measures on Imports of Leather examined, and the national treatment obligation of Article III, which Canada and the EEC invoked in the present case, have essentially the same rationale, namely to protect expectations of the contracting parties as to the competitive relationship between their products and those of the other contracting parties. Both articles are not only to protect current trade but also to create the predictability needed to plan future trade. That objective could not be attained if contracting parties could not challenge existing legislation mandating actions at variance with the General Agreement until the administrative acts implementing it had actually been applied to their trade. Just as the very existence of a regulation providing for a quota, without it restricting particular imports, has been recognized to constitute a violation of Article XI:1, the very existence of mandatory legislation providing for an internal tax, without it being applied to a particular imported product, should be regarded as falling within the scope of Article III:2, first sentence.

This report suggests that laws that have not produced any effects, but that are mandatory (in that they leave no discretion as to the behavior that must be followed), still violate Article III (and Article XI.1) of GATT. US–Superfund dealt with a case of de jure discrimination, since the level of tax imposition was exclusively a function of the origin of the good: domestic goods paid one tax, while imported goods paid a higher tax. Japan–Leather II (US) also dealt with a challenge against a quota. The Panel on Japan–Semiconductors extended the coverage of US–Superfund and Japan–Leather II (US) to cases of “other measures” as well, without thinking whether a more nuanced approach was appropriate. This approach is erroneous for the reason we explain in what follows. Before we provide our assessment explaining why this is the case though, we first need to bring in more recent case law that, prima facie, seems to cast doubt on the validity of the standard of review adopted by the panel on Japan-Semiconductors. 2.2.7.3 Breaking with the Past? In Argentina–Hides and Leather, a dispute that arose fifteen years after Japan–Semiconductors, the question before the panel was whether an Argentine law that allowed for the presence of delegates of the downstream industry (leather products) at the customs clearance of hides was inconsistent with Article XI.1 of GATT. The EU had argued before the panel that the presence of delegates of the downstream industry had a dissuasive effect on producers of hides: Argentine producers of hides might be unwilling to export their produce to Europe for fear that they would be earmarked by the domestic downstream industry and excluded from the Argentine market altogether (§ 11.18).

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This panel held that Article XI.1 of GATT should not be construed as tantamount to an obligation imposed on WTO members to eliminate the potential for private parties to restrict trade (§ 11.19): [W]e do not think that it follows either from that panel’s statement or from the text or context of Article XI:1 that Members are under an obligation to exclude any possibility that governmental measures may enable private parties, directly or indirectly, to restrict trade, where those measures themselves are not trade-restrictive.

Consequently, following this approach, the panel requested from complainants claiming a violation of Article XI.1 of GATT to demonstrate, at the very least, a nexus between the challenged measure and the QR effect. Now, the question arises whether this is a departure from the test established in Japan–Semiconductors. The Panel on Argentina–Hides and Leather distanced itself from the previously followed approach by distinguishing between the standard of review applied to quotas and that applied to “other measures.” With respect to the latter, the panel was of the view that, for a successful legal challenge to be mounted, the complainant must demonstrate a causal nexus between the challenged measure and the reduced level of imports or exports. Without elaborating further, the panel articulated that the evidentiary standard should be lower in cases where the consistency of a quota with the multilateral rules is being challenged (§§ 11.21 and 11.22): Finally, as to whether Resolution 2235 makes effective a restriction, it should be recalled that Article XI:1, like Articles I, II and III of the GATT 1994, protects competitive opportunities of imported products, not trade flows. In order to establish that Resolution 2235 infringes Article XI:1, the European Communities need not prove actual trade effects. However, it must be borne in mind that Resolution 2235 is alleged by the European Communities to make effective a de facto rather than a de jure restriction. In such circumstances, it is inevitable, as an evidentiary matter, that greater weight attaches to the actual trade impact of a measure. Even if it emerges from trade statistics that the level of exports is unusually low, this does not prove, in and of itself, that that level is attributable, in whole or in part, to the measure alleged to constitute an export restriction. Particularly in the context of an alleged de facto restriction and where, as here, there are possibly multiple restrictions, it is necessary for a complaining party to establish a causal link between the contested measure and the low level of exports. In our view, whatever else it may involve, a demonstration of causation must consist of a persuasive explanation of precisely how the measure at issue causes or contributes to the low level of exports. (italics in the original)

In a footnote to § 11.22, the panel noted: The Appellate Body in European Communities–Measures Affecting the Importation of Certain Poultry Products similarly required of the complaining party in that case a demonstration of a causal relationship between the imposition of an EC licensing procedure and the alleged trade distortion. See the Appellate Body Report on European Communities–Measures Affecting the Importation of Certain Poultry Products (hereafter “European Communities–Poultry”), adopted on 23 July 1999,

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WT/ DS69/AB/R, at paras. 126–127. While this interpretation related to a claim under the Agreement on Import Licensing Procedures, it is not apparent why the logic should be any different in the case of a claim under Article XI:1 of the GATT 1994. (italics in the original)

The panel thus rejected the EU claim in Argentina–Hides and Leather and found that the presence of representatives of the domestic industry was insufficient (or rather the causal link too remote) for establishing a violation of Article XI.1 of GATT (§ 7.35): We agree that it is unusual to have representatives from a downstream consuming industry involved in the Customs process of export clearance. As noted above, it seems to us that the levels of exports of raw hides from Argentina may be low. The European Communities have stated the matter to us in the form of a rhetorical question—what other purpose could these downstream industry representatives have in this government process of export clearance than restricting exports? However, it is up to the European Communities to provide evidence sufficient to convince us of that. In this instance, we do not find that the evidence is sufficient to prove that there is an export restriction made effective by the mere presence of tanners’ representatives within the meaning of Article XI.

There is, thus, a difference between Japan–Semiconductors on the one hand, and Argentina–Hides and Leather on the other, in that the former does not distinguish between de jure and de facto restrictions, whereas the latter does. The former requires the same standard of review to apply to all cases coming under the purview of Article XI of GATT, whereas the latter suggests that this should not be the case. The low burden of persuasion in Japan-Semiconductors could in principle be justified because the regulatory intent was to abolish QRs. Recall that unless the door to QRs was hermetically shut, negotiators might have found it difficult to negotiate concessions on tariffs only. Uncertainty regarding which QRs could be justified and which not, might have led to underinvestment (fewer tariff concessions). Nevertheless, a low burden of persuasion can lead to false positives, and WTO panels might be outlawing perfectly legitimate measures. WTO members might lose their confidence in a world trading regime that strikes down measures aiming to advance social preferences and not to protect domestic producers. The test adopted by the panel on Argentina-Hides and Leather provides some guarantee to this effect, even though one might have legitimately suspected that the objectives sought by Argentina in this case were of economic nature. This approach makes intuitive sense. Quotas are like per se violations of antitrust law. It is the practice that is illegal regardless of its consequences. When it comes to challenges against “other measures” though, for a violation to be established, one needs to know not only what the measure was, but, crucially, how it operated. We know that quotas restrict trade, we do not know which measures in the realm of “other measures” do so. Recall, that this term must operate as a “restriction” or a “prohibition”, as we have stated supra in this chapter. An approach akin to the “rule of reason” known in many antitrust statutes is thus warranted.

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Japan–Semiconductors got it wrong in this respect, and Argentina–Hides and Leather got it, in principle, right. A number of questions remain unanswered though, and we are very far from establishing a genuine “rule of reason” test in case law. In Argentina–Hides and Leather, the panel on the one hand suggests that a different approach is indeed warranted when the consistency of “other measures” with Article XI.1 of GATT is at stake, but on the other, it often refers to Japan–Semiconductors and does not explicitly discard its relevance. It does not even provide an explicit statement for the proposition that trade effects should matter, at least as a proxy to show the nexus. Thus, it could be interpreted as a request to make a plausible case of a nexus between challenged measure and trade outcome, rather than an empirically robust demonstration that this is indeed the case. In fact, this is exactly how a subsequent panel understood this finding. In Argentina–Import Measures, the panel was dealing with de facto QRs and held that absence of trade data was not fatal to the claims presented by the complainant (§ 6.264). Even if this is so, this report is irreconcilable with Japan–Semiconductors, precisely because of the dichotomy introduced.39 Now that the door has opened, panels could and should go the extra mile in future.40 2.2.8 The Relationship with Article III of GATT The Interpretative Note to Article III reads: Any internal tax or other internal charge, or any law, regulation or requirement of the kind referred to in paragraph 1 which applies to an imported product and to the like domestic product and is collected or enforced in the case of the imported product at the time or point of importation, is nevertheless to be regarded as an internal tax or other internal charge, or a law, regulation or requirement of the kind referred to in paragraph 1, and is accordingly subject to the provision of Article III.

This note imposes a limit on the ambit of Article XI of GATT: domestic measures, even if applicable at the border, will continue to be covered by the discipline included in Article III of GATT, and consequently evade the purview of Article XI of GATT. The two disciplines impose distinct obligations, and that is why one needs to be sure about their respective coverage. Case law has acknowledged this point. The Panel on Canada–FIRA suggested that with the exception of truly unique circumstances, such as state trading companies, which often operate as both importers and distributors, a dividing line must be drawn between measures covered by Article III and by Article XI of GATT. In the WTO era, the Panel on India–Autos added that different facets of the same measure could be regarded differently, some as border- and some as internal measures. The same facet of a measure, though, cannot simultaneously fall under the ambit of Articles III and XI of GATT.

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2.2.9 The Relationship with Article VIII of GATT In Argentina–Import Measures, the panel faced a claim regarding the consistency of DJAI with various GATT provisions, including Article XI of GATT. Recall from the previous discussion that the DJAI was a document that all importers had to file and submit to the relevant authority before they could import certain commodities (§ 6.364). Argentina argued before the panel that this measure came under the purview of Article VIII of GATT, since it was a customs formality. The panel responded that even if that were the case (an issue on which it refused to pronounce), nothing stopped it from examining the consistency of the measure with Article XI of GATT. The panel, thus, saw no firewall between the two provisions (§ 6.444): [T]he Panel finds that, irrespective of whether the DJAI procedure is considered to be a customs or import formality subject to the obligations contained in Article VIII of the GATT 1994, this fact per se does not exclude the applicability of Article XI:1 to the examination of the measure. Therefore, there is no impediment that prevents the Panel from examining the complainants’ claims against the DJAI procedure under Article XI:1 of the GATT 1994.

On appeal, the AB upheld the panel’s findings in this respect in their entirety (§§ 5.247ff., and especially 5.264). 2.3

Exceptions

GATT contains a number of exceptions to the prohibition to use QRs. The majority41 concern both import and export restrictions. Some of them, though, like the possibility to deviate from the imperative of Article XI.1 of GATT if a WTO member faces critical shortages of a specific product, concern only export restrictions.42 2.3.1

Critical Shortages

If a WTO member experiences critical shortages of a foodstuff or any other essential product, export restrictions can be temporarily applied. The ambit of this provision is circumscribed by the coverage of the terms “essential products,” and “temporarily applied.” We will discuss both terms later. For now, we turn our attention to the understanding of the term “critical shortages,” the quintessential term in Article XI.2(a) of GATT. In China–Raw Materials, the AB understood the term “critical shortage” to refer to (§ 324) “those deficiencies in quantity that are crucial, that amount to a situation of decisive importance, or that reach a vitally important or decisive stage, a turning point.” In § 325, the AB noted the difference in the language between this provision and Article XX(j), where the term “critical” does not appear before the term “short supply,” to make the point that the coverage of Article XI.2(a) of GATT should be narrower than that of Article XX(j) of GATT. Note, nevertheless, that the AB did not put into question the panel

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finding (§ 7.294) to the effect that this provision covers preventing actions, as well as attempts to relieve the population from problems caused by critical shortages. So while the class of measures (the “extensive margin”) is construed narrowly, their ambit (the “intensive margin”) is not prejudged by the AB findings quoted previously. 2.3.1.1 Essential Products It is critical shortages of “essential products” (and not just of any product) that are covered by this provision. The term “essential product” is not defined there, but it is defined in Article 4 of the “Understanding on BoP” (see a more detailed discussion of this later in this chapter) as covering goods that meet basic consumption needs or help a WTO member improve its BoP situation. The question arose before the panel on China–Raw Materials whether this statutory definition could also be used for the purposes of addressing a claim under Article XI.2 of GATT. The panel felt that this should not be the case, since the Understanding reflected a definition, which was unduly restrictive for the purposes of Article XI.2(a) of GATT, that was meant to address situations beyond BoP (§§ 7.278 ff.). In the view of the panel, a product is “essential” if it is “important,” “necessary,” or “indispensable” to a particular WTO member (§ 7.282). These are open-ended terms. The panel did not go so far as to provide a numerical figure, such as, the percentage of gross domestic product (GDP) that should be affected for a product to be considered essential. It did, nevertheless, provide some clarification regarding the ambit of the term. It stated, for example, that substitutability across products could cast doubt on the essential character of a product when in the presence of other substitutable products (§ 7.344). The panel also held that an input to a final product could be regarded as essential, and consequently, that there was no need for a good to be final in order to be essential (§ 7.340). This is all that exists for now. So we know that even goods, which do not address basic consumption needs, could be considered “essential products,” but we do not know where exactly to draw the line between essential and nonessential products. The AB upheld the panel’s understanding of the term without providing any additional clarification (§ 326). 2.3.1.2 Foodstuff or “Other Products” The negotiating record of Article XI of GATT that we have cited above44 supports the view that, initially, the “essential” products, the critical shortages of which are being addressed, should be farm goods only. The drafters of GATT, though, eventually added the words “or other products,” as shown previously, without specifying what “other” means. Thus, in China–Raw Materials, China had imposed a restriction on bauxite, and it claimed before the panel and the AB that its measure was necessary to address critical shortages of an essential product. The AB noted that the term “other products” appearing in the body of Article XI.2(a) of GATT was wide enough to cover this product as well (§§ 326, and 335ff.). “Other” in this reading should mean “other than foodstuff”, without any further precision. What matters thus, is the definition of “essential product,” since foodstuff, as well as any other product, can at least in principle be essential.

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2.3.1.3 Temporarily Applied The Panel on China–Raw Materials underscored that Article XI.2(a) of GATT deals with temporary shortages only, and not with chronic shortages of essential products (§ 7.297). In that, this provision was, in its eyes, distinguished from Article XX(g) of GATT, which deals with conservation of exhaustible natural resources (§ 7.349) without imposing time limits on the action undertaken. The panel found that in the case before it, the Chinese action was already ten years old, and that for this reason, it was essentially irreconcilable with the requirement that the action be temporary. The AB upheld the panel’s finding in this respect (§§ 339–340). Before doing so, the AB (§ 327) had already established that this provision allowed WTO members to undertake both preventive (e.g., measures aiming to avoid a critical shortage in the future) and repressive action (e.g., measures aiming to address a critical shortage that already exists). In other words, the term “temporarily” limits the duration of action undertaken but does not require that action should be aimed to address future or past shortages. Although the AB did not explicitly state it as such, it must be the case that any action undertaken to address critical shortages must be close in time to the situation being addressed. In other words, WTO adjudicating bodies should outlaw speculative action regarding shortages that might or might not occur in the future, or critical shortages that occurred years ago whose effects have been wiped out since. Case law could be informed in this respect by the case law on “threat of injury” in contingent protection instruments, which is discussed in chapters 2, 3, and 4 in volume 2. 2.3.1.4 Burden of Proof There are three issues that should be discussed in this context. First, is burden of proof an issue at all here—that is, can panels on their own initiative, once they have established that a violation of Article XI.1 of GATT has occurred, move on and examine whether it can be cured through invocation of another GATT provision? Second, if not, who should carry the burden of proof, the original complainant (e.g., the party arguing that a QR has been imposed) or the defendant? The third issue is prima facie counterintuitive: how does the allocation of burden of proof affect the relationship of Article XI.2 of GATT with Article XX of GATT (e.g., the list of general exceptions, and vice versa)? The question could be reformulated as follows: Is Article XI.2 of GATT a self-standing obligation, which, if violated, can be justified through recourse to Article XX of GATT? If yes, should this construction affect the allocation of burden of proof under Article XI.2 of GATT? Note that this third question is asked with respect to all exceptions included under Article XI.2 of GATT, and not only with respect to “critical shortages.” This is so because it has been addressed in this way in case law. Panels will not ex officio examine whether a violation of Article XI.1 of GATT can be justified through recourse to one of the grounds available mentioned in the body of Article

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XI, or elsewhere in GATT. A series of GATT panels have underscored this point.43 The question, thus, is whether it is the original complainant or the original defendant that should carry the burden to justify a violation of Article XI.1 of GATT. In China–Raw Materials, the panel held that it must be China (e.g., the defendant seeking justification for violating the imperative included in Article XI.1 of GATT) that should carry the burden of proof. To do that, the panel first stated prior case law citing the AB report on US–Wool Shirts and Blouses (p. 16): Articles XX and XI:(2)(c)(i) are limited exceptions from obligations under certain other provisions of the GATT 1994, not positive rules establishing obligations in themselves. They are in the nature of affirmative defences. It is only reasonable that the burden of establishing such a defence should rest on the party asserting it.

Note that the AB in this report was dealing with a situation coming under the aegis of a different provision (namely, Article XI.2(c) of GATT). The panel went on to find that a similar solution also should be applied in cases coming under the aegis of Article XI.2(a) of GATT (§ 7.212–213). It follows that all the complainant needs to show is violation of Article XI.1 of GATT, and the burden will then shift to the defendant to invoke Article XI.2 of GATT in order to justify its measures. The question has also arisen in case law whether a party that has invoked unsuccessfully Article XI.2 of GATT (an exception to Article XI.1 of GATT) can still invoke Article XX of GATT (an exception to the exception, that is). The AB in China–Raw Materials stated that when the requirements of Article XI.2(a) of GATT have been met, no recourse to Article XX of GATT is possible (§ 334): By contrast, Article XI:2 provides that the general elimination of quantitative restrictions shall not extend to the items listed under subparagraphs (a) to (c) of that provision. This language seems to indicate that the scope of the obligation not to impose quantitative restrictions itself is limited by Article XI:2(a). Accordingly, where the requirements of Article XI:2(a) are met, there would be no scope for the application of Article XX, because no obligation exists. (italic in the original)

This is a puzzling statement at first sight, but a sensible one all the same. The AB is making one simple claim: a transaction that qualifies, say, as a “critical shortage” justifies the imposition of a QR. In this case, recourse to an additional justification (that offered by Article XX of GATT) would be redundant. If, on the other hand, a transaction does not meet the Article XI.2 GATT-standard, then the WTO member concerned would have to look for a different justification. The AB, thus, following its own report on US–Wool Shirts and Blouses, did not construe Article XI.2 of GATT as a self-standing obligation, but as a provision limiting the coverage of Article XI.1 of GATT. The overall conclusion is that Article XI.2 of GATT is construed as an exception to Article XI.1 of GATT, and the party invoking it carries the associated burden of proof.

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Standards for Classification, Grading, or Marketing of Commodities

There is not much practice regarding this provision, which was thought of as a means to avoid challenges against measures aiming to promote the quality of goods sold and related matters. 2.3.2.1 Key Terms The GATT Panel on Canada–Herring and Salmon discussed the key terms appearing in this provision [Article XI.2(b) of GATT]. The consistency of Canada’s export restrictions on pink salmon and herring with Article XI.1 of GATT had been challenged. Canada responded that it had applied quality standards to fish, and that it had decided to ban exports of fish not meeting these standards. In its view, allowing only high-quality fish to be exported would have a beneficial effect on all Canada’s fish exports. Since, nevertheless, it was proved before the panel that even exports of fish that did meet the standards were prohibited, the panel rejected the Canadian argument (§ 4.2). Implicitly, thus, this report accepted that trading nations could adopt one production standard for the domestic market and a different one for exports. The problem with similar export-promoting strategies is that often, under the guise of export promotion, an advantage is granted to domestic producers. Take the case, for example, of inputs that are lawfully sold in the domestic market. Assume further that the final product is sold both in the domestic and the exporting market. In this case, could a WTO member impose an export ban on similar inputs? The facts in Canada–Herring and Salmon were quite straightforward and allowed the panel to reach an uncontroversial finding of inconsistency between Canada’s practices and the GATT regime. Unavoidably, nevertheless, a more in-depth inquiry will be required in order to address issues like the one described in the previous scenario. Panels will have to use tools that will allow them to decide whether WTO members employing similar measures do so in order to increase the quality and reputation of their goods in export markets or, conversely, whether through similar policies, they simply aim to provide their downstream industry a commercial advantage (since, arguably, the price of the input restricted for sale in the domestic market will drop). This understanding is consonant with the intentions of the drafters as well. In §4.3 of its report on Canada–Herring and Salmon, the panel noted the purpose for including this paragraph in Article XI of GATT: “During the drafting, mention was made only of export restrictions designed to promote foreign sales of the restricted product but not of export restrictions on one commodity designed to promote sales of another commodity.” 2.3.2.2 Burden of Proof The conclusions given earlier in this chapter apply here as well since they cover all of Article XI.2 of GATT. Moreover, the panel report on Canada–Herring and Salmon supports this conclusion (at least implicitly), since it was Canada that advanced the claim regarding the applicability of Article XI.2 of GATT.

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QRs Necessary for Enforcing Governmental Measures

Article XI.2(c) of GATT allows the imposition of import QRs on farm and fishery products, which are necessary for the enforcement of a “governmental measure”: • To restrict the quantity of the domestic similar (or substitutable) product • To address temporary surpluses • To restrict the quantity of animal goods, the production of which depends on the restricted import 2.3.3.1 The Test The Panel on Canada–Ice Cream and Yoghurt laid down in pertinent terms the test for consistency with this provision. All of the following must be shown (§ 62): (a) An import QR is in place. (b) It concerns agricultural or fishery products. (c) The restriction is imposed on all like products. (d) The government measure restricts the quantity of domestic products marketed, produced, or both. (e) The QR is necessary to enforce the government measure. (f) A public notice has been issued. (g) The ratio between imports and domestic goods circulating in the market remains unchanged.46 All these conditions must be met cumulatively. Therefore, it is a demanding test, as the Panel on EEC–Dessert Apples observed (§ 12.4): The Panel observed that the requirements of Article XI:2(c)(i) for invoking an exception to the general prohibition on quantitative restrictions made this provision extremely difficult to comply with in practice. Indeed no contracting party had to date been found by a Panel to comply with all its requirements. The Panel was also aware that there existed widespread dissatisfaction with this provision and that its revision was under discussion. The Panel recalled, however, that it was not the function of panels to propose changes to the provisions of the General Agreement but to make findings regarding their interpretation and application.

2.3.3.2 The Rationale The Panel on Japan–Agricultural Products held (§ 5.1.2) that this provision was necessary because in agriculture and fisheries you have to deal with the capricious bounty of nature, which will sometimes give you a huge catch of fish, a huge crop, which knocks the bottom out of prices. You also have the phenomenon peculiar to agriculture and fisheries of a multitude of small, unorganized producers that cannot organize themselves. It often happens that the government has to step in and

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organize them. But if it does so, it cannot allow the result of its organization to be frustrated by uncontrolled imports. The exception was not intended to provide a means of protecting domestic producers against foreign competition but simply to permit … the enforcement of … governmental measures necessitated by the special problems relating to the production and marketing of agricultural and fisheries products.45

The Panel on EEC–Dessert Apples underscored this view even further in the following terms (§§ 12.15–17): Concerning the purpose of Article XI:2(c)(i), the Panel recalled that the title of Article XI was “General Elimination of Quantitative Restrictions.” Article XI:2(c)(i) made an exception to this general rule. It permitted governments, under certain conditions, to enforce domestic output restrictions at the border. The Panel furthermore considered that, as one of the basic functions of the General Agreement was to provide a legal framework for the exchange of tariff concessions, great care had to be taken to avoid an interpretation of Article XI:2(c)(i) which would impair this function. The Panel noted that Article XI:2(c)(i)—unlike all provisions of the General Agreement specifically permitting actions to protect domestic producers—did not provide either for compensation to be granted by the contracting party invoking it, or for compensatory withdrawals by contracting parties adversely affected by the invocation. This reflected the fact that Article XI:2(c)(i) was not intended to be a provision permitting protective actions. If Article XI:2(c)(i) could be used to justify import restrictions which were not the counterpart of any governmental measure capable of limiting production, the value of the General Agreement as a legal frame-work for the exchange of tariff concessions in the agricultural field would be seriously impaired.

This panel noted that during the drafting of the provision, it was agreed that the exception under Article XI:2(c)(i): “... was not intended to provide a means of protecting domestic producers against foreign competition, but simply to permit, in appropriate cases, the enforcement of domestic governmental measures. ...” The drafters had also given some guidance as to the nature of the governmental measures intended to be covered by the provision. They recognized that output limitation might coexist with subsidies, but that: “in interpreting the term ‘restrict’ for the purposes of paragraph 2, the essential point was that the measures of domestic restriction must effectively keep output below the level which it would have attained in the absence of restrictions.” In the light of the considerations set out here, the panel found that the measures taken under the intervention system for apples did not constitute marketing restrictions of a type that could justify import restrictions under Article XI:2(c)(i). Intervention by the EU authorities was thus viewed as a measure aimed to protect domestic EU producers. Of course, there is a fine line between measures aimed at organizing farm production and measures aiming to protect farmers outright. This provision has been largely superseded by the Uruguay Agreement on Agriculture, that we discuss in volume 2. 2.3.3.3 What Is a Governmental Measure? There is, of course, no doubt that a measure is “governmental” if it is performed by government agents. In this vein, the Panel on Canada–Eggs had no trouble qualifying a supply

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management program of eggs as “governmental” since government entities were entrusted with its administration. The question arises whether schemes operated by private agents can also be considered “governmental,” and if yes, what level of government involvement in similar schemes is necessary? Case law has established that the measures covered will be considered “government measures” even if the government concerned has not exercised compulsion, so long as it has provided traders with sufficient incentives to adopt a particular behavior.47 It thus established a parallel with the approach adopted in Japan–Semiconductors that was discussed previously. The Panel on EEC–Dessert Apples addressed a series of measures relating to the common organization of the market for apples in the EU coming under the aegis of the common agricultural policy (CAP). The EU would buy in at fixed prices apples of EU origin, should the market price be below the “fixed price” (e.g., the price at which the EU would buy, and which was a regulated and not a market price) for three days in a row. It would also buy in at fixed prices when prices were likely to fall because of a temporary surplus. In this case, the EU member states’ authorities would permit withdrawal operations, and the “withdrawal price” would be the fixed price plus 10 percent (withdrawn goods would go to free distribution, animal feed, industrial processing, and other areas). Apples were protected by a variable duty as well (the difference between the world price and the EU fixed price for buying in), which would be added to the bound duty. Chile was challenging the consistency of these measures with GATT. The EU did not contest that an import restriction had been in place, and, to justify it, invoked Article XI.2(c) of GATT. To decide whether these measures were indeed GATTinconsistent, the panel had to first decide whether they could be regarded as “governmental measures.” It quoted approvingly prior case law that had found that incentives sufficed for a measure to be considered “governmental.” In other words, governments did not need to compel (§§ 12.8–9): The Panel proceeded by examining first whether the EEC did have “governmental” measures consistent with Article XI:2(c)(i), and second whether such measures did operate to restrict domestic supply in terms of the same provision. The Panel noted that the EEC did not claim that it restricted production of apples, but that it effectively restricted their marketing, through a system of market withdrawals carried out mainly by producer groups. The Panel also took note of the argument that these could not be considered “governmental” measures in terms of Article XI:2(c) because of the voluntary basis of the organization and the non-obligatory method of their operation. The Panel recalled that the concept of “governmental” measure had been previously examined on a number of occasions in respect of different articles of the General Agreement. A 1960 Panel, examining the question of whether subsidies financed by non-governmental levy were notifiable under Article XVI, expressed the view that “... the question ... depends upon the source of the funds and the extent of government action, if any, in their collection.” Another Panel found that the informal administrative guidance caused by the Japanese Government to restrict production of certain agricultural products could be considered to be a governmental measure within the meaning of Article XI:2 because it

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emanated from the Government and was effective in the Japanese context. A third Panel considered that legally non-mandatory measures could constitute restrictions within the meaning of Article XI:1 if “sufficient incentives or disincentives existed for non-mandatory measures to take effect ... [and] the operation of the measures ... was essentially dependent on Government action or intervention [because in that case] ... the measures would be operating in a manner equivalent to mandatory requirements such that the difference between the measures and mandatory requirements was only one of form and not of substance.”

The panel examined the measures in the light of these decisions by the CONTRACTING PARTIES. It noted that the internal regime for apples was a hybrid one that combined elements of public and private responsibility. Legally, there were two possible systems: direct buying-in of apples by member state authorities and withdrawals by producer groups. Under the system of withdrawals by producer groups, which was the EU’s preferred option, the operational involvement of public authorities was indirect. However, the regime as a whole was established by EU regulations, which set out its structure. Its operation depended on EU decisions fixing prices, and on public financing; apples withdrawn were disposed of in ways prescribed by regulation. The panel, therefore, found that both the buying-in and withdrawal systems established for apples under EEC Regulation 1035/72 (as amended) could be considered to be governmental measures for the purposes of Article XI:2(c)(i). 2.3.3.4 Product Coverage The coverage of this provision was limited in the GATT years to chapters 1–24 of the Customs Cooperation Council Nomenclature.48 In the WTO era, the coverage has been modified since agricultural products are now defined in Annex 1 of the Agreement on Agriculture. Although chapters 1–24 continue to form the basis for the provision, some of the products mentioned therein have been excluded, whereas others (e.g., cigarettes) were not. In this vein, for example, before the advent of the WTO, the Panel on Thailand– Cigarettes held that the reference to “fresh” products in the Interpretative Note to this provision meant that leaf was covered but cigarettes were not (§§ 69–70). Note, nonetheless, that the preparatory work suggests narrower product coverage. During the negotiation of GATT, the view was held that measures applying to seasonal goods at a time when like domestic goods were not available could not qualify as “necessary” under this provision.49 The GATT Working Party on Quantitative Restrictions adopted a less stringent view in its report, to the effect that similar measures would be GATTconsistent only if they were necessary to achieve the objectives of government measures relating to the control of domestic products.50 2.3.3.5 Restrictions on Like or Substitutable Domestic Goods When a restriction is imposed, it must be extended to all “like goods.” If similar restrictions on domestic (and foreign) “like goods” have not been adopted, then the WTO member enacting this measure will be found to be in violation of its obligations under this provision: the GATT Panel on EEC–Minimum Import Prices ruled as much.

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The Panel on EEC–Apples (US), echoing prior case law, held that two goods that perform a similar function for the consumer are like: hence, it is consumers that will decide whether two goods are like in the context of this provision (§ 5.7). Article XI.2(c) of GATT refers to “restrictions” only, whereas the previous two provisions, Articles XI.2(a) and (b), refer to “prohibitions and restrictions”: the linguistic difference suggests that outright bans on imports or exports are not covered by Article XI.2(c) of GATT. The Panel on US–Canadian Tuna has confirmed this point (§ 4.6):51 The sub-Committee agreed that in interpreting the term “restrict” for the purposes of paragraph (2)(c), the essential point was that the measures of domestic restriction must effectively keep domestic output below the level which it would have attained in the absence of restrictions.”52 In EEC–Dessert Apples, the panel explained that, when deciding on the restrictive effect of challenged measures, measures imposing no restrictions on quantities sold could not come under its purview. In this vein, measures banning sales below a certain price threshold could not come under the purview of this provision. This finding might seem surprising, and indeed it is. The panel paid attention to the fact that no limit on quantities sold was imposed, but no attention at all to another aspect of the measure: because of the prohibition to sell below a certain price, the overall quantities sold were affected. It is unclear whether this finding was aimed as endorsement of only de jure QRs. There is no subsequent practice, either, that would help clarify this point. In light of the uncertainty regarding the ambit of this finding, we cite it as such (§§ 12.12–14): The Panel considered it necessary to examine a basic interpretative issue involved in this GATT requirement––i.e., did Article XI:2(c)(i) cover only schemes which set quantitative limits on the amount producers could offer for sale, or did it also cover schemes which could result in a reduction of products reaching the consumer through withdrawals activated by reference to a floor price without quantitative targets? The Panel examined this interpretative issue in the light of the wording of Article XI:2(c)(i), the context in which this provision appears in the General Agreement, the purpose of the General Agreement and the intentions of the drafters. The Panel noted that Article XI:2(c)(i) referred to governmental measures which “operated to restrict the quantities” of the domestic products “permitted to be marketed or produced.” Given the ordinary meanings of “to permit” (to authorize or allow) and “to market” (to expose for sale in a market or to sell) the wording of the provision suggested in the view of the Panel that the governmental measures must include an effective limitation on the quantity that domestic producers are authorized or allowed to sell. Measures which simply prevented consumers from buying products below certain prices would not appear to be covered by this wording. If the withdrawal of a product from the market without any governmental limitation on the amount that could be sold was included within the purview of Article XI:2(c)(i), the words “permitted to be” would not have any function. The Panel took into consideration, however, the argument that in the official languages of the General Agreement this provision could possibly be interpreted in a way which concentrated more on the market effects than on the government policy direction. It had been argued, for example, that the fact that a quantity of apples had been withdrawn from the dessert apple market as a result of governmental measures amounted, in effect, to a marketing restriction in terms of Article XI:2(c)(i). This interpretation would involve a more flexible reading of “permitted to be marketed.” The Panel

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recalled the legal principle that exceptions were to be interpreted narrowly and considered that this argued against such a flexible interpretation of Article XI:2(c)(i). As to the context in which the provision appears, the Panel noted that the final paragraph of Article XI:2 stipulated that imports may be restricted under Article XI:2(c)(i) only in proportion to domestic production, whether the government has chosen to restrict the quantities permitted to be marketed or those permitted to be produced. It is thus clear that in the case of marketing restrictions, also, imports may only be reduced to the extent that production declines. Schemes which operate to prevent, or effectively discourage, producers from selling their products beyond fixed amounts can reasonably be expected to have an effect on production because producers will tend to produce only up to the quantitative ceiling set. By contrast, a scheme which imposes no limitations on what producers may sell cannot, by itself, bring about a restriction of production. It therefore follows from the context of the provision that such a scheme would not be covered by Article XI:2(c)(i). The Panel also noted that, unlike Article XI:2(c)(i), Article XI:2(c)(ii), which concerned the removal of a temporary surplus, did not stipulate any restriction on domestic output in order to justify import restrictions. A withdrawal program not capable of limiting production could possibly come under Article XI:2(c)(ii), provided that the specific requirements of the provision were met. The difference between the two sub-paragraphs was a further contextual indication that Article XI:2(c)(i) could not be interpreted as widely as argued by the EEC.

2.3.3.6 Temporary Surplus In EEC–Apples I (Chile), the panel faced a situation where for several years, the EU was facing a surplus. In 1979, though, the surplus was abnormally high. The panel held that that it could legitimately consider that year as the surplus year (§ 4.10). Thus, the arithmetic difference between two years (a point-to-point comparison) sufficed for the panel to decide that a surplus was indeed present. In EEC–Dessert Apples, the panel took a different view. In its ruling, it said that it should compare the situation in the year when measures had been adopted with the situation leading up to that year. It was not point-to-point comparisons that mattered, therefore, but trends. In this case, the EU had adopted restrictions in 1988. The panel examined the situation during the previous years and found that the EU had been consistently running surpluses. In its view, the EU was running a structural and not a temporary surplus under the circumstances; as a result, it could not invoke Article XI.2(c)(ii) of GATT (§ 12.19): Article XI:2(c)(ii) provides an exception to Article XI:1 for “import restrictions ... necessary to the enforcement of government measures which operate to remove a temporary surplus of the like domestic product ... by making the surplus available to certain groups of domestic consumers free of charge or at prices below the current market level.” The Panel also took note of the views of the 1980 Panel on this point, noting that that Panel’s finding of a “temporary surplus above the recurring surplus” related only to the situation in 1979. Article XI:2(c)(ii) clearly required the Panel to consider whether the EEC’s surplus at the time the import restrictions were imposed, i.e. April 1988, had been demonstrated to be temporary. The Panel considered that the only practicable way to reach a finding on this point was to compare the EEC’s apple surplus in 1988 with that in the previous years. From the statistics available to it (see Table I), it observed that while amounts withdrawn had varied in the years up to and including the 1987–88 marketing year, stocks had remained relatively stable

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at levels which indicated a substantial structural surplus. The Panel thus found that the 1988 surplus could not be considered a temporary one, and that therefore the EEC did not meet the conditions for imposing import restrictions under Article XI:2(c)(ii). In the light of this finding the Panel did not consider it necessary to examine whether the EEC measures were in conformity with the other requirements of this provision.

2.3.3.7 Compensation In Japan–Agricultural Products I, the panel held that, contrary to other provisions, no obligation to compensate for damage suffered is provided for in Article XI.2(c) of GATT. This is why, in the panel’s view, this provision requires similar restrictions on domestic goods (§ 12.15). 2.3.3.8 Public Notice A public notice must be issued by virtue of the last sentence in Article XI.2 of GATT. The EU was found in violation of its obligations in this respect in EEC–Apples I (Chile).53 2.3.3.9 Burden of Proof In light with this chapter’s generic discussion of this issue, the GATT panel report on Japan–Agricultural Products I, held that it is the trading nation imposing the restriction that carries the associated burden of proof (§ 5.1.3.7). 2.3.4

Balance of Payments (Articles XII and XVIII of GATT)

WTO members can legitimately deviate from their obligations under Article XI of GATT if they encounter BoP problems, and, to this effect, they are in a position to demonstrate that they have complied with the requirements of Article XII of GATT. Developing countries facing similar concerns can invoke Article XVIII of GATT, a twin provision that contains less stringent requirements for compliance than those embedded in Article XII of GATT. 2.3.4.1 The Rationale The inclusion of these two provisions in GATT was supported by the UK delegation, as chapter 1 described, and was deemed necessary in light of the inflexibilities associated with the system of fixed exchange rates (fixed parities) that prevailed when GATT/ITO were originally negotiated.54 Under the fixed parities regime, a country with a payments deficit could not unilaterally devalue its currency, as it would have to follow the multilateral process established to this effect. The International Monetary Fund (IMF) had an important role to play in this respect. Its role was recognized in the GATT legal order, as Article XV.6 of GATT makes clear that: Any contracting party which is not a member of the Fund shall, within a time to be determined by the CONTRACTING PARTIES after consultation with the Fund, become a member of the Fund,

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or, failing that, enter into a special exchange agreement with the CONTRACTING PARTIES. A contracting party which ceases to be a member of the Fund shall forthwith enter into a special exchange agreement with the CONTRACTING PARTIES. Any special exchange agreement entered into by a contracting party under this paragraph shall thereupon become part of its obligations under this Agreement.

At present, most countries have shifted to flexible exchange rates. Given that the exchange rate is a more appropriate instrument to deal with BoP disequilibria as part of a comprehensive macroeconomic adjustment program, the GATT provisions on BoP have become largely redundant. Other things being equal, WTO members would rather devaluate and profit from the increase in export income than impose a QR and keep their exchange rate intact.55 In other words, this provision, although still present in GATT, is largely confined to historic interest.56 2.3.4.2 Procedural and Institutional Issues Articles XII and XVIII of GATT did not contain elaborate provisions detailing the procedural steps to be taken whenever recourse to restrictions adopted on BoP grounds was being made. The “Understanding on the BoP Provisions of the GATT 1994” was concluded during the Uruguay round, adding to the existing framework. WTO members must announce publicly a “time-schedule” for all measures they have unilaterally taken to address BoP problems (§ 1 of the Understanding). The same provision allows for subsequent changes to announced time-schedules and even provides WTO members with the opportunity to avoid announcing a time-schedule, if they can justify doing so. From that moment onward, a parallel procedure comes into place. On the one hand, the WTO member concerned might find itself before the Committee on Balance of Payments Restrictions (BoP Committee) discussing its measures; on the other, it incurs an obligation of transparency toward the General Council of the WTO. The BoP Committee carries out consultations in order to review all restrictive import measures taken for BoP purposes. It follows the procedures for consultations on BoP restrictions, which were formally approved on April 28, 1970 (“full consultation procedures”).57 A WTO member applying a new restriction, or raising the general level of its existing restrictions, shall enter into consultations with the BoP Committee within four months of the adoption of such measures, either upon its request, or upon invitation by the chair of the BoP Committee [Article XII.4(a), and Article XVIII.12(a) of GATT]. Parallel to this process, whenever recourse to BoP restrictions is made, WTO members must notify the WTO General Council of: (1) The introduction of, or any change in, the application of trade-restricting import measures taken for BoP purposes; and (2) Any modification concerning the timing of withdrawal of such measures. These notifications shall include information at the tariff-line level about the product coverage and trade flows affected.

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At the request of a WTO member, notifications may be reviewed by the BoP Committee. The BoP Committee shall periodically review restrictions applied for BoP purposes. The two processes (WTO member consulting within BoP Committee and WTO member informing the General Council) de facto merge when the BoP Committee contacts the General Council directly. It can go so far as to include proposals for a recommendation (§ 13 of the Understanding). This will be the case, of course, if the BoP Committee can manage to “speak with one voice.” In this case, assuming agreement at the General Council level (which is to be expected since all WTO members participate in both the BoP Committee and the General Council), the final recommendation by the General Council to the WTO member in question will include the General Council opinion regarding the timeschedule. If the WTO member adheres to the recommendation of the General Council, it will be deemed in compliance with its obligations (§ 13 of the Understanding). It could be the case, though, that no agreement was possible at the BoP Committee level (and, consequently, at the General Council level as well). In this case, the recommendation by the General Council will reflect the divergent views expressed at the BoP Committee level (§ 13 of the Understanding). It stems from all this that consultations within the BoP Committee are, for all practical purposes, an exercise in transparency. Trading nations do not have to await the green light by the committee in order to adopt measures. The committee is the place where the measures adopted are being discussed. Moreover, it is also quite possible that no agreement regarding the phasing-out of measures adopted (i.e., the time-schedule) has been reached. Or, it could even be that the very invocation of the provision has been contested. Disputes thus may arise, and they do not have to await adjudication until the committee has finished its work. WTO members affected by recourse to the BoP exception have the right to request the establishment of a panel to adjudicate their complaint. This raises the question of “institutional balance” between WTO committees (the “legislative” cum “administrative” branch of the WTO) and WTO panels (the “judiciary” of the WTO), which will be detailed later in this chapter. The role of the BoP Committee has not always been pivotal. Originally, BoP-related measures would be discussed in the context of Special Working Parties established to this effect. Its role was strengthened during the Tokyo round, when the CONTRACTING PARTIES adopted the “Declaration on Trade Measures taken for Balance-of-Payments Purposes,”58 which subjected all measures taken for BoP purposes to an examination by the BoP Committee (and not by a Special Working Party). 2.3.4.3 A Typology of Measures Adopted Article XII of GATT was designed as an exception to Article XI of GATT.59 In practice, however, trading nations have often had recourse to measures such as import surcharges (e.g., tariff measures, not QRs) in order to safeguard their BoP position. In the absence of specific language to this effect, it was at best unclear whether measures like import

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surcharges, which are tariff measures, could be justified through a textual reading of Article XII of GATT. It was clear, on the other hand, that import surcharges would have had less of a disruptive effect on trade than a QR in principle. Early on, Jackson (1972) held the view that import surcharges violated Article II of GATT and could not be exempted through recourse to Article XII, which had been thought of as only an exception to QRs. He mentioned, however, evidence of tolerance of similar practices in GATT. The dispute concerning the import surcharge applied by the US in 1971 (covered later in this chapter) is a case in point. The “Declaration on Trade Measures taken for Balance-of-Payments Purposes” (1979) is the first legal document to acknowledge in its preamble the use of measures other than QRs for BoP purposes—in fact, it encouraged their use. Through this declaration, the CONTRACTING PARTIES expressed the common preference for the use of measures, which would have less disruptive effect on trade than QRs. The “Understanding on the BoP Provisions of the GATT 1994” strengthened the surveillance of restrictions (§§ 9–12), and contained provisions that reproduced the essence of the 1979 Declaration. According to the Understanding, WTO members were encouraged to give preference to measures with the least disruptive effect on trade (“price-based” measures); e.g., import surcharges, import deposit requirements that can lawfully be applied in excess of bound duties, and other measures (§ 2 of the Understanding). WTO members should seek to avoid applying QRs, and, whenever they do so, they should explain why they did not have had recourse to price-based actions (§ 3 of the Understanding). None of these documents qualified price-based measures as “other measures” in the sense of Article XI.1 of GATT. The legal qualification nevertheless is unimportant at this stage. Price-based are explicitly mentioned among the measures that WTO members can adopt in order to address BoP-related issues. When applying their measures, WTO members should make sure that they are tailored to address the BoP crisis that they face and should not have incidental effects beyond what is needed to address it. To this effect—e.g., in order to eliminate (reduce) incidental effects—WTO members are required to administer their measures in a transparent manner (§ 4 of the Understanding). WTO members should apply restrictions across the board, except for essential products;60 that is, products that meet basic consumption needs or that contribute to the members’ efforts to improve their BoP situation, such as capital goods (§ 4). 2.3.4.4 Invocations Developed countries, with a few notable exceptions, almost never made use of this provision, and none of the restrictions on BoP grounds are still in place today.61 Developing countries have used Article XVIII(b) of GATT (that is, the provision corresponding to Article XII of GATT), which developing countries can invoke when facing BoP problems (see table 2.1). The requirements for compliance with this provision are less stringent62 than the corresponding requirements for compliance with Article XII of GATT. Recourse

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Table 2.1 Invocations of Article XVIII(b) of GATT WTO Member

Period

Argentina Bangladesh Brazil Chile Colombia Egypt Ghana India Indonesia Korea Nigeria Pakistan Philippines Peru Sri Lanka Tunisia

1972–1978, 1986–1991 1974–2008a 1962–1971, 1976–1991 1961–1980 1981–1992 1963–1995 1959–1989 1960–1997 1960–1997 1969–1989 1985–1998 1960–2002 1980–1995 1968–1991 1960–1998 1967–1997

a. Bangladesh notified its intention to phase out its remaining restrictions by 1 January 2005 (WTO Document WT/BOP/N/54 of 15 December 2000 and WT/BOP/N/62 of 18 February 2004). Subsequent to this notification, Bangladesh imposed import restrictions under Article XVIII(c) of GATT, invoking infant industry protection; see WTO Document G/C/7 of 16 January 2002.

to the former provision (Article XVIII of GATT) is reserved to developing countries with “inadequate monetary reserves” that are members of the WTO. Recourse to the latter (Article XII of GATT) is reserved to developed countries with “very low monetary reserves” that are members of the WTO. Arguably, the term “inadequate monetary reserves” leaves more discretion to the state invoking this provision and, consequently, would entail a more deferential standard of review should litigation occur. The differences regarding the requirements embedded in the two provisions do not stop here. Whereas Article XII of GATT requires that WTO members progressively relax the restrictions imposed, Article XVIII(b) of GATT provides that no member shall be required to modify restrictions on the grounds that a change in its development policy would render such restrictions unnecessary.63 Finally, a “simplified consultation procedure” is available for developing countries invoking the BoP safeguard, and it was approved on December 19, 1972.64 This procedure is available to all developing countries and least developed countries (LDCs); the latter, however, can have recourse to it provided that they are pursuing trade liberalization efforts in conformity with the schedule presented to the BoP Committee in previous consultations. 2.3.4.5 Dispute Settlement and Internal and External Institutional Balance As discussed earlier in this chapter, the legitimacy of measures adopted on BoP grounds (and their phasing out) is discussed before the BoP Committee and the General Council and can be challenged before a panel. Scholarship has been divided on the issue concerning the justiciability of BoP restrictions. Some have argued that decisions regarding the

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legitimacy of BoP restrictions are of a political nature and should be best left to the WTO organs; but then, others have argued that, since political organs might not be in a position to reach a conclusion, recourse to dispute settlement should always be possible.65 This issue did not take long to find its way before a GATT panel. In Korea–Beef (New Zealand), the panel faced the Korean argument that it had no jurisdiction to review the legality of its invocation of Article XVIII of GATT because the issue was pending before the BoP Committee. The panel rejected this claim outright, arguing that it had no support at all in GATT (§§ 110–113). In the panel’s view, nothing in GATT supported the claim that certain provisions of the agreement were not justiciable. One might have thought that this issue was settled as a result of this ruling—and yet it resurfaced. The reason for that was the argument that, because of the reinvigorated institutional infrastructure of the WTO—a far cry from the institutional deficiencies that GATT had to live with—similar issues should be best left to the discretion of WTO committees. In India–Quantitative Restrictions, India attempted to justify its QRs on over 2,700 agricultural and industrial product tariff lines by invoking Article XVIII(b) of GATT. India maintained QRs on consumer goods in 2,714 tariff lines (i.e., approximately 30 percent of the total number of tariff lines where India had made concessions). India, when challenged by the US, invoked its status as a developing country (thus falling under Article XVIII of GATT) in order to justify its violation of Article XI of GATT. It also claimed that Article XVIII of GATT was not justiciable, as decisions regarding the legitimacy of measures adopted to address BoP fell, in its view, under the exclusive jurisdiction of the BoP Committee. The panel found India’s measures to be inconsistent with Article XI.1 of GATT. It also went on to find that they could not be justified through recourse to Article XVIII.11.66 Most important, the panel found (and the AB upheld) that, in contrast to the argument advanced by India, BoP restrictions could legitimately be the subject of judicial review.67 On appeal, the AB noted the relevance of institutional balance within the framework of the WTO Agreement, rejecting India’s argument that only the WTO BoP Committee could review the consistency of its measures with GATT. It stated that (§ 105): such a requirement would be inconsistent with Article XXIII of the GATT 1994, as elaborated and applied by the DSU, and footnote 1 to the BOP Understanding which, as discussed above, clearly provides for the availability of the WTO dispute settlement procedures with respect to any matters relating to balance-of-payments restrictions. (italics in the original)

The AB upheld this finding and went on to rule against India because it had not demonstrated that it had met its burden of proof, and because it had not explained why the removal of the QRs would lead to a change in its development policy, and ultimately to a deterioration of its overall situation. Critically, expertise provided by the IMF supported the view that India was no longer facing BoP problems, and the AB, like the panel before it, relied on the provided expertise to reach its conclusions (§§ 150ff.).

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This is a well-founded decision since the BoP Committee might not be in a position to decide an issue where there was disagreement between its members. The discussion so far concerns the “internal institutional balance”; that is, the relationship between panels and other WTO organs. The panel and the AB on India–Quantitative Restrictions dealt with a different issue as well: by inviting expertise from the IMF, the question arose whether they were bound to respect what the IMF experts had to suggest. The relationship between the WTO and the IMF concerns the “external institutional balance”; that is, the relationship between WTO and non-WTO organs. The relationship between WTO and the IMF is an issue that concerns not only Article XII, but also Article XV of GATT, which deals with exchange restrictions. There is little doubt that the whole system of Article XV of GATT was meant to establish a bridge between the trade issue (QR), and the wider macroeconomic concerns that gave rise to the trade measure.68 Expertise by the IMF concerning the latter aspect thus should, in principle, be welcome since this is an area where WTO has neither institutional expertise nor a mandate to recommend action. That much was clear to the GATT framers who, recall from our discussion in chapter 1, were negotiating GATT in the shadow of the Bretton Woods negotiation. GATT discusses explicitly the relevance of IMF expertise into GATT legal proceedings in Article XV, that we discuss later. Case law and subsequent practice have provided their own understanding of how much deference to IMF was warranted. Chapter 1 discussed the agreement signed between the WTO and the IMF as evidence of the treaty-making power of the WTO, the natural consequence of endowing it with legal personality. In line with the spirit of “global coherence” reflected in the IMF/WTO Agreement, IMF experts can participate in panel proceedings. Typically, it is panels using their discretion under Article 13 of the Dispute Settlement Understanding (DSU) that will initiate this process, requesting the participation of IMF experts whenever warranted. The IMF can also on its own initiative submit its views to a panel: Article 4(b) of the agreement between the WTO and the IMF provides as such.69 The Panel on India–Quantitative Restrictions followed well-established practice in this area, turning to IMF experts to request their views regarding the solidity of the Indian action.70 Of interest to this discussion is the degree of deference that WTO panels will show to expertise supplied by IMF officials. In India–Quantitative Restrictions, the panel showed considerable deference since it endorsed for all practical purposes the views expressed by IMF experts. The Panel on Dominican Republic–Import and Sale of Cigarettes adopted a similar approach and deferred to the IMF expertise as well. This has not always been the case, as in a remarkable, high-profile case, discussed next, where a panel showed no deference toward IMF expertise: the GATT panel adjudicating the consistency of the import surcharge that the US imposed in 1971 with the relevant GATT rules. In 1971, the US unilaterally decided to put an end to the “fixed parities” scheme that was established during the Bretton Woods conference. The US dollar was consistently

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valued at $35/ounce of gold, and the “London Gold Pool,” in which eight central banks (that of the US and seven European nations, namely, Belgium, France, Germany, Italy, the Netherlands, Switzerland, and the United Kingdom) participated, was pooling gold reserves in order to maintain this rate. Over the years, nevertheless, the US accumulated for various reasons (ranging from the cost of former president Lyndon Johnson’s social policies establishing what became known as the “Great Society” to the cost of the Vietnam War) a negative BoP. The US dollar was overvalued, and the US economy suffered as a result. President Richard Nixon suspended the convertibility of the dollar to gold, opening the door to free convertibility of currencies, in what became known as the “Nixon shock.” A pact called the “Smithsonian Agreement” was signed in 1971, where the dollar was valued at $38/ounce with 2.25 percent trading bands, and the “Group of Ten” (the seven European states mentioned above, Sweden, plus Canada and Japan) agreed to appreciate their currencies vis-à-vis the US dollar. Of interest to this discussion is primarily the US decision to impose an import surcharge on all dutiable goods (not all goods) as a shortterm measure to allow the US industry to “breathe” until the realignment of currencies would allow exports to grow again. It was not the first time the US would run a deficit in merchandise trade, but it was the first since 1893, as Vincke (1972) notes. The US notified GATT of its import surcharge,71 and a Working Party was established to examine its consistency with the GATT rules.72 The rationale offered by the US was that its trade account had deteriorated significantly, and this deterioration had been an important factor in the overall BoP problem. In parallel with the proceedings before GATT, Yoshida, a Japanese company, challenged the legality of the surcharge before a US court.73 It lost. The proceedings before GATT continued, however, unaffected by the US court’s ruling. The GATT Working Party consulted with the IMF when preparing its report. In §§ 4–5 of its report, the officials of IMF wrote that the import surcharge can be regarded as being within the bounds of what is necessary to stop a serious deterioration in the United States balance of payments position. However, a corrective adjustment in the pattern of exchange rates would be a preferred means for achieving a better balance in international payments… the Fund had no suggestion to make as to any alternative measures that the United States might take at present.

In Annex II to the report, nevertheless, it said that Austria, Canada, Chile, Ghana, Greece, India, Japan, Spain, Sweden, Switzerland, and Trinidad and Tobago all intervened before the Working Party, expressing critical views of the US measure, the IMF view notwithstanding. Most of them insisted that developing countries’ goods should be totally exempted from surcharges. The US received sympathy only from the UK delegate. Article XV.2 limits the discretion of the WTO when it comes to issues coming under the aegis of the IMF: In all cases in which the CONTRACTING PARTIES are called upon to consider or deal with problems concerning monetary reserves, balances of payments or foreign exchange arrangements, they

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shall consult fully with the International Monetary Fund. In such consultations, the CONTRACTING PARTIES shall accept all findings of statistical and other facts presented by the Fund relating to foreign exchange, monetary reserves and balances of payments, and shall accept the determination of the Fund as to whether action by a contracting party in exchange matters is in accordance with the Articles of Agreement of the International Monetary Fund, or with the terms of a special exchange agreement between that contracting party and the CONTRACTING PARTIES.

This paragraph would suggest deference toward the IMF expert. Deference, however, is limited to facts and “determinations” by the IMF, not to opinions expressed by IMF experts in GATT adjudication. Arguably though, this provision could be seen as some sort of more general deference towards opinions expressed by IMF experts when acting in their official capacity. In § 9 of the report we read, nonetheless, that the Working Party distanced itself from the views expressed by the IMF, and the reasons for doing so. It considered that the measures restricting imports were not an appropriate means to correct the US BoP disequilibrium. They could not endorse the IMF’s view because they considered that the trade balance had only a minor role to play in the US BoP. In § 10 is this characteristic excerpt: “In the view of these members, the most important and immediate cause of the present balanceof-payments deficit in the United States had been the massive outflow of short-term capital, which reflected a loss of confidence in the stability of the United States economy.” It seems that the Working Party did not attribute the problems that the US was facing to trade, trade being relegated to a proximate, but not the ultimate, cause of the US imbalances. In §27, the report went even further, suggesting that, pending the abolition of the surcharge, the US should explore all ways and means available to it that would help reduce the incidence of its measure on trade: [T]he latter process could advisably start at an early date with the few primary commodities not yet benefiting from an exemption. Considering the stable demand and supply of these products, and their low elasticity of demand, the application of the surcharge to these products seemed to serve little purpose and their liberalization was not expected to have a significant on the United States bill.

In §§ 39–40, the Working Party stated its overall conclusion—namely, that the surcharge was inappropriate given the nature of the United States balance-of-payments situation and the undue burden of adjustment placed upon the import account with consequent serious effects on the trade of other contracting parties … the Working Party explored with the United States the feasibility of exempting more products exported by developing countries from the surcharge … the measure should be eliminated within a short time.74

Consequently, panels have shown asymmetric deference toward expertise supplied by IMF experts. Suffice to state here that so far, the Working Party discussing the consistency of the US surcharge with the GATT rules is an outlier. Usually panels show considerable deference not only toward expertise supplied by IMF experts, but also toward scientific expertise in general. Case law under the SPS Agreement (discussed in chapter 6 of volume 2) provides ample proof in this respect.

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2.3.4.6 Burden of Proof Intuitively, one would expect that it should be the party invoking BoP as rationale for justifying a QR that would be called to carry the associated burden of proof. Case law, however, has not always been crystal clear on this score. In Korea–Beef (US), the panel refers to a claim by the US that Korea violated Article XVIII.11 of GATT, and a defense raised by Korea to the effect that it had met the conditions under Article XVIII, Section B, of GATT (§§ 116ff.). It did not clearly state who carried the burden of proof to show compliance with Article XVIII of GATT. The situation got a bit more perplexed in India–Quantitative Restrictions. Recall that India had in place widespread trade impeding measures that it sought to justify through reference to Article XVIII of GATT. The US had presented claims under both Articles XI and XVIII of GATT, and the panel ruled (§ 5.119): In all instances, each party has to provide evidence in support of each of its particular assertions. This implies that the United States has to prove any of its claims in relation to the alleged violation of Article XI:1 and XVIII:11. Similarly, India has to support its assertion that its measures are justified under Article XVIII:B. We also view the rules stated by the Appellate Body as requiring that the United States as the complainant cannot limit itself to stating its claim. It must present a prima facie case that the Indian balance-of-payments measures are not justified by reference to Articles XI:1 and XVIII:11 of GATT 1994.

What if the US had presented claims only with respect to Article XI of GATT? Would the panel have reached the same decision? The correct response should be no. The rationale for imposing QRs is in principle in the realm of private information. Consequently, it should be India that should carry the burden of proof to show that its measures are justified because they were adopted as response to BoP problems. This should be the correct response. The AB, nevertheless, has cast doubt on similar allocations of burden of proof. In the context of the TBT Agreement (chapter 5 of volume 2), it held that the transparency obligations embedded in the TBT Agreement effectively address concerns about private information. It could be that similar case law is exported in this area as well: since WTO members must notify the BoP Committee of their measures adopted to address BoP concerns, complainants are well aware of the rationale for QRs and should consequently carry the burden of proof to show violation of Article XII/XVIII of GATT. This is a hypothesis. As chapter 5 of volume 2 explains in more detail, this view rests on the very questionable assumption that measures have been notified, and the true rationale for their adoption has been revealed as well. This is not always the case, and the question will eventually arise as to what to do with cases where no measure has been notified. Once again, it will be impermissible to have one sauce for the goose and another for the gander. The proper allocation of burden of proof would thus request that the WTO member that adopted measures on BoP grounds is the one that should carry the burden of proof to show that the requirements of Article XII/XVIII of GATT have been met.

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2.3.5.1 Global Coherence WTO members can impose exchange restrictions, provided that they have done so in accordance with their obligations under the IMF,75 or impose import and export restrictions and controls in order to make their exchange restrictions effective. Article XV.9 says to this effect: Nothing in this Agreement shall preclude: (a) the use by a contracting party of exchange controls or exchange restrictions in accordance with the Articles of Agreement of the International Monetary Fund or with that contracting party’s special exchange agreement with the CONTRACTING PARTIES, or (b) the use by a contracting party of restrictions or controls in imports or exports, the sole effect of which, additional to the effects permitted under Articles XI, XII, XIII and XIV, is to make effective such exchange controls or exchange restrictions.

There is a limit, though, when undertaking similar action (Article XV.4 of GATT): Contracting parties shall not, by exchange action, frustrate the intent of the provisions of this Agreement, nor, by trade action, the intent of the provisions of the Articles of Agreement of the International Monetary Fund.

The term “frustrate,” appearing in Article XV.4 of GATT, is further interpreted in an Interpretative Note added to GATT as follows: The word “frustrate” is intended to indicate, for example, that infringements of the letter of any Article of this Agreement by exchange action shall not be regarded as a violation of that Article if, in practice, there is no appreciable departure from the intent of the Article. Thus, a contracting party which, as part of its exchange control operated in accordance with the Articles of Agreement of the International Monetary Fund, requires payment to be received for its exports in its own currency or in the currency of one or more members of the International Monetary Fund will not thereby be deemed to contravene Article XI or Article XIII. Another example would be that of a contracting party which specifies on an import licence the country from which the goods may be imported, for the purpose not of introducing any additional element of discrimination in its import licensing system but of enforcing permissible exchange controls.

Consequently, WTO members are entitled, by virtue of Article XV.9 of GATT, to impose, under certain conditions, exchange restrictions in accordance with the IMF provisions, and they will be violating these provisions only if they frustrate the intent of the GATT provisions. Alas, the term “frustrate,” the quoted definition of the term notwithstanding, is difficult to define. This provision calls for all practical purposes for an “intent” analysis and offers two examples (of the thousands possible) that would lead to the conclusion that no violation has been established. To understand the “intent” of the provision, though, we need to go back to the negotiation of Bretton Woods. Pisani-Ferry (2014) discusses this point succinctly (p. 20):

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At the Bretton Woods conference in 1944, the principle of national autonomy over the national currencies prevailed. The only deviation was a collective commitment to refrain from manipulating exchange rates to gain market shares and export unemployment. But for the rest, national monetary authorities were free to interest rates at the level they though appropriate. Some were tough on inflation and some were tolerant, some regarded full employment as an imperative and some a desirable aim only. The abandonment of the fixed-exchange-rate regime in 1973 further enhanced national autonomy. By the end of the 20th century, the strictures of the Gold Standard were a matter of interest to students of the international monetary system, not for policymakers or politicians. The one-country, one-currency configuration was seen as a natural order.

There was, thus, a quest of coherence between GATT and the Bretton Woods institutions from early on. Actually, the relationship between trade and the financial system predates GATT, as it was already in the mind of negotiators during the ITO negotiations76 (as shown in chapter 1) and was eloquently presented in the Declaration of Ministers at the opening of the Tokyo round:77 The policy of liberalizing world trade cannot be carried out successfully in the absence of parallel efforts to set up a monetary system which shields the world economy from the shocks and imbalances which have previously occurred. The Ministers will not lose sight of the fact that the efforts which are to be made in the trade field imply continuing efforts to maintain orderly conditions and to establish a durable and equitable monetary system. The Ministers recognize equally that the new phase in the liberalization of trade which it is their intention to undertake should facilitate the orderly functioning of the monetary system.

The WTO continued down this path, and Article III.5 of the Agreement Establishing the WTO reads: With a view to achieving greater coherence in global economic policy-making, the WTO shall cooperate, as appropriate, with the International Monetary Fund and with the International Bank for Reconstruction and Development and its affiliated agencies.

The 1996 agreements with the IMF and the World Bank (referred to chapter 1) epitomize this view.78 The IMF expertise is channeled to various areas of WTO activities and, crucially, for the purposes of this chapter, to issues relating to BoP and exchange restrictions.79 Coherence, however, was not best served in a world where the discussion to decide on exchange rates was subjected to little (if any) discipline, especially after the gold standard (the fixed exchange rates regime that was discussed previously) became a thing of the past. Indeed, where precisely should the line be drawn between devaluation to address actual concerns, and devaluation to gain a competitive export advantage? Very often, if a line exists at all, it is a line in the sand. All this leads directly into a discussion of currency manipulations. 2.3.5.2 Currency Manipulations In the commonplace scenario, a trading nation devalues its currency to gain an export advantage. Similar actions, of course, are not inconsequential, and hence they do not occur

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without some additional thinking. What if, for example, the nation at hand is also burdened with debt? Devaluation of its national currency will ipso facto lead to an increase in the overall amount that it owes to its creditors. Or, what if others follow? This issue did not create much acrimony in the GATT years. Indeed, beyond the US unilateral decision to undo the fixed parities system, not much has happened. The issue of exchange rates gained prominence during the “Great Recession” of 2007– 2008 with voices, essentially in the US, saying that China was engaging in currency manipulation, keeping its domestic currency (renminbi, RMB) artificially low and thus boosting its exports. So, what should the WTO do in similar cases? A very narrow reading of the WTO contract suggests that not much can be done. Voices have been heard in the literature, though, arguing for an active role for the WTO when competitive devaluations occur. Article XV of GATT has been invoked in this vein as one of the potential points of departure justifying WTO involvement. Mattoo and Subramanian (2009) have argued for the WTO to be given a role in addressing similar practices. A number of possible legal bases have been offered as potentially relevant to attack the Chinese practices. Article XV of GATT, because of its subject matter, is the obvious candidate. Assuming that the attitude of the Panels on India–Quantitative Restrictions, and Dominican Republic–Import and Sale of Cigarettes is followed (a rather safe assumption), panels would defer to the IMF, and hence, the WTO’s involvement would be minimal. The next section discusses the panel report on Dominican Republic– Import and Sale of Cigarettes in detail. Suffice to say for now that, for Mattoo and Subramanian’s views to hold, a change in the attitude of these panels is warranted. The same authors also argue in favor of treating currency manipulations as subsidies. This argument does not seem to hold since the legal definition of “subsidy” in the SCM Agreement does not reconcile with the facts here. For a subsidy to exist, a financial contribution by government must be paid to a specific recipient that could not obtain the benefit conferred under market conditions.80 Even if one extends the concept of “financial contribution” to cover similar instances, the specificity requirement, a condition that must also be met for a subsidy to exist, would be impossible to show since the benefit would not be conferred to a few, targeted recipients. All using the Chinese “undervalued” currency (e.g., traders, private citizens, currency speculators, etc.) would, in principle, profit from “currency manipulation.” Finally, an argument has been made in favor of WTO members raising a nonviolation complaint (NVC). In this case, however, as noted in chapter 1, plaintiffs would have a mountain to climb when arguing that they legitimately expected China to act against its own interests by raising the value of the RMB against other currencies; the Chinese policy (refusal to reevaluate) is exactly what a rational agent facing the same set of facts would be following. Staiger and Sykes (2010) conclude that there is some difficulty in identifying trade effects stemming from currency practices and, because of this factor, the role of WTO dispute settlement is (or should be) limited. They note that, with respect to arguments

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raised under Article XV of GATT, there is not much a panel could do in light of the high burden of proof (that the intent was “frustrated”) associated with this provision.81 This is a very fair conclusion to which one could add two further points. First, it would be quite awkward to entrust panels composed of trade delegates with the authority to decide on monetary issues. Deference to IMF is highly warranted as well because no expertise regarding similar issues is embedded in the WTO. Second, even the IMF itself, the body with expertise on such issues, has found it difficult to conclude whether currency manipulation has occurred, although it has been treating similar questions on hundreds of occasions. It should be noted that in this context, IMF has yet to decide that currency manipulation has occurred. Under the circumstances, it is hard to see what role the WTO could play in this context. There is probably an additional argument here. The whole idea of “global coherence,” of policies that would not meet the test of WTO consistency when they have failed that of IMF, would argue against an active role for WTO panels. IMF, in this framework, would take the lead in monetary issues, and WTO in trade.82 2.3.5.3 Dispute Settlement There is scant practice in this context. The panel, in its report on Dominican Republic– Import and Sale of Cigarettes, dealt with an exchange restriction imposed by the Dominican Republic.83 Essentially, the Dominican Republic had modified its original measure, which covered all transactions, but subsequently replaced it with a measure that covered only imports. Thus, it was discriminating against imports. In the panel’s view, this change was evidence that the Dominican Republic was not genuinely addressing the issue that, in name, it was purporting to address. However, to cement its opinion on this issue, the panel decided to consult with the IMF.84 In the panel’s view, if the IMF authorities held that the measures imposed by the Dominican Republic were in accordance with the IMF Articles of Agreement, these measures would ipso facto be deemed to be GATT-consistent as well (§ 7.139). This approach was the only one that, in the panel’s view, was consistent with a textual reading of Article XV.2 of GATT. So, the panel decided to request the IMF’s advice on whether the restriction applied by the Dominican Republic could be regarded as an exchange restriction in the sense of Article XV of GATT that had its approval. The IMF responded that the measure at hand was not a “multiple currency practice” (since it was only targeting imports and, as such, could not qualify as an exchange restriction in accordance with Article XV of GATT), and, hence, was no longer approved.85 Against this background, the panel concluded that the Dominican Republic could not justify its measures through recourse to Article XV.9 of GATT (§§ 7.143–7.145).86 This finding was not appealed. This panel, hence, was quite deferential to the IMF. Its attitude was at the antipodes of the approach followed by the Working Party discussing the 1971 US import surcharge.87

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2.3.5.4 Burden of Proof The panel on Dominican Republic–Import and Sale of Cigarettes held that the party invoking Article XV of GATT carries the burden of proof associated with this provision (§ 7.131). 2.3.6

Infant Industry Protection

2.3.6.1 The Rationale Article XVIII(c) of GATT allows developing countries that are WTO members to deviate from their obligations to protect their infant industries. Such practices were quite popular in the 1960s and 1970s, but recently developing countries have not made much use of this provision.88 This provision was negotiated during the 1955 Review Session of the GATT to provide developing countries with the necessary legal space to adopt import substitution policies. In theory, one could make the case in favor of protection during the early stages of development.89 The manner in which similar measures have been practiced, nevertheless, has quite often been counterproductive. Lucas (1988), for example, offers a skill acquisition model of endogenous growth and suggests that, by allowing countries to establish a comparative advantage in the production of high learning goods, the erection of trade barriers during the early stages of development may enhance their long-term growth. It is, of course, a totally different issue whether Lucas is followed in the practice of Article XXVIII(c). The test that economists apply in similar cases is called “Mills-Bastable.” It consists of two legs: the first leg is that, assuming existence of learning effects external to a firm, a firm should receive support if, in the medium run, it becomes viable so as to pay back received benefits (Mills). The second leg is that the firm should pay back the present cost of protection assuming discounted future benefits (Bastable). The GATT provision does not replicate this test. It does not even take a stance on the welfare implications of similar invocations. It leaves it to WTO members to make their calculation and decide whether to avail themselves of this possibility. All GATT does is explain the substantive and procedural requirements if recourse to this provision has been decided. In essence, the invoking state must show that the measure favoring a particular industry is meant to raise the general standard of living (a judgment that can hardly be brought into question by its trading partners) and has to respect notification requirements, as well as having an obligation to enter into consultations if the measure envisaged concerns a commodity that has to respect a bound tariff. 2.3.6.2 Dispute Settlement The Panel on India–Quantitative Restrictions made it clear that an invocation of Article XVIII(c) of GATT is justiciable. At the time of writing, the only such restriction in place is by Bangladesh.90

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2.3.6.3 Burden of Proof The previous discussion of BoP and exchange restrictions applies here as well. 2.3.7

General Exceptions (Article XX of GATT)

Assuming that a violation of Article XI of GATT has been established, the violating WTO member can seek justification by invoking one of the grounds mentioned in Article XX of GATT. This provision is discussed further in chapter 9. 2.3.8

National Security (Article XXI of GATT)

Assuming that a violation of Article XI of GATT has been established, the violating WTO member can seek justification by invoking one of the grounds mentioned in Article XXI of GATT. This provision is discussed further in chapter 9. 2.3.9

Safeguards (Article XIX of GATT)

WTO members can limit the amount of imports in their market (and thus legitimately have recourse to a QR), if they have complied with the various conditions included in Article XIX of GATT and the SG Agreement. This point is covered in chapter 4 of volume 2. 2.3.10

Can QRs Be Permissible in Order to Avoid Dumping?

The question arose in case law whether, in an effort to avoid dumping,91 they could legitimately impose a QR. The question, thus, was whether nonstatutory grounds (because this possibility is not provided for anywhere in GATT or the Annex 1A Agreements) could be advanced to justify the imposition of QRs. A GATT panel decided that this could not be the case. In Japan–Semiconductors, Japan was in violation of its GATT obligations because it had provided its economic operators with incentives not to dump. Japan had argued before the panel that, even if its actions were considered to be inconsistent with the discipline embedded in Article XI of GATT, it was still justified in acting in this way since it was aiming to dissuade Japanese economic operators from dumping. Dumping is a practice condemned by Article VI of GATT, as will be explored in more detail in chapter 2 of volume 2. It does not feature anywhere, though, , as an exception to Article XI of GATT. The panel was thus, led to discuss the relationship between Articles VI and XI. It held that Article VI did not address actions by exporting countries. It addressed only actions by importing countries, since it allowed them to impose antidumping duties in order to counteract dumping. It then went on to conclude that (§ 120) “Article VI did not provide a justification for measures restricting the exportation or sale for export of a product inconsistently with Article XI:1.”

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Consequently, one cannot justify an export QR in the name of an effort to avoid dumping practices. 2.4 Applying QRs Article XIII of GATT deals with the application of QRs. It essentially requests from WTO members to respect nondiscrimination when imposing QRs. This provision is silent on a couple of issues. First, it does not mention the period of time that a QR can remain in place. This must be a voluntary omission, though, since the length depends on the “distortion” that it aims to address. Ostensibly, the length of time that a QR can be imposed depends on the rationale behind it. For instance, a WTO member experiencing BoP problems for two years should logically have a QR in place for the same period of time. Conversely, safeguard action that takes the form of QRs can remain lawfully in place for a maximum of eight years, by virtue of Article 7.3 SG. Second, obligations regarding the administration of QRs should kick in only after the consistency of a QR with GATT has been established. For example, if a QR has been justified on BoP grounds, it also must comply, in principle, with Article XIII of GATT.92 In the opposite scenario (that is, if a QR has been judged GATT-inconsistent), recourse to Article XIII would have been superfluous. Article XIII.5 of GATT applies to TRQs as well, a point confirmed in the AB report on EC–Bananas III (§ 160).93 The EU had in place two TRQs, one applicable to bananas originating in the so-called ACP (African, Caribbean, and Pacific) countries94 and another applicable to bananas originating in the rest of the world. The tariff rate for the former was much lower than that for the latter, and, as a result, non-ACP producers had suffered an important trade loss. The EU also agreed during the Uruguay round to provide preferential treatment for bananas originating in countries that signed the so-called Framework Agreement with it (which the EU had attached in its schedule). The panel and the AB upheld the claim advanced by the complainants to the effect that the two-quota system ran afoul of the MFN requirement (§ 191 of the AB report). The AB went on to find that the EU regime was also in violation of Article XIII of GATT, without, however, establishing first that a violation of Article XI of GATT had also occurred. 2.4.1

Nondiscrimination, in Principle

Article XIII.1 of GATT reads: No prohibition or restriction shall be applied by any contracting party on the importation of any product of the territory of any other contracting party or on the exportation of any product destined for the territory of any other contracting party, unless the importation of the like product of all third countries or the exportation of the like product to all third countries is similarly prohibited or restricted.

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So, in principle, legal QRs should not favor a particular source of supply. This was very much the negotiating rationale, to wit: “The basic rule laid down is the rule of non-discrimination. The rest of that Article is an attempt to define what is meant by non-discrimination.”95 The rest of the provision provides three different ways that could be used for this principle to be applied in practice: global quotas, import licensing without quotas, and historic quotas. It is debatable whether the last option (historic quotas) promotes nondiscrimination since it freezes existing market shares. 2.4.2

Nondiscrimination, in Practice

No matter which of the three options a WTO member chooses to adopt, it must be guided by the following principle, embedded in Article XIII.2 of GATT: “In applying import restrictions to any product, contracting parties shall aim at a distribution of trade in such product approaching as closely as possible the shares which the various contracting parties might be expected to obtain in the absence of such restrictions.” This provision reflects a “but for” test: what would the share of the import market look like but for the imposition of the quota? The three options, though, speculate on the counterfactual in different ways, as will be explained next. 2.4.2.1 Global Quotas Article XIII.2(a) of GATT reads: Wherever practicable, quotas representing the total amount of permitted imports (whether allocated among supplying countries or not) shall be fixed, and notice given of their amount in accordance with paragraph 3(b) of this Article.

The words in parentheses make it clear that there is no need to allocate the global quota established to particular sources of supply. According to the preparatory work: Imports could be distributed among traders by any system it chose, provided it did not require them to import from any particular source of supply: in other words, provided it was left to the trader to choose his source.96

2.4.2.2 Origin-Specific Quotas: Historical Shares Paragraphs (c) and (d) of Article XIII.2 of GATT read: Contracting parties shall not, except for purposes of operating quotas allocated in accordance with subparagraph (d) of this paragraph, require that import licences or permits be utilized for the importation of the product concerned from a particular country or source; In cases in which a quota is allocated among supplying countries the contracting party applying the restrictions may seek agreement with respect to the allocation of shares in the quota with all other contracting parties having a substantial interest in supplying the product concerned. In cases in which this method is not reasonably practicable, the contracting party concerned shall allot to

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contracting parties having a substantial interest in supplying the product shares based upon the proportions, supplied by such contracting parties during a previous representative period, of the total quantity or value of imports of the product, due account being taken of any special factors which may have affected or may be affecting the trade in the product. No conditions or formalities shall be imposed which would prevent any contracting party from utilizing fully the share of any such total quantity or value which has been allotted to it, subject to importation being made within any prescribed period to which the quota may relate.

Pursuant to Article XIII.2(d) of GATT, a WTO member lawfully imposing a QR is required to allocate quotas to various suppliers in a manner that respects their pre-QR market shares. A reference period (usually the previous three to five years)97 will be used as the benchmark for the calculation of market shares.98 Hence, it is not nondiscriminatory administration of quotas that is privileged through this provision; rather, it is respect for historical shares. This is, nevertheless, a rather discriminatory policy since new aggressive suppliers will not be put on an equal footing with old suppliers. It could be, for example, that new suppliers come from Home, whereas old suppliers originate in Foreign, and that Home is a more competitive producer than Foreign. Foreign, nevertheless, will be treated better than Home since its share in the export market will be preserved, whereas Home might find it impossible to penetrate the same market because of the advantage granted to Foreign. In similar situations, the constitutive elements of MFN violation will all be present. Article XIII.2(d) of GATT, by preserving historical shares, thus does not account for changes in supply and demand. Therefore, one cannot exclude alignment of incentives between some exporters and the WTO member imposing the QR either: exporters fearing a maverick would support QRs as a means of preserving (at least in the short run) their market share; the importing state would serve its purpose by facilitating agreement toward legalizing its QR in, say, the BoP Committee. In short, preserving historical shares is, in a very superficial manner, only an application of the principle of nondiscrimination. 2.4.2.3 Licenses/Permits without Quotas A third possibility is provided for in Article XIII.2(b) of GATT: “In cases in which quotas are not practicable, the restrictions may be applied by means of import licences or permits without a quota.” The negotiating record explains that importers must not be required to use the licenses they got for imports from any particular source. If licenses are issued, the importer must choose the source from which he will buy. There is the further proviso that full information will be provided as to the licenses granted over a past period. The purpose is to enable supplying countries to see what the distribution among supplying countries in fact was.99

Although not all of this was reflected in Article XIII of GATT, it still has some legal value, being part of the travaux préparatoires. Moreover, as will be explained in chapter 1 of volume 2, the spirit of this quoted passage was embedded in the ILA.

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Discriminatory QRs

Article XIV of GATT allows WTO members that have invoked either Article XII or Article XVIII of GATT to deviate from their obligations under Article XIII. The rationale for this provision is that a WTO member invoking the BoP provision may, by virtue of Article VIII of the IMF Articles of Agreement (which is explicitly mentioned in Article XIV.1 of GATT), be authorized to deviate from its obligations not to discriminate based on the origin of the goods that it will be restricting in its own market.100 The following two conditions must be met: first, the quota must have been imposed to address problems relating to BoP; and second, the discriminatory quota must affect a small part of its trade. 2.4.4

Import Licensing in the WTO Era

The ILA entered into force on 1 January 1995, and regulates import licensing. It is lex specialis to Article XIII of GATT and deals with the obligations imposed on WTO members wishing to have recourse to an import licensing scheme. This point will be discussed in detail in chapter 1 of volume 2. 2.5

Institutional Issues

2.5.1 The Committee on Market Access There is no committee established to deal exclusively with QRs. Consequently, it is the Committee on Market Access that deals with this issue (as well as with tariffs). 2.5.2 Transparency On 22 June 2012, the Council for Trade in Goods (CTG) adopted the “Decision on Notification Procedures for Quantitative Restrictions,” a revision of the previous decision on this score.101 There is nothing remarkable about this legal instrument, other than that it confirmed the prevailing view in academia that notifications are function of the incentives that trading nations have to be transparent.102 According to the decision, WTO members were required to notify the WTO of all QRs they had in place by 30 September 2012, and twice a year after that, as well as of all changes to QRs within six months from the date that a change occurred (§ 1). The notification is quite elaborate, since they must include a description of the QR and the products covered, the type of restriction,103 the tariff lines affected, the grounds for justifying the QR in place, and any additional comments deemed appropriate (§ 2). One might wonder what this decision adds to the legal arsenal, since all QRs are illegal anyway unless a justification has been advanced by the WTO member imposing it. The short answer is transparency. Footnote 3 to the decision states:

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The justification is provided for transparency purposes only and is therefore indicative. It shall not prejudice any legal position a Member may take on the particular measure that the justification is intended to cover.

So, notifications do not immunize notifying members from challenges. Moreover, notifying members can change the legal grounds for justifying their QRs. Under the circumstances, it should come as no surprise at all that only a handful of notifications have taken place, the possibility for “reverse notifications” notwithstanding (§ 1). Eighteen WTO members notified QRs in 2012,104 followed by a few more subsequently.105 2.6

Concluding Remarks

The GATT framers chose wisely when allowing for tariffs and eliminating QRs. Trade liberalization had to be undertaken progressively for various reasons, and the next chapter will return to the necessity for graduation. In this light, tariff concessions are easier to administer within a context of nondiscriminatory trade liberalization. The question, of course, is: How much has been eliminated, and how much has been left to negotiate? There is an inherent indeterminacy in the term “QR,” and unavoidably, absent legislative efforts to specify its meaning, the onus fell on the adjudicators to do so. It was more of a “hot potato” than a softball. Case law has understood the term in a liberal manner in two ways. First, it established that even actions by private persons might be judged GATT-inconsistent if a government had provided private agents with enough incentives to act this way. Second, it subsumed under this term both measures reflecting a numerical target, as well as other measures that de facto lead to a QR effect. Absent extension to de facto QRs, WTO members might have found it easy to circumvent the obligation embedded in Article XI of GATT, and thus defy the spirit of the law. This much is true, but that is not the end of the story. The problem with de facto QRs (“other measures,” in the terminology of Article XI.1 of GATT) is that a line needs to be drawn somewhere, or else we might be casting the net too wide. In equilibrium, all measures at least directly or potentially will affect trade flows. There is some legislative guidance to be sure, but a lot has been left for the interpreter to do. The standard of review that panels will adopt holds the key here: a relaxed standard might lead to type I errors (false positives), and panels will be sanctioning practices that they should not be bothered with in the first place. A very demanding standard might lead to the opposite result and provide disservice to the original intent to widen the coverage of the provision. This is still an open discussion in case law since panels have adopted hard to reconcile attitudes on this score. Think of Japan–Semiconductors for a moment. It is quite unclear, based on the available facts, whether Japanese producers would have behaved the way they did had they not been incited to do so by the Ministry for International Trade and Industry (MITI).106 For

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example, do we really know whether Japanese producers exported less of their produce because of a government scheme asking them to disclose their prices and avoid dumping? How do we know whether they had any incentive to dump when they were obviously more productive than their US competition (otherwise, why would the US have requested the Semiconductor Pact in the first place)? Yes, one could plausibly construct a hypothetical where this could have been the case, but is it enough? What probability can one attach that a similar scenario will occur? And why construct hypotheticals in the first place? Why not ask what happened in the case at hand? Argentina—Hides and Leather was, against this background, a step in the right direction. It established the dichotomy between quotas and “other measures” and paved the way to a more demanding test with respect to the latter category. The analogy with antitrust regulation seems well placed here. Quotas should amount to per se violations. Any numerical target should be considered GATT-inconsistent, and if the WTO member imposing it believes that it does so on legitimate public policy grounds, then it should seek to justify it by citing one of the mentioned exceptions. “Other measures,” on the other hand, should be adjudicated following the rule of reason. We share the idea that the evidentiary standard should be higher for them. Argentina–Hides and Leather went some way in this direction by requesting evidence from complainants challenging the consistency of de facto QRs with GATT beyond the potential for restrictive effect. The term “nexus” used, nevertheless, is rather uninformative. It is high time for panels to start spelling out what specific items they see reflecting the idea of “nexus.” In this endeavor, they will be well advised to drop the sterile “no-intent-cum-no-effects” test, which makes sense only with respect to per se violations (e.g., quotas). They should open the door to entertaining all available evidence that could cement a finding that an “other measure” has operated as a QR. Trade effects could be a powerful indicator in this endeavor, although often they are not dispositive in and of themselves. A government-sponsored diversion of a river, for example, could lead to better irrigation of lands and thus to fewer imports of farm goods. Yes, similar schemes do produce trade effects, and maybe some suffer more than others. But this type of knowledge is many times unknown to the regulator ex ante, and it would be quite far-fetched to label similar practices QRs. In the context of their analysis of “other measures,” panels will inevitably have to ask whether the measure was intended to operate as an import QR. This is a tall order because the party detaining private information here (i.e., the WTO member imposing the contested measure) is also the party with the least incentive to behave in a cooperative manner. It is a classic Prisoner’s Dilemma: tell the truth and go to jail; or lie and face a soft sanction, if any sanction at all. Chapter 7 will return to this discussion, detailing the various elements that could form a coherent test to show de facto violation of a GATT provision. The analysis there applies here as well.

3

Tariffs

3.1 The Legal Discipline and Its Rationale 3.1.1 The Legal Discipline The term “tariffs” (also referred to as “customs” or “import duties”) can be loosely defined as a monetary burden on imports. Following accession to the WTO, tariffs can be “bound”; that is, they have to respect a “tariff ceiling,” a level of tariffs that parties have agreed to observe following negotiations to this effect.1 Once “bound,” tariffs cannot be unilaterally increased any more. If they want to increase the bound level of duty, WTO members must be prepared to pay compensation. Tariffs can also remain unbound, either because negotiations were not held or because they proved unsuccessful; in this case, WTO members remain free to unilaterally set the level of tariffs. At any rate, no matter whether they have bound their tariffs or not, WTO members must observe, in principle, the most favored nation (MFN) obligation when imposing tariffs; that is, they cannot impose a different level of tariffs on “like” products originating in different WTO members. The next chapter will discuss the MFN obligation in more detail. For now, this discussion will focus on the binding of tariffs. Of course, WTO members can impose lower customs duties (than the established “ceiling”) anyway, as per Article II.1(b) of GATT. Although there is no obligation to bind all duties, as suggested previously, WTO members have done so, quite extensively. GATT was a tariff bargain with a supporting act after all, as shown in chapter 1.2 3.1.2 The Rationale for the Legal Discipline To understand the rationale behind the legal discipline on tariffs, it is quite appropriate to think of the counterfactual—that is, the world before the advent of GATT. In the pre-GATT years, in the absence of international commitments to this effect, trading nations were free to change their level of tariffs as they deemed appropriate. They were also free to

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distinguish the tariff treatment between sources of supply. The advent of GATT signaled the end of these two practices. The latter aspect (tariff discrimination) will be covered in the next chapter. For now, we focus on the rationale for agreeing on a “ceiling” for tariffs. The reason for introducing the “ceiling” on the level of tariffs has to do with the need for certainty regarding transaction costs. Tariff volatility could be (and indeed was) the consequence of unlimited freedom to set unilaterally the level of tariffs. International trade would suffer as a result since it would be impossible for traders to calculate the cost of import and export transactions, precisely because of the uncertainty surrounding the level of tariffs imposed. Producers would have to decide on their exports (and importers on their imports) in the face of uncertainty regarding the final price of goods in export and import markets. Uncertainty might in and of itself be an important dissuading factor, and rational agents, characterized by a reasonable amount of risk aversion, could very well decide not to engage in international trade at all and focus on their domestic market instead.3 By agreeing on a tariff ceiling, uncertainty regarding transaction costs would be dealt a fatal blow. Over the years, by lowering the agreed level of tariffs, trade would be incrementally liberalized. We stated earlier that not all tariffs on all goods traded were simultaneously bound. Initially, negotiators focused on tariffs of the important markets for the exported goods they cared most. Over the years, the sample of bound tariffs expanded substantially, and few tariffs remain unbound nowadays. Trade Profiles, an annual publication by the WTO, is an invaluable source for this type of information. For 2013, Brazil, China, the EU, and the US had 100 percent of their tariff lines bound; South Africa stood at 96 percent; India, at 74.4 percent; and only a few developing countries and LDCs exhibited low levels of binding (Cameroon, 13 percent; Chad, 13 percent; Congo, 16 percent; Benin, 39 percent.) It is also quite striking that the more recent the accession to the WTO, the higher the percentage of bindings.4 3.1.3

Discussion

3.1.3.1 The First Tariff Negotiations The first multilateral tariff negotiation took place in Geneva between the late spring and summer of 1947. The legal framework for the Geneva negotiations had been established at the London Conference. Article 24 of the London Draft dealt with the process of binding duties, but did more than that. It imposed an obligation on all states to negotiate tariff reductions, if requested to do so. If this obligation had not been observed (i.e., if a request to negotiate were refuted), requesting states could be authorized by the ITO to withhold the extension of MFN rights on tariff reductions negotiated with third partners. This is a remarkable provision, which was omitted from subsequent drafts. It obviously aimed at reducing the free rider problem. Trading nations could not stay idle, reduce their

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involvement to that of innocent bystanders, and still profit from tariff reductions that others agreed upon in the context of reciprocal negotiations.5 It was some sort of an early version of “conditional MFN.” There was a caveat, though. Countries with low tariffs could justifiably refuse to negotiate because their pre-negotiation level could not be regarded as a serious obstacle to international trade. What constituted a “low tariff” was not defined.6 It was left to the discretion of negotiators, and the (often elusive) common sense that hopefully would prevail. This provision was later dropped. Article VIII of the New York Draft7 kept some of the elements of Article 24 of the London Draft. It stopped short, though, of including an obligation to negotiate whenever a request to this effect had been tabled.8 Cordell Hull wanted to allow some countries (those that mattered less in international trade) to profit from tariff reductions without paying a price. In his view, discussed in chapter 1, this was the contribution of the “big guys”—the duty of leaders, indeed—to incite cooperation from everybody else. Cooperation could occur in trade, of course, as well as in other areas of international relations. Trading nations, though, did not stop worrying about the free rider problem. Hull won the battle as far as the first negotiation was concerned, but he did not win the war. In later years, the idea of a conditional MFN reentered the picture in a more relaxed form—admittedly, in the form of “critical mass agreements,” discussed in the following chapter. 3.1.3.2 The Economics of Tariffs Tariffs represent a tax on imports. They have a distributive impact, in the sense that some win (domestic producers of the competing good), and some lose (consumers, and industrial users of the input). At any rate, there will be deadweight losses, in the form of underconsumption. Tariff income will be directed to the National Treasury.9 Recall from our discussion in chapter 2 that the administrative costs of clearing goods through customs are low since tariff income will be on its way to the National Treasury every time a transaction is cleared at customs and the dutiable amount has been imposed. Conversely, in the case of import quotas, governments will make income only if they auction the right to import the scarce commodity. The auction, of course, is associated with its own transaction costs.10 3.1.3.3 The Rationale for Tariffs Tariffs are imposed for a variety of reasons. Governments might want to protect domestic producers. Olson (1965) stated the “collective action” problem, which producers are more successful than consumers in organizing representations of their interests, and lobby their government successfully to this effect. Protecting domestic producers does not exhaust governments’ decisions to impose tariffs, as they might, assuming they have the necessary bargaining power to this effect, want to affect the terms of trade. They might even want to punish foreign producers polluting the environment, or they might simply wish to raise income. And they might as well want to do so for a combination of the reasons mentioned

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so far, or for many other reasons. In short, governments might be willing to impose tariffs for a variety of reasons. GATT does not discuss at all the rationale for tariff imposition, even though the rationale might affect the negotiating strategy of trading nations. It simply requests that, regardless of the rationale for imposing tariffs, tariff commitments must be respected once they are entered into. 3.1.3.4 Tariff Ceilings and Rigid Tariffs It was stated earlier in this chapter that tariff commitments were meant to curb uncertainty with regard to transaction costs that would have persisted in their absence. Against this background, one might legitimately ask why have tariff ceilings, and why not have rigid tariff bindings? A ceiling is preferable to a rigid tariff binding because, while it serves curbing uncertainty, it also allows downward flexibility to preference shocks and permits efficiencyenhancing tariff reductions. Certainty is served anyway, since traders know the maximum tariff imposition anyway. Flexibility in trade relations is quite welcome since legal commitments entered represent preferences at a given time, but preferences might change before the legal framework does. And it is not simply a question of preferences. For example, governments might find it opportune to reduce their level in case their domestic industry does not need protection because of a technology shock that increased its productivity. Furthermore, Maggi and Rodriguez-Clare (2007) have explained why, due to political economy considerations, governments might have an incentive to opt for ceilings rather than for rigid tariff commitments. With rigid tariff commitments, lobbying effectively ends at the time of the agreement (since the agreement leaves no discretion for governments to choose tariffs in the future). With tariff ceilings, on the other hand, governments retain the option of setting tariffs below the maximum level,11 and thus they might invite lobbying (and the corresponding contributions) after the agreement has been signed. A threat to lower tariffs could persuade lobbies to contribute to the government in order to keep to the agreed level. 3.2

Expressing Goods in a Common Language

The process for binding duties entails a discussion regarding the forum where tariff promises will be made and exchanged, as well as an additional discussion regarding the ambit of the legal obligations assumed. To do all this, negotiators need to be clear as to what exactly they will be contracting (e.g., the identity of goods on which they will be promising to reserve a particular tariff treatment). The Harmonized System (HS) is the instrument to do this job. The HS is not the only available taxonomy for goods. The UN CPC (Central Product Classification) has a similar function, and was first enacted in 1990. The UN CPC in fact,

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unlike the HS, classifies not only goods but also services. In fact, Marchetti and Mavroidis (2011) explain that the W/120, the document used by WTO negotiators to schedule commitments under the GATS, was modeled after the UN CPC. Why then not use the CPC for both goods and services? Two are the important reasons why. First, as we explain infra, the trading nations had been using the predecessors to the current HS for many years before the enactment of the CPC. Switching to another classification regime is costly, a cost that WTO Members did not wish to incur. Second, whereas the CPC is elaborated by “bureaucrats,” this is not the case of the HS, an instrument to the preparation of which national customs authorities have substantial input. The HS could thus, more appropriately take care of the needs of traders around the world. 3.2.1 The Harmonized System 3.2.1.1 The Need for Common Language Goods can be expressed in various ways. Think of the following: the terms “shirt,” “textile product,” and “cotton shirt” could all describe the same item; and “shirt” itself could refer to ostensibly different goods, such as an elegant polyester shirt with a brand name or a very prosaic T-shirt. Add to this the fact that each of these terms can be translated into French, Spanish, Chinese, or Hindi, for example, and you have a Pandora’s box unlocked in front of you. The need for common language to describe traded goods is the consequence of the possibility to express the same item in different ways and the resulting insecurity regarding what precisely is being traded. However, a caveat is warranted at this point. One should not approach the concept of a “common language” as a panacea, since common language is not synonymous to “complete” contract. As will be described in some detail later in this chapter, common descriptions of traded goods still leave room for discretion regarding classification to the implementing domestic authorities. The creators of common language had to balance two competing interests: the level of detail needed to eliminate misunderstandings as much as possible and the need to subsume various products and their varieties under common descriptions. The former objective calls for specific language, whereas the latter requires generic. The level of detail matters, and the more detailed a description is, the more legal security regarding the parameters of the transaction will be served. If, nevertheless, descriptions become too detailed, then not only the lists become longer and longer, but included classifications become so specific, that they might be ill equipped to accommodate new products or varieties. Compromises are necessary, but not always fortunate. Ferrantino (2014) mentions this most appropriate example (p. 1): In 2003, the US Court of International Trade (CIT) ruled in a landmark case, Toy Biz vs. United States, that the X-Men, Marvel’s popular mutant superheroes, were not human. Or at least, action figures representing the X-Men, and imported from China, were not “Dolls representing only human

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beings and parts and accessories thereof” (HS 9502.10), but “Toys representing animals or other nonhuman creatures (for example, robots and monsters) and parts and accessories thereof” (HS 9503.49). It is pecuniary interests, of course, that largely explain the interest in the proper classification (and, thus, the incentive to litigate), and they might be served sometimes by precision, and other times by lack of precision. In this example, when acceding the US market, items falling under HS 9503.49 carry a duty of 6.8 percent, whereas items falling under HS 9502.10 have a duty of 12 percent—nearly twice as much.12

3.2.1.2 The History of Goods Classification The first attempt to provide a multilaterally agreed description of traded goods led to the Geneva Nomenclature (GN), which came into being on July 1, 1937. The GN was replaced in 1959 by the Brussels Convention on Nomenclature for the Classification of Goods in Customs Tariffs (BTN). The BTN was, in turn, replaced in 1974 by the Customs Cooperation Council (CCC) Nomenclature in 1974, which was eventually replaced by the WCO in 1988. The WCO is the successor institution that now supplies the common language for describing goods. It is an international organization with headquarters in Brussels, Belgium. The HS is a document prepared by the World Customs Organization (WCO).13 The WCO has 179 members. The HS Convention is used by more than 200 countries worldwide, and serves as the basis for defining goods for customs purposes. The WCO prepares and updates the HS Convention, which comprises about 5,000 commodity groups. The HS has been amended five times since 1988 (largely in order to account for changes in technology): 1992, 1996, 2002, 2007, and 2011 (the last of these entered into force in 2012).14 3.2.1.3 What Does the HS Do? The HS provides a classification for all traded goods, as well as a series of rules to help address conflicts regarding classification that might arise. The sum of classifications circumscribes of course the coverage of the GATT. The HS is administered by the HS Committee, which is composed of representatives from each HS contracting party, usually customs officers with substantial experience in classifying goods. The HS Committee decides on the classification of goods, on the introduction of new goods in the existing classification, or the deletion of goods that have fallen into desuetude.15 Descriptions of goods (“tariff lines”) are expressed in two, four, and six digits. The fewer the number of digits there is, the more generic the product category will be. Conversely, the greater the number of digits, the more specific the product category described therein will be. For example, at the two-digit level, one might find the term “vehicles,” whereas at the six-digit level, the term is “passenger cars of less than 2 tons.” Any given good is classified under the same tariff line (“heading”) across national jurisdictions. For example, bumpers come under the heading 8708.10, which reads “Bumpers and Parts Thereof” in the schedules of all WTO members. What might vary is the

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tariff treatment of bumpers: for instance, the United States (US) might impose a 2 percent import duty, whereas Pakistan might impose a 10 percent duty on bumpers. Not all WTO members have formally adhered to the HS, but all of them follow the HS classification, either because they are legally bound to do so (by virtue of their membership to the WCO), or de facto (by virtue of state practice). Assuming that a WTO member has made a concession at the four-digit level, it can only treat subclassifications more favorably. Here is an illustration from the US Tariff Schedule: chapter 87 of the HS is entitled “Vehicles Other than Railway Rolling-Stock, and Parts and Accessories Thereof.” HS 8708 is entitled “Parts and Accessories of the Motor Vehicles of Headings 8701 to 8705” (the categories corresponding to tractors, motor vehicles for the transport of ten or more persons, and motor cars principally designed for the transport of persons). HS 8708.10 reads “Bumpers and Parts thereof.” HS 8708.10.60 reads “Bumpers” (i.e., stampings).16 The US bound its tariffs in chapter 87 at the eight-digit level at 2.7 percent. This means that, if it enters a new subcategory (of 8708.10.60) at the 10- or 12-digit level, it will be able to impose a maximum duty of 2.7 percent. A similar outcome would result had the US committed to observe a 2.7 percent ceiling at the four-digit level—that is, for the entry 8708. Any subclassification of this entry (i.e., 8708.01, 8708.02, or 8708.01.01) would have to observe this 2.7 percent ceiling. Headings often include more than one product. HS 5702.10 for example includes carpets and floor coverings, and specifically mentions “kelem” and “schumacks” in its list of covered products. If Home makes a binding with respect to all goods mentioned, it will be making a “full binding,” and if it enters a binding only with respect to “kelem,” it will be making a “partial binding.” Two instruments complement the HS Convention: the Harmonized System Explanatory Notes (HSEN), and the General Interpretative Rules (GIR). These two instruments help decide on the proper classification of goods. HSEN constitute the official interpretation of the HS, and typically clarify the scope of tariff headings and—subheadings. Conflicts regarding their scope, though, might still arise in case for example, a good could come under two distinct headings. GIRs, a legal instrument akin to “conflict rules,” help decide what the scope should the explanation offered by the HSEN not suffice. There are six GIRs, and each one of them addresses a different situation. GIR 3(a) stipulates, for example, that the heading, which provides that the most specific description shall be preferred to headings providing a more general description, whereas GIR 4 deals with cases where recourse to GIRs 1–3 cannot help resolve the problem posed, and states that: “Goods which cannot be classified in accordance with the above Rules shall be classified under the heading appropriate to the goods to which they are most akin.”17 It is hoped that recourse to HSEN and GIR would reduce the size of interpretative issues that might arise, but this is not necessarily always the case. There is a Plan B

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embedded in the HS Convention, in case recourse to the GIRs has been fruitless. Since disputes regarding the proper classification might still arise, for whatever reason, the HS Convention allows dispute resolution. This instrument will be discussed later in this chapter. We stated earlier that the HS de facto circumscribes the coverage of the GATT as well, since it reflects all goods for which tariff concessions can be exchanged. The GATT does not contain a provision on its coverage. From day one it was assumed that tariff concessions would take place using the predecessor of HS as the background for goods’ descriptions. This was all there was. The NAMA (non-agricultural market access) negotiation of the Doha round, conversely, contains explicit reference to the effect that the coverage of the negotiations extended to HS chapters 25–97 except for specific entries that concern farm goods.18 What about non-NAMA goods? The Agreement on Agriculture that we discuss in chapter 8 of volume 2 contains an explicit provision regarding its coverage. Still, issues regarding the coverage of the GATT have arisen in practice because of the so-called optional headings in HS, and because of the uncertainty regarding the line of demarcation between GATT and GATS. We take each issue in turn. No goods are ex ante excluded from the scope of the GATT. Even electricity is considered a good and there is a specific entry in the classification regime of the “Harmonized System,” namely 2716.00. The HS explicitly labels this code as “optional heading.” In fact, HS2716 is the only “optional heading” there is. WTO Members wishing to exchange concessions on electricity do not have to use this heading, its long presence in the HSsystem notwithstanding (it corresponds to heading 27.17 of the CCC nomenclature); they can use a different description for electricity. In fact, Australia, New Zealand, and Maldives decided not to include this heading in their schedule. Some WTO Members, on the other hand, have taken tariff commitments under this heading. The CTS (Consolidated Tariff Schedules) database shows 80 schedules with commitments on electrical energy (counting the EU-28 as one). The WTO operates two databases concerning tariffs: the IDB (Integrated Database), and the CTS. Whereas the IDB contains data regarding imports, and “applied rates,” and CTS reflects data regarding ‘bound’ level of duties. It is not the case nonetheless, that all 80 schedules contain “specific” commitments on 2716. Many of them include generic “ceiling bindings” on all products, that is, a maximum level of duty on all goods (included those reflected in the “optional heading”). The remaining Members did not include the “optional heading” in their schedules. The question has arisen of late about whether energy products like electricity should evade—as far as Members unwilling to transpose heading 27.16 in their schedules are concerned—not only the scope of tariff concessions, but the scope of GATT altogether. A detour in the Uruguay round negotiations is necessary in order to shed light on this point. The question whether energy goods are covered by the GATT was raised during the Uruguay round within the Negotiating Group on Nature Resource-Based Products (NRBP).

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This group picked up the mandate of the 1982 “Working Group on Trade in Natural Recourse Products,” which focused on trade in non-ferrous metals and minerals, forestry products, and fish and fisheries products. The question arose early on in the negotiating process whether the coverage would stay the same or whether electricity and more generally energy products would also be covered.19 The Nordics, the EU, the US, and Australia all tabled proposals in favor of inclusion of energy products.20 Developing countries were between skeptical to hostile to the idea of extending the coverage of this group.21 Various GATT Secretariat document reflect that there was disagreement between the members of the negotiating group on this score.22 Participants in the Uruguay round were thus, left free to decide whether they would enter commitments on similar goods (using the HS “optional heading” to this effect) or not, without addressing the overarching issue regarding the coverage of the GATT. The issue reemerged in the context of the negotiation on Trade Facilitation, where the EU on the one hand (WTO Docs. G/C/W/422, TN/TF/W/79), and Egypt and Turkey on the other (WTO Doc. TN/TF/W/179) presented opposite views as to the coverage of electricity by the GATT. The same issue occupied the Panel on Canada—Renewable Energy, where electricity was treated as good only because the parties to this dispute agreed this to be the case (footnote 46). This Panel did not provide a definitive finding on the coverage of the GATT on this issue. In our view, the GATT covers all products mentioned in the HS, including those referred to in the “optional heading.” The latter should be understood as “suggested” classification and nothing beyond that. In other words, WTO Members should be free to classify energy goods in any other way they deem appropriate, but by not accepting the “optional heading” they are not ipso facto escaping their obligations with respect to energy products under Articles I, III, V GATT, etc. The “option” in other words, concerns the classification suggested by the HS, and it is not carte blanche to decide on the coverage of electricity. Electricity comes under the purview of GATT, and WTO Members retain discretion as to the classification they want to use in order to exchange concessions (as they have done in the past). Energy is regulated under the GATS as well. The GATS-equivalent to the HS is the document “W/120” prepared by the WTO Secretariat (WTO Documents MTN. GNS/W/120), which was based on a UN CPC that we discussed earlier. Neither W/120, nor the CPC contain a separate section for energy services, but include a reference to “services incidental to energy distribution” under the heading “business services.” It is clear, nevertheless, that under GATS commitments will be made regarding services relating to energy goods, and not the goods as such.23 In this vein, the production of electricity is not a service. But the distribution, transport, trading and other related services are. For WTO law purposes what matters is whether a commitment has been entered under GATT or GATS. The line between commitments in goods and in services is often a line in the sand, and we will revert to this issue in chapter 7 of this volume, where we explain why commitments under the GATS should be given precedence.

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3.2.1.4 How Common Is Common Language? The “optional heading” is not the only reason for discrepancies across schedules regarding the factual description of goods. From the six-digit level onward, WTO members retain some discretion in describing goods. Article 3.3 of HS reads: Nothing in this Article shall prevent a Contracting Party from establishing, in its Customs tariff or statistical nomenclatures, subdivisions classifying goods beyond the level of the Harmonized System, provided that any such subdivision is added and coded at a level beyond that of the six-digit numerical code set out in the Annex to this Convention.

Descriptions of 8 digits and above are national classifications. There is no guarantee that they are lawful, and thus they can be challenged before the WTO for not observing Article 3.3 of HS.24 The argument could be, for example, that two subdivisions reserve different tariff treatment to two “like products.” The only guidance so far on this issue is provided by the GATT panel report on Japan–SPF Dimension Lumber. Japan was imposing a 0 percent duty on some lumber, and 8 percent on spruce, pine, and fir (SPF) lumber. Canada was producing more of the latter, and it argued that the two goods were like, and, consequently, that Japan had violated its obligations under Article I of GATT. Japan’s tariff treatment was on “national” classifications (e.g., beyond the six-digit level). The panel started its analysis by acknowledging that the HS structure was intentional, and it had been designed the way it was in order to leave room for further specifications (§ 5.8). It recognized that the lack of absolute uniformity carried the inherent risk of abuse, but it insisted that this had to be accepted, and so the panel’s role would be to ensure that the risk would not be material (§ 5.9). To this effect, it devised a test that would allow it to distinguish wheat from chaff: it would counterbalance the interest for internal protection (Japan), against the impact that the measure had on imports (Canada) (§5.10). When applying the test in the case before it, it held that Canada’s claim could not succeed since it had not established that the goods were like. Canada had insisted that the two types of lumber qualified as “dimension” lumber. Japan, nevertheless, had not even used this term in its classification. Canada was exporting its own classification and denomination and, for this reason, was not sufficiently taking into account the Japanese interest in internal protection (§§ 5.15ff.). This case law is not much help, alas. The problem is that the interest for internal protection can be presumed to exist—otherwise, why establish the subdivision in the first place? Some will be positively affected by the subdivision, and others will be negatively affected, that much is certain. We know nothing, though, about the single most important feature of this test (namely, the balancing exercise). The panel stopped its analysis where it should have started it, and, as a result, we remain in the dark as to what the balancing test entails. Some trading nations [the US and the European Union (EU) among them] routinely schedule their commitments at the eight-and-above digit level. To decide whether similar classifications are lawful, Panels would have to first decide whether “like goods” are treated in unlike manner. We will return to this discussion in the next chapter.

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3.2.1.5 Dispute Settlement Regarding Classification Disputes regarding tariff classification can of course, be resolved before the GATT/WTO.25 They can also be resolved before the HS Committee. There is no “hierarchy,” there is no sequence between the two adjudicating fora. In principle thus, “forum shopping” cannot be excluded. This possibility, nevertheless, is not realistic, for the reasons explained in what immediately follows. Article 10 of HS reflects the dispute settlement provisions available to its signatories. All disputes will be submitted to the HS Committee, which will make recommendations to the parties. This is not necessarily the end of the story, though, since the losers might just ignore the ruling. The WCO does not include a mechanism to enforce its rulings. Moreover, nothing will stop parties to a dispute before the WCO from raising the same dispute before the WTO. Of interest to this volume is the question of what happens if a dispute about tariff classification becomes a WTO dispute. This raises the question of whether WTO panels should (or must) observe prior rulings by the HS Committee, if of course a ruling to this effect exists.26 The legal status of the HS in WTO law is not addressed in the Agreement Establishing the WTO (WTO Agreement) but has been clarified in case law. The panel on EC–Chicken Cuts dealt with this issue. The facts of this case are as follows. Brazil exported salted meat to the EU market. The EU had entered a commitment whereby a higher tariff level was imposed on meat, and a lower tariff level on salted meat. Brazil claimed that it did not profit from the lower level of tariff, the fact that it had been exporting salted meat to the EU notwithstanding. Its claim was that it was paying the higher duty reserved for meat when it should be paying the lower duty applicable to salted meat. The EU justified its refusal to apply the lower duty to Brazilian exports of meat, arguing that meat, if not salted for preservation purposes, could not benefit from the lower tariff since that tariff line (e.g., “salted meat”) was intended to cover meat salted for preservation purposes only. This was not the case with Brazil’s exports, which in the EU view was meat sprinkled with salt, but the quantity of salt would not suffice in order to preserve the meat exported. The panel rejected the arguments advanced by the EU and agreed with Brazil.27 In its view, nothing in the HS description conditioned the classification of salted meat under 02.10 (the relevant HS tariff heading) on the purpose of salting. As a result, any salted meat, regardless whether it was salted for preservation purposes or otherwise, should come under this heading. In doing that, it went through all interpretative elements of the Vienna Convention on the Law of Treaties (VCLT) system, paying particular attention to the HS system since it considered it to be the context of the negotiation. It saw nothing in the HS tariff heading linking salting meat to an attempt to preserve it. There is even evidence in the report that the panel corresponded with the HS Committee to this effect. At the end of the day, how-

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ever, it decided the issue based on its own evaluation of the facts (§§ 7.104ff). The Appellate Body (AB) upheld the panel’s findings in this respect (§§ 199ff).28 The AB stated clearly in its report that the HS Convention provided legal context to the Agreement Establishing the WTO (and more specifically, to the schedules of concessions29 submitted by WTO members), in the VCLT sense of the term (Article 31.2). As a result, panels have no discretion—they must always take it into account when the issue of interpretation of a particular concession arises. WTO panels should thus be looking at the HS Convention, the HSEN, and the GIR before deciding tariff classification issues. The AB report left unclear one important angle, however: what about the HS “secondary law” (e.g., the decisions of the HS Committee)? In the absence of any guidance to this effect, it is left to panels to decide this issue. The panel on EC–Chicken Cuts cooperated with the HS organs but reserved the final decision of the dispute before it to its own judgment. It did not feel compelled to defer to similar decisions. From a pure legal perspective, this seems to be the correct approach. It is doubtful, nevertheless, whether this is a sound approach. The HS Committee, in light of its institutional mandate, is probably better placed to decide on classification issues. At any rate, in the interest of easing transaction costs, it would be probably useful for the WTO to enter into a more detailed contractual arrangement with the WCO, inspired by its practice with the WB and the IMF. This panel did not have to decide whether, for WCO members, there is an obligation to first attempt to solve their differences using the WCO adjudication procedures before having recourse to the WTO. From a WTO law perspective, a negative response seems warranted. WTO law (Article 1 of the DSU) does not contain any clause akin to “exhaustion of local remedies.” To the extent that a dispute comes under the ambit of Article 1 of the DSU, the establishment of a WTO panel can legitimately be requested. EC–Computer Equipment concerned a similar disagreement between the EU and the US—namely, the proper classification of certain computer equipment that the US had been exporting to the EU market. The particular commodity [local area network (LAN) equipment] could, conceivably, come under two different HS classifications. In light of the difference in the tariff level, the US had a strong trade interest in seeing that it classified under the heading with the lower import duty.30 To make matters even more complicated, there were divergent practices with respect to the classification of LAN equipment even among individual EU member states. The panel was asked, among other things, to decide whether the legitimate expectations of the WTO member that had negotiated the concession (the US) mattered for the classification of the good. The panel agreed with the US, finding that in the case of ambiguity, legitimate expectations mattered. The AB rejected the panel’s interpretation. In its view, if expectations were relevant at all, it should be the legitimate expectations of the WTO membership, not of one individual member (§§ 80–96). In its words (§ 84):

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The purpose of treaty interpretation under Article 31 of the Vienna Convention is to ascertain the common intention of the parties. These common intentions cannot be ascertained on the basis of the subjective and unilaterally determined “expectations” of one of the parties to a treaty. Tariff concessions provided for in a member’s Schedule—the interpretation of which is at issue here—are reciprocal and result from a mutually advantageous negotiation between importing and exporting members. A Schedule is made an integral part of the GATT 1994 by Article II:7 of the GATT 1994. Therefore, the concessions provided for in that Schedule are part of the terms of treaty. As such, the only rules which may be applied in interpreting the meaning of a concession are the general rules of treaty interpretation set out in the Vienna Convention. (italics and emphasis in the original)31

This passage is a bit cryptic,32 but it seems to provide even more support for the proposition that HS should be the legal context for schedules of concessions. After all, it is there, in the premises of the WCO, that the common approach regarding the proper classification of any given good will be established. 3.3 The Types of Duties Bound People colloquially refer to “duties,” “customs duties,” “tariffs,” “import tariffs,” and “charges” as if they all mean one and the same thing. Indeed, some of the terms are interchangeable, but some are not. In what follows, we aim to analyze what exactly is being bound for the purposes of customs clearance. In the classic scenario, duties will be bound following reciprocal negotiations, where trading nations give a tariff promise in exchange for a tariff promise they receive. Reciprocity holds the key in the process of binding duties, and it is only natural for any discussion to start there. 3.3.1

Reciprocity

Tariff (and nontariff) concessions can, of course, and do on occasion, take place unilaterally. This possibility will be explored later in this chapter. Typically, however, they are based on reciprocal commitments that take place in the context of the so-called “trade rounds.” Why reciprocity though? Recall that classical trade theory (reviewed in chapter 1) holds that unilateral trade liberalization is advantageous. Viewed from this angle, why bother about reciprocity? We saw in chapter 1, when referring to optimal tariff, that countries representing a sizeable amount of the overall demand for a commodity can profit by imposing a tariff that will force exporters of commodity to reduce the price. Terms of trade theorists base their work on examples where countries that can affect terms of trade of different commodities can profit through reciprocal reductions of tariffs. But even outside this framework, Home will simply profit more if Foreign also reduces its tariffs, since, in this scenario, it will benefit both in the import and export size as well.33 Recall from chapter 1 that negotiations on tariff liberalization generally been based on reciprocal commitments, especially during the first years of the GATT era. Eric Wyndham-

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White, ex–director general (DG) of GATT, captured “reciprocity” in the following terms, when speaking during the Torquay round: ... a number of European countries with a comparatively low level of tariff rates considered that they had entered the Torquay negotiations at a disadvantage. Having bound many of their rates of duty in 1947 and 1949, what could these low tariff countries offer at Torquay in order to obtain further concessions from the countries with higher level of tariffs?34

Reciprocity in tariff negotiations (and nontariff negotiations as well) is first-difference reciprocity. The value of commitments will be appreciated against the background of the pre-existing situation. Home for example, imposes a 25 percent duty on widgets, and Foreign 20 percent on the same good, and they agree to reduce their levels by 50 percent each. In contrast, full reciprocity would require that Home and Foreign impose identical tariff levels on widgets, say 10 percent. GATT/WTO negotiations are about first-difference, and not about full reciprocity.35 Reciprocity is often referred to as a GATT legal principle. The term “reciprocal” is mentioned twice in connection with tariff reductions, the first time in the GATT Preamble, and the second time in Article XXVIIIbis of GATT. We quote: Being desirous of contributing to these objectives by entering into reciprocal and mutually advantageous arrangements directed to the substantial reduction of tariffs … The contracting parties recognize that customs duties often constitute serious obstacles to trade; thus negotiations on a reciprocal and mutually advantageous basis, directed to the substantial reduction of the general level of tariffs and other charges on imports and exports and in particular to the reduction of such high tariffs as discourage the importation even of minimum quantities, and conducted with due regard to the objectives of this Agreement and the varying needs of individual contracting parties, are of great importance to the expansion of international trade.

Both times, thus, it is a mention of hortatory nature, and not of a binding legal obligation. The term “reciprocal” is also mentioned in Article XXVIII of GATT, which deals with renegotiation of tariffs as we shall see later in this chapter: “… the contracting parties concerned shall endeavour to maintain a general level of reciprocal and mutually advantageous concessions.” And then, there are numerous references throughout GATT and the various Annex 1A Agreements to terms like “substantially equivalent concessions” that reflect the concept of “reciprocity.” Most notably, Article 22.4 DSU states that (multilaterally authorized) retaliation against violations of the covered agreements shall be limited to withdrawal of “substantially equivalent concessions,” aiming thus to preserve reciprocity when recalcitrant WTO members are punished. The WTO is a “multilateral contract” though, and not a series of bilateral relationships. In the name of reciprocity, for example, WTO members are not free to disrespect their obligations, simply because one of their partners has failed to do so. Foreign cannot argue that it does not have to observe the WTO contract because Home has failed to do so: if

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Home violates the contract, Foreign cannot, by invoking “non adimplenti contractus” (reciprocity), stop honoring its own commitments. At most, Foreign can challenge Home’s practices before the WTO adjudicating bodies, and Home will, if found guilty, have to implement the rulings. In the meantime, Foreign will have to continue observing the contract. Only if Home refuses to implement the multilateral rulings can Foreign request authorization to stop honoring its own commitments, on a transitional basis, until Home starts respecting the contract once again. Reciprocity is, of course, the negotiating principle adopted during negotiations aiming to consolidate the level of tariffs. In a request-offer, for example, unless both parties are happy with the offer (counteroffer) they have received, they will not leave the negotiating table, or they will leave it empty-handed.36 Reciprocity is very much present in the context of the other negotiating techniques used in reducing tariff protection mentioned later in this chapter, although it might, on occasion, be more complicated to calculate the value of concessions received in a nonbilateral context. Indeed, even when it comes to measuring the impact of tariff concessions that Home and Foreign will operate in two goods, equivalence of concessions is hard to establish. It suffices that offer and counteroffer seem “equivalent” in the eyes of the negotiators. For the rest, time in and of itself will swing the bargain one way or the other. These are forwardlooking endeavors, and even if one could demonstrate that a 5 percent reduction of Home’s duties on widgets today equals a 2 percent of Foreign’s duties on wheat, no one can demonstrate with certainty that this will be the case tomorrow. There are, of course, mechanisms (like Article XXVIII of GATT, which will be discussed later in this chapter) that aim to reestablish the balance of rights and obligations when it has been altered. Keohane (1986) distinguishes between two elements in reciprocity: contingency and equivalence. Contingency means that action by Home will be contingent on action by Foreign. Contingency, nevertheless, is not enough. Why would Home accept to reduce its tariffs drastically (and, thus, eviscerate its power to affect terms of trade, remove an instrument of protection for its domestic industry, or both), unless Foreign does (at least) the same? This is where equivalence kicks in. Home will do this if Foreign does the same, even with the caveat regarding the measurement of offer and counteroffer mentioned previously.37 Keohane (1986) further distinguishes between “specific” and “diffuse reciprocity.” Specific reciprocity is best suited to bilateral agreements where the exchange of equivalent treatments can be better measured. Diffuse reciprocity is better suited to multilateral agreements, like GATT and the WTO. Various trading nations participate, and one country’s tariff reductions affect (positively or negatively) nations other than the one that negotiated the tariff reduction. Hence, the inclusion of disciplines, like MFN and National Treatment, which we discuss in chapters 4 and 7 in this volume, and which reflect general standards of behavior. The innate characteristics of both MFN, and National Treatment are hard to reconcile with “specific reciprocity,” and quite akin to “diffuse reciprocity.”

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All this to return to the point made earlier in this chapter: namely, it is difficult to measure equivalence when it comes to evaluating trade concessions. This is why Keohane has rightly insisted that diffuse reciprocity better suits the GATT setting. The former DG of GATT himself, Arthur Dunkel, put it very eloquently, when stating: “Reciprocity cannot be determined exactly, it can only be agreed upon.”38 In a similar vein, one GATT document says: No rules were laid down regarding the measurement of reciprocity other than those already contained in Article XXVIII bis, and the traditional view of the GATT on this matter (that “governments participating in negotiations should retain complete freedom to adopt any method they might feel most appropriate for estimating the value of duty reductions and bindings”) was reaffirmed.39

This is true for tariff concessions, and a fortiori true for concessions on regulatory barriers, hence the insistence on general standards of behavior when contracting in this area. Wherever the line of reciprocity has been drawn, it constitutes the point of departure from which compensation will be calculated in case the original contract is renegotiated. This question will be considered later in this chapter. 3.3.2

OCDs and ODCs: Different Yes, but How?

Article II of GATT explains that it is the level of “ordinary customs duties” (OCD) and “other duties and charges” (ODC) that will be “bound.” Neither of the two terms is detailed any further in the body of Article II of GATT. The wording of Article II of GATT, however, suggests that a dividing line must be drawn between the two terms since different obligations were assumed with respect to each one of them, at least initially. The relevant part of Article II.1(b) of GATT reads: The products described in Part I of the Schedule relating to any contracting party, which are the products of territories of other contracting parties, shall, on their importation into the territory to which the Schedule relates, and subject to the terms, conditions or qualifications set forth in that Schedule, be exempt from ordinary customs duties in excess of those set forth and provided therein. Such products shall also be exempt from all other duties or charges of any kind imposed on or in connection with the importation in excess of those imposed on the date of this Agreement or those directly and mandatorily required to be imposed thereafter by legislation in force in the importing territory on that date.

3.3.3 What Is an Ordinary Customs Duty? Surprisingly, there is no statutory definition of the term “ordinary customs duty” (ODC), although as we have stated a number of times so far in this volume, the main purpose of GATT was the “binding” of customs duties. It is imaginative impositions of customs duties that brought the question of definition of OCDs before GATT/WTO panels. The Panel on Chile—Price Band System first, and the AB later, dealt with this issue in considerable detail. The thrust of the analysis in the two reports is that a measure cannot simultaneously

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be both an OCD and an ODC. The issue before the WTO adjudicating bodies was the consistency of the notorious price band system (PBS) that Chile practiced with the WTO rules. In § 7.39 of its report, the panel explained the function of PBS in the following terms: When a product covered by the Chilean PBS arrives at the border for importation into Chile, Chilean customs authorities will determine whether the total amount of applicable duties declared by the importer corresponds to the amount due under Chilean legislation, and, if necessary, revise the amount accordingly. In application of the Chilean PBS, they will levy an 8 per cent ad valorem duty, plus an “additional specific duty” if an administratively determined lowest offer price from a selected foreign market (hereinafter referred to as “the Reference Price”) falls below the lower threshold of the PBS. They will apply only the 8 per cent ad valorem duty if the same Reference Price is between the lower and upper thresholds of the PBS. They will grant a “rebate” on the 8 per cent ad valorem duty if the Reference Price is above upper threshold of the PBS. The PBS is determined annually on the basis of f.o.b. prices observed on a particular international market over the course of the preceding 60 months, which are adjusted in accordance with a Central Bank of Chile index, and listed in descending order. The lower and upper thresholds of the PBS are obtained by discarding 25 per cent at the bottom and at the top of that list and adding “usual import costs” to the prices. The lowest and highest prices which are obtained after these operations constitute the lower and upper thresholds of the PBS. The specific duties and rebates corresponding to different f.o.b. prices are published in the Official Journal of Chile. The Reference Price is determined weekly, every Friday, using the lowest f.o.b. price for the covered products on foreign “markets of concern to Chile.” Unlike the prices used for the composition of the PBS, it is not subject to adjustment for “usual import costs.” The applicable Reference Price for a particular shipment is determined in reference to the date of the bill of lading. The Reference Price is not published, but can be consulted by the public at the offices of the Chilean customs authorities. As indicated, if the Reference Price falls below the lower threshold of the PBS, an “additional specific duty” will be levied in addition to the 8 per cent ad valorem applied rate. We will term this additional duty the PBS duty. The PBS duty will equal the difference between the Reference Price applicable on the date of the bill of lading and the lower threshold of the PBS.

As a result (§ 7.41): “Thus, the Chilean PBS operates to insulate the Chilean market from world market prices.”40 Argentina had complained that, when applying this system, Chile sometimes imposed duties in excess of the bound level. One of the questions was whether the Chilean system qualified as an OCD in the first place. The panel41 defined OCDs as duties that, as an “empirical” matter, take the form of ad valorem, specific duties, etc., and as a “normative” matter, they relate to the value of the imported good but are levied without regard to exogenous factors; e.g., market prices (§7.52). The AB disagreed with this definition, arguing that many applied duties take into account exogenous factors such as the needs of producers and consumers. In the AB’s view, all that is required for a measure to constitute an OCD is that it is expressed in a particular form. The AB thus endorsed only the empirical element in the panel’s analysis (§§ 264–278).

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Since the empirical element is what matters when qualifying a measure as an OCD, we need to look at the practice regarding forms of duties. Schedules of concessions reveal that (except for tariff quotas, as already discussed in chapter 2) WTO members practice the following forms of duties: 1. Ad valorem 2. Specific 3. Compound 4. Alternative (or mixed) 5. Technical duties An ad valorem duty is a percentage of the value of the imported product (e.g., 15 percent of a fax machine, the import price of which is $400). A specific duty is related to the weight, volume, surface, and other aspects of the good at hand (e.g., $20 per ton of imported wheat). A compound duty comprises an ad valorem duty to which the customs authority adds or from which it subtracts a specific duty (e.g., 10 percent on the import price of wheat plus $2 per imported kilogram of wheat). An alternative or mixed duty ensures a minimum or maximum tariff protection through the choice between say an ad valorem and a specific duty (e.g., 10 percent on the import price of wheat, or $2 per imported ton, whichever is the greater). Finally, particularly where agricultural products are concerned, a technical duty is determined by complex technical factors such as alcohol or sugar content. 3.3.4 What Is an Other Duty or Charge? In the absence of a legislative definition, the GATT Secretariat was requested to produce a document,42 which provided the first step toward a definition. The Secretariat document suggested elements that should be used in order to define ODCs. The Secretariat document used state practice regarding ODCs as inspiration for the criteria proposed. It focused on elements around which a consensus had been built through state practice, namely: 1. ODCs should be applicable only to imports. 2. The applicable date concerning the binding of an ODC. 3. The legal effect of inscribing an ODC in a schedule of concessions. Most of these points found their way into the Understanding on the Interpretation of Article II.1(b) of GATT, concluded during the Uruguay round. The travaux préparatoires of the Understanding reveal that it was agreed that it would have been a daunting task to attempt to draw up an exhaustive list of ODCs, a point that the panel, in its report on Dominican Republic–Import and Sale of Cigarettes, first observed and then fully endorsed (§ 7.114).

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The Understanding, thus, provides that: 1. ODCs have to be recorded in schedules of concessions; otherwise, they are ipso facto GATT-inconsistent. 2. Since ODCs are linked to customs duties, and since only bound customs duties appear in a schedule, in practice, ODCs applicable to unbound duties do not have to be included in schedules of concessions.43 Nevertheless, ODCs do not become GATT-consistent by the mere virtue of inclusion in a schedule of concession. WTO members were entitled, for a period of three years after the entry into force of the WTO Agreement, to challenge the consistency of ODCs reflected in a schedule of concessions with GATT, either because an ODC did not exist at the time of the original binding of the item in question or because it exceeded its prior level ((§ 4). WTO members can still challenge ODCs after the established three year-deadline on grounds other than those mentioned previously, and argue that they are GATTinconsistent (§5). Nowadays, ODCs are being negotiated just like OCDs and, in practice, they are usually expressed in ad valorem terms.44 As is the case with OCDs, ODCs have to respect the negotiated ceiling. 3.3.5 Terms, Conditions, and Qualifications Recall that, as per Article II of GATT, imported goods will not be burdened with duties higher than those reflected in the schedule of concessions, subject to “terms, conditions, and qualifications” specified therein. There is nothing like statutory definitions of the terms. They referred to the level of duties agreed, as well as various clauses that would have been added. Since schedules of concession contained few clauses other than the level of duties agreed, little attention was paid for years to these terms. It was made clear, though, early on, that they could not be offered to justify the violation of WTO obligations. The GATT Panel on US—Sugar reviewed the preparatory work of Article II of GATT, holding that (§ 5.6): “Schedule provisions qualifying obligations under the General Agreement were not included in the specimen Schedule, nor was the possibility of such Schedule provisions mentioned by the drafters.” In the same paragraph, this panel explained that the term “terms and qualifications” was added next to “conditions” in order to make room for additional concessions (as opposed to qualifying existing obligations). Practice, in the post-Uruguay round era, brought these terms back to the center of the discussion. The countries that acceded to the WTO after 1995 were in large part former communist countries—“transition economies,” as they were labeled. They accepted numerous obligations that incumbents did not have to accept when they had joined. Their

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obligations were reflected in their Protocols of Accession. Similar obligations were typically judged necessary by the incumbents because otherwise (e.g., in the absence of similar arrangements), the effectiveness of trade commitments agreed would have been curtailed. They were thought necessary because the newly acceding countries did not have mature market economies yet, and it was feared that the value of trade concessions would be eviscerated because of the absence of functioning markets. Many of the obligations assumed had to do with trading rights; that is, for the possibility to allow private agents to freely import and export, or do so within agreed transitional periods. These arrangements aimed at circumventing (or eliminating) existing import and export institutional bottlenecks that hampered international trade and could qualify as “terms, conditions, and qualifications.” Countries that have acceded after 1995, thus, have to observe obligations that incumbents did not have to adhere to. The legal justification for this two-tier system is included in the various “terms, conditions, and qualifications.” 3.3.6

Consolidating Nontariff Barriers

The fact that it is tariffs that are routinely consolidated in schedules of concessions does not mean that nontariff barriers (NTBs) cannot be consolidated as well. The report of the Review Working Party on Other Barriers to Trade states: The Working Party also agreed that there was nothing to prevent contracting parties, when they negotiate for the binding or reduction of tariffs, from negotiating on matters such as subsidies, which might affect the practical effects of tariff negotiations; provided that the results of such negotiations should not conflict with other provisions of the Agreement.45

Subsidies are now being regulated in a separate agreement, discussed in chapter 3 of volume 2. Commitments on NTBs do exist and appear (albeit not often) in some schedules of concessions. 3.4 The Forum for Tariff Concessions Tariffs have been typically reduced in trade rounds, progressively. Why progressively, and not all at once? It is clear from the negotiating history related in chapter 1 that trading nations were, for various reasons, unprepared to eliminate tariffs right away. Economic theory lends support to this approach: Mussa (1986) showed that elimination of tariffs at one go would be optimal only when trading nations can credibly commit to tariff rates and there are no distortions in goods and factor markets. At that time, the first condition was not met, and the second was highly exceptional, if not illusory altogether.46 There is one exception to this rule. In 1998, the WTO Members agreed to abolish customs duties on all goods traded electronically.47 Their decision (entitled Work Programme

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for Electronic Commerce) to do so defined “electronic commerce” (or “e-commerce,” as it is often referred to in the following terms: “‘electronic commerce’ is understood to mean the production, distribution, marketing or sale or delivery of goods and services by electronic means.” An e-book, for example, would satisfy this definition. In Bali, in December 2013, WTO Members reiterated their support for the Work Programme on Electronic Commerce.48 We stated in chapter 1, that reduction of tariffs is the single most important success of the GATT. As of 2013, the simple average tariff for all goods in China is 10 percent for bound duties, and 9 percent for applied duties. The corresponding numbers for the EU are 5.2, and 5.5 percent; Brazil, 31.4, and 13.5 percent; for India, 48.6, and 13.5 percent; for South Africa, 19, and 7.6 percent, and for the US, 3.5, and 3.4 percent. It is only small developing countries and LDCs that continue to have very high duties. The numbers for Togo for example are 80 and 12 percent.49 Notice nonetheless, that the WTO members with high bound duties are also the members with a lot of “water,” that is, the members with substantial difference between the bound and the applied rate of duty.50 3.4.1 The “Usual” Forum for Binding Duties: Trade Rounds The “usual” forum for tariff reductions is a “trade round.” This term denotes the period of time within which trading nations engage in negotiations and eventually agree on further liberalization of trade. Article XXVIIIbis of GATT explains that it is the WTO membership that will decide when to start a trade round, without including a precise date to this effect. As described in chapter 1, eight rounds have been completed, and the ninth, the Doha round, has produced some results (“Bali package”) but has not concluded on all negotiating items that were featured in its original negotiating agenda, the notorious Doha Development Agenda (DDA). The Trade Negotiating Committee (TNC), in which representatives of all WTO members participate, is the body entrusted with the overall administration of negotiations. The DG of the WTO presides over the TNC. Duties will be bound in trade rounds following different procedures: request-offer; linear reductions, harmonized formula, tiered cuts, and sectoral approach. There is no compulsion to use one or the other, and all are discussed later in this chapter. Trading nations will typically decide the procedure to follow in the context of any given round. 3.4.1.1 Trade Rounds, a Public Good Staiger (2004) first argued that the WTO provides trading partners with a global public good in the form of the negotiating forum where tariff commitments will be exchanged. Although arguments could be raised regarding the absence of costs for participants, a hallmark of public goods,51 there is no doubt that no trading nation would by itself have the incentive to establish this framework. Actually, the proliferation of PTAs is ample

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proof that trading nations would rather invest in relationships where they are the exclusive or quasi-exclusive beneficiaries than in relations where they can only benefit in small part. Various techniques have been employed over time in order to negotiate tariff reductions within trade rounds, and the next sections cover these. 3.4.1.2 Request—Offer Two WTO members will bilaterally negotiate tariff cuts until a mutually agreed solution has been reached and the WTO has been notified thereof. Home will present a list to Foreign that it wishes to negotiate with, indicating the tariff item number, the description of products, the present rate of duty, and the requested rate of duty.52 Foreign will do the same. When Home and Foreign are happy with the outcome of their negotiation, they will communicate it to the WTO, and it will be multilateralized, that is, the tariff duties agreed by Home and Foreign will be applied on MFN basis. In this case, things are left “to the market,” so to speak, and one would expect that the WTO members with the greatest interest in negotiating the tariff treatment of a particular commodity with another WTO member, to do so. Ideally, the WTO member with the bargaining power to extract the maximum promise from another WTO member would be expected to conduct a negotiation, the outcome of which will benefit the rest of the WTO membership. The benefit, of course, will consist of the low duty extracted from the negotiator with the bargaining power that will have to be applied, in principle, on an MFN basis (e.g., to all goods that benefit from the tariff concession regardless of their nationality). In this scenario, the potential for free riding is, in principle, substantial. Even the WTO Members though, with the maximum bargaining power do not possess unlimited negotiating resources, and they might wish to concentrate on the export markets that they care most about. As a result, different WTO members will negotiate different tariff treatments of different commodities with different WTO members. There is, thus, to some extent, distribution of the negotiating costs across the membership.53 One cannot exclude, however, that some might be unhappy with the outcome of the first negotiation. To make room for similar reactions, negotiations on “request and offer” have in practice developed as follows. Assume, that Home and Foreign negotiate the import duty on wheat that Home will be applying. Assume further that Foreign manages to extract from Home a promise that the latter will apply a 10 percent duty ad valorem. Foreign and Home will notify the WTO Secretariat of the outcome of their negotiation. Their agreement, however, remains confidential until the end of negotiations. In the meantime, nothing stops say Third, another WTO member, from negotiating with Home. Home can either repeat the promise it already made to Foreign, or move even further and make a better offer if Third has something to offer that Foreign does not. In this latter case, one cannot exclude the possibility that Third might extract a promise from Home that the latter imposes a 7 percent duty on imports of wheat. Third, as well, will notify the WTO Secretariat of the bilateral agreement that it has reached with Home.

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At the end of the negotiations, Home will have to impose, by virtue of the MFN obligation, a 7 percent import duty on all wheat imported into its market, regardless of its origin. Still, the promise of a 10 percent duty that it gave to Foreign is not without legal consequences. Assuming, subsequent to the original negotiation, that Home wishes to invoke the procedures established by Article XXVIII of GATT, and to revise its duty on wheat upward, for example to 12 percent, Foreign will be recognized as a holder of initial negotiating rights (INR) and will have the right to participate in the negotiations. If, conversely, Home wishes to revise its duties upward, but to 9 percent, Foreign will not enjoy this right. We will return to the mechanics of renegotiation of customs duties later in this chapter. 3.4.1.3 Linear Reductions During some rounds, instead of opting for bilateral negotiations, trading partners agreed upon tariff cuts across the board. In this setting, WTO members will agree on reducing bound, or applied tariffs by a fixed percentage, say 5 percent. The percentage of reduction is thus symmetric across trading nations (and could be symmetric across goods as well). 3.4.1.4 Harmonized Formula This method leads to tariff cuts by a fixed percentage. In contrast to linear reductions, though, it is meant to lead those WTO members that had been imposing higher tariff levels to more substantial reductions than those WTO members practicing lower duties. WTO members that had been imposing low duties will be requested to make less important cuts, since past liberalization efforts will be acknowledged; the WTO membership will be asking that this group of countries make it less of a liberalization effort. This type of tariff cuts is often referred to in WTO-speak as “Swiss formula.” Here is an illustration. Home imposes a tariff of 50 percent on widgets and Foreign of 20 percent on the same good. According to the “Swiss formula,” Home might be asked to reduce its duties by 35 percent, and Foreign by only 5 percent. The “Swiss formula” was practiced, for example, during the Doha round for the nonagricultural market access (NAMA) negotiations, which cover tariff reductions for manufactured goods. It owes its name to the fact that a Swiss delegate first proposed it during the Tokyo round.54 3.4.1.5 Tiered Cuts The tiered cuts approach is reminiscent of, but not identical to, the “Swiss formula.” Duties will be divided into bands (tiers) and the duties of higher bands will be cut more drastically than those of the lower band.55 The level of aggregation is, thus, different in tiered cuts from that applied in the “Swiss formula,” where it is individual tariff lines and not bands that provide the benchmark for tariff cuts. 3.4.1.6 Terms of Trade and Tariff-Cutting Techniques In chapter 1, the terms of trade theory was described as one of the possible explanations for the original GATT, which was negotiated using “request and offer.” This technique

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allows trading nations to pick and choose who they will be negotiating with, as well as the amount of tariff reductions that they should be willing to achieve. The other techniques seem to foreclose the relevance of terms of trade-based tariff negotiations. Only accidentally, for example, would an x percent reduction of tariffs across all trading nations for particular commodities would correspond to the number that would be obtained had the negotiations been aimed to reduce tariff levels while preserving terms of trade between two or more goods. It is, thus, difficult to reconcile the terms of trade theory with tariff negotiations during rounds where the request-and-offer approach has not been followed. 3.4.2

Sectoral Agreements

3.4.2.1 Distinguishing Sectoral from Critical Mass Agreements The term “sectoral” refers to agreements where the membership as a whole agreed to liberalize trade in a particular sector. The term “critical mass” refers to agreements, which we discuss later in this chapter, where a subset of the membership agreed to do so. Although both sets of agreements are sectoral in the sense that they cover tariff reductions in one product-area, it is the level of participation that usefully distinguishes one from the other. As we will see in what follows, the GATT history is full of sectoral agreements (or, rather, sectoral initiatives). Critical mass agreements came in vogue during and following the Uruguay round, when some WTO members became uneasy with the extent of free riding following MFN tariff reductions negotiated between the “usual suspects.” Critical mass agreements are not an invention of the WTO. Nations have been sensitized to the dangers of free riding for many years now. A good illustration is offered by the Convention on the Regulation of Whaling, which was signed in 1931, and entered into force in 1935 (United States Treaties Series 880). Important whaling nations, like Germany and Japan, had not signed the treaty, and in 1931 alone 43,000 whales were killed. Nowadays, the International Whaling Convention (the successor treaty) is in place, with 89 members, and the volume of killings has been substantially reduced. There are two critical mass agreements: the Information Technology Agreement (ITA) and the Pharma Agreement. Later in this chapter, these will be covered in succession. For now, though, the discussion turns to sectoral agreements. There is a long history of sectoral agreements in GATT.56 It all started as part and parcel of an exercise in transparency. A WTO document, dedicated to sectoral liberalization ever since the advent of GATT,57 distinguishes between sector specific discussions and sector specific negotiations. The GATT recipe for liberalization concerned all goods. Over the years some contracting parties complained about the slow growth of trade in particular goods, whereas others saw an opportunity to liberalize faster in some specific sectors. For these and many other reasons, sector-specific discussions were initiated, and eventually led to sector-specific negotiations.

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The trading nations became interested in examining the evolution of trade in specific areas. The first initiative of the sort was recorded as early as 1956, when the trading nations decided to annually follow the trends in trade of various commodities.58 They would review trends in commodity trading based on a report prepared by the chairman of the Interim Coordinating Committee for International Commodity. Since then, a number of sector-specific discussions took place. Following a proposal by Australia submitted in 1959, a group was established during the Dillon round to examine trends in trade of farm goods.59 A Special Group on Trade in Tropical Products was then established in 1962.60 A Committee on Trade in Industrial Products was established in 1967;61 A Group on Quantitative Restrictions and Other Non-Tariff Measures, aimed at reviewing trade of goods of particular interest to developing countries, was agreed and established in 1982.62 And, finally, a Working Group on Problems of Trade in Certain Natural Resource Products saw the light of day in 1984.63 3.4.2.2 The Identity of Sectoral Agreements Based on input from these groups, a series of sectoral negotiations were initiated and concluded. Sectoral agreements have been concluded in the last three completed rounds, namely, the Kennedy-, the Tokyo-, and the Uruguay round.64 During the Kennedy round, the Committee on Agriculture was established, as well as the Groups on Cereals, Meat, Tropical Products, and the Pilot Group on Dairy Products. Although the working hypothesis for the round was a 50% reduction of pre-existing tariffs, in some of the groups mentioned above actual reductions as reflected in the schedules of concessions shied away from the original target.65 In the Tokyo round, the Group on Tropical Products, the Group on Agriculture (with subgroups on cereals, meat, and other products), and most important of all, the group called “Sectoral Approach” were established. The former discussed the evolution of farm trade, whereas the latter discussed the role of sectoral approaches in GATT in general, the criteria for selecting sectors, and other related topics. The “Sectoral Approach” group focused on the negotiation of goods such as aluminum, chemicals, electronics, and fish and fisheries products. Tariff reductions were agreed following the “Swiss formula” previously discussed.66 In the Uruguay round, sectoral negotiations were held (besides agricultural and textile goods, discussed in chapters 8 and 9 of volume 2, respectively) in pharmaceuticals, chemicals, construction equipment, medical equipment, steel, beer, furniture, farm equipment, and distilled spirits (brown), paper, and toys.67 All in all thus, eleven sectoral agreements were successfully concluded during the Uruguay round. Two approaches were followed for tariff reductions: the “zero-for-zero” and the “harmonization” approach. The former meant that in some areas negotiators would agree to a zero tariff level. When having recourse to the latter, trading nations would agree to apply the same level of duty.

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3.4.3 The Information Technology Agreement (ITA) 3.4.3.1 Why Critical Mass? The ITA is the first of the two critical mass agreements adopted so far (the other one being the Pharma Agreement, discussed later in this chapter). These two negotiations represent a break with past practice. Until their advent, negotiations would take place across those interested in negotiating, and the outcome would have to respect the MFN obligation. On two occasions (i.e., ITA and the Pharma Agreement), WTO members agreed ex ante that their agreement would not enter into force unless if a certain percentage of world production had first agreed to liberalize the product-market under negotiation. If this were the case, they would agree to extend all benefits to all nonparticipating WTO members, accepting the realistic probability that free riders might profit from their negotiation. The free rider problem, though, would be severely mitigated since all major stakeholders would have already agreed to participate in the negotiation and be bound by the outcome. Those who profited from the ensuing liberalization would be, for all practical purposes, consumers worldwide and not important producers of the liberalized goods among the nonparticipating WTO members. By securing that a critical mass of the world producers of goods would negotiate and agree on liberalization, they managed to facilitate the process (since like-minded countries would be present) without running the risk of massive free riding. It is not hard to understand why these two conditions are not easily met; otherwise, the history of the GATT/ WTO integration might have been full of critical mass agreements since, as we stated in chapter 1, conditional MFN has long been the subject of been serious debate in the US. Why critical mass agreements? This chapter has already alluded to the response to this question. Trading nations that were getting tired of free riders did not have many other options left. Preferential trade agreements (PTAs) cannot be signed for just one or several products only since that would not not satisfy the “substantially all trade requirement,” as we will see in the chapter 6. Conditional MFN, no matter how dear to the heart of some nations, is, on its face, inconsistent with GATT, and we will return to this point in the next chapter. A request for a waiver would realistically not succeed because of the high percentage of concurring votes required, as chapter 9 will discuss. Finally, plurilateral agreements cannot be negotiated unless the WTO membership has given its consent. In light of all this, the only thing trading nations could do, when facing lack of unanimity in pursuing the trade liberalization agenda, was to minimize the potential of free riding. In this vein, faced with the unwillingness of some information technology (IT)–producing WTO members to participate in the negotiation, negotiators were not left with much of a choice. They had to extend the benefits from their negotiation to all WTO membership (by virtue of the MFN clause, discussed in chapter 4), if they wanted to avoid legal challenges. They did, however, manage to minimize the problem of free riding by securing first that a substantial percentage of worldwide production of IT products would make liberalization commitments.

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3.4.3.2 The Negotiation The ITA was concluded at the Singapore Ministerial Conference68 in December 1996. At that time, 29 countries (including the then-15 member states of the EU) or separate customs territories signed a declaration to this effect.69 The successful conclusion of the ITA followed a failed sectoral initiative on electronic goods in the Uruguay round. The Japan Electronic Industries Development Association (JEIDA) and the Information Technology Association of Canada (ITAC) together represented the private sector behind the negotiation of the ITA. These entities came up with the name “ITA” to describe what the negotiation was all about. The original target was that WTO members representing 90 percent of world trade would participate in the agreement. The target was not met right away. It was revised downward to a more realistic level, and WTO members representing 80 percent of world trade initiated the talks. The original target (90 percent) was met only a few months after the beginning of the negotiations. All results of the ITA negotiations are now applied on a nondiscriminatory basis. Today the ITA has 76 members70 (counting the 28 members of the EU), most of which are developing countries. No least developed country (LDC) has joined so far, though. Together, the 76 members of the ITA represent approximately 96 percent of world trade in IT products. To date, Mexico and Brazil remain the most important non-ITA participants, accounting for about 3 percent of world ITA trade. After its peak in 2000 (16.5 percent), the ITA now accounts for approximately 12 percent of total world exports (in value terms).71 In 2013, the share of ITA products in world trade exceeded that of farm products. With the outcome of the Doha round still pending, it is probably fair to state that the ITA is the most important MFN trade liberalization initiative enacted since the conclusion of the Uruguay round.72 3.4.3.3 Dispute Settlement The negotiation of the ITA was not problem-free, and the final text reflects a number of compromises that had to be secured for the agreement to enter into force. Unsurprisingly, it has given rise to disputes regarding classification of products coming under its purview, largely because it suffers from a birth defect. When concluded, its product coverage was reflected in two attachments. The first of these, “Attachment A,” included HS numbers and was divided into two sections. Section 1 dealt with specific products, the tariff classification of which was undisputed (112 items, corresponding to 110 HS 1996 classifications), whereas Section 2 took a hybrid form in which 78 items corresponding to 45 HS 1996 classifications were included, whereas an additional 42 items were labeled “for Attachment B.” Attachment B included 13 product descriptions, the tariff classification of which was in dispute among the WTO members.73 Contrary to Attachment A that included tariff lines, Attachment B included only product descriptions that could be classified under various tariff lines. The WTO Secretariat had put in place a process to help WTO members classify goods in harmonized manner; there was, however, no legal compulsion to do so.

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As a result, various WTO members classified the same good under different tariff lines, and disputes arose regarding the consistency of national classifications with the WTO. We read in Attachment B, for example, entries such as “network equipment,” “flat panel displays,” or “multimedia upgrade kits.” Similar entries were prone to creating a divergence of views across participants as to what precisely had been agreed. To make matters worse, technology moved fast, and new products appeared in the market. To respond to the challenges presented by technological evolution, signatories to the ITA agreed to meet periodically in order to specify and update the coverage of the ITA, and ideally to make unanimous suggestions to the WCO Committee.74 Technology surprised traders all right, but this is not a totally new issue, and even early GATT practice saw cases along these lines. In Greece–Phonograph Records, a GATT panel faced the following situation: Greece had bound its duties for long-playing records (LPs) based upon revolutions per minute. New technology developed after the Greek binding— namely, LPs of 33 1/3 and 45 revolutions per minute. Greece had imposed a duty higher than its binding and, when challenged by Germany, argued that it could do so since the products at hand did not exist at the time the binding had been entered. The panel disagreed and found that Greece should have followed the procedures regarding modification of duties instead of unilaterally setting a duty.75 Panels are still called to pronounce on similar instances nowadays. The periodic meetings of the WCO notwithstanding, divergences across WTO members regarding the treatment of new products might still arise in practice76 and gave rise to disputes.77 The question, for example, did arise in practice regarding what to do with new “multifunctional goods” that could be described either as an ITA or as another, non-ITA consumer good. “Technological convergence” might present similar issues. This term aims to capture cases where different systems can perform similar tasks—for example, when an interface with multiple devices becomes a reality as a result of technological innovations. Classification of goods then becomes an issue. The HS Convention gets updated every six to seven years on average. In the meantime, four different products (TV, CD, PC, and speakers) might converge into one (multimedia). How should they be classified until a new classification has been agreed? In theory, various criteria are available: one could use, for example, the “preponderant commercial use” criterion to classify multifunctional goods.78 In practice, nevertheless, disputes often arise from similar practices, the rationality of criteria used notwithstanding. The local area network (LAN) dispute (EC–Computer Equipment) between the US and the EU involved a disagreement between the two parties as to the proper classification of certain computer equipment.79 The products concerned were computers and network equipment. Computers had been defined in the ITA as “automatic data processing machines” capable of storing the processing program or programs and at least the data immediately necessary for the execution of the program; being freely programmed in accordance with the requirements of the user; performing arithmetical computations specified by

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the user; and executing, without human intervention, a processing program which requires them to modify their execution by logical decision during the processing run.

The agreement covers “automatic data processing machines,” whether they are able to receive and process with the assistance of central processing unit telephony signals, television signals, or other analog or digitally processed audio or video signals. Machines performing a specific function other than data processing or incorporating or working in conjunction with an automatic data processing machine, and not otherwise specified under Attachment A or B, were not covered by this agreement. “Network equipment” is defined as LAN and wide area network (WAN) apparatuses, including products dedicated for use solely or principally to permit the interconnection of automatic data processing machines and units thereof for a network that is used primarily for the sharing of resources, such as central processor units, data storage devices, and input or output units, including adapters, hubs, inline repeaters, converters, concentrators, bridges and routers, and printed circuit assemblies for physical incorporation into automatic data processing machines and units thereof. In light of these definitions, a number of products could either totally or partially come under the coverage of the ITA. The panel had found in favor of the US claim to subsume the products at hand under the coverage of the ITA. As discussed previously, though, the AB disagreed with the panel only as to the relevance of the US expectations, arguing that the expectations of the membership were what mattered. At the end of the day, although the AB did not exclude the applicability of the ITA, it did not condone it either. More or less the same products gave rise to another dispute between the EU and the US, albeit raising different legal issues: in EC–IT Products, the panel dealt with a challenge against the EU classification of three goods that, in the complainants’ opinion, were covered by the ITA and hence should be benefiting from tariff-free entry, whereas in the EU view, they should be classified as consumer goods and accordingly burdened by a 14 percent duty. The panel did not accept the EU view that the products, because of one additional function, were totally new, thus escaping the disciplines of the ITA. It consequently requested the EU to take corrective action. The panel inquired into whether the goods could come under one of the product descriptions included in Attachment B. If the response was affirmative, then the good would enjoy zero tariff treatment. If the response was negative, then it would be subjected to the tariff treatment provided for in the national schedule and applicable to the relevant consumer good. In those cases where the panel felt more at ease that the additional function did not substantially alter the nature of the original product, it recommended that the EU applied the lower tariff treatment. 3.4.3.4 ITA I and II On November 12, 2014, the US and China announced their agreement in principle on the liberalization of a series of goods coming under the ITA. Their agreement was hailed as the necessary impetus to unblock the negotiations of ITA II.

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ITA II aimed to eliminate the level of tariffs and ODCs for all IT goods. IT goods were classified under six categories (computers; semiconductors; semiconductor manufacturing equipment; telecoms; other instruments and apparatus, like cash registers and electronic calculators; and data storage media and software) and their parts and accessories. Negotiators did not manage to conclude the agreement within the originally agreed time frame, but voices were increasingly multiplying to conclude ITA II. It is estimated that an additional $800 billion of gains would be added to the staggering $4 trillion already created through prior liberalization.80 Originally, 6 WTO members, known as the “Technical Group” (Chinese Taipei, Costa Rica, EU, Japan, Korea, US), started the ITA II negotiation on the product coverage with heavy involvement of the private sector. China and 21 more WTO members subsequently joined in the negotiations, and the eventual group of 28 represented over 90 percent of world trade in the covered field. The new negotiation marked a shift of goods from Attachment B to Attachment A: only five goods will remain in the former, with the latter now comprising 286 HS subheadings.81 On July 28, 2015, the ITA II was finally agreed (WTO Doc. WT/L/956 of 28 July 2015). WTO members participating in the negotiation agreed to eliminate duties for a total of 201 products. Elimination of duties would take place within a period of three years. 3.4.4 The Pharma Agreement The Agreement on Trade in Pharmaceutical Products, widely known as the “Pharma Agreement,” was negotiated and concluded during the Uruguay round. As is the case with the ITA, a critical mass approach was followed to create this. The participants (Australia, Austria, Canada, the Czech Republic, the EU, Finland, Japan, Norway, the Slovak Republic, Sweden, Switzerland, and the US)82 accounted for well over 90 percent of world trade in pharmaceutical products. The purpose of the agreement was to eliminate duties on pharmaceutical products or, if this was not feasible right away, to do so in the near future.83 This agreement includes a complete list of products covered, ranging from goods coming under chapter 30 of HS to pharmaceutical active ingredients that bear international nonproprietary names from the World Health Organization (WHO), the notorious “INNs,” (International Non-proprietary Names) and intermediates used for production and manufacture of finished pharmaceuticals.84 The subsequent reviews, which take place (at least) every three years following the conclusion of the original agreement, have expanded the coverage of the agreement and further liberalized the market for pharmaceutical goods.85 3.4.5

Coalitions

WTO members rarely negotiate on their own. Hegemonic powers dwindle down, and new hegemons emerge. If the US was the “only game in town” for a few years, it soon learned to share power with the EU, to a lesser extent with the original Quad (which also included

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Canada and Japan), and to an increasing extent with the new Quad (China and India having taken the place of Canada and Japan). It is unrealistic for a WTO member to think that it can push an issue by itself. Bargaining power is one consideration, and consensus voting another. WTO members will find it easier to block an issue because of the consensus rule than to press forward their point of view. In an effort to increase bargaining power (and curb problems posed because of the consensus rule), alliances have been formed during rounds across like-minded countries to push forward a particular agenda.86 The Cairns group, for example, named after the city in Australia where it was first established, became notorious during the Uruguay round for pushing for lower duties in farm goods. Brazil, India, and South Africa head the NAMA 11 group, which has been very active during the NAMA negotiations of the Doha round. During the Doha round, negotiations have mainly centered around three groups: the Organisation for Economic Cooperation and Development (OECD)—that is, the rich countries’ club; the G-20, comprising the leading developing countries, such as Argentina, Brazil, and India; the G-90, comprising the LDCs, as well as other developing countries. Most of the negotiations of the Doha round concern demands that the G-20 has been formulating and are directed toward the OECD group (and some counterdemands by the latter directed at the former). The G-90 has been to a considerable extent absent from the negotiating scene, partly because of declarations from EU officials that they should have the round for free (that is, without making any concessions). Notorious across rounds are the so-called green room meetings, where only chosen delegations participate in meetings in the DG’s office (which used to be green). The objective is to restrict access to a few key delegations in order to facilitate agreement. The meetings of “Heads of Dels” (i.e., Heads of Delegations) regroup all heads of delegations to the WTO. 3.4.6

Unilateral Action

Nothing, of course, stops WTO members from unilaterally lowering import duties at any time and notifying the WTO of the new level. In 1997, for example, two WTO members, through unilateral modification procedures, bound their tariffs for “white” spirits (petroleum-deprived liquid used as solvent for painting and/or decorating) at 0 percent.87 Unilateral reductions do not have to be approved by consensus voting (as per Article XXX of GATT): the GATT panel report on US–Margins of Preference held as much. Similar actions are rare, however. As much as economists plausibly make the case for unilateral reduction of tariffs, at least by those who cannot affect the terms of trade, reality goes in the opposite direction, probably because tariffs are imposed for a variety of reasons extending beyond the concern to make income. Trade rounds remain the usual forum for tariff reductions.

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3.5 The Schedules of Concession The tariff promise of each WTO member will be reflected in a document called the “schedule of concession.” 3.5.1

Certification, Rectification, and Modification of Schedules

Schedules of concessions of all WTO members must be certified in order to ensure that their content conforms to the agreement reached. Changes in the form of rectification, modification, or both can be inserted following the procedures established. 3.5.1.1 A Centralized Process Through the procedures adopted regarding certification, rectification, and modification of schedules, the WTO aims at providing a centralized system for ensuring the accuracy of commitments entered. The WTO Secretariat is at the center of the system established whereby the authenticity of commitments will be certified (“certification”). The Secretariat is the institutional bottleneck, and it will be notified of subsequent changes as well (such as rectification and modification of schedules). Certification is the process that attests the validity of entries in a schedule of concessions as a result of the successful conclusion of a trade round. It also can occur in between rounds. Over the years, schedules of concessions undergo changes since, as a result of negotiations, trading nations agree to reduce their duties. Think of the ITA negotiation, for example, where a substantial number of the WTO membership agreed to reduce tariffs in IT products between the end of the Uruguay round and before the conclusion of the Doha round. The resulting new schedules of concessions on IT goods had to be certified. It is the WTO Secretariat that will circulate the members’ schedules of concessions (or, as it is sometimes called, the “list of commitments”) for verification and certification.88 The Legal Affairs Division of the WTO is in charge of the certification process. The protocol, including all certifications of schedules, will be registered in accordance with the provisions of Article 102 of the UN Charter.89 Rectification captures mundane changes (whereby the level of the tariff concession is not affected), whereas modification is about substantive changes, such as those resulting from a renegotiation of duties conducted under Article XXVIII of GATT. Rectifications and modifications were originally informal. Over the years, formalism has been introduced in response to disputes that arose regarding what exactly had been committed. Until 1959, changes at the tariff level were incorporated into GATT and its schedules through a series of protocols. There were five protocols of rectification, one protocol of modification, and nine protocols of both rectification and modification. In 1959, the CONTRACTING PARTIES agreed, subject to the revised text of Article XXX of GATT being accepted, to adopt a procedure of certification and discontinue the

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practice of preparing protocols of rectifications and modifications. The protocol amending Article XXX of GATT was adopted, but its authority lapsed in 1967. The CONTRACTING PARTIES decided next, in November 1968, to establish certification procedures applicable to both modifications and rectifications. To this effect, they adopted the Procedures for Modification and Rectification,90 according to which all modifications and rectifications would have to take place through certification. The idea was that certification would constitute some sort of formal multilateral approval of all modifications and rectifications entered.91 Six collective certifications were adopted under this decision, which was finally replaced by another, more detailed, decision adopted in 1980: the Decision on Procedures for Modification and Rectification of Schedules of Tariff Concessions (known for short as “the 1980 Decision”).92 Although that term refers to modifications resulting from actions under specified articles, in practice these procedures have also been used to include schedules of unilateral commitments. The 1980 Decision confirms that modifications imply substantive change of the concession (§ 1), whereas rectifications imply no such change (§ 2). Modifications could be the outcome of action under various provisions, and the 1980 Decision mentions to this effect Articles II, XVIII, XXIV, XXVII, and XXVIII of GATT. The 1980 Decision further confirms that multilateral review of both rectifications and modifications was necessary, probably because there is often a fine line between the two, and WTO members might have an incentive to cheat and call “rectification” what should be understood as “modification.” It is to be expected, of course, that the WTO membership would pay attention to every modification notified, whereas it will not heed rectifications. The proper classification, therefore, matters. Both modifications and rectifications are communicated to the DG of the WTO. Modifications have to be communicated within three months after the action (under one of the abovementioned provisions) has been completed. Rectifications must be communicated within six months after the amendment has been introduced in national legislation or, in the case of other rectifications, whenever the circumstances permit this to be the case. If no objection has been raised within three months of the communication, the notified modifications and rectifications become certifications (§ 3 of the 1980 Decision). There should be no doubt that the 1980 Decision is part of GATT 1994 by virtue of Article 1(b) (iv) of this agreement since it is a formal decision adopted by the CONTRACTING PARTIES, and thus binding upon all WTO members. 3.5.1.2 Certification Does Not Confer Legality Certification, nevertheless, does not ipso facto confer legality to whatever has been certified. In EC–Bananas III, a dispute between the EU and various banana-exporting countries, the AB had the opportunity to address this point.

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Schedules of concessions will be typically annexed to the final agreement concluding a round and are then open to all WTO members to sign.93 The EU had included in its schedule of concessions a condition whereby some WTO members could profit from a preferential duty rate on bananas. These members were Costa Rica, Colombia, Nicaragua, and Venezuela—the countries with which the EU had concluded the Banana Framework Agreement (BFA).94 The preferential rate (an import duty substantially lower than the MFN rate) was already applicable to bananas originating in ACP countries (i.e., African, Caribbean, Pacific countries, ex-colonies of EU member states that had concluded the Lomé Convention with the EU), and was extended to the signatories of the BFA. A series of banana-exporting WTO members that did not sign the BFA continued to pay the MFN rate. They complained to the WTO, claiming that the EU measure (the preferential rate applied to ACP- and BFA bananas) was inconsistent with the MFN rule (namely, Article I of GATT). The EU had argued, among other things, that its regime was consistent with Article II.1(b) of GATT since the WTO had been notified, and the certification process had been observed, without any WTO member raising an issue as to its legality.95 The panel and the AB, recalling the earlier “Headnote” jurisprudence96, held that a WTO member can grant other WTO members rights but cannot diminish its own obligations through conditions added to its schedule (§§ 157–158): That said, we do not see anything in Article 4.1 to suggest that market access concessions and commitments made as a result of the Uruguay Round negotiations on agriculture can be inconsistent with the provisions of Article XIII of the GATT 1994. There is nothing in Articles 4.1 or 4.2, or in any other article of the Agreement on Agriculture, that deals specifically with the allocation of tariff quotas on agricultural products. If the negotiators had intended to permit Members to act inconsistently with Article XIII of the GATT 1994, they would have said so explicitly. The Agreement on Agriculture contains several specific provisions dealing with the relationship between articles of the Agreement on Agriculture and the GATT 1994. For example, Article 5 of the Agreement on Agriculture allows Members to impose special safeguards measures that would otherwise be inconsistent with Article XIX of the GATT 1994 and with the Agreement on Safeguards. In addition, Article 13 of the Agreement on Agriculture provides that, during the implementation period for that agreement, Members may not bring dispute settlement actions under either Article XVI of the GATT 1994 or Part III of the Agreement on Subsidies and Countervailing Measures for domestic support measures or export subsidy measures that conform fully with the provisions of the Agreement on Agriculture. With these examples in mind, we believe it is significant that Article 13 of the Agreement on Agriculture does not, by its terms, prevent dispute settlement actions relating to the consistency of market access concessions for agricultural products with Article XIII of the GATT 1994. As we have noted, the negotiators of the Agreement on Agriculture did not hesitate to specify such limitations elsewhere in that agreement; had they intended to do so with respect to Article XIII of the GATT 1994, they could, and presumably would, have done so. We note further that the Agreement on Agriculture makes no reference to the Modalities document or to any “common understanding” among the negotiators of the Agreement on Agriculture that the market access commitments for agricultural products would not be subject to Article XIII of the GATT 1994.

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For these reasons, we agree with the Panel’s conclusion that the Agreement on Agriculture does not permit the European Communities to act inconsistently with the requirements of Article XIII of the GATT 1994. (italics in the original)

The AB did not even summarily discuss the legal value of the certification process. By finding against the EU, though, the AB, at the very least, implicitly accepted that certification does not confer legality. This outcome might upset the formalist, but actually it is quite defensible. To decide on the legality of schedules at the moment of certification, one would need to discuss each and every entry in a schedule of concessions. Were one to introduce a comprehensive legal review of all schedules at the end of a negotiation, the process would have been disproportionately burdened. Moreover, in the absence of centralized monitoring of the legality of certified schedules, it would have been essentially incumbent upon WTO members to check each other’s schedules from a GATT-consistency perspective. Disagreements would have to be submitted to a panel, by virtue of Article 23.2 DSU, and one could potentially imagine dozens of panels introduced at this stage. The WTO Secretariat, which is the certifying entity, does not have the power to decide the question of legality. Its involvement aims at ascertaining the accuracy of submitted schedules of concessions only. Under the circumstances, it seems quite reasonable to argue that the certification process is limited to verification of the accuracy of commitments, for good reason, and does not prejudge their legality one way or the other. The AB, in EC–Bananas III, through its decision also closed the door to MFN deviations that the EU was opening up through the Framework Agreement. MFN deviations can only be based on provisions of GATT (legal exceptions), and not on bargained (e.g., negotiated) solutions.97 3.5.1.3 Uncertified Actions Unilateral actions that have not been certified risk being challenged before the WTO and eventually deemed illegal. This issue arose for the first time in Spain–Unroasted Coffee, a GATT dispute. Spain had originally made a tariff concession without differentiating between the various types of unroasted coffee.98 It then modified its negotiated concession by reserving a tariff treatment to “unwashed Arabia” and “Robusta” coffees that was less favorable than that reserved for “Colombia” and “Colombia mild” coffee (all three types of coffee being unroasted). Whereas it kept a 0 percent duty on the latter, it imposed a 7 percent duty on the former. All types of coffee came under CCCN 09.01 (the Brussels Nomenclature), since this case preceded the advent of the HS Convention. Brazil complained that, as a result of this intervention, its coffee exports to the Spanish market were being negatively affected (since Brazil was not exporting “mild” coffee). Spain responded that, under the Brussels Nomenclature system, it was allowed to make

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subclassifications to tariff headings, and this is exactly what it had done in this case (§ 3.3 of the panel report). The panel did not agree with the Spanish claim, finding the Spanish measure to be inconsistent with GATT. It held that Spain was free to make tariff classifications, provided that it had done so when scheduling its commitments, not ex post facto without consulting its trading partners (§ 4.4). The panel found that there was no obligation under GATT to follow any particular system for classifying goods, and that a contracting party had the right to introduce in its customs tariff new positions or subpositions as appropriate. A footnote to this paragraph reads: “Provided that a reclassification subsequent to the making of a concession under GATT would not be a violation of the basic commitment regarding that concession (Article II:5).” [emphasis added] In this case, nevertheless, a violation had occurred as a result of the Spanish subclassification. This was the case because, in the panel’s view, the various types of coffee were like products and, in the absence of prior distinction across the three types, Spain was in violation of its obligations since it was treating like products in an unlike manner (§ 4.10).99 The AB on Argentina–Textiles and Apparel faced a different case of unilateral action that occurred after certification of a national schedule and allegedly affected the value of commitments entered. Argentina had bound its duties on footwear during the Uruguay round at 35 percent. Subsequently, it had been applying to imports of footwear either an ad valorem duty of 35 percent or a specific duty that was calculated on the basis of the world price. It later decided to apply specific duties only. Since, in its view, the case did not concern a change in the bound duties, it did not provide notification of the various duties it was applying (as it should have done, in accordance with the 1980 Decision). The complainant had argued that a change between different types of tariffs was not permissible. In its view, through binding, WTO members had agreed neither to impose tariffs beyond the established ceiling nor to change the type of duty (e.g., move from ad valorem to specific duties). The panel upheld its claim. The AB overturned this finding and held that switching between different types of duties is perfectly legitimate so long as the overall ceiling of protection had not been violated (§§ 44–55). The AB did, nevertheless, find that Argentina had violated its obligations since, following the conversion from ad valorem to specific duties, the level of duty exceeded the negotiated ceiling. To decide whether this has indeed been the case, one would need to go back in time to the moment when the concession was negotiated and convert the rate of protection from ad valorem to a specific duty (keeping the price of the dutiable item constant, of course). Argentina had not notified the WTO of its measure, as briefly mentioned earlier in this chapter. In fact, Argentina did not have to follow the procedures of the 1980 Decision at all since the case concerned applied and not bound duties. Argentina, nonetheless, disrespected the General Council Decision dating from 1997,100 which requests from WTO

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members to notify the organization of all information regarding not only current bound, but also current applied, duties on an annual basis.101 The panel and the AB report did not insist on this failure—wrongly so, in my view.102 The AB examined the consistency of the Argentine measure with Article II.1(b) of GATT. This provision disallows the imposition of duties upon importation in excess of the level bound. Probably, though, the correct legal basis would have been Article II.3 of GATT, which reads: “No contracting party shall alter its method of determining dutiable value or of converting currencies so as to impair the value of any of the concessions provided for in the appropriate Schedule annexed to this Agreement.” In effect, Argentina had changed its method of determining dutiable value by switching from one form to another form of duty. The question to ask, then, would be whether the value of concessions it had agreed to had been impaired. Note that this issue had already been raised, but the AB decided to totally disregarded prior case law. In 1984, the GATT panel report on EEC–Newsprint referred to the “longstanding practice” in GATT that “even conversion” from ad valorem to specific duties required renegotiation (§ 50). By opening the door to unilateralism in this context, the AB adopted an interpretation that is hardly supported by logic and practice. 3.5.2 The Content and Legal Value of Schedules of Concessions The legal value of schedules of concessions is clarified in Article II.7 of GATT: “The Schedules annexed to this Agreement are hereby made an integral part of Part I of this Agreement.” The content of schedules of concessions differs across rounds. The agreed form of the Uruguay round schedules is that they should consist of four parts:103 1. Part I is divided into two sections: Section 1 includes all agricultural tariff concessions, whereas Section 2 reflects tariff concessions on nonfarm goods. Section 1 is subdivided into two subparts, the first reflecting tariff concessions, whereas the second applies to tariff quotas. 2. Part II includes historic preferential tariffs from the early GATT days, not preferential rates that are applied in free trade areas or customs unions since the latter are not considered tariff concessions. This part is empty across all schedules since no historic preferential rates exist anymore;104 3. Part III reflects nontariff measures; e.g., commitments regarding import licensing. 4. Part IV reflects WTO members’ commitments on farm goods of nontariff nature; e.g., commitments with respect to domestic support, and export subsidies.105 Part I needs some additional explanation. It contains “headnotes,” where a WTO member explains the implementation of its commitments,106 as well as ten “columns.” Column

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1 reflects the tariff line (e.g., HS 224646); Column 2, the product description; Column 3, tariff quotas; Column 4, the “base rate of duty” (e.g., the point of departure for the Uruguay round cuts, either bound or applied on 1 September 1986); Column 5, the “final bound rate of duty” (i.e., the bound level committed during the Uruguay round); Column 6, the implementation period at the end of which the WTO member must at the very least apply its final bound rate of duty; Column 7, special provisions for agricultural products;107 Column 8, initial negotiating rights;108 Column 9, ODCs; Column 10, other terms and conditions [e.g., clarifications on the scope of the commitment which, as per the AB report on Canada–Dairy (§ 7.151) are not void of legal effect]. Recall, nonetheless, the ruling of the AB in EC–Bananas III: WTO members cannot add terms and conditions that violate GATT obligations. 3.5.3

Defining the Tariff Value: Customs Valuation

Customs duties will be imposed on imported goods by reference to the declared “import price.” Importers, as well as exporters, might have an incentive to cheat, though, when declaring the import price. By raising the import price of goods, customs authorities might be raising the overall tariff revenue (assuming that quantities of imports will not be severely affected as a result), or protecting domestic competing goods more efficiently (in the opposite case, such as when import quantities are affected as a result). By lowering the price of exported goods, exporters will be burdened with lesser duties and their goods will be more competitive in the export market. There is, thus, a genuine need for insurance policy against the incentive to cheat. Customs valuation (CV) is the process applied to determine the true customs value of imported goods upon which import duties will be imposed. The CV Agreement provides the legal framework to organize this process. CV procedures are, of course, applicable only when imported items have to face ad valorem duties, or duties of which a component is ad valorem. The starting point is the declared import price, or the “actual value” of the imported goods, as it is known in WTO jargon. Article VII of GATT states that the value of imported merchandise for customs purposes should be based on the actual value of the imported merchandise on which the duty is assessed, and should not be based on the value of merchandise of national origin or on arbitrary or fictitious values. Article VII.2(b) of GATT defines “actual value” as follows: “Actual value” should be the price at which, at a time and place determined by the legislation of the country of importation, such or like merchandise is sold or offered for sale in the ordinary course of trade under fully competitive conditions. To the extent to which the price of such or like merchandise is governed by the quantity in a particular transaction, the price to be considered should uniformly be related to either (i) comparable quantities, or (ii) quantities not less favorable to importers than those in which the greater volume of the merchandise is sold in the trade between the countries of exportation and importation.

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The 1950 Convention on the Valuation of Goods for Customs Purposes, better known as the “Brussels Definition of Value (BDV),” contained a similar concept: the “normal price,” defined as follows: “The price which [the imported goods] would fetch at the time when the duty becomes payable on a sale in the open market between buyer and seller independent of each other.”109 It was the CCC, now known as the WCO, as described earlier in this chapter, that would administer customs valuation using BDV, the widestknown method at that time. During the Tokyo round, a CV Agreement was adopted that introduced new disciplines and that has since been superseded by the Agreement on Customs Valuation, decided during the Uruguay round (discussed in detail in chapter 1 of volume 2). This agreement has added a lot of detail about CV disciplines. Through preshipment inspection, part of the Agreement on Preshipment, also concluded during the Uruguay round and discussed in chapter 1 of volume 2, one aims to ensure that the quantity and quality of the goods to be exported conform to the specifications reflected in a sales contract. 3.6

Safeguarding the Value of Tariff Concessions

Article II of GATT contains various clauses aiming to safeguard the value of concessions. The value of concessions is, of course, further safeguarded by the obligation to avoid adding to the agreed tariff protection by means of domestic policies (Article III of GATT), as well as by so-called nonviolation complaints (NVCs), which aim to guarantee that WTO members abide by the good faith principle and implement their various commitments in line with the spirit and not only the letter of GATT. Chapter 7 discusses Article III of GATT in detail; for now, we look only at safeguards included in the body of Article II of GATT. 3.6.1

Change in the Method of Determining Dutiable Value

We briefly referred to Article II.3 of GATT earlier in this chapter, when discussing the AB report on Argentina–Textiles and Apparel. Suffice to add here that this provision captures not only changes in the method of determining dutiable duties, but also conversion of currencies. This brings this discussion squarely to the relationship between IMF and GATT. We have already discussed this relationship in the previous chapter, and we will be complementing our discussion of the issue so far when analyzing Article II.6 of GATT later in this chapter. 3.6.2

Import Monopolies

GATT does not contain disciplines on competition law, as seen in chapter 1. As a result, WTO members can legally put in place import monopolies in charge of channeling trade

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into their sovereignty. There is a risk, nevertheless, that through similar policies, they might be negatively affecting the value of tariff concessions. This is so because import monopolies do not operate on commercial considerations, as they might be favoring domestic production. Similar practices were very much in vogue at the time when the GATT was negotiated, and this is what explains the inclusion of this paragraph in the GATT. They are less of an issue nowadays. Article II.4 of GATT is the insurance policy against this risk, as it explains that WTO members cannot, through the operation of import monopolies,110 add to the agreed protection: If any contracting party establishes, maintains, or authorizes, formally or in effect, a monopoly of the importation of any product described in the appropriate Schedule annexed to this Agreement, such monopoly shall not, except as provided for in that Schedule or as otherwise agreed between the parties which initially negotiated the concession, operate so as to afford protection on the average in excess of the amount of protection provided for in that Schedule.

A footnote of the provision explains that Article 31 of the Havana Charter is relevant to understanding this provision. Article 31 of the Havana Charter explains in more detail the basic obligation embedded in Article II.4 of GATT. This provision requests from WTO members, practicing import monopolies, to enter into negotiations with affected parties in order to limit or reduce the protection afforded through the operation of the import monopoly to domestic goods. To this effect, a maximum import duty could be agreed between the parties, as well as measures aiming to relax limitations in the quantities imported.111 Article II.4 of GATT allows, thus, only for protection that has been either included in the schedule of concessions or agreed between the parties. The question has arisen in practice how to quantify “protection” in case of litigation: 1. The GATT Panel on Canada–Provincial Liquor Boards (EEC) held that an import monopoly can lawfully charge, beyond the customs duty, transportation- and distribution costs, as well as a “reasonable amount of profit”;112 2. The GATT Panel on Korea–Beef (Australia) found a profit to be reasonable if it corresponded to the margin obtained under normal conditions of competition (e.g., when no monopoly was in place). The GATT Panel on Canada–Provincial Liquor Boards (US) confirmed this finding, adding that monopoly profit margins should be excluded since the profit margin should correspond to what could be obtained under normal conditions of competition (§ 4.15);113 3. The GATT Panel on Canada–Provincial Liquor Boards (US) accepted that differential markups (e.g., costs imposed on imported products only) were legitimate to the extent that they corresponded to costs necessarily associated with the marketing of imported goods.114

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Disputes Regarding the Proper Classification of Goods

Article II.5 of GATT deals with a sui generis issue. If one WTO member believes that its exports do not receive the tariff treatment contemplated by GATT, and the reason for that is a court order by the importing WTO member that has, in its view, improperly classified imported goods, then the WTO members concerned, as well as any other WTO member substantially interested in the proper tariff treatment of the same good in the same market, will enter negotiations to reach a compensatory adjustment. The Greece–Phonograph Records case discussed earlier in this chapter falls into this category. The parties managed to settle their dispute eventually without informing the GATT Secretariat of a compensatory adjustment. The GATT Analytical Index mentions only one case under this provision, where the GATT Secretariat was informed of a compensatory adjustment. It concerned “flash guns,” and the dispute was between Canada and the EU. The GATT Secretariat issued a note that stated that disputes under Article II.5 of GATT typically would be resolved through reclassification of goods following the procedures of WCO.115 3.6.4

Reduction in Par Values

Article II.6 of GATT116 was drafted with the system of fixed exchange rates in mind. Article IV of the original Articles of Agreement of the IMF required from its members to declare par values for their national currencies in terms of gold, or US dollars, or a fixed gold value. A “par value” is a finance/accounting term and denotes the face or stated value of a currency. A change in par values could only occur following consultations with the IMF. The obligation to declare par values bound members of the IMF, as well as those countries that have entered into a special exchange agreement with it. The terms “or provisionally recognized” were added to the body of Article II.6 of GATT in order to address the case of Brazil, which had not formally established a par value, but had provisionally agreed to do so.117 Article II.6 of GATT states that, if reductions of par values by more than 20 percent take place, and they are in accordance with the IMF (and not unilateral), customs duties have to be adjusted to take account of similar reductions. It is, of course, only specific duties that would need to be adjusted since the bite of ad valorem duties is impervious to reductions in par value (or devaluations). Specific duties, on the contrary, are expressed in national currency. As a result, a 50 percent devaluation of the national currency would lead to a substantial loss (by 50 percent) of the bite of the tariff rate. A Working Party on Specific Duties was established and was charged with the task to review the modalities of application of this provision. The Articles of Agreement of the IMF were amended in 1978 since the members of the fund had moved to a system of “floating exchange rates.” The amended Article IV of the IMF reads: “… each member undertakes to collaborate with the Fund and other members

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to assure orderly exchange arrangements and to promote a stable system of exchange rates.”118 Article II.6 of GATT had to be adjusted, as well. The Guidelines for Decisions Under Article II.6 of the General Agreement on Tariffs and Trade were adopted in 1980.119 These guidelines read in pertinent part: The CONTRACTING PARTIES shall be deemed to have authorized the contracting party to adjust its specific duties … if the IMF advises the CONTRACTING PARTIES that the depreciation calculated as set out above … is in excess of 20 per cent and consistent with the Fund’s Articles of Agreement, and if, during the sixty days following the Fund’s advice to the contracting parties, no contracting party claims that a specific duty adjustment to take into account the depreciation would impair the value of a concession.

Depreciation took the place of reduction in par value, but the primary responsibility to pronounce on the legitimacy of the ensuing actions rests with the IMF. 3.7

Renegotiation of Tariff Protection

WTO members might, for various reasons, be willing to renegotiate their tariff protection, and intuitively one would expect that political economy-driven considerations would rank high in this context. The reasons for renegotiating the originally agreed level of tariffs are not put into question by the GATT. This procedure, nonetheless, is not geared toward addressing momentary imbalances. The provision on safeguards that we discuss in chapter 4 of volume 2 is meant to deal with this issue. Article XXVIII of GATT is meant to redress the level of tariffs on more permanent basis. After all, one should not neglect that it is because of the possibility to renegotiate tariff protection (offered by Article XXVIII of GATT) that trading nations might have had the incentive to agree to “generous” tariff reductions in the first place. Eventually, they might want to take back some of their concessions, and Article XXVIII of GATT is the institutional vehicle to help them realize similar endeavors. Case law has over the years contributed toward ensuring that renegotiations of duties will be discussed following the multilateral procedure to this effect. It has thus, as a result, closed the door to unilateral practices by some trading nations that have had, over the years, recourse to outright violations of their commitments, instead of requesting a renegotiation. In Greece–Import Duties (1952), a GATT panel observed that Greece was facing acute, persistent financial difficulties that had led it to the imposition of import surcharges. Greece did not attempt to renegotiate its duties and had unilaterally proceeded to the increase of some of its duties. It was requested to remove the new measures by 1 July 1953. A similar story gave rise to the complaint that led to the GATT panel report on France–Compensatory Tax (1955). Canada was a bit more imaginative. Instead of imposing a blunt import surcharge, it adopted the value for duty, which in this case was fixed at $2.67 per 100 pounds of

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potatoes. Any imported good that was priced less than the fixed price would see a “dumping duty” levied against it. The US complained, arguing, inter alia, that the Canadian measure was violating the Canadian tariff concession, which had been agreed at $0.375 per 100 pounds of potatoes. The GATT Panel on Canada–Potatoes asked first if Canada had been violating Article VII of GATT, and its decision was in the negative (§ 16). It then asked the question whether the measure could qualify as AD duty, only to respond in the negative yet again (§ 47). The only claim that it upheld was that concerning Article II of GATT, siding with the complainant that had argued that the Canadian measure was above and beyond the agreed tariff ceiling on potatoes (§ 18). Case law, thus, contributed toward closing the door to imaginative bureaucratic practices aiming at circumventing tariff concessions entered, and channeling those interested in renegotiating the agreed tariff protection toward the mechanism instituted by Article XXVIII of GATT. 3.7.1

Maintaining the Level of Concessions

The quintessential element of Article XXVIII of GATT is that, postconsolidation, the level of tariffs can be altered only through multilateral action.120 GATT puts in place a procedure whereby a WTO member requesting to revise its duties upward must consult with those affected by the change and eventually pay compensation in order to do so. Since consideration had been provided for the original tariff bindings (Home promises a tariff concession in exchange for Foreign doing the same), consideration should be paid if the original balance of rights and obligations is affected (Home must be compensated if Foreign wants to undo the agreed balance of concessions). A series of procedural obligations have been introduced in order to serve this objective. A WTO member can increase its bound protection on a given tariff line provided that the multilateral process reflected in Article XXVIII of GATT has been followed. In the typical case, the member wishing to raise its duties on a bound item will negotiate and agree on compensation (in practice, a lowering of tariff protection on some items in exchange for tariff increase in others) with a subset of the WTO membership that has been more severely affected by the tariff change. The agreed compensation will then be applied on an MFN basis. According to Article XXVIII.2 of GATT, the WTO members participating in the renegotiation of the concession “shall endeavour to maintain a general level of reciprocal and mutually advantageous concessions not less favourable to trade than that provided for in this Agreement prior to such negotiations.” Article XXVIII of GATT epitomizes, thus, the idea that GATT is about maintaining a level of reciprocally negotiated concessions. Tariff adjustments might be deemed necessary for a variety of reasons over time, and what matters is that WTO members feel that they get their concession’s worth at all times. Recall that, as stated previously, GATT does not inquire into the reasons why a WTO member might want to avail itself of this possibility. Consequently, although

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good theoretical arguments could support the inclusion of this provision in the GATT system,121 there is nothing legally wrong with invoking it out of mere political expediency.122 3.7.2 The Participants The procedure starts with a request tabled by the WTO member interested in renegotiating its bound level of duties on a tariff line (the “applicant contracting party”).123 The request will have to be submitted to the WTO. As we will see later in this chapter, for some negotiations, there is requirement that the WTO membership agrees to the opening of negotiations, whereas for others, no such requirement exists. Three questions need to be addressed: • Who will participate in the renegotiation of duties? • Who should be compensated? • How will compensation be calculated? This section deals only with the first question. To respond to this question, one needs to ask first what the benchmark for choosing participants should be. It could be, for example, that only those affected by the renegotiation be allowed to participate in the first place. In principle, though, all WTO members might actually, or potentially, be affected by the new higher duty, and hence, they should all be invited to participate in the process. Indeed, even those not currently producing the commodity the import duties on which will be revised, might be dissuaded from entering the market precisely because of the anticipated higher duties. On the other hand, if all affected (or potentially affected), WTO members were accepted to participate in the negotiation, the negotiation itself would have become quite burdensome. Stalling the negotiation is in and of itself a factor that contributes to uncertainty regarding the tariff treatment of the particular commodity. The whole purpose of GATT is, of course, the exact opposite—that is, to bring about certainty regarding the transaction costs of commercial transactions. Additionally, the much-needed flexibility, which is necessary to induce generous commitments in the first place, would be jeopardized. The GATT framers thus had to balance two competing objectives: a fairness requirement (namely, to compensate those negatively affected by the tariff increase); and the wish for speedy completion of the negotiation. GATT privileged the latter objective without unduly prejudging the former. In an effort to speed up the negotiation process, GATT limits participation to those WTO members that are primarily affected by the request to renegotiate the concession: the INR holders and the principal supplying interest (PSI). These two categories of WTO members, along with the applicant contracting party, are the “primarily concerned parties.” A third category, the WTO members having a substantial interest, will be consulted but have no legal right to participate in the negotiations.

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The GATT framers implicitly assumed that the cost of neglecting the fairness requirement was not disproportionate. Nonparticipants would still benefit from the new MFN tariffs. Participants enjoy an important advantage. They take a seat at the table of negotiations and design the compensation package. It is for them to decide where compensation should be paid. As a result, in the extreme case, compensation risks being meaningless for nonparticipants who might be offered lower tariffs on commodities that they do not produce or export. To avoid this being the case, they could, of course, always try to influence participants through informal means in order to avoid the agreed compensation being of no trade interest to them. This risk was much higher in the early years of GATT because of the high percentage of trade that few enjoyed and the absence of internationalized investment. The emergence of new trade powers and the internationalization of investment have decidedly tilted the balance in recent years. Global value chains keep proliferating, and thus, the risk of being offered a useless gift has been reduced even further as far as nonparticipants are concerned. 3.7.2.1 INR Holders An “INR holder” is a WTO member that has negotiated a specific concession with the applicant contracting party. Detecting who an INR is might seem trivial, but sometimes it proves to be a cumbersome task. The form of international negotiations holds the key in identifying INRs (since there can be more than one). During some rounds, concessions are negotiated and concluded on a bilateral basis (request-offer), as demonstrated earlier in this chapter. In these cases, the identification of the INR holder is a simple factual question (these are the so-called fixed INRs). Fixed INRs are subdivided into historic INRs and current INRs. An illustration can help us distinguish between the two. Assume that during the Tokyo round, Home had bound duties on fax machines at 15 percent as a result of a negotiation that it conducted with Foreign. During the Uruguay round, Home agreed to reduce the duty on fax machines to 10 percent; this time, however, it negotiated the concession with Third. Foreign is the historic INR holder, and Third is the current INR holder. Foreign, the historic INR holder, retains the legal right to participate in an Article XXVIII of GATT negotiation only if the proposed tariff increase exceeds 15 percent. Third, on the other hand, will participate no matter what the proposed increase is. Historic INRs have not always been incorporated into schedules of concessions. The situation changed when the Council for Trade in Goods (CTG) adopted the Decision on the Establishment of Loose-Leaf Schedules: Each Member shall include in its schedule all INRs at the current bound rate. Other Members may request the inclusion of any INR that had been granted to them. Historic INRs different from the current bound rate not specifically identified shall remain valid where a Member modifies its concession at a rate different from the rate at which the INR was granted.124

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The situation has further improved with the finalization of the Consolidated Tariff Schedules (CTS) Database, which provides consolidated information on the schedules of concessions of members. As a result, when the request-offer mode is followed, it is now quite easy to detect INRs. During other rounds, however (e.g., the Kennedy round), trading nations have agreed on tariff cuts using a formula like the Swiss formula (as discussed earlier in this chapter), or tiered cuts. In similar cases, no fixed INRs exist, and the question arises of how to identify who the INR is. The GATT CONTRACTING PARTIES adopted the following decision to address this issue: In respect of the concessions specified in the Schedules annexed to the Geneva Protocol (1967), a contracting party shall, when the question arises, be deemed for the purposes of the General Agreement to be the contracting party with which a concession was initially negotiated if it had during a representative period prior to that time a principal supplying interest in the product concerned.125

These are the so-called floating INRs, who will be identified in the same way as PSI countries.126 This is discussed in the next sections. 3.7.2.2 PSI Countries There are two definitions of the term “PSI country,” which, according to the Interpretative Note of Article XXVIII of GATT, typically covers a WTO member that has had, over a reasonable period of time prior to the negotiations, a larger share in the market of the applicant contracting party than a contracting party with which the concession was initially negotiated or would, in the judgment of the CONTRACTING PARTIES, have had such a share in the absence of discriminatory quantitative restrictions by the applicant contracting party. (emphasis added)

The same provision provides the second, exceptional definition: the CONTRACTING PARTIES may exceptionally determine that a contracting party has a principal supplying interest if the concession in question affects trade which constitutes a major part of the local exports of such contracting party. (emphasis added)

The Understanding on the Interpretation of Article XXVIII of GATT, which was adopted during the Uruguay round negotiations, further explained the “exceptional definition” of PSIs in its § 1 in the following manner: For the purposes of modification or withdrawal of a concession, the WTO member which has the highest ratio of exports affected by the concession (i.e., exports of the product to the market of the Member modifying or withdrawing the concession) to its total exports shall be deemed to have a principal supplying interest if it does not already have an initial negotiating right or a principal supplying interest as provided for in paragraph 1 of Article XXVIII. (emphasis added)

This clause, as made explicit in the Understanding, would be reviewed within five years to check whether it has functioned in a satisfactory manner or whether it has to be

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amended. In early 2000, the CTG requested the Committee on Market Access to undertake the review, and the Committee noted in its report that “… at this stage, there was no basis to change the criterion contained in paragraph 1 of the aforementioned Understanding.”127 The absence of use of this possibility notwithstanding, developing countries were eager to keep it in place.128 This item was discussed more than once.129 No action was taken and, as a result, the clause was neither amended nor abolished. The rationale for including PSIs in the negotiation is explained in the Interpretative Note of Article XXVIII of GATT, which relevantly provides: The object of providing for the participation in the negotiation of any contracting party with a principal supplying interest, in addition to any contracting party with which the concession was originally negotiated, is to ensure that a contracting party with a larger share in the trade affected by the concession than a contracting party with which the concession was originally negotiated shall have an effective opportunity to protect the contractual right which it enjoys under this Agreement. It would … not be appropriate for the CONTRACTING PARTIES to determine that more than one contracting party, or in those exceptional cases where there is near equality more than two contracting parties, had a principal supplying interest.

It is not intended that the scope of the negotiations should be designed to make negotiations and agreement under Article XXVIII unduly difficult, nor to create complications in the application of this article in the future to concessions that result from negotiations thereunder. The inclusion of INRs is justified on the grounds that, historically at least, they had a strong export interest in this particular market. They should be compensated either because there is a presumption that they continue to do so, or simply because of their negotiating efforts that led to the extraction of the original tariff promise. PSIs take a seat at the table because the legislator wanted to account for the new market situation and ensure that those who suffer the largest damage at the moment when the renegotiation takes place will play a role in the negotiations. Thus, Article XXVIII of GATT aims to strike a balance between the old and the new market situation. It could, of course, be the case that the INRs are PSIs, in the sense that INRs continue have the largest share in the market of the WTO member requesting renegotiation. In this case, PSIs will be selected according to the exceptional definition. INRs and PSIs derive, by virtue of their participation in the negotiation, an advantage since they can, either acting separately or collectively, identify the commodity (or list of commodities) where compensation will be paid. Of course, the advantage consists of selecting the area of compensation, as already noted earlier in this chapter. So, even though compensation will be nondiscriminatory, it will be in product-markets where INRs and PSIs have a strong presence.130 For the abovementioned reasons, the damage to nonparticipants resulting from their physical absence from the negotiation is being gradually reduced as a result of the internationalization of production.

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3.7.2.3 SI Countries The term “substantial interest (SI) country” is defined in the Interpretative Note of Article XXVIII: The expression “substantial interest” is not capable of a precise definition and accordingly may present difficulties for the CONTRACTING PARTIES. It is however, intended to be construed to cover only those contracting parties which have, or in the absence of discriminatory quantitative restrictions affecting their exports could reasonably be expected to have a significant share in the market of the contracting party seeking to modify or withdraw the concession.

In practice, WTO members with 10 percent or more of the market of the “applicant contracting party” are considered as having SI in the concession. A report of the Committee on Tariff Concessions dating from July 1985 confirms that the 10 percent share has been generally applied.131 The Understanding on the Interpretation of Article XXVIII of GATT, decided in the Uruguay round, states in § 3: In the determination of which Members have a principal supplying interest … or substantial interest, only trade in the affected product which has taken place on a MFN basis shall be taken into consideration. However, trade in the affected product which has taken place under non-contractual preferences shall also be taken into account if the trade in question has ceased to benefit from such preferential treatment, thus becoming MFN trade, at the time of the negotiation for the modification or withdrawal of the concession, or will do so by the conclusion of that negotiation.

It is, thus, MFN trade only that will define PSI and SI countries. WTO members that have preferential arrangement with the applicant contracting party can thus never become PSIs or SIs. This analysis presupposes the existence of trade statistics; otherwise, how could anyone measure market shares for PSIs? What if, for example, renegotiation of duties is requested for a product-market for which no statistics exist? Usually, the period of three years before the renegotiation is considered in order to define what a PSI is. In the case of new products, though, production patterns in the same tariff line (and not necessarily the same product) will serve as the basis to define PSIs. The Understanding on the Interpretation of Article XXVIII of GATT provides in § 4: When a tariff concession is modified or withdrawn on a new product (i.e., a product for which three years’ trade statistics are not available) the Member possessing initial negotiating rights on the tariff line where the product is or was formerly classified shall be deemed to have an initial negotiating right in the concession in question. The determination of principal supplying and substantial interests and the calculation of compensation shall take into account, inter alia, production capacity and investment in the affected product in the exporting Member and estimates of export growth, as well as forecasts of demand for the product in the importing Member. For the purposes of this paragraph, “new product” is understood to include a tariff item created by means of a breakout from existing tariff line. [italics in the original]

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3.7.3 The Various Procedures for Renegotiating Tariff Protection Article XXVIII of GATT distinguishes between procedures where no prior approval is required and procedures where it is. The first is described in Article XXVIII.1 of GATT, where the applicant contracting party must initiate negotiations during a specified period (July–October) in any three-year period starting on January 1, 1958 (e.g., 1958–1961; 1961–1964, etc.). The applicant contracting party will notify the CTG of its interest in initiating negotiations, and the CTG will determine the identity of the other primarily concerned parties.132 The second category of procedures where no prior approval is required is described in Article XXVIII.5 of GATT. WTO members can reserve their right to renegotiate and eventually exercise this right at a later date: Before 1 January 1958 and before the end of any period envisaged in paragraph 1 a contracting party may elect by notifying the CONTRACTING PARTIES to reserve the right, for the duration of the next period, to modify the appropriate Schedule in accordance with the procedures of paragraph 1 to 3. If a contracting party so elects, other contracting parties shall have the right, during the same period, to modify or withdraw, in accordance with the same procedures, concessions initially negotiated with that contracting party.

Practice in this context constitutes the majority of Article XXVIII of GATT negotiations. This discussion is, mutatis mutandis, applicable in this context as well. The procedures in which no prior approval is required for the negotiation to begin have one important downside, in that the right to renegotiate can be exercised only within a particular time period. WTO members that have not reserved their right to renegotiate, or those that wish to negotiate outside the period prescribed in Article XXVIII.1 of GATT, can do so only if they have first secured the authorization of the WTO membership (following the procedure included in Article XXVIII.4 of GATT). For the remaining cases, the WTO member concerned will submit its request to the CTG, the competent organ to decide. Any request for authorization must include the elements specified in the Interpretative Note of Article XXVIII of GATT (§ 4.1): “Any request for authorization to enter into negotiations shall be accompanied by all relevant statistical and other data. A decision on such request shall be made within thirty days of its submission.” The time period within which the negotiation must be completed should be short (60 days), but could be extended. The Interpretative Note of Article XXVIII of GATT relevantly provides in this respect (§ 4.3): It is expected that negotiations authorized under paragraph 4 for modification or withdrawal of a single item, or a very small group of items, could normally be brought to a conclusion in sixty days. It is recognized, however, that such a period will be inadequate for cases involving negotiations for the modification or withdrawal of a larger number of items and in such cases, therefore, it would be appropriate for the CONTRACTING PARTIES to prescribe a longer period.

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Recall that the purpose and object of negotiations are reflected in Article XXVIII.2 of GATT: In such negotiations and agreement, which may include provision for compensatory adjustment with respect to other products, the contracting parties concerned shall endeavor to maintain a general level of reciprocal and mutually advantageous concessions not less favorable to trade than that provided for in this Agreement prior to such negotiations.

The Interpretative Note of Article XXVIII of GATT adds (§ 4.6): It is not intended that provision for participation in the negotiations of any contracting party with a principal supplying interest, and for consultation with any contracting party having a substantial interest in the concession which the applicant contracting party is seeking to modify or withdraw, should have the effect that it should have to pay compensation or suffer retaliation greater than the withdrawal or modification sought, judged in the light of the conditions of trade at the time of the proposed withdrawal or modification, making allowance for any discriminatory quantitative restrictions maintained by the applicant contracting party.

It is, thus, clear that flexibility in this context should be understood as allowing for rebalancing of tariff protection. The idea is that because trading nations would be allowed to revise tariffs upward after they have been consolidated, their original tariff concessions would be more generous than otherwise. The question is, of course, what is the optimal amount of flexibility? Should an agreement for compensation be the authorization necessary for the applicant contracting party to revise its duties upward? Or should it be allowed to do so even in absence of an agreement to compensate? The GATT framers opted for allowing changes in tariff levels even in the absence of agreement between participants regarding the amount of compensation. They might have anticipated that, had they done otherwise, the flexibility of this provision would have been eliminated in the face of unreasonable demands. 3.7.4 Agreement on the Amount of Compensation Assuming that an agreement has been reached between the participants at the end of the negotiations, the applicant contracting party will notify the WTO of its new schedule of concessions, which will be applied on an MFN basis. It could be, though, that a WTO member that qualifies as having SI in the commodity is unsatisfied with the agreement reached. If this is the case, then it can take action against the applicant contracting party, as per Article XXVIII.3 (b) of GATT: If agreement between the contracting parties primarily concerned is reached but any other contracting party determined under paragraph 1 of this Article to have a substantial interest is not satisfied, such other contracting party shall be free, not later than six months after action under such agreement is taken, to withdraw, upon the expiration of thirty days from the day on which written notice of such withdrawal is received by the CONTRACTING PARTIES, substantially equivalent concessions initially negotiated with the applicant contracting party.

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This solution obtains regardless whether it is dealing with a procedure where prior approval for initiation is required or not. 3.7.5

Failure to Agree on the Amount of Compensation

If negotiations do not manage to produce an agreement, the applicant contracting party is still free to increase its tariff protection. INR holders, PSIs, and SIs will have, according to Article XXVIII.3 of GATT, the right to withdraw substantially equivalent concessions. Thus, this provision allows “efficient breach of contract” without explicitly saying so. The text of the agreement, though, as will be covered in more detail later in this chapter, leaves unanswered the question whether withdrawal of concessions will be on a bilateral or on an erga omnes basis. 3.7.5.1 Procedures Where No Prior Approval Is Required If the applicant contracting party decides to withdraw concession even in the absence of agreement on the compensation, it runs the risk of facing retaliation, not only from the members participating in the negotiation but from the rest of the WTO membership as well. The relevant part of Article XXVIII.3(a) of GATT reads in this respect: If agreement between the contracting parties primarily concerned cannot be reached before 1 January 1958 or before the expiration of a period envisaged in paragraph 1 of this Article, the contracting party which proposes to modify or withdraw the concession shall, nevertheless, be free to do so and if such action is taken any contracting party with which such concession was initially negotiated, any contracting party determined under paragraph 1 to have a principal supplying interest and any contracting party determined under paragraph 1 to have a substantial interest shall then be free not later than six months after such action is taken, to withdraw, upon the expiration of thirty days from the day on which written notice of such withdrawal is received by the CONTRACTING PARTIES, substantially equivalent concessions initially negotiated with the applicant contracting party.

PSIs, INRs, and SIs can react, provided that they do so on goods initially negotiated with the applicant contracting party. The provision is, nonetheless, incomplete, and it provides no definitive response to the following questions that might arise in practice: • What if PSIs and SIs have no concessions initially negotiated with the applicant contracting party? Should they lose their right to retaliate? • Should the retaliation by PSIs and SIs be only vis-à-vis the applicant contracting party, or vis-à-vis the WTO membership? • It could be the case that WTO members other than INRs, PSIs, or SIs are affected by the unilateral modification of the concession.133 Should they not be entitled to react as well? Let us start with the first question. The number of WTO members nowadays makes it quite likely134 that “primarily concerned parties,” SIs, or both have no initially negotiated concessions with the applicant contracting party.

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There is not much precedent in this area. The only known instance suggests that retaliating WTO members indicate the goods where they purport to increase tariffs in retaliation, regardless of whether they have initially negotiated concessions on these goods with the applicant state. This is what almost happened in Canada/European Communities–Article XXVIII Rights. The negotiation in this case occurred as a result of the enlargement of the EU (and the ensuing obligation of new EU members to raise their level of protection in some goods to the EU level), and Canada’s dissatisfaction with the offer for compensation that was tabled by the EU. This case is covered in more detail later in this chapter, but for now, it is enough to state that Canada threatened to retaliate by raising duties on goods for which it was no INR-holder vis-à-vis the EU. It did not eventually act upon its threat, however, since an agreement with the EU was finally reached. Had it done so, though, this practice would have run counter to the explicit wording of Article XXVIII of GATT. Let us move now to the second question, namely, who should be the object of retaliation? Article XXVIII of GATT is not explicit in this respect. Intuitively, though, one would expect that retaliating WTO members should do so only on a bilateral basis—that is, they should be barred from raising their tariffs in retaliation erga omnes. Indeed, why should innocent bystanders pay for the absence of agreement in a negotiation where they did not participate? Surprisingly, there are at least two instances in practice where the WTO member reacting to a unilateral modification threatened to do so erga omnes. First, the 1990 award by the Arbitrator on Canada/European Communities–Article XXVIII Rights notes, with respect to Canada’s threat to withdraw concessions substantially equivalent to those modified by the EU, that “should Canada exercise her right to withdraw concessions, she undertakes obligations to compensate third countries having negotiating rights in respect of Canada for the products on which concessions would be withdrawn.”135 Canada assumed that it would incur no obligations to compensate anyone, had its retaliation taken place on a bilateral basis. Implicitly, therefore, this passage suggests that Canada would be raising duties, not only vis-à-vis the EU, but also vis-à-vis the rest of its trading partners on an MFN basis. This view has been confirmed in subsequent practice. Canada and the EU were also the protagonists in the second instance, when they ran into the same argument in the context of the EU’s enlargement from 12 to 15 member states (with the accession of Austria, Finland, and Sweden in 1995). The three acceding countries had to raise their duties with respect to some products from their prior unilateral level to the new, harmonized EU level. According to Article XXIV.6 of GATT, the members of the preferential trade agreement and the outsiders enter into negotiations in similar cases: the aim is to compensate those affected by tariff increases. When discussing the amount of compensation, a benefit that results because acceding countries had to lower their tariffs in some tariff lines to the EU level with respect to

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certain goods will be taken into account (referred to as “in-built compensation”). This is where Canada and the EU disagreed. The former believed that the in-built compensation was inadequate, but the latter believed the opposite.136 Canada threatened to retaliate: As a result of tariff modifications which became effective 1 January 1995, the access of Canadian exporters to the acceding countries has been impaired. Consequently, Canada wishes to notify Members that it will exercise its rights under Article XXVIII:3 to withdraw substantially equivalent tariff concessions on products of interest to the European Union as outlined in the attached table. These modifications shall take effect 30 days after distribution of this notification to WTO members. Members may wish to note that in this respect, these modifications will not affect the application of rates under the Generalized System of Preferences. Any Member that believes it has supplier rights which are affected by this action is invited to inform the Permanent Representative of Canada to the WTO.137

The last sentence here indicates that Canada’s purported retaliation was erga omnes. The parties finally agreed to a settlement, and as a result, Canada never enacted its threat.138 This practice suggests that, for some WTO members at least, erga omnes retaliation in response to unilateral modifications is very possible. The negotiating record, and especially the interventions by the US and India delegates (based on which the agreement on this score finally emerged), seem to support this view. The interventions by these two delegates suggest that, should a WTO member withdraw concessions without prior agreement, affected members will use the value of the withdrawn concessions as the basis to calculate their own withdrawal, which should be on an MFN basis.139 This is regrettable for two reasons. First, innocent bystanders will have to pay the price of trade wars between aliens. Second, since the incentive of the retaliating member is to overshoot the amount of suspended concessions to provide the applicant contracting party with an incentive not to unilaterally modify the concession in the first place, one might end up with trade wars spiraling with no end in sight because of counterretaliation by WTO members. Moreover, the current institutional framework is ill equipped to deal with the scenario of MFN retaliation. Assume that Canada had retaliated on an MFN basis in its dispute with the EU, and that it had then invited any affected parties to negotiate their compensation with it. Under what GATT provision would such negotiations take place? Arguably, Article XXVIII of GATT is not applicable to this context since none of the three statutory procedures for renegotiation applies here and no other provision emerges as a candidate to host similar negotiations. An amendment of Article XXVIII of GATT is warranted to prevent similar instances in the future. Two elements should be introduced into the current text: • If no agreement has been reached between the interested parties, retaliation shall be bilateral.

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• The amount of retaliation, in the case of disagreement, shall be fixed through recourse to binding arbitration (as per Article 22.6 of the DSU).140 With respect to the third question—e.g., whether WTO members other than INRs, PSIs, or SIs can legitimately retaliate against the trading nation raising its duties—the current text does not explicitly acknowledge that they have a legal right to retaliate under this provision. On the other hand, they will, in all likelihood, be affected by a modification of the schedule, regardless of whether an agreement between the primarily concerned parties has been reached. What can be done if such an occasion arises? The most reasonable way out would be to acknowledge the right of WTO members to take an NVC against the applicant contracting party.141 This solution seems warranted in light of the explicit acknowledgment in Article XXVIII.3 of GATT that the applicant contracting party has the right to unilaterally modify its schedule of concessions even in the absence of agreed compensation. Its actions to this effect are thus lawful. The only question remaining in this context is whether the right to file an NVC can be exercised regardless of whether an agreement between the primarily concerned parties has been reached. In the absence of relevant practice, I tend to respond to this question in the affirmative. From the perspective of the affected state, it could be totally immaterial whether an agreement occurred or not since in either scenario, its rights might be negatively affected.142 So long as damage has been suffered as a result of unexpected behavior, the affected WTO members should have the right to raise an NVC. 3.7.5.2 Procedures Where Prior Approval Is Required If no agreement can be reached, then according to Article XXVIII.4 of GATT: the applicant contracting party shall be free to modify or withdraw the concession, unless the CONTRACTING PARTIES determine that the applicant contracting party has unreasonably failed to offer adequate compensation.

Hence, in the case of disagreement between the negotiating partners, the CTG will determine whether adequate compensation has been offered. The Interpretative Note of Article XXVIII of GATT states that the CTG must decide a matter before it within 30 days from its submission unless the applicant member agrees to a longer period (§ 4.4). The Interpretative Note of Article XXVIII of GATT further provides some useful information as to the elements that the CTG should take into account when determining whether adequate compensation had indeed been offered (§ 4.5): In determining under paragraph 4 (d) whether an applicant contracting party has unreasonably failed to offer adequate compensation, it is understood that the CONTRACTING PARTIES will take due account of the special position of a contracting party which has bound a high proportion of its tariffs at very low rates of duty and to this extent has less scope than other contracting parties to make compensatory adjustment.

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If the CTG determines that adequate compensation has indeed been offered, the modified concession will be allowed to stand. If not, the applicant WTO member might still go ahead and unilaterally modify the concession. In this case, INRs, PSIs, and SIs have the right to suspend substantially equivalent concessions (Article XXVIII.4 of GATT): If such action is taken, any contracting party with which the concession was initially negotiated, any contracting party determined under paragraph 4 (a) to have a principal supplying interest and any contracting party determined under paragraph 4 (a) to have a substantial interest, shall be free, not later than six months after such action is taken, to modify or withdraw, upon the expiration of thirty days from the day on which written notice of such withdrawal is received by the CONTRACTING PARTIES, substantially equivalent concessions initially negotiated with applicant contracting party. In light of the fact that: (a) An authorization is required before the applicant WTO Member enters into an Art. XXVIII.4 GATT negotiation; (b) The authorization will be granted following a consensus decision to this effect; and (c) The agreement of potential INRs, PSIs, SIs is essential, indeed the conditio sine qua non for a favorable decision, it is to be expected that the negotiation on the level of compensation, in similar cases, effectively takes place before the authorization has been granted. This might explain why some requests are being withdrawn (in the absence of agreement on the compensation).143

3.8

Charges Exempted from Article II of GATT

A number of impositions, other than OCDs and ODCs, typically burden imports at the port of entry to a market. Article II of GATT mentions some of them (internal taxes and charges; antidumping and countervailing duties; fees and charges for services rendered), but there are others (import surcharges for balance of payment reasons; safeguards), that have not been explicitly mentioned up to this point, but will be in the following sections. 3.8.1

Internal Taxes and Charges

Article II.2(a) of GATT reads: Nothing in this Article shall prevent any contracting party from imposing at any time on the importation of any product: a charge equivalent to an internal tax imposed consistently with the provisions of paragraph 2 of Article III* in respect of the like domestic product or in respect of an article from which the imported product has been manufactured or produced in whole or in part;

This provision is reminiscent of the Interpretative Note of Article III of GATT. Internal measures, like a sales ban of a health-hazardous commodity imposed at the border, should not be considered to be in violation of Article XI of GATT.

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In India–Additional Import Duties, the panel and the AB had the opportunity to set the record straight and establish this parallelism. They were facing a claim that two Indian measures were in violation of Articles II and III of GATT. The measures were the “Additional Duty,” imposed on alcoholic beverages, and the “Extra Additional Duty” imposed on a wider range of goods. The two measures were discriminatory, and there is no doubt that they were violating Article III of GATT. The claim that the two measures ran afoul of Article II of GATT as well was mounted probably because they were being imposed at the border. The AB could have simply stated that the measures at hand violated Article III of GATT, but that would have sidestepped the subject matter of Article II of GATT, as per Article II.2(a) of GATT. Instead, it adopted a roundabout way (§§ 165ff.) to reach its findings, which, for all practical purposes, do not contradict the abovementioned preferred approach. In § 193 of its report, the AB did clarify that the complaining party carries the burden of proof to establish violation of Article II.2(a) of GATT. 3.8.2 Antidumping and Countervailing Duties WTO members can impose antidumping (AD) duties, countervailing duties (CVDs), or both if imports are dumped or have been subsidized. This topic will be discussed further in chapters 2 and 3 of volume 2, respectively. 3.8.3

Fees and Charges for Services Rendered

Article VIII.1 of GATT is akin to a catchall provision, covering all measures imposed at the border corresponding to a service that is being provided at the border in connection with importation. 3.8.3.1 Preparatory Work This provision was initially reflected in Article 13, as well as in Article 19 of the London Draft. Items that corresponded to ODCs, as well as fees and formalities that come under the ambit of today’s Article VIII of GATT, would fall under these two provisions. Both ODCs and fees and formalities were distinguished from ordinary customs duties, which were the subject matter of Article 24 of the London Draft. The negotiators agreed that duties and charges coming under the aegis of Article 19 of the London Draft should not be used as indirect protection for domestic products.144 This provision was intended to operate as an anticircumvention, ensuring that Article 24 of the London Draft would not be undermined through the imposition of duties and charges other than ordinary customs duties. No change is reported in the subsequent reincarnations of this provision.145 The negotiators believed that some harmonization (standardization) of national practices was probably necessary to reduce this risk, but they did not go beyond expressing a wish

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to this effect.146 Harmonization could be realized along the lines of the Geneva Convention of 3 November 1923. In fact, France, with the support of Belgium, Luxembourg, Czechoslovakia, the Netherlands, and the United Kingdom, held the view that this provision would be useless unless all ITO members agreed to adhere to the Geneva Convention.147 The World Economic Conference of 1927 had made similar recommendations, and a number of countries, following France’s lead, wanted to ensure consistency across its recommendations and the eventual ITO provision.148 Nevertheless, the negotiators could not agree on the modalities.149 Another area of disagreement was the availability of penalties depending on the gravity of the act (whether it was due to negligence or accidental error).150 At the end, although negotiators managed to agree on an indicative list of charges coming under the purview of this provision,151 they decided that deeper harmonization should be left for a later stage.152 Alas, it never happened. 3.8.3.2 Relationship with Article II of GATT The previous discussion of the negotiating record strongly supports the conclusion that there should be no overlap between the subject matter of this provision and that of Article II of GATT. This point was confirmed in case law in the panel report on Dominican Republic–Import and Sale of Cigarettes (§ 7.115).153 3.8.3.3 Measures Covered There is no need to provide the same services across national borders, nor is there a need to show that the service is necessary for importation to occur. It suffices that a service is “in connection with importation (or exportation).” For the rest, WTO members are free to decide on the services that they will be providing upon importation of goods. Article VIII.4 of GATT provides an indicative list of measures that come under its purview: consular transactions, such as consular invoices and certificates; quantitative restrictions; licensing; exchange control; statistical services; documents, documentation, and certification; analysis and inspection; and quarantine, sanitation, and fumigation: All fees and charges of whatever character (other than import and export duties and other than taxes within the purview of Article III) imposed by contracting parties on or in connection with importation or exportation shall be limited in amount to the approximate cost of services rendered and shall not represent an indirect protection to domestic products or a taxation of imports or exports for fiscal purposes.

This list, like all indicative lists, serves two purposes. It reduces the potential for a type II error (false negative). A judge cannot decide that, say, a statistical service or sanitation mechanism does not come under the purview of Article VIII of GATT. On the other hand, the types of services featured in the indicative list set the tone for the type of other (not explicitly mentioned) measures that should be considered fees and formalities covered by Article VIII of GATT. Therefore, although the class of measures has not been exhaustively

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provided for, the typecasting operated through the indicative list will provide the judge with enough ammunition if a dispute to this effect appears. 3.8.3.4 Standard of Review The GATT panel report on US–Customs User Fee provided a series of clarifications regarding the ambit of Article VIII of GATT. The facts of the case that are crucial to our study are summarized in § 7 of the report: The term “customs user fee” refers to a number of fees imposed by the United States for the processing by the US Customs Service of passengers, conveyances and merchandise entering the United States. Only one of these fees is at issue in this dispute. It is the “merchandise processing fee,” an ad valorem charge imposed for the processing of commercial merchandise entering the United States. (italics in the original)

The panel went on to explain that the services rendered, for which a charge would be imposed, did not have to be requested by the traders, as they could be unilaterally decided by the importing state (§ 77). It further explained that the service rendered must be linked to a particular transaction, not to the total cost of service (§ 81). Based on this analysis, the panel went on to find that the US measure at hand was GATT-inconsistent since, by virtue of its nature (ad valorem), the duty imposed was not linked to the cost of the provided service. Minor value transactions would pay less than major value transactions for exactly the same service (§§ 84–86). The analysis in US–Customs User Fee has not been brought into question in subsequent cases. WTO panels that had to deal with this issue borrowed from it and explicitly referred to this case law when dealing with a legal claim under Article VIII of GATT. The Panel on Argentina–Footwear reflects a quasi-identical ruling on a similar issue. Argentina had an ad valorem charge for services rendered in connection with the importation of goods. The panel found the Argentine measure to be GATT-inconsistent, confirming that ad valorem schemes are by construction inconsistent with Article VIII of GATT.154 3.8.4

Import Surcharges for BoP Reasons

Recall that import surcharges are often practiced to address balance of payments (BoP) problems. They are not explicitly provided for in the body of Article XI of GATT, but both practice (the Working Party on the US surcharge, discussed in chapter 2) and the literature [Jackson (1972) cites GATT practice to this effect] support the argument that similar instruments can legitimately come under Article XII of GATT. 3.8.5

Safeguards

Curiously, Article II of GATT mentions AD and CVDs and omits references to safeguards. Yet, as will be seen in chapter 4 of volume 2, the majority of safeguards do take the form of import duties (surcharges) in practice.

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3.9 Withdrawal from GATT/WTO The consequence of withdrawal from the WTO is that neither the withdrawing member, nor those that have decided to stay in the WTO, are bound by their previous contractual relationships as a result of their membership at the WTO. 3.9.1 Withdrawing from the WTO A WTO member leaving the WTO is not bound by the obligations that it assumed because of its membership in the organization. Article XV of the Agreement Establishing the WTO provides that: 1. Any Member may withdraw from this Agreement. Such withdrawal shall apply both to this Agreement and the Multilateral Trade Agreements and shall take effect upon the expiration of six months from the date on which written notice of withdrawal is received by the Director-General of the WTO. 2. Withdrawal from a Plurilateral Trade Agreement shall be governed by the provisions of that Agreement. 3.9.2 The GATT Solution The provision quoted here is the successor to Article XXVII of GATT. It allowed, in a similar vein, WTO members to withhold or withdraw concessions vis-à-vis other trading nations that had left GATT. Since GATT was no institution, formally speaking, as explained in chapter 1, the agreement did not provide for the possibility of withdrawal of its contracting parties. It did provide, though, for the possibility to withdraw concessions vis-à-vis other contracting parties that either never became or ceased to be “contracting parties” to GATT. Article XXVII of GATT reads: Any contracting party shall at any time be free to withhold or to withdraw in whole or in part any concession, provided for in the appropriate Schedule annexed to this Agreement, in respect of which such contracting party determines that it was initially negotiated with a government which has not become, or has ceased to be, a contracting party. A contracting party taking such action shall notify the CONTRACTING PARTIES and, upon request, consult with contracting parties which have a substantial interest in the product concerned.

China is a good example of this concept. It participated in the GATT negotiations but did not become a contracting party. This was the case because the split between China and the Chinese Taipei occurred while GATT was entering the last stages of negotiation. Following the split that led to the independence of Chinese Taipei, China decided to abstain from participating in GATT. Chinese Taipei did not participate either. A number of the contracting parties withdrew concessions that they had made to China during the negotiation of GATT.

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Table 3.1 Withdrawal of Concessions under Article XXVII of GATT Concessions Granted By

Initially Negotiated With

Reference

Australia Benelux: Section A—Metropolitan Territories Benelux: Section C—Netherlands, New Guinea Canada Ceylon Chile Czechoslovakia Finland France Germany, Federal Republic of India Pakistan Sweden United Kingdom United States Uruguay

China, Syria/Lebanon, Philippines China, Syria/Lebanon, Liberia, Philippines

L/1266 L/674

China China, Liberia, Philippines, Korea China Colombia Palestine China China, Syria/Lebanon, Philippines Philippines China, Colombia, Philippines China Colombia, Philippines, China China China China, Colombia

L/658 and Add. 1 L/553 L/1102, L/1505 L/3191 GATT/CP/23 L/659 L/460 and L/1269 L/1264 G/77 and L/1430 L/1293 L/950 L/786 GATT/CP/115, Add. 3 L/1613

Of course, in 2001, China joined the WTO, and, at around the same time, Chinese Taipei joined as well. Table 3.1 provides a list of invocations of Article XXVII of GATT. 3.9.3

GATT Practice

Article XXVII of GATT does not exhaust the possibility for withdrawing concessions. Practice has added to it in two cases. The territorial scope of a member’s obligations can be modified over time, and an appropriate illustration to this effect is offered by the first example, the mandate in favor of the United Kingdom to also represent Palestine before GATT. Upon termination of the mandate that the League of Nations had provided the United Kingdom with respect to Palestine, the successor state could not be regarded as being bound by obligations under GATT. The Declaration adopted by the CONTRACTING PARTIES on May 9, 1949, provides: Whereas the Government of the United Kingdom in the course of the negotiations leading up to the drawing up of the General Agreement on Tariffs and Trade in 1947, negotiated on behalf of the mandated territory of Palestine for concessions to be accorded to products originating in such territory and for concessions to be accorded to the products of other contracting parties entering such territory, and Whereas the Government of the United Kingdom ceased to be responsible for the mandated territory of Palestine on 15 May 1948, The CONTRACTING PARTIES Declare that, since the United Kingdom ceased, as from 15 May 1948, to be a contracting party in respect of the territory formerly included in the Palestine mandate,

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Section E shall be deemed to be no longer part of Schedule XIX; and Any contracting party shall, in accordance with Article XXVII of the General Agreement, be free to withhold or withdraw, in whole or in part, any concession provided for in the appropriate schedule annexed to the GATT which such contracting party determines was initially negotiated with the United Kingdom on behalf of Palestine, provided that the contracting party taking such action shall give notice to all other contracting parties and, upon request, consult with the contracting parties which have a substantial interest in the product concerned. (italics in the original)

The second instance concerns Yugoslavia following the civil war that erupted in this country in the late 1980s and early 1990s, and led to the freezing of Yugoslavia’s participation in GATT. During this period, the Yugoslav Federation slowly collapsed, and new state entities appeared on the international scene. One of them, the Federal Republic of Yugoslavia, claimed to be the successor to the Yugoslav Federation and requested to be acknowledged as such. Had its request been accepted, the new state would have preserved the GATT contracting party status originally enjoyed by the Yugoslav Federation. GATT contracting parties reacted negatively to this request and decided to freeze the participation of the Federal Republic of Yugoslavia:155 Yugoslavia —Status as a contracting party (L/7000, L/7002, L/7007, L/7008, L/7009, L/7022) The Chairman said that the break-up of the former Socialist Federal Republic of Yugoslavia had posed the question of its status as a contracting party. While the delegation speaking in the name of the Federal Republic of Yugoslavia (FRY) had laid claim to the status of successor to the former Socialist Federal Republic of Yugoslavia (L/7000), this claim had been contested by some contracting parties and some others had reserved their position on the issue. Some contracting parties had also suggested that the delegation claiming to represent the FRY as a successor to the Socialist Federal Republic of Yugoslavia (SFRY) in GATT should not participate in GATT activities until the FRY had sought fresh membership, while others held the view that its participation should be without prejudice to the FRY’s claim to successor status. He had held extensive informal consultations with contracting parties and believed there was agreement that this issue would need consideration by the Council. In these circumstances, without prejudice to the question of who should succeed the former SFRY in the GATT, and until the Council considered this issue, he proposed that the representative of the FRY should refrain from participating in the business of the Council. The Council so agreed.

As a result of all this, the Federal Republic of Yugoslavia did not participate in the General Council meetings. Later, with the advent of the WTO, Serbia and Montenegro (a state entity corresponding geographically to the Federal Republic of Yugoslavia), followed by other former Yugoslav republics, requested accession to the WTO anew, and working parties were established to this effect.156 3.10

Exceptions

Articles XX and XXI of GATT can justify deviations from the obligation assumed under Article II of GATT, as do waivers. All these subjects will be discussed in detail in chapter 9.

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Institutions

We stated in the previous chapter that the Market Access Committee deals with issues relating to both tariff- and nontariff barriers. It thus, runs the IDB/CTS (Integrated Data Base, Consolidated Tariff Schedules) dataset, which comprises data regarding both boundas well as applied duties by WTO members. We discuss it in more detail in chapter 12, volume 2.157 There are many extra-WTO initiatives aiming to increase transparency regarding tariffs (as well as nontariff measures). The most ambitious is the recent Transparency in Trade Initiative (TNT), which aimed to bring under one roof a number of pre-existing transparency mechanisms. The TNT is a joint initiative by the AfDB (African Development Bank), the ITC (International Trade Centre), the UNCTAD (United Nations Conference on Trade and Development), and the WB (World Bank). It brings together various initiatives: namely the WITS (World Integrated Trade Systems), a joint UNCTAD/WB initiative, which puts together the UN COMTRADE (International Trade Statistics Database), a repository of official trade statistics, the UNCTAD TRAINS (Trade Analysis Information System), a computerized information system at the HS six digit-level, and the WTO IDB/CTS; the MAcMap (Market Access Map), an ITC initiative that provides tools for market analysis for MFN and preferential rates for 190 countries, and is accessible by private operators as well; and the TTBD (Temporary Trade Barriers Database), a dataset regrouping all contingent protection measures, namely, antidumping, countervailing, and safeguards. 3.12

Concluding Remarks

The decision to differentiate the legal treatment of tariffs from that reserved to quantitative restrictions (QRs) is quite sensible. Tariff-based negotiations are easier to reconcile with the resolute belief of the GATT framers to move to nondiscriminatory trade liberalization, and the economic theories discussed in this chapter provides ample support for this view. Reduction of tariffs is probably the single most important success that the GATT/WTO has recorded so far. It is because of this success that WTO members could switch their focus to the negotiation of disciplines on NTBs, the main focus during the Tokyo and Uruguay rounds. This success had another by-product: tariff-preferences under preferential trade agreements have been eroded because the margin of preferences granted has gradually reduced as a result of the reduction of MFN tariffs. The regulation of renegotiation of tariffs leaves a lot to be desired, especially when it comes to the compensation paid in case no agreement is reached and the applicant goes ahead and raises tariffs. Only a legislative amendment would settle this issue once and for all.

4

Most Favored Nation

4.1 The Legal Discipline and Its Rationale 4.1.1 The Legal Discipline By virtue of Article I of GATT, WTO members must automatically and unconditionally accord to products originating in any WTO member any trade advantage that they have granted to a like product originating in another nation, regardless of whether the latter is a WTO member. 4.1.2 The Rationale for the Legal Discipline The most favored nation (MFN) obligation is the quintessential GATT/WTO discipline. As we saw in chapter 1, the whole GATT edifice was built around this concept since the aim of the GATT framers was to establish a world trading order where like goods would be treated in the same way regardless of their origin.1 The negotiating rationale involved the conviction (at least among the leaders at the negotiating table) that existing preferences were not only bad for business, but also a factor contributing to conflicts among nations. GATT, through MFN, its cornerstone, was conceived as the means to equalize conditions of competition across its adherents in an effort to curb asymmetric access to foreign markets. The MFN also represented a gift for those with weak bargaining power, who could not effectively negotiate the reduction of trade barriers. Cordell Hull believed that this was the leaders’ duty and their contribution to world peace. MFN largely represents the value of joining GATT; by introducing the MFN requirement into GATT, club members (e.g., GATT contracting parties) were insured against the risk of being treated worse than outsiders (hence the term “MFN”). If a club member accorded better or the same treatment to an outsider, then what would have been the purpose of joining GATT in the first place? To make adherence to GATT worthwhile, club members would have to immediately and unconditionally extend to all other club members any advantage they had previously accorded to outsiders.2 Conversely, club members were

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not obliged to accord to outsiders the advantages they had accorded to other club members. Joining the GATT provided trading nations with certainty in the treatment of traded goods, a luxury that was not extended to outsiders. While club members were certain that they would never be disadvantaged over outsiders, the latter could not count on similar treatment.3 4.1.3

Discussion

4.1.3.1 The Historic Dimension of MFN Nondiscriminatory trade liberalization is not an invention of the GATT system. Hudec (1988) explains that, as early as medieval times, the city of Mantua, Italy, obtained from the Holy Roman Emperor the promise that it would always benefit from any privilege granted by the emperor to “whatsoever other town.” Jackson (1997, p. 158) notes that the term “MFN” appears for the first time at the end of the seventeenth century. During the nineteenth century, the provision appeared in a number of treaties between European states. For instance, the Cobden-Chevalier treaty of 1860, which liberalized trade between Great Britain and France, included an MFN clause guaranteeing that neither signatory would be treated worse in each other’s market than any other state with which one of the two signatories had, or would assume, trade relations. In the earlier part of the twentieth century, the US signed many bilateral treaties containing an MFN clause. The League of Nations included a clause to this effect and based its formulation on treaties signed by the US, as well as numerous other bilateral trade treaties that saw the light of day before World War I. Although not quite an MFN clause as it is known today, Article 21 of the Covenant of the League of Nations stated: The high contracting parties agree that provision shall be made through the instrumentality of the League to secure and maintain freedom of transit and equitable treatment for the commerce of all states members of the League, having in mind, among other things, special arrangements with regard to the necessities of the regions devastated during the war of 1914–18.4

The drafters of the GATT MFN clause were inspired by this formulation but opted for an explicit prohibition of discrimination.5 4.1.3.2 MFN at the GATT Negotiating Table The MFN obligation was reflected in Article 14 of the London Draft and did not change much afterward. The London Draft looks very much like Article I of GATT. There was, in principle, an agreement early on with respect to at least some of the policies that should be left out of the coverage of MFN.6 There was, however, dissatisfaction with the formulation of the legal provision. Terms such as “like products” that had been used to operationalize the obligation not to discriminate were prone to confusion. Still, negotiators took the view that it would be counterproductive to delay the negotiation in search of more appropriate language. In the view of those around the table at the time, one could always attempt

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clarifications later, when the ITO would come into force.7 Thus, only cosmetic changes were agreed on subsequent to the London Conference. MFN was, of course, a frontal attack against British imperial preferences. The UK would not go down without a fight. It did not wish to battle against MFN, though. It was fighting in order to secure a carve-out from MFN. The UK was in favor of nondiscriminatory trade liberalization so long as room could be made to accommodate its preferential trade. A substantial part of the negotiations during the London conference, and in the subsequent conferences as well, centered around one theme: which preferences would be grandfathered? It was finally agreed that, in addition to the imperial preferences, § 3 should be added, which concerns the special position of certain countries of the Near East (specifically the Ottoman Empire),8 some annexes that concerned Portuguese territories, and the special regime between Italy, San Marino, and the Vatican.9 4.1.3.3 MFN at the GATT Negotiating Table: The Economics of MFN There is a widespread view of a strong economic rationale in favor of nondiscrimination, and that economists do not hesitate at all to recommend it. For instance, it seems to be a rather commonly held view (particularly among noneconomists) that nonuniform tariff structures give rise to inefficient production and consumption patterns in a static sense. Other arguments in favor of nondiscrimination hold that it eases tariff negotiations or may even prevent the formation of preferential trading agreements that are formed to exploit market power in world markets. A general, theoretical prima facie case for nondiscrimination is not that simple and obvious, though. Indeed, Johnson (1976) goes as far as to argue that “the principle of non-discrimination has no basis whatsoever in the theoretical argument for the benefits of a liberal international trade order in general, or in any rational economic theory of the bargaining process in particular.” This statement, which is probably a bit extreme, should not be equated to a rejection of the principle of nondiscrimination either. In fact, a nuance here is appropriate: economic theory does support the claims concerning the beneficial effects of MFN, but not without reservation. Horn and Mavroidis (2001), in their survey of the economic literature on this score, concluded that models show that there would be less trade liberalization without MFN. They also point to literature that adopts a more nuanced position when arguing the case for nondiscrimination.10 There are other reasons why the introduction of MFN is sensible. Concession erosion is particularly relevant in trade negotiations, and it is probably the best reason for introducing MFN into GATT in the first place. MFN is an insurance policy against concession erosion, which could occur in multiparty negotiations. Here is how it works: Home and Foreign reciprocally exchange concessions. Subsequently, Home provides a third country with an advantage larger than that that it had originally granted to Foreign. Absent some assurance that similar behavior will not happen, Foreign will have little incentive to negotiate with Home ever again. MFN is the insurance policy that Foreign buys in order to

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guarantee that concession erosion will not occur (since whatever advantage Home grants third countries in the future will automatically and unconditionally be extended to Foreign as well). It is important that Foreign continues to be “incentivized” to negotiate in a setting like GATT. As discussed in chapter 1, tariffs were quite high when GATT came to fruition, and the road to tariff liberalization was a slow, incremental process where tariffs would be gradually reduced through reciprocal commitments, not eliminated in one go.11 MFN is the means to avoid concession erosion, but concessions can be eroded through the formation of preferential trade agreements (PTAs). Many PTAs were indeed formed (and continue to be); this issue will be explored further in chapter 6. By conditioning the legality of PTAs on a series of conditions, the potential for erosion was somewhat restricted. Alas, as chapter 6 will reveal, these conditions were almost never enforced in practice. This is not to suggest that the value of MFN is limited to avoiding concession erosion. MFN is about protecting and preserving multilateralism. It is as relevant for unbound duties as it is for all nontariff barriers. In a world where tariffs will be a thing of the past, MFN will still apply and require that policies affecting trade are applied in nondiscriminatory manner, providing thus the umbilical cord to multilateralism. It is also important to note that MFN greatly simplifies trade negotiations. Multiparty tariff negotiations are inherently complex. Imagine a world without MFN. Negotiators would have to enter into bilateral deals with all trading nations, a tall order by any reasonable standard. While it is fine to acknowledge that theoretically, the case for nondiscrimination is not watertight, it is quite optimistic (if not altogether illusory) to hope that negotiators would actually achieve a more efficient international allocation of production and consumption if they were allowed to agree on non-MFN tariffs, which require highly complicated negotiations. The simplicity associated with MFN negotiations must look attractive to negotiators. Therefore, there are strong grounds to support its inclusion into GATT/WTO. MFN is not free of problems, though. As briefly alluded to earlier in this section, the case for nondiscrimination is not watertight. It is a bit like Churchill’s saying about democracy: to paraphrase, it is the worst system we know of except for everything else. Free riding is probably the first thing that comes to mind when one thinks of the weak points of MFN. MFN promotes, or at least allows, free riding because countries may opt to wait for agreements between other countries to spill over via MFN, rather than contribute by making concessions themselves. This would be inefficient, however, because there would be delays in achieving an agreement or because the agreement would feature higher tariffs compared to some other, undefined situation. Assume that Home and Foreign have signed an agreement including an MFN clause. Home subsequently negotiates with a third country and knows that whatever benefit it grants this third party has to automatically extend to Foreign as well. Foreign, in other words, will be free riding on Home’s negotiation with the third country. Any subsequent

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negotiation to obtain advantages involves additional negotiating costs for Home, but Foreign just gets the additional advantages. Under the circumstances, Home might be dissuaded from entering into subsequent negotiations with third countries. Moreover, MFN prevents countries from punishing free riding since punishments must be nondiscriminatory and not targeted, in light of the fact that free riding does not amount to illegality. The free rider problem has occupied the minds of both economists and policy makers. One obvious solution to it would be to invite all participants to participate in the negotiation simultaneously. But what if they do not accept?12 The GATT system has other mechanisms and instruments that reduce the impact of free riding. Reciprocity, for a start, reduces the size of the problem. The size of the reduction depends, of course, on the number of players entering into reciprocal concessions, and this is where the critical mass agreements that we saw in chapter 3 are relevant.13 It is of limited value though, since any advantages negotiated must be extended “unconditionally” to all WTO members. When a subset of the membership participates in the negotiation, then reciprocity can only limit the extent of the problem that free riding presents us with. It is to be expected though, that principal suppliers will participate in tariff negotiations, and, consequently, free riders will be those that do not matter (or do not matter much) in the trade context—at least in most cases. This is the most effective instrument in the fight against free riding. In short, the problem continues to exist, but its size is being reduced through the mechanisms described previously. Another criticism frequently voiced is that MFN incites narrow commitments. Under MFN, countries may have incentives to use narrow product classifications to avoid having to extend concessions granted on an MFN basis to a greater variety of products. This could create reasons for countries to try to manipulate customs classification schemes. The danger of having too fine-tuned tariff classifications exists, but its importance should not be exaggerated. When classifications are expressed in a higher-than-six-digit level, as shown in chapter 3, then the danger is real. Those who practice similar classifications, though, tend to have the lowest bound duties across goods. 4.1.3.4 MFN and Preferential Trade In light of trade liberalization within the hundreds of free trade areas that have been formed over the years, a number of analysts have described MFN as the least favored nation (LFN) clause. De facto, MFN is the default payment to WTO members, assuming that one of the many preferential payments does not occur. Over the years, non-MFN schemes—be it PTAs14, preferences for developing countries, and, more recently, plurilateral agreements—have proliferated and substantially reduced the volume of MFN trade. A series of empirical works has demonstrated15 that most trade nowadays is conducted on non-MFN terms, and the proportion of non-MFN trade in the overall volume of trade is only increasing.

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Coverage of the Legal Discipline

The coverage of MFN was of course, the sticking point during the negotiations of GATT as discussed in chapter 1. The UK delegation was not willing to multilateralize its imperial preferences, and the US had to eventually concede this point. The final compromise was that any state measure affecting trade would be, in principle, subjected to MFN, unless explicitly exempted from the coverage of the clause. The focus was of course on border measures that were explicitly mentioned in the body of Article I of GATT. Internal measures were mentioned as well, since, unless disciplined, they too could lead to erosion of tariff commitments. Article I of GATT mentions some measures specifically but adds that any “favor” or “advantage” with respect to the mentioned measures must be extended automatically and unconditionally to all WTO members. The terms “favor” and “advantage,” as well as the term “of any kind” following the terms “duties and charges” denote the preference of the legislator for wide coverage of the MFN clause. In principle, thus, unless a measure affecting trade that has been adopted by a WTO member has not been excluded, it must observe the MFN clause. We kick off our discussion with a few words on de jure- and de facto discrimination, since both forms of discrimination are outlawed by virtue of case law construction of the MFN clause to this effect. 4.2.1

De Jure versus De Facto Discrimination

The question arose in Canada–Autos whether both de jure and de facto discrimination were covered by the discipline embedded in Article I of GATT. The former term refers to measures that are discriminatory on their face, or a law whereby an advantage is granted by explicitly using origin as the criterion for its conferral (e.g., widgets originating in Home will pay a 10 percent import duty when imported into Foreign, whereas widgets originating anywhere else will pay 20 percent). The latter term covers measures that on their face are origin-neutral but still confer an advantage to some imported goods, or a law that confers an advantage on a condition that only one or more particular WTO members can satisfy (e.g., Home imposes 10 percent customs duty on widgets produced in a country with which it has a positive trade balance, and 20 percent on widgets originating elsewhere). Confining the ambit of Article I of GATT to cases of de jure discrimination only has an obvious advantage: it is an easy-to-use rule of thumb, as practitioners and judges alike can apply it without having to delve into elaborate thought processes. It also has an obvious disadvantage: it can be circumvented, sometimes with remarkable ease. Extending the coverage of this provision to cases of de facto discrimination addresses the circumvention issue. It opens the door to problems, though, since proof that advantage was granted because of the origin of the good and for no other reason might not be easy to obtain.16

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The AB, in its report on Canada–Autos, held that both de jure and de facto discrimination are covered by the prohibition included in Article I.1 of GATT (§ 78): In approaching this question, we observe first that the words of Article I:1 do not restrict its scope only to cases in which the failure to accord an “advantage” to like products of all other Members appears on the face of the measure, or can be demonstrated on the basis of the words of the measure. Neither the words “de jure” nor “de facto” appear in Article I:1. Nevertheless, we observe that Article I:1 does not cover only “in law,” or de jure, discrimination. As several GATT panel reports confirmed, Article I:1 covers also “in fact,” or de facto, discrimination. Like the Panel, we cannot accept Canada’s argument that Article I:1 does not apply to measures which, on their face, are “origin-neutral.” (italics in the original)

The burden of persuasion associated with establishing de jure or de facto MFN violation should be different—in principle, at least. In case of a claim of de jure discrimination, all a complainant needs to show is that two like goods are treated differently. Citing prior case law established by the AB, the Panel on US–Tuna II (Mexico) (Article 21.5–Mexico) held that complainants claiming a case of de facto discrimination face the arduous task of showing why seemingly nondiscriminatory measures still discriminate in favor of domestic goods. To this effect, recourse to proxies might be necessary. In the words of the Panel (§ 7.65): To establish this fact, the complainant must provide evidence of the measure’s design, architecture, and revealing structure, and link these aspects of the measure to the detrimental impact that it claims its imports are suffering. A complainant, especially in a case of de facto discrimination, cannot simply point to the measure at issue and then expect the panel to find a violation where the respondent fails to show that the measure at issue never could result in a violation of one or more WTO obligations. In cases of de facto discrimination, the complainant must provide evidence and argument sufficient to show why a measure that appears to be non-discriminatory on its face nevertheless in fact provides less favourable treatment to imported products in a way that is repugnant to WTO law.

4.2.2

Measures Covered: Any “Advantage,” “Favor,” Etc.

The coverage of the MFN discipline extends to any “advantage,” “favor,” “privilege,” and “immunity” with respect to four categories of measures mentioned in the body of Article I of GATT, namely: • Customs duties and charges of any kind imposed on or in connection with importation and exportation • Any method for calculating the measures mentioned previously • Rules and formalities in connection with importation and exportation • Internal measures The word “any” prefacing the terms “advantage,” “favor,” etc., is indicative of the will of the framers to ensure wide coverage for the MFN clause. Its coverage extends to border

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measures (all charges imposed on imported and exported goods, the method for calculating them, as well as all other rules and formalities in connection with both importation and exportation), and domestic instruments—that is, behind-the-border measures covered by Article III of GATT. We discuss the coverage of this provision in chapter 7. Not only actions, but also omissions (to the extent that they confer an advantage) are covered by the discipline laid down in Article I.1 of GATT. The GATT panel on US–Customs User Fee held that an exemption from the imposition of a customs fee should be considered an advantage under Article I.1 of GATT.17 The panel on US–Non-Rubber Footwear dealt with the issue of the so-called unit account, to wit: should we understand “advantage,” “favor,” etc., with respect to one specific measure imposed on imports, or should we look at the total treatment of imports to decide whether MFN has been respected or not? In other words, should we allow rebalancing in the treatment of imports? The US had claimed that it could legitimately rebalance or offset the damage done to some imports through more favorable treatment of the same imports through other measures. In its view, it was permissible under Article I.1 of GATT to discriminate negatively with respect to some measures, so long as some positive discrimination were provided through other measures. In the US view, what matters is the total treatment of imports— that is, the treatment with respect to all the legislation applied to a particular import transaction. Thus, claims that an advantage had not been extended immediately and unconditionally should be dismissed, absent proof that imports from a particular source had been treated in a discriminatory manner when the totality of law applicable to them has been considered. The panel disagreed with the argument presented by the US. In its view, no rebalancing is permissible under Article I of GATT (§§ 6.10ff). The panel held that MFN must be respected with regard to each and every measure that comes under its ambit. This seems like the only plausible conclusion. Otherwise, importers would be allowed to discriminate with respect to specific measures across imports, and complainants would have a tough time demonstrating that differentiated measures applied to different imports conferred an advantage to some and not to others. 4.2.2.1 Customs Duties and Charges of Any Kind Customs duties (like other duties or charges) can be either bound or unbound, as we saw in chapter 3. The GATT panel on Spain–Unroasted Coffee held that the MFN clause is equally applicable to both bound and unbound customs duties (§ 4.3): “Having noted that Spain had not bound under the GATT its tariff rate on unroasted coffee, the Panel pointed out that Article I:1 equally applied to bound and unbound tariff items.” The words “of any kind” that qualifies the terms “duties and charges” appearing in Article I.1 of GATT suggest that the charges and duties envisioned in this provision are not limited to OCDs and ODCs. They also cover fees paid for services rendered at the

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border that are covered by Article VIII of GATT (a point confirmed by the panel on US–Customs User Fee), as well as antidumping (AD) duties, countervailing duties, surcharges, etc. In this vein, the AB held, in its report on EC–Poultry (§§ 96ff.), that Article I.1 of GATT covers tariff quotas as well. When deciding on rates within and outside the tariff quota, WTO members must ensure that they have adhered to the nondiscrimination principle. In this vein, in EC–Bananas III, the panel found that conditioning the imposition on certain bananas of the in-quota (lower) tariff rate upon their origin was an advantage that came under the purview of Article I of GATT (§§ 7.235ff., confirmed by the AB in its report in § 207). GATT practice further suggests that other customs-related activities come under the purview of Article I of GATT as well. In Cuba–Consular Taxes, for example, a GATT panel held that consular fees must respect the MFN clause.18 4.2.2.2 Methods for Calculating the Level of Duties and Charges Article I of GATT makes it clear that methods for calculating the level of duties (e.g., the actual value for customs valuation purposes) must be applied on an MFN basis. 4.2.2.3 Rules and Formalities Case law has identified a number of rules and formalities that come under the purview of Article I of GATT. The leading case in this respect is EC–Bananas III. This panel found that the following rules and formalities in connection with importation came under the ambit of Article I.1 of GATT: • The use of a less complicated licensing procedure (§§ 7.188ff.) • The incentive given to operators to purchase bananas of a particular origin (§ 7.194) • The issuance of a license to import bananas of a particular origin upon the economic activity performed by the economic operator requesting the license (§§ 7.220ff.) • The granting of licenses only to operators representing producers from certain countries (§§ 7.251ff.) • The imposition of the in quota tariff rate on certain bananas, provided that they originate in particular countries (§§ 7.235ff.) The AB confirmed all these findings (§§ 206ff.).19 The GATT panel on US–Non-Rubber Footwear further found that the automatic backdating of the revocation of a countervailing duty order without the need to conduct an injury review is an “advantage” in the sense that this term is used in Article I.1 of GATT (§ 6.8). And the GATT panel on US–CVD (India) held that the US was in violation of its obligations under Article I of GATT because it did not apply the injury criteria featured in Article VI.6 of GATT to imports originating in India, but did so to imports originating in any other place.

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4.2.2.4 Internal Measures Article I.1 of GATT makes it clear that, by virtue of explicit reference to Articles III.2 and III.4 of GATT, MFN covers internal measures as well. Very early in GATT history, the GATT panel on India–Tax Rebates (1948) dealt with a case of rebates of domestic excise duties: exported goods would not be subject to the same taxes as goods sold in the domestic market. The topic of differential treatment between goods sold in the domestic and export markets is discussed in chapter 7. For now, the issue is (and indeed was before the panel) whether rebates should respect MFN. The panel responded affirmatively. Four years later, the GATT panel on Belgium–Family Allowances held that internal tax exemptions for products purchased by public bodies were covered by Article I.1 of GATT. 4.3

Exemptions

The MFN discipline does not cover the UK imperial and other historic preferences, which have been explicitly exempted through their inclusion in the various annexes to GATT. At the moment of the advent of GATT, probably no one expected that the imperial preferences would survive the test of time. Their dismantlement, though, had to wait almost 50 years, as we explain in what follows. 4.3.1

Grandfathering Imperial Preferences

Articles I.2 and I.3 of GATT contain the “grandfathering” clause. According to the former provision, GATT contracting parties agreed to exempt from the MFN coverage the imperial preferences granted by the UK to countries and territories participating in its Commonwealth. In return, a few other preferences in place before 1 January 1948, were also grandfathered. They appear in Annexes A–F to GATT.20 Imperial preferences involved higher duties for goods that did not originate in the British Empire and lower duties on “Dominion goods” (i.e., goods that originated in the British Empire). This drew the ire of excluded countries for discriminating against their trade. Recall from the discussion in chapter 1 that Cordell Hull was an especially sharp critic of imperial preferences because of their adverse effect on US exports, particularly to the UK and Canada, two of the most important US markets. Testifying before Congress in 1940, Hull called imperial preferences “the greatest injury, in a commercial way, that has been inflicted on this country since I have been in public life.”21 Will Clayton was very much in line with Hull with respect to his attitude toward imperial preferences. Recall from chapter 1 that he went so far as to suggest suspending the talks in Geneva as one of the options that the US government should contemplate if the UK delegation insisted on preserving imperial preferences. It was only a decision by President Truman to override Clayton’s counsel to push for an agreement outlawing the system of imperial preferences that ultimately ensured the success of the Geneva tariff

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negotiations and the advent of GATT. To Clayton’s disappointment, Britain’s imperial preferences remained largely intact.22 All the US negotiators achieved was to impose a standstill obligation on imperial preferences so they could not be increased beyond the level existing on 1 July 1939, or 1 July 1946, whichever was lower. The imperial preferences were included in Annex A to GATT. 4.3.2

Other Historical Preferences

During the London Conference, it was agreed that, in addition to imperial preferences, other long-standing preferences would be temporarily permitted.23 All preferences of this sort that would provisionally remain intact were included in Annexes B–F as follows: • B, preferences granted by France • C, preferences granted by Belgium, the Netherlands, and Luxembourg • D, US preferences to dependent territories and the Philippines • E, preferences between Chile and Argentina, Bolivia, and Peru • F, preferences between Lebanon, Syria, Palestine, and Transjordan The remaining grandfathered preferences concerned Portuguese territories and the special regime between Italy, San Marino, and the Vatican.24 In a similar vein, § 3 was added to Article I of GATT at the Havana Conference. This paragraph deals with preferences across certain countries of the former Ottoman Empire, and, contrary to Article I.2 of GATT, it does not refer to the absence of a requirement to eliminate existing preferences; new preferences are, thus, conceivable. To this effect, though, they would be waived through the procedures established in Article XXV.5 of GATT. This provision found application in the accession of the United Arab Republic and the preferences that it accorded to a host of countries.25 The margin of preference would, in accordance with Article I.4 of GATT, be explicitly stated in the relevant Annex (e.g., preferences by France would be reflected in Annex B), or the schedule of concession. If this had not been the case, then it is the rate applicable in 1947 (that the donor applied to imports from the beneficiary) that would be grandfathered.26 4.3.3

Imperial and Historical Preferences Today

Already during the negotiation of the GATT, a provision had been agreed whereby parties granting preferences would enter into negotiations in order to reduce them, upon request of the Organization. The provision referred to “substantial reduction” of preferences as a result of mutually advantageous negotiations to this effect. The Organization was, of course, the ITO. Because the ITO never saw the light of day, this provision was never

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applied either.27 Preferences grandfathered during the GATT stayed in place for a long, long time. During the Uruguay round, it was agreed that parties would notify the Legal Drafting Group, one of the negotiating groups, of all remaining preferences. It turned out that most of the schedules of concession did not reflect any of the grandfathered preferences that were originally excepted. This signaled the end of not only the imperial preferences, but all preferences that had been originally reflected in Article I of GATT and its annexes. There is one exception to this rule. Cuba still retains its preferential treatment with the US, although de facto there have been no commercial ties between the two following the ascent of Fidel Castro to power.28 The recent (April 2015) rapprochement between the US and Cuba is expected to result in the normalization of trade relations between the two countries. 4.4 The WTO “Club” Must Receive the Best Treatment 4.4.1 WTO Members versus the Rest of the World Article I.1 of GATT refers to “any advantage, favor, privilege or immunity granted by any contracting party to any product originating in or destined for any other country”(emphasis added). As a result, WTO members cannot treat outsiders (non-WTO members) better than they treat insiders (WTO members) with respect to any of the measures coming under the purview of Article I of GATT. 4.4.2 As Membership Increases, So Does the Impact of MFN At the inception of GATT, this provision was thought of as the carrot offered to numerous outsiders to join the club. Since only 23 countries originally joined, the value of MFN was limited, the presence of the US and the UK in the club notwithstanding. Its practical importance has substantially increased as a result of the rise of WTO membership from 23 to its current level of 161 nations. 4.5

Favors/Advantages Must Be Accorded Immediately and Unconditionally

A WTO member must extend to all WTO members, immediately and unconditionally, a trade advantage that it has already granted to another WTO or a non-WTO member. WTO adjudicating bodies will typically review the consistency of a measure with the two requirements (immediately and unconditionally) at the same time. The AB report on Canada–Autos is a good illustration of this (§§ 75–86). The two terms, nonetheless, have different meanings, a point that will be discussed next.

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Immediately

The term “immediately” suggests a temporal criterion. No time should lapse between granting an advantage to one country and extending it to all WTO members. As such, the word does not lead to confusion. 4.5.2

Unconditionally

4.5.2.1 The US Attitude toward Conditional and Unconditional MFN We saw in chapter 1 that Hull did not demand full reciprocity (that is, reciprocity of access) during the original GATT negotiation; rather, he sought what economists usually call “first difference reciprocity,” where the goal was to match concessions from the initial conditions.29 The road to unconditional MFN was not smooth, though. Many a fight was fought inside the US administration, and the end result in GATT risked being overturned in subsequent years. Irwin (2015) explains that, except for Hull, William Culbertson of the Tariff Commission played the key role in getting the US to adopt the unconditional MFN clause in US commercial agreements signed before the advent of GATT. The US desire for equality of treatment in world trade went back to the days of the revolution and Thomas Jefferson’s report on foreign trade barriers and discriminations. In his Farewell Address at the end of his second term as president, George Washington advised that “our commercial policy should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences.” The US almost always opposed discriminatory treatment in international trade policies. With few exceptions for tariff preferences (Cuba, the Philippines, Puerto Rico, Hawaii), the US offered all countries equal access to its market.30 In return, it expected that other countries would grant it equal, nondiscriminatory access for its exports as well. European countries pursued discriminatory tariff policies in the decades prior to World War I through bilateral trade agreements and colonial trade preferences. The US found itself increasingly discriminated against in world commerce. As a result, prior to World War I, it found itself embroiled in an increasing number of tariff disputes over the treatment of its goods in foreign markets. The US would have to become more assertive if it wanted to ensure equal treatment for its exports in foreign markets. Before World War I, European countries such as France and Germany had maximum-minimum tariff schedules and the United States was ineligible for the lower tariff rates. The US faced widespread discrimination against its trade as a result of colonial trade networks and maximum-minimum tariff schedules. Irwin (2015) further mentions that in 1919, the Tariff Commission issued a report entitled “Reciprocity and Commercial Treaties,” which addressed how the US should confront this new problem. Completed under the guidance of the commission’s chairman, Frank Taussig, the document proved to be one of the most influential government reports on trade since Alexander Hamilton’s “Report on Manufactures.”31 The report noted that,

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to the extent that the US sought to eliminate discrimination by other countries through bilateral negotiations, it was handicapped by its long-standing use of the conditional interpretation of the MFN clause. Under conditional MFN, a concession granted to one country would not be given automatically to other countries unless they also granted new concessions. This policy dated back to the Treaty of Amity and Commerce with France in 1778. If taken seriously, this meant that if the US agreed to reduce its tariff on some goods to secure equal treatment for its exports in another country, those US tariff reductions could not be applied to imports originating in other countries unless they also agreed to grant the US new concessions. The Tariff Commission argued that the old conditional-MFN policy no longer served the nation’s best interests. Given its increasing participation in world affairs, the US could not realistically craft a country-by-country trade policy. But if it offered equal treatment to all countries unconditionally, the US risked losing bargaining leverage against others. Such leverage could be restored either by giving special concessions to countries that gave equal treatment to US goods or by imposing penalty duties on countries that did not. Irwin (2015) cites a series of documents produced by the Tariff Commission arguing that penalty duties imposed at the discretion of the US president would be the better option. At the end of the day, although the Tariff Commission did not make a specific policy recommendation, it strongly implied that a policy of unconditional MFN with penalty duties for countries discriminating against the US would be the best outcome. Irwin (2015) notes that the US Congress did not act upon this recommendation until it took up the tariff revision in early 1921. The House version of the Fordney-McCumber Tariff of 1922 included a provision, designed with a view for securing reciprocal trade with foreign countries, similar to that in the Dingley Tariff of 1897. It gave the US president permission, for a period of three years, to reduce import duties by no more than 20 percent on selected commodities in agreements with foreign countries. These new duties could be established by presidential proclamation and would not require congressional approval, although the reduction would expire after five years unless renewed by legislation. Culbertson was working to convince Congress that unconditional MFN with penalty duties would be better than conditional MFN with special concessions. Culbertson persuaded Senator Reed Smoot to adopt this approach and scrap the one endorsed by the House. The Senate approved this provision, which was accepted by the House. It became section 317 of the Fordney-McCumber Tariff. This section, based on the maximumminimum provision of the Payne-Aldrich Tariff of 1909, allowed the president to proclaim new or additional duties (not exceeding 50 percent) upon imports of any or all products of a country that discriminated and placed US goods at a disadvantage compared with those from any foreign country. Section 317 sparked virtually no debate in Congress, which was preoccupied with the precise duties in the tariff schedule. The phrasing of Section 317 appeared to endorse

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unconditional MFN, although it did not explicitly mandate it. Culbertson then turned his attention to the executive branch and the president to make sure that it was implemented as administration policy. It is largely thanks to his efforts that the US adopted the unconditional MFN clause. The new unconditional-MFN policy was unveiled in a new commercial treaty with Germany. The treaty did not alter any import duties but required that each country extend unconditional MFN benefits to each other in the application of its tariff and other commercial benefits.32 This is not the end of the story, though. Over the years, unhappy with the response its offer for unconditional MFN had received around the world, voices arguing for MFN conditionality were being raised and gathering steam. Bhagwati and Irwin (1987, p. 109) quote President Ronald Reagan stating in 1987:33 “We are always willing to be trade partners, but never trade patsies.” “Patsies” would be trading nations that, in the name of unconditional MFN, offer concessions that remain unanswered. Similar thoughts have led to critical mass agreements, as discussed in chapter 3, as well as to some negotiations outside the WTO [the Trade in Services Agreement (TISA) being the most prominent example]. The US however, did not manage to introduce full-fledged conditional MFN into the multilateral trading regime. The extent of free-riding was of course reduced through critical mass agreements, and preferential trade agreements. It is against this background that we propose to discuss the case law regarding the term “unconditionally” as it appears in Article I of GATT. 4.5.2.2 “Unconditionally” in Case Law The term “unconditionally” can be interpreted in different ways and, unsurprisingly, has often become the subject matter of litigation. There is, of course, nothing like “total” unconditionality. MFN involves a one good, two countries comparison. Home, Foreign and Third are all WTO Members, and Home grants Foreign a 5 percent duty on polyester shirts (assume they belong to a tariff line on their own). Third wants to profit from this rate, but must of course first satisfy the condition that its shirts are made of polyester. Home cannot impose on Foreign additional conditions for granting this treatment. It cannot request, on reciprocity grounds, a tariff reduction by Third. This is, or at least should be, the meaning of “unconditional” in the MFN clause. Home has been paid a consideration by Foreign for agreeing to the 5 percent rate, it should not be paid an additional consideration by Third. This might pose a problem regarding the distribution of negotiating costs as we noted in chapter 1, but in the “Hullian” view, this was the price to pay by the leaders of the world in the post WWII era. Case law has exacerbated this understanding of “unconditionally,” and moved to reject conditions of whatever nature imposed by the party granting a benefit. Originally, panels adopted an uncompromising stance. In this vein, the GATT Panel report on Belgium–Family Allowances held that tax exemptions for products purchased

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by public bodies that were made conditional on the existence of a certain system of family allowances in force in the exporting country were inconsistent with Article I.1 of GATT. Many other panels followed this approach. The GATT Panel on EEC–Imports of Beef found that conditioning a duty waiver on certification by a particular government violated the obligation to grant MFN unconditionally. The report of the Working Party on the Accession of Hungary34 stated that to condition a tariff treatment upon the prior acceptance of a cooperation agreement is a violation of the requirement imposed by Article I.1 of GATT. The WTO Panel on Indonesia–Autos found that granting tax advantages to Korean companies, which had entered into arrangements with Indonesian companies, was inconsistent with the obligation under Article I.1 of GATT because the tax advantages had not been extended to other WTO members that had not entered into similar arrangements. The Panel on EC–Tariff Preferences probably best captures this line of thinking by explicitly stating that the term “unconditionally” should be understood as “not limited by or subject to any conditions,” regardless of whether conditions had been imposed ex ante for the granting of the advantage, or simply ex post, which would make the requirement more akin to a requirement of symmetry (§§ 7.59–60): In the Panel’s view, moreover, the term “unconditionally” in Article I:1 has a broader meaning than simply that of not requiring compensation. While the Panel acknowledges the European Communities’ argument that conditionality in the context of traditional MFN clauses in bilateral treaties may relate to conditions of trade compensation for receiving MFN treatment, the Panel does not consider this to be the full meaning of “unconditionally” under Article I:1. Rather, the Panel sees no reason not to give that term its ordinary meaning under Article I:1, that is, “not limited by or subject to any conditions.” Because the tariff preferences under the Drug Arrangements are accorded only on the condition that the receiving countries are experiencing a certain gravity of drug problems, these tariff preferences are not accorded “unconditionally” to the like products originating in all other WTO members, as required by Article I:1. The Panel therefore finds that the tariff advantages under the Drug Arrangements are not consistent with Article I:1 of GATT 1994.

Is this case law reasonable? What if, for example, paraphrasing the facts in EEC– Imports of Beef, the EU had conditioned imports of beef from regions that had experienced mad cow disease upon certification that the products had not been contaminated? Should the EU be obliged to impose that certification obligation of beef products on WTO members that had not been subjected to mad cow disease as well? It simply cannot be the case that the obligation not to discriminate should be equated to an obligation to impose no conditions upon importation at all. A similar construction of the MFN clause would lead to an understanding of this discipline as an instrument for deregulation that only the ayatollahs of free trade at all costs would subscribe to. The WTO panel on Canada–Autos, probably aware of this risk, adopted a more nuanced approach. In its report, the panel suggested that imposing conditions unrelated to the origin

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of a good does not violate the requirement to extend advantages unconditionally if the same requirement has been imposed on those benefiting from the advantage. The facts of the case are as follows: Canadians had in place a duty-free mechanism provided to importers of automobiles, buses, and other vehicles by certain manufacturers.35 In § 9 of its report, the AB reflects its understanding of the conditions that had to be satisfied for duty-free treatment to apply: Under the MVTO 1998, the import duty exception is available to manufacturers of motor vehicles on imports “from any country entitled to the Most-Favored-Nation Tariff,” if the manufacturer meets the following three conditions: (1) it must have produced in Canada, during the designated base year, motor vehicles of the class imported; (2) the ratio of the net sales value of the vehicles produced in Canada to the net sales value of all vehicles of that class sold for consumption in Canada in the period of importation must be “equal to or higher than” the ratio in the “base year,” and the ratio shall not in any case be lower than 75:100 (the “ratio requirements”); and (3) the amount of Canadian value added in the manufacturer’s local production of motor vehicles must be “equal to or greater than” the amount of Canadian value added in the local production of motor vehicles of that class during the “base year” (the “CVA requirements”). (italics in the original)

The AB did not have to address the issue of whether the conditions imposed were lawful since this issue had not been added to the grounds for appeal. It was the panel that had to respond to the question of whether the Canadian condition constituted a violation of MFN. It did so in §§ 10.22 and 10.24, to wit: In our view, whether an advantage within the meaning of Article I:1 is accorded “unconditionally” cannot be determined independently of an examination of whether it involves discrimination between like products of different countries. … In this respect, it appears to us that there is an important distinction to be made between, on the one hand, the issue of whether an advantage within the meaning of Article I:1 is subject to conditions, and, on the other, whether an advantage, once it has been granted to the product of any country, is accorded “unconditionally” to the like product of all other Members. An advantage can be granted subject to conditions without necessarily implying that it is not accorded “unconditionally” to the like product of other Members. More specifically, the fact that conditions attached to such an advantage are not related to the imported product itself does not necessarily imply that such conditions are discriminatory with respect to the origin of imported products. We therefore do not believe that, as argued by Japan, the word “unconditionally” in Article I:1 must be interpreted to mean that making an advantage conditional on criteria not related to the imported product itself is per se inconsistent with Article I:1, irrespective of whether and how such criteria relate to the origin of the imported products.

In the last sentence of the quoted passage, the panel suggests that conditioning access to MFN treatment is perfectly legitimate, so long as the conditions are unrelated to the origin of goods, and are applied in nondiscriminatory manner across all WTO members. This case remains an outlier in case law. Still, the question that arises is whether the panel was addressing a false or a real risk by distancing itself from the case law mentioned earlier in this section and summarized in EC–Tariff Preferences.

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Think again of the example that began this discussion, where Home requests a certificate for importation of beef only from regions that have been plagued with mad cow disease. How else could Home protect itself, other than through this request? Note that, the underlying assumption in this scenario is that it would be totally unnecessary to request similar certification from WTO members that had not experienced the same disease. Why burden them with additional costs in the name of respecting MFN when it is well known that they are safe suppliers of bovine meat? Home could have bought an insurance policy by including in its schedule of concessions elaborate tariff classifications that respect Article 3.3 HS:36 for example, one could imagine in this vein that Home distinguishes say in its eight- or ten-digit classification between bovine meat slaughtered in houses that observe demanding hygiene standards and bovine meat slaughtered in other houses where less demanding standards are being observed. “Likeness” of goods, thus, could take care of some of the problems. But it would not solve all the problems: “likeness” cannot address the issue brought up earlier, where a certificate for importation is being requested only for the importation of beef from regions that have been plagued by mad cow disease. New diseases, or new facts in general, arise that warrant adjustment in trade policies. In similar cases, of course, Home can always take recourse in Article XX of GATT and argue that the conditions across countries that have and have not been hit by mad cow disease are different thus justifying the asymmetric requirements on certification that it had imposed.37 Was Canada–Autos addressing a false problem, then? In a way, this report was shifting the burden of proof. Under the orthodox approach (i.e., the approach followed by panels and summarized in EC–Tariff Preferences), Home, the defendant, should be the one explaining why asymmetric certification procedures had been put in place. Under Canada– Autos, the panel ruled that Foreign, the affected WTO member, should bring forward the evidence that the conditions in its own market are symmetric to the members enjoying privileged access into Home’s market. Foreign would be required to demonstrate that its exports of bovine meat were safe even though mad cow disease had been seen in the country.38 Canada–Autos, in a way, saw elements of the chapeau (that is, the introductory paragraph) of Article XX of GATT in the tenets of Article I of GATT. It requests that nondiscrimination be observed where similar conditions prevail. In that, the test is perfectly reasonable. It would be awkward for different conditions to be treated in an identical manner, merely in the name of MFN. One might have thought that this discussion would be brought to an end in EC–Seal Products. In this case, the AB had the opportunity to address this issue once and for all in a definitive manner. Alas, the AB’s solution left yet again many questions unanswered. Here are the facts: the EU had banned imports of seal products in the name of protection of public morals (animal welfare), but it did allow some imports under the following limited conditions: (1) IC hunts (products from seals harvested by the Inuit community); (2) MRM hunts, provided that they were commercialized on a nonprofit basis (seal

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products originating in countries where marine resource management programs were in place, and harvesting of seals took place only for the purpose of sustainable development); and (3) seal products imported by travelers for their personal use.39 The panel had found that the EU was in violation of its obligations because it had not extended to seal products of Canadian and Norwegian origin the same advantage (access to the market) that it had extended to seal products originating in the Inuit community established in Greenland. The EU appealed this finding (§§ 5.78ff. of the AB report), claiming that the panel had erred since the term “unconditionally” should not be interpreted as prohibiting conditions in general. In its view, the policy rationale of the measure should be taken into account and should exonerate even measures that have a detrimental impact on some imports, provided that the impact stems from a “legitimate regulatory distinction” (§ 5.89). The AB accepted that imposing conditions was not per se an unlawful act but rejected the EU argument all the same. It held first, in § 5.88: … it does not follow that Article I:1 prohibits a Member from attaching any conditions to the granting of an “advantage” within the meaning of Article I:1. Instead, it prohibits those conditions that have a detrimental impact on the competitive opportunities for like imported products from any Member. Conversely, Article I:1 permits regulatory distinctions to be drawn between like imported products, provided that such distinctions do not result in a detrimental impact on the competitive opportunities for like imported products from any Member. (emphasis in the original)

And then, in (§ 5.90), it stated: … we see no basis in the text of Article I:1 to find that, for the purposes of establishing an inconsistency with that provision, it must be demonstrated that the detrimental impact of a measure on competitive opportunities for like imported products does not stem exclusively from a legitimate regulatory distinction.

Thus, unsurprisingly, the AB rejected the EU claim a few paragraphs later (§ 5.90). The quoted excerpts raise more questions than they purport to answer, and it seems that the AB got more than it had bargained for when entering this analysis. It is clear by the construction of case law that it is tariff classifications that define likeness in Article I of GATT. One might understandably ask then what kind of legitimate regulatory distinctions exist between like imported products that do not result in a detrimental impact on the competitive opportunities and like imported products from any Member the AB had in mind? How can it ever be the case that regulatory distinctions between competing goods do not affect competitive conditions? The AB muddied the waters here, and, alas, did not provide any illustrations to help us understand what it had in mind. As is often the case, the AB kept its cards very close to chest, and, like Pythia, expressed a Delphic oracle rather than a clear statement. In light of the above, it is probably safe to conclude that WTO members that do include conditions will most likely have to justify them under Article XX of GATT. Indeed, the fact that Article I does have an exception (i.e., Article XX of GATT) emerges as the reason

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why the AB applied a test of likeness that was different than its analysis of Article 2.1 of Technical Barriers to Trade (TBT), which does not have a similar exception.39 4.6

Defining Origin

WTO members must immediately and unconditionally extend any advantage with respect to the measures mentioned in the body of Article I.1 of GATT granted to a product originating in one country to all like goods originating in all other WTO member countries. This raises the question of how to define the origin of the goods. How do we know whether a good originates in Home or in Foreign? This question was easy to answer when goods were being routinely produced (“wholly obtained” or “wholly produced” in the frequently used terminology) in one country only. It is a particularly difficult exercise today, when parts of many goods are being produced in different countries. The continuing rise of global value chains (GVCs) or supply chains that include offshoring/outsourcing is quite remarkable and has made determining origin an elusive notion. Indeed, check the picture of the Volvo car in figure 4.1 and ask the question “where does this car originate?” What is the answer? To make matters worse, it is not simply the rise of GVCs that has made detection of origin onerous. It is also political economy. Actually, political economy probably has

Figure 4.1 Production chain of a Volvo car. Source: Reproduced from Richard Baldwin and Philip Thornton, “Multilateralising Regionalism,” Centre for Economic Policy Research, 29 February 2008.

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complicated things more than any other factor. Rules of origin are distinguished into MFN, preferential, and those applied only to developing countries. They are also distinguished in light of the legal context where they operate so that, for example, rules of origin in AD can be different from those applied in the subsidies context. They can be further distinguished using the level of “industrialization” as a benchmark, and thus agree that a lower percentage of value added suffices to confer origin for primary goods, but a higher percentage is required when primary goods are being processed. They can allow “cumulation,”—that is, allow for a good to have the origin of Home if say x percent of its total value originates in Home and Foreign, or a form of cumulation when defining origin, or they can disallow it altogether. (See the discussion on preferential rules of origin later in this chapter.) Domestic lobbies have managed to make out of rules of origin one of the most thorny, complicated, and indeed Byzantine themes in world trade. And it is domestic lobbies that have largely contributed to the deadlock that the multilateral trading system finds itself in nowadays, despite its valiant attempt to come up with a harmonized framework. Rules of origin are of course necessary for the various WTO disciplines to apply. For one, WTO members need to be sure about the WTO origin of goods; otherwise, they might be affording fiscal treatment to non-WTO goods that they are not entitled to. The size of this problem has diminished in practice, of course, since the WTO is nowadays 161 members strong, and so fewer and fewer goods originate in non-WTO countries. Rules of origin can of course matter for other reasons as well. It is useful to know, for example, that imported beef originates in Foreign when it is known that “mad cow disease” has been observed there, and imported beef will need additional sanitary control at the border. And then there are cases where it is a particular source of supply that will be compensated for with a lower tariff rate. Rules of origin are especially useful in the context of PTAs. Absent a “certificate of origin,” an issue that will be discussed further in chapter 6, members of a PTA will not be in a position to profit from the preferential tariff rate that they are entitled to. In a similar vein, rules of origin are necessary in order to confer origin to goods produced in developing countries, which are also entitled to preferential rates under the conditions of special and differential treatment that are discussed in detail in chapter 5. An illustration is appropriate here. If Home enacts a law whereby a car will be granted WTO origin if 50 percent of its value added originates in a WTO member, some WTO members that outsource more than 50 percent of the total value of cars to non-WTO members will not be in a position to profit from the MFN rate when exporting to Home. This is no longer a big problem because of the current WTO membership. Assume, however, that Home and Foreign have signed an agreement to create a free trade area (FTA), and goods are granted FTA origin only if 50 percent of the value added originates in the two countries. Assume further that Foreign outsources, for the production of cars, 55

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percent of the added value to Third, a country that does not participate in the FTA (free trade area) signed with Home. In this case, depending on the size of the preference, Third might have the incentive to invest in Foreign and start shipping its goods to Home from its plants in Foreign. Thus, rules of origin in this scenario switch trade from low-cost nonregional producers to high-cost regional partners.40 Since rules of origin can shift costs to foreigners who did not participate in their elaboration, there is a good argument to include them in the framework of a trade agreement. Conferring origin is thus, more of an issue in PTAs, where conferral is tantamount to granting a tariff advantage. It is of interest to MFN trade, though, as well. Take the example of a “Swatch” watch. Origin can be conferred based on the nationality of the designer or the engineer (responsible for the watch’s movement). If the former, it is Swiss, if the latter, it is Chinese. If the former, Chinese private producers might be happy to “free ride” on the Swiss “brand name”; China itself might be happy as well, since its trade surplus, a source of acrimony in some quarters, will be reduced. The US when importing “Swatch” watches might classify it as “Swiss origin,” whereas the EU, might opt for “China origin.” The link of rules of origin to issues such as marks of origin, trade statistics, and consumer protection becomes apparent. The US and EU have followed different paths towards conferring origin. Whereas there is no difference between origin and marking in the US regime, a significant difference can very well be the case in the EU context. Their divergent regimes have led them to many disputes, with some taking place before the WTO. Their dispute regarding origin of textiles and apparel products was the reason for two disputes, and eventually to a mutually agreed solution.41 Before discussing the WTO regulation of rules of origin, let us first briefly review the GATT regulation of rules of origin. Actually, we will pick the trail from the pre-GATT years, as the GATT discussion did not take place in a vacuum. 4.6.1 The Pre-GATT Years Trade relations have existed since humans acquired goods to exchange , and the origin of goods became an issue when nations started granting trade advantages. The first comprehensive attempt to address origin in a multilateral manner came with the signing of the 1923 International Convention relating to the Simplification of Customs Formalities (signed in Geneva on 3 November 1923). Thirty-three nations signed it, with Britain signing it on behalf of the Commonwealth of Australia, the Union of South Africa (as it was known then), New Zealand, and India—that is, four additional nations. Many of the GATT original members (with the notable exception of the US) signed the agreement, and it is against this background that they subsequently negotiated origin in GATT. The overarching objective of the 1923 Agreement was to ensure that trade would not be (Article 1): “… hindered by excessive, unnecessary or arbitrary customs or other similar formalities.”

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Article 11 is of utmost interest to our discussion here. In its chapeau, it acknowledged the right of importing nations to verify the origin of the good, while expressing the wish to reduce the number of cases where certificates of origin or other documents testifying origin (such as “consular invoices”) would be required. In Article 11.4 it provided concrete examples where request to produce a certificate of origin would be unwarranted: goods, for example, that lawfully were entitled to regional appellation did not have to be accompanied by a certificate of origin. In Article 11.1, the Agreement endorsed the need for simplification of procedures regarding certification of origin, and in Article 11.2 it provided that the latter be issued not only by official authorities but by any organization that might possess the authority to issue similar documents. Simplification of procedures, exemptions from compulsory demonstration of origin, and avoiding bottlenecks when it comes to issuing certificates of origin are three of the issues that occupied the minds of trading nations following their accession to the GATT. 4.6.2 The GATT Regime GATT, as we saw in chapter 1, adopted a friendly attitude towards prior agreements to which its members had adhered. It stopped short, nonetheless, of fully espousing the 1923 Convention, and the discussion on origin started anew. Those that had participated in the 1923 Convention reproduced the spirit of that agreement. The GATT regime is characterized by a scattered regulation of origin, and by subsequent efforts to harmonize rules of origin, which, alas, remained unsuccessful. We take each issue in turn. 4.6.2.1 Article VIII of GATT Article VIII.1 of GATT, which we have discussed in the previous chapter, recognizes the need to minimize the incidence and complexity of import and export formalities. To this effect, the Interpretative Note number 2 to this provision states that “… it would be consistent with paragraph 1 if, on the importation of products from the territory of a contracting party into the territory of another contracting party, the production of certificates of origin should only be required to the extent that is strictly indispensable.” This sounds like the provisions embedded in the 1923 Convention, does it not? The other relevant provision to our discussion is Article IX of GATT, to which we now turn. 4.6.2.2 Marks of Origin A mark of origin, as the name indicates in no uncertain terms, is meant to communicate the origin of imported goods. It is, thus, a signaling device, a label, addressed to importing WTO members (so that they can impose the appropriate customs duty, which is of course a function of the origin of the good), as well as to consumers and industrial users in the importing market. Marks of origin should not be confused with certificates of origin. While a mark of origin is affixed on goods, certificates of origin accompany imported goods. WTO members request both or none. The link is that, in practice, unless WTO members

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request mark of origin, they will not be requesting origin at all, but if they do, some proof of origin will be required. As we will see later, WTO members are free to choose whether they will use it or not. No matter what the choice, WTO members must respect the MFN clause. This provision had been originally included in Article 20 of the London Draft.42 Negotiators had aimed to strike a balance between consumer protection and burdens on commercial transactions. The idea was that the former should be protected without unduly burdening the latter.43 Marks of origin had been previously regulated in various international agreements, such as the Madrid Convention of 14 April 1891; the Washington Arrangement of 2 June 1911; the Hague Arrangement of 6 November 1925; and the Union Agreement of Paris/Brussels of 14 December 1900.44 Negotiators aimed to ensure that Article IX would be compatible with the aforementioned agreements.45 France, which played a prominent role in the discussion of this provision, wanted to bring under the heading “Marks of Origin” a discussion of marks of geographical or regional origin as well. Recall that “appellations of origin” featured in the 1923 Convention, and France was a signatory of that Convention. France wanted to seize the opportunity and take the discussion one step further.46 The majority of the delegates, however, thought that this should not be an issue of concern for GATT or the ITO Charter; and that similar issues would be more appropriately dealt with in bilateral consultations, or, at most, that a multilateral conference should be organized to specifically discuss the matter.47 France insisted on protection for geographical or regional origin (wines, etc.), referring to the obligations already imposed on signatories of the Madrid Convention of 1891.48 Subsequently, a joint US/UK proposal aimed at eliminating, in principle, compulsory marks of origin was tabled.49 France’s proposal was not retained, at least not as France had contemplated. All it achieved was a best-endeavors (the current Article IX.6 of GATT), a duty to cooperate in order to avoid damage against goods carrying “appellation of origin,” e.g., distinctive names of products of the territory of a GATT contracting party protected under domestic laws. The US/UK proposal became for all practical purposes Article IX of GATT, as it is now known. Article IX.1 of GATT imposes an obligation to act in a nondiscriminatory manner, but it does not require “compulsory marks of origin.” In principle, WTO members are free to decide that no mark of origin is necessary at all. In that, it stops short of even including the corresponding best-endeavors provision we encountered in the Interpretative Note to Article VIII.1 of GATT. Article IX of GATT thus condones regulatory diversity in the sense that the system for affixing marks of origin on goods is left to the discretion of the importing WTO member. It requests that WTO members apply their regime on an MFN basis, and further requests that they cooperate to ensure that fraudulent practices regarding the indication of origin will be avoided. In US–Tuna (Mexico), the panel confirmed that the legal obligation

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with respect to marks of origin is restricted to MFN, and WTO members do not incur a national-treatment obligation with respect to marks of origin (§ 5.41). In doing so, it rejected Mexico’s claim to the effect that the US was violating Article IX.1 of GATT, since the US was imposing the same requirements regarding dolphin-safe tuna on US producers as well. Although, Article IX of GATT does not impose a harmonized regime for marking origin, some steps had been taken toward prejudging national discretion in this respect. Article IX.2 of GATT contains a best-endeavors clause to the effect that when adopting their regime, WTO members strive to minimize the cost of international trade. Simple indications of origin are thus preferred over complicated schemes. No damage should result for imported goods because of the manner in which national legislation requires marks of origin to be affixed, and no disproportionate cost should result in an effort to avoid similar damage (Article IX.4 of GATT). In a similar vein, Article IX.3 of GATT suggests that, if “administratively practicable”, marks of origin should be affixed at the moment of importation. Furthermore, WTO members, following the French request to this effect as stated above, incur an obligation to cooperate to ensure that the true origin of a product has been indicated and that consumers have not been misled as a result of a false mark of origin. This duty also must respect the MFN requirement (Article IX.6 of GATT). The panel on Japan–Alcoholic Beverages I referred to the drafting history of Article IX.6 of GATT, which includes the duty to cooperate, and the panel understood that this provision should not have the effect of prejudicing the present situation as regards certain distinctive names of products, provided always that the names affixed to the products cannot misrepresent their true origin. This is particularly the case when the name of the producing country is clearly indicated. It will rest with the governments concerned to proceed to a joint examination of particular cases which might arise if disputes occur as a result of the use of distinctive names of products which may have lost their original significance through constant use permitted by law in the country where they are used. (Havana Reports, p. 79)

In § 5.15, the panel found that Japan had not violated its obligation under Article IX.6 of GATT, simply because it was using foreign names to describe domestic goods. Japan, in the eyes of the panel, was not violating distinctive regional or geographical names of products by acting this way. Moreover, Japan was observing its duty to cooperate by participating in the Madrid Agreement for the Repression of False or Deceptive Indications of Source on Goods: The Panel did not dispose of evidence and was unable to find that the use by Japanese manufacturers of labels written partly in English (in the case of whisky and brandy) or in French (in the case of wine), the use of the names of varieties of grapes (such as “Riesling” or ‘semillon”), or the use of foreign terms to describe Japanese spirits (“whisky,” “brandy”) or Japanese wines (“chateau,” “reserve,” “vin rose”) had actually been to the detriment of “distinctive regional or geographical names of products” produced and legally protected in the EEC. Nor could the Panel find that Japan

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given, for example, its participation in the Madrid Agreement for the Repression of False or Deceptive Indications of Source on Goods and its internal laws and regulations on labelling and on the protection of distinctive regional or geographical names (such as “Armagnac” or “Chianti”) had failed to meet its obligation to cooperate pursuant to GATT Article IX:6.

Thus, Article IX.6 of GATT was understood as imposing a mere obligation to cooperate in order to ensure that the true mark of origin will be indicated. If the exporter does not cooperate, though, importing states are not defenseless. They can, as a last resort, disallow imports of goods with false indications and then justify the ban through recourse to Article XX(d) of GATT, that we discuss infra in brief. This provision is discussed in detail in chapter 9. The advent of TRIPs (Trade Related Intellectual Property Rights) has taken care of some of the problems discussed in Japan–Alcoholic Beverages I regarding the use of names like “cognac,” for example. 4.6.2.3 False Origin: A Deceptive Practice Assuming violation of say Article XI of GATT or any other provision because the importer had taken the view that origin had been falsely declared, then it could seek to justify its measures by invoking Article XX(d) of GATT. We discuss this provision in detail in chapter 9. Suffice to state that for now false declaration of origin would definitely qualify as “deceptive practice,” one of the grounds for which violations of obligations assumed under the GATT can be justified. 4.6.2.4 Efforts to Harmonize Following the advent of the GATT, a few initiatives were undertaken in order to add to the regulatory framework as described above. The impetus came from a resolution of the ICC (International Chamber of Commerce), which requested from GATT contracting parties to consider the adoption of uniform rules determining the nationality of imported goods. This led to the establishment of the Working Party on Certificates of Origin, Marks of Origin, and Consular Formalities. The Working Party 5 on Valuation, Nationality of Goods and Consular Formalities, operating under its aegis, issued its report in 1953.50 The twelve members of the Working Group were divided. Eight of them (and most notably, France, Germany, and Italy) were in favor of adopting an international definition of origin along the following lines: • A distinction would be drawn between goods “resulting exclusively from materials and a labour of a single country,” and goods “resulting from materials and labour of two or more countries.” • Whereas the former would have the nationality of the country where they were produced, the latter would have the nationality of the country where they had “last undergone a substantial transformation.” • “A substantial transformation shall—inter alia—be considered to have occurred when the processing results in a new individuality being conferred on the goods.”

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The four members that dissented (United Kingdom and New Zealand leading the group) thought that the proposed definition only amounted to an illusion of assuring uniformity since the term “substantial transformation” could be easily manipulated. The divide proved hard to bridge. In a subsequent report by the Technical Group on Customs Administration, the GATT body which was called upon to decide on the proposed definition, we read the acrimony with which the ICC had to come to grips with the (unpleasant to it) reality: “… It has become clear … that the time is not yet ripe for attempting to obtain general acceptance by governments of a standard definition of origin.”51 The discussion regarding the harmonization of conditions for conferring origin continued in various GATT fora.52 Following the advent of the Kyoto Protocol (1975), there was an attempt by the CCC (now WCO) Secretariat to increase its powers in dispute adjudication in this area, which was met with skepticism if not outright hostility by its members.53 The ball stayed in the camp of the GATT, and its members tried yet again to reach a solution during the Uruguay round, as we detail later in this chapter. Advances were made with respect to the limits that should be imposed on requests for certificates of origin, the use of marks of origin, and the abolition of consular formalities, but not on the main theme—harmonized definition of origin.54 In 1958, the CONTRACTING PARTIES to GATT adopted a recommendation that further reinforced the idea that there should be no widespread requirement to indicate origin. In the document, §§ 1–2 stated that the requirement to indicate origin should be reduced to the cases where it is judged indispensable; § 3 required trading nations to accept any method of legible and conspicuous marking and not to impose a particular method; § 5 expressed in bestendeavors terms the wish that trading nations accept that the designation “made in” (as expressed in English), satisfies their requirement to indicate the origin of import goods; in similar best-endeavors terms, § 6 stated that commonly used abbreviations (like “UK” and “US”) should be acceptable; and, finally, § 11 stated that goods in transit should be free from the mark-of-origin requirement.55 A 1981 document prepared by the GATT Secretariat56 sheds light on two issues: • it presents the criteria to confer origin used; • it also presents the rules of origin applied in various PTAs. It turns out that trading nations have employed a variety of methods to confer origin and sometimes a combination of distinct processes. All countries and PTAs reviewed distinguish between instances where goods are wholly obtained (or wholly produced) in one country, and instances where this is not the case. In the latter case, the question would be to define substantial transformation. The three most frequently used regimes to this effect were (1) change in tariff classification; (2) added value (“percentage criterion”); and (3) specific manufacturing process. Wholly obtained (or wholly produced) was (and is) mostly used with respect to farm goods and minerals, whereas practice showed that different trading nations used different

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methods to decide whether substantial transformation had indeed occurred. Still, the Note of the Secretariat states that change in tariff heading was the most frequently used criterion to demonstrate that substantial transformation (“sufficient working or processing”) had occurred.57 The question asked here is whether, as a result of processing a particular good, the resulting good should be classified differently in the Harmonized System (HS) than the good from which it has been obtained.58 If yes, then the country producing the processed good will be considered the country of origin of the good. The value added method, also known as “percentage criterion,” asks the question whether a certain percentage of value has been added to the input good. The percentage may vary by country, good, etc. Assuming that the statutory threshold has been met, then the WTO member producing the output will be considered the origin of the good. The specific manufacturing process, also known as the “technical criterion,” prescribes certain production or sourcing processes that may (positive technical criterion) or may not (negative technical criterion) confer originating status. To produce a fertilizer for example, three ingredients must be mixed together, and through this process a new product is produced. All methods have their pros and cons. The “value added” method is clear but could act as disincentive to use the “cheapest source of supply.” The “specified manufacturing process” could become unusable if the specified process becomes obsolete. The “change in tariff classification” invites substantial discretion by the importing member, which will need to be constrained in order to avoid abuses/discriminatory practices. Palmeter (1990a) adds that the fact that the HS was not negotiated with attributing origin in mind, has added to the problems. The HS, it is true, implicitly reflects some sort of “value escalation”: it starts with farm products, moves to industrial products, and finally to more complex goods, such as information technology. It does not at all however, explain how changes in the tariff heading occur.59 There is no perfect method, and to make matters worse, trading nations have been making things worse by employing a variety of methods, often nontransparent as Vermulst and Fjellner (2015) note, that have substantially increased transaction costs for international trade. The criteria to confer origin, unavoidably probably, often leave substantial discretion to the administering authority. As a result, disputes regarding the origin of goods arise frequently before national forums, although not so frequently before the WTO.60 It could be, for example, that the manufacturing process chosen to confer origin has not been described adequately, or that the value added is judged in an unduly restrictive or discriminatory manner. Besides differences, regimes are often characterized by increased complexity, and it is no exaggeration to state that complexity in and of itself was reason to attempt to simplify and harmonize. We will see, for example, in chapter 5 in this volume that complexity of rules of origin emerges as the main reason why beneficiaries of preferences apply for the MFN—rather than the preferential rate when exporting to donors. Complexity is an issue for both preferential- as well MFN rates. Quoting from Gilbert Ryle, Palmeter (1990),

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when referring to the various methods of conferring origin, goes so far as to state (p. 27): “… to the guests of Charybdis, Scylla appears to be the more hospitable resort.” In a similar vein, McGovern (1986) describes EU rules of origin as follows (p. 186): “Community rules of origin are at best complicated, and at worst almost unfathomable. It is against this background that negotiators tried yet again during the Uruguay round to define origin in harmonized manner. 4.6.3 The WTO Regime At the wake of the Uruguay round, the situation regarding regulation of origin could be described as follows: • Regulation of origin was left to discretion of domestic authorities. National definitions would have to respect MFN since, otherwise, a trade advantage could be granted to a sub-part of the WTO membership in contravention to Article I of GATT. • Preferential rules of origin were applied as well. By 1994, at the end of the Uruguay round, a hundred PTAs had entered into force, so this issue was gaining in importance. The consistency of preferential rules of origin with the GATT remains to this day an open issue. The legal benchmark to evaluate consistency of preferential rules of origin was Article XXIV of GATT. As we explain in chapter 6 in more detail, WTO members did not manage to decide on this issue. • Article VIII of GATT would require restrain when it comes to requesting production of certificates of origin. • Article IX of GATT did the same with respect to marks of origin. • Finally, Article X of GATT, that we discuss in detail in chapter 12 of volume 2, would require from WTO members that they administer their customs rules and formalities (including thus, rules of origin) in an impartial manner. • All violations of GATT provisions could, in principle, be justified through recourse to Article XX(d) of GATT, which could offer the appropriate means to justify violations of obligations assumed under the GATT if necessary to combat deceptive practices (like the false declaration of origin). It is against this background that, during the Uruguay round, an Agreement on Rules of Origin (ROO) was negotiated and concluded. Negotiators did not make any link to the preexisting regime. They felt they should be starting from a clean slate, and we cannot blame them too much for that. The regime we describe above is highly scattered, and the safest way to defend national definitions of origin seems to be the exceptional provision, e.g., Article XX(d) of GATT. The idea was to come up with a harmonized understanding for conferring origin in an effort to reduce transaction costs and facilitate trade liberalization. The idea was also to simplify existing complex procedures. The previous regime was,

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as briefly described in the previous section, a forest of rules of origin, even at the national level. Some consolidation was deemed warranted. Alas, the efforts to do this failed. The size of the failure is even more spectacular if one takes into account that the biggest thorn, preferential rules of origin, was left outside the negotiation: WTO ROO deals with MFN rules of origin—that is, with rules of origin that apply when considering MFN as opposed to preferential trade (e.g., trade across partners in a customs union or an FTA [Article 1.2 of ROO]).61 This is of course a very severe limitation since, as stated previously, the trade impact of rules of origin is more meaningful in the PTA context nowadays. The WTO ROO imposes two sets of obligations: during the transitional period, and following it. During the transitional period, all the ROO adds to what we have described above is that WTO members must respect national treatment when defining origin, that is, they must, by virtue of Article 2(d) of ROO, apply the same criteria for conferring origin to domestic and foreign goods. A few other obligations of lesser importance were added as well, and we discuss them infra. During the transitional period the Harmonized Working Programme (HWP), aimed at simplifying and harmonizing MFN rules of origin, was supposed to be agreed as well. Alas, this was not to be the case. 4.6.3.1 An Agreement to Disagree The ROO does not impose a harmonized set of rules that WTO members must observe when it comes to conferring origin. WTO members remain free to adopt their own rules of origin for goods they produce and must apply them in a nondiscriminatory manner. Thus, regulatory diversity is condoned, and a requirement of nondiscrimination is imposed on national definitions, as explained above. Besides nondiscrimination, WTO members must also ensure that their rules of origin are transparent [Article 2(a) ROO], that they do not have restricting effects on international trade [Article 2(b) ROO], and that they are administered in a consistent, uniform, impartial, and reasonable manner [Article 2(e) ROO].62 WTO members can confer origin in different ways even on the same good. For example, nothing stops a WTO member from deciding that canned tomatoes are considered domestic if 30 percent of their added value is domestic, whereas fresh tomatoes are domestic if 75 percent of their added value is domestic. Moreover, they can adopt different rules of origin under different agreements for the same good. WTO members can (and very often do) state that say 25 percent of domestic added value is necessary for a product to originate in a particular market for all customs purposes, but only 15 percent is necessary for AD purposes. There is thus, no obligation to act consistently, either across goods or across agreements, when conferring origin. By acting inconsistently across agreements (while respecting MFN), WTO members have more discretion to accommodate domestic lobbies’ demands.63

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In the only reported case so far before the WTO, US–Textiles Rules of Origin, the panel underscored the wide discretion that WTO members enjoy when designing their rules of origin (§§ 6.23–24): With regard to the provisions of Article 2 at issue in this case—subparagraphs (b) through (d)—we note that they set out what rules of origin should not do: rules of origin should not pursue trade objectives directly or indirectly; they should not themselves create restrictive, distorting or disruptive effects on international trade; they should not pose unduly strict requirements or require the fulfilment of a condition unrelated to manufacturing or processing; and they should not discriminate between other Members. These provisions do not prescribe what a Member must do.

4.6.3.2 MFN In, Preferential Rules of Origin Out WTO members have often expressed their wish to harmonize rules of origin, since they seem to share the belief that the current regulatory diversity is quite costly. The most important objective of the ROO is to eventually harmonize nonpreferential rules of origin (Article 9), this is what64 the Harmonization Work Programme (HWP) is all about. Negotiations have been taking place under the aegis of the WTO Committee on Rules of Origin,65 and the Technical Committee operating under the auspices of the World Customs Organization (WCO), where all WTO members participate, as well as non-WTO members acting as observers. Article 9 of ROO does reflect a preference for the change in tariff classification method discussed supra. In § 1, it calls for negotiations to define a product that is wholly obtained in a particular sovereignty. In § 2(c)(ii), it calls for negotiations on goods that have not been wholly obtained in one particular sovereignty. To this effect, negotiations should focus on streamlining the change in tariff classification method, and, as supplementary criteria only, the value added and the specific manufacturing process methods. To attain this objective, work on 5,000 tariff lines was initiated. This work was originally due to be completed by July 1998, but several deadlines have been missed since that date, and conclusion of the negotiation is still elusive. Although meaningful discussions have taken place, trading partners are still quite far from agreeing on a harmonized way of conferring origin.66 It has been unofficially reported that WTO members have reached a consensus on rules of origin for 55 percent of the products negotiated. Some core policy issues have been heavily negotiated, and product-specific rules of origin have also been negotiated. Still, some hard issues remain open. The rules of origin applied to AD, countervailing, safeguards, Sanitary and Phyto-sanitary Measures (SPS), TBT, and labeling figure to be among the thorniest issues, where no consensus has been reached yet.67 The question has also been repeatedly raised whether the Committee of Rules of Origin is the appropriate forum for the negotiation of the HWP, in view of the fact that some of the issues involved are not purely technical, but essentially of political nature.68

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So far, attempts to conclude work on the agreement have failed largely because of the so called implication issue: once the harmonized set of nonpreferential rules of origin has been agreed, it must be applied to various WTO Agreements (Articles 1 and 3(a) ROO). This has not been the case so far, as various WTO members have been applying different rules of origin to say the same good when dealing with it under various agreements. This is the major reason for the current stalemate, although the whole purpose of the HWP was to ensure that rules of origin would apply across the board. Substantial progress has been made, and, although it is highly speculative at this stage to suggest that the text, in principle, agreed—leaving disagreements aside—will have policy impact, it is worthwhile to describe briefly the regime that has been reflected in the various negotiating documents. The question is first asked whether a good has been “wholly obtained” in one WTO member. A product is wholly obtained even when some of the inputs used for its production originate elsewhere. To this effect, nonetheless, they would have to qualify as “neutral elements,” which are defined in General Rule 3 of the ROO as it now stands as follows: “In order to determine whether a good originates in a country, the origin of the power and fuel, plant and equipment, including safety equipment, or machines and tools used to obtain a good or the materials used in its manufacture which do not remain in the good or form part of the good shall not be taken into account.” If a good is produced with components from more than one country, then the final good will carry the origin of the last WTO member in the production chain, if the good has undergone “substantial transformation.” The ROO includes the following three independent methodologies inspired from the practice described above that will allow a WTO member to show whether the downstream good has indeed undergone “substantial transformation: • Change in tariff heading • Value added • A specific process has been used The last one of these is the “cleanest” method, but it is highly restrictive. WTO members, as stated previously, have been using the first two methods, and they both have their pros and cons. The HWP expresses a preference for the first method—change in tariff heading—because it is widely used, and because it solves many of the encountered problems. There are areas, though, where its use is problematic. For example, should any assembly of parts confer origin, even if we deal with classic “screwdriver operations”? This is an acute issue and created a lot of acrimony during the negotiations of the HWP. At the end a compromise was necessary to deal with conferral of origin in machinery when all the importing market does is assembly of finished parts. The “dual rule for machinery” was agreed, where WTO members remain free to use either the change in tariff heading or a 35 percent value-added rule to decide on the origin of machinery.

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Negotiations are ongoing at present.69 While awaiting the successful conclusion to the negotiations, it is Article 2(d) of ROO that is applicable, and it explicitly condones regulatory diversity when conferring origin:70 Until the work program for the harmonization of rules of origin set out in Part IV is completed, Members shall ensure that … the rules of origin that they apply to imports and exports are not more stringent than the rules of origin they apply to determine whether or not a good is domestic and shall not discriminate between other Members, irrespective of the affiliation of the manufacturers of the good concerned.

As things stand, forty-four WTO members have notified the WTO Committee on Rules of Origin (the committee responsible for this issue) that they apply nonpreferential rules of origin. An additional fifty members have notified the same committee that they do not apply nonpreferential rules of origin, whereas the remaining members of the WTO have not notified the committee one way or the other.71 4.6.4

Preferential Rules of Origin

Besides MFN, there are preferential rules of origin; in fact, there is a plethora of preferential rules of origin, including the PanEuroMed system, comprising the 28 EU members, the European Free Trade Association (EFTA), the Faroe Islands, Turkey, and those participating in the Barcelona process (e.g., Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia, and the Palestinian Authority); the North American Free Trade Agreement (NAFTA) system; and Asian systems. The term “preferential rules of origin” refers to both reciprocal (e.g., between members of an FTA), as well as unilateral (e.g., one way development aid–related) preferences. Preferential rules of origin are an enigma. In principle, there is no need for preferential rules of origin in order to grant preferences. The same criteria for conferring origin could apply to both MFN- and preferential patterns. The only change would be the level of duty applied. Arguably, the rules emerged in practice as instrument to grant an additional preference. We will see in what follows if this is indeed the case. Moreover, there is no explicit legal basis for providing preferential rules of origin. As we will see in what follows, though, a legal basis to evaluate their consistency emerged in practice. 4.6.4.1 Out of HWP, Out of WTO? Earlier in this chapter, we explained that until the successful conclusion and advent of ROO, WTO members can unilaterally define the rules of origin applied in their home market, and must observe nondiscrimination as well; that is, they must be imposing the same rules of origin on imported and domestic like goods. What about preferential rules of origin? What is the legal standard to evaluate their consistency with the WTO since, by construction, preferential rules of origin must be discriminatory? Recall, preferential rules of origin do not come under the HWP mandate.72

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In theory, the consistency of preferential rules of origin with the WTO can be challenged. As chapter 6 will explain in more detail, rules of origin could be regarded as “other regulations of commerce” (Article XXIV.5 of GATT), or as “restrictive regulations of commerce” (Article XXIV.8 of GATT). These two provisions require WTO members that establish PTAs to avoid adding to existing protection (the former), and to liberalize all trade substantially (the latter). Indeed, this issue has already been discussed (although sometimes tangentially) in the context of the Committee on Regional Trade Agreements (CRTA), the organ entrusted with the surveillance of noted PTAs, and its predecessors. Nevertheless, WTO members have not managed to agree on a solution, and all there has been is a series of inconclusive debates. Following 2006 and the advent of the Transparency Mechanism discussed in chapter 6 in detail, there have been no more multilateral discussions on the consistency of similar schemes with the WTO rules. In the absence of multilateral solutions, of course, interested parties could litigate and claim that preferential rules of origin within a given FTA are in violation of Article XXIV of GATT. This has not happened for various reasons, which will be explored further in chapter 6.73 Essentially, potential claimants lack the incentives to litigate the consistency of a PTA with the multilateral rules. Neither the multilateral process nor the dispute settlement has thus managed to yield responses regarding the legality of preferential rules of origin. Under the circumstances, it is warranted to see how preferential rules of origin have been operating in practice. 4.6.4.2 Empirical Studies Reveal a Mess There are common elements in some preferential rules of origin, but there is substantial discrepancy between them as well. Literature has emerged aiming to trace both the extent of overlap and the important differences across schemes.74 To provide an illustration about the latter, different rules apply depending on the percentage of value added, the overall integration process pursued, the possibility for cumulation, the type of cumulation (that we discuss later), and various other criteria conferring origin.75 There is a plethora of preferential rules in place, and very often the same “hub” has adopted different rules with its various “spokes.” Literature has tried to understand what drives the current multiplication of preferential rules of origin, as well as the consequences of this phenomenon. There is by now ample evidence to the effect that preferential rules of origin have substantially contributed to trade diversion.76 The studies by Hoekman (1993), Krishna and Krueger (1995), and Krueger (1999) provide a horizontal evaluation of the size of the problem. Then, there are studies that evaluate the record for specific integration schemes. Cadot et al. (2005) looked at the EU/ PANEURO and US/NAFTA regimes and concluded that the rules employed are tailormade to fit protectionist requests by EU and US lobbies. Serra et al. (1997) showed that

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rules of origin are one of the most important causes of trade diversion in the NAFTA context. Many others studying the same issue have arrived at this conclusion. Lack of cumulation and very complicated rules of origin emerge as the two devices that have effectively transformed preferential rules of origin to an empty shell. The term “preferential,” when used in conjunction with rules of origin, is the apotheosis of sugarcoating. 4.6.4.3 Cumulation “Cumulation” loosely refers to the idea that goods will be considered to originate within an FTA (and thus, benefit from the preferential customs rate) if they have been produced within the WTO members belonging to the FTA and not wholly obtained in one of them. Assume that Home and Foreign have concluded an FTA stating that cars must have 50 percent FTA value added to be granted FTA origin. If no cumulation was allowed, then the car should have 50 percent either Home or Foreign value added. Under cumulation, a car would be granted FTA origin if it included 25 percent Home and 25 percent Foreign value added. There are different forms of cumulation. There is bilateral cumulation (that is, the example given just previously).77 This is not necessarily an economic advantage since it can lead to trade diversion, as already discussed. A shirt from Senegal would qualify as an African, Caribbean, Pacific (ACP) shirt and thus benefit from the preferential rate contained in the Cotounou Agreements signed between the EU and ACP countries, even if it contained fabric from the EU. The EU is not a low-cost fabric-producing entity, though. Senegalese shirt producers would have been much more competitive had they been allowed to use fabric, say, from Pakistan or Bangladesh. This is where diagonal cumulation kicks in. In this shirt example, a shirt will be considered an ACP-shirt if the fabric originates in Pakistan or Bangladesh, two countries that have not signed the Cotounou Agreements. The pan-European system discussed previously allows for diagonal cumulation. Other regimes also follow this example. including EFTA, the Central and Eastern Europe Free Trade Area, Association of Southeast Asian Nations (ASEAN), the Central American Common Market (CACM), the Andean Community, and the South American Association for Regional Cooperation (SAARC).78 Diagonal cumulation could contractually be limited in geographic space. And then there is full cumulation, where origin will be conferred to any processing activity regardless of whether it is sufficient to confer originating status to the materials themselves. Brenton (2011) states that full cumulation is rare; he notes its existence in the Cotounou Agreements, as well as in Generalized Systems of Preferences (GSP) schemes offered by Japan and the US.79 Here is an example of cumulation from the EU webpage:80 The existing Free Trade Agreements with the Western Balkans (Stabilization and Association Agreements with Croatia and the former Yugoslav Republic of Macedonia) are based on a system of bilateral cumulation. This means Croatia and the former Yugoslav Republic of Macedonia can

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cumulate with the Community but not among each other. Under the system of diagonal cumulation they will also be able to cumulate among each other. For a system of diagonal cumulation to work, it requires that all partners have Free Trade Agreements with the same rules of origin among each other.

The benefits can best be illustrated by using a simple illustration. A product receives 30 percent value added in Croatia and 30 percent value added in the former Yugoslav Republic of Macedonia. Let’s assume the EU requirement for the import of a good as “originating in Croatia” is 50 percent value added in that country. Under bilateral cumulation, this product will not be exportable to the EU under preferential conditions, while with diagonal cumulation, these percentages can be cumulated and the product qualifies with 60 percent originating in Croatia or in the former Yugoslav Republic of Macedonia.81 Some forms of cumulation, specifically bilateral cumulation, are more restrictive than others. As a result, beneficiaries might be hampered in their effort to export at preferential rates. 4.6.4.4 Complying with Complicated Rules Transaction costs emanating from complicated rules of origin often increase in a highly disproportionate manner.82 Litigation regarding preferential rules of origin is, unsurprisingly, also quite substantial, as Vermulst (1992, pp. 37ff), for example, details. The following illustration offered by Palmeter (2003, p. 143) is self-explanatory: Catsup (or, “ketchup”) is classified in chapter 21 of the HTS [Harmonized Tariff Schedule], under items 2103.20, while tomato paste is classified in chapter 20, under item 2002.90. The Canada-US FTA rule of origin provides that the operations necessary to convert a product classified in any chapter of the HTS other than chapter 21 into a product classified in that chapter will confer preferential origin on the resulting chapter 21 product. Thus, when imported tomato paste (chapter 20) is processed into catsup (chapter 21), the catsup qualifies for the FTA preference. Not so under NAFTA. The formulation of the NAFTA rule is that a change to item 2103.20 (catsup) from any other chapter except subheading 2002.90 (tomato paste) will confer origin. Under NAFTA, then, the tomato paste itself must be produced within the territory of a NAFTA member if the resulting catsup is to receive preferential treatment. Now it happens that in 1992, just before NAFTA’s rules were drawn up, Chile was the leading foreign supplier of tomato paste to the United States, and catsup made in Canada or the US from Chilean tomato paste received preferential treatment under the FTA. Interestingly, in 1992, Mexico was the second leading supplier of tomato paste to the United States, but by 1998 it was overwhelmingly first. We might speculate that the occasion of the negotiation and drafting of NAFTA’s rules of origin was used by the Mexico tomato paste industry to squeeze its Chilean competitors out of the NAFTA market. Or we might speculate that the change is merely the result of a decision by the negotiators that truth, justice, and consumer welfare required it.

What rules of origin did for Mexican ketchup producers in this context, they have done for numerous producers of dozens of products originating in countries signing PTAs. Brenton (2011, p. 168) offers yet another characteristic illustration: A change to subheading 620111 from any other chapter except from heading 5106 through 5113, 5204 through 5212, 5307 through 5308, or 5310 through 5311, chapter 54 or heading 5508 through

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5516, 5801 through 5802, or 6001 through 6006, provided that the good is both cut and sewn or otherwise assembled in the territory of one or more of the parties.

Bhagwati, Krishna, and Panagariya (2015) looked at the ASEAN experience, and more specifically the FTAs signed by ASEAN with third countries. Their conclusion was that only one-third of tariff lines share rules of origin in FTAs signed by ASEAN with third countries. Faced with similar rules, trading nations might decide to forego the preferential rate and opt for the MFN rate instead. The ultimate decision will depend on the calculation of the preference margin, the costs of complying with the rules, and the transaction costs for benefitting from lower rates. Trading nations often decide to go for MFN rates precisely because transaction costs are quite substantial. As a result, the utilization rate of preferences often remains low. The next section of this chapter explores this topic. 4.6.4.5 Utilization Rate In his pioneering study that sensitized observers about the bite of rules of origin and provided the impetus for dozens of studies in this area, Herin (1986) researched the impact that rules of origin have had on European Free Trade Association (EFTA)83 traders when trading with the EU. He concluded that many of them would rather pay the MFN rate when exporting to the EU rather than going to the trouble of applying for the preferential rate. The small significance of the preferential margin coupled with administrative costs were cited as the main reasons behind this attitude. In a similar vein, Sapir (1998a) shows that 78 percent of imports from GSP beneficiaries qualified for preferential import rates, and yet only 38 percent of them entered at this rate. The majority of qualifying imports paid the MFN rate, for essentially the reasons already cited by Herin (1986). The studies by Krishna and Krueger (1995), Krueger (1999), and Hoekman (1993) pointed in the same direction. Cadot and de Melo (2008) reached the same conclusion. In their study, they explained how rules of origin oblige developing countries to buy inefficient intermediate goods from developed countries in order to qualify for favorable treatment, pointing, thus, to the limits of cumulation. Worse, as a result of the multiplication of rules of origin, traders might find it too much of an investment to spend time and effort familiarizing themselves with the procedures. As a result, the amount of overall preferential trade might suffer, and both producers in developing countries and consumers in developed countries experience adverse welfare implications.84 Mattoo et al. (2003) estimate the medium-term benefits for African exporters stemming from the US Africa Growth and Opportunity Act (AGOA) and argue that the gains would be five times as much were the US to relax its current stringent rules of origin.85 Unsurprisingly, there are some experts arguing for total recall in this context. Brenton and Manchin (2003), to cite but one of the many papers in this area, investigated EU

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preferential schemes (such as “Everything but Arms”)86 and suggest that, to generate substantial improvements for developing countries, the EU should first and foremost reconsider its current rules of origin.87 It is true that rules of origin have been relaxed over the years, although much remains to be done in the years to come. One area where efforts have led to some results concerns the treatment of imports originating in least-developed countries (LDCs). 4.6.4.6 Rules of Origin for LDCs Complicated rules of origin could be even more of a challenge for those WTO members with reduced capacity to process the required information (e.g., developing countries, especially LDCs). Acknowledging this fact, the WTO has recently undertaken some action to address the problems encountered by LDCs when it comes to complying with rules of origin. The Bali Ministerial Declaration included a Decision on Preferential Rules of Origin for Least-Developed Countries.88 Without imposing any concrete legal obligations, this decision is a call to the willing to simplify existing procedures: (a) In § 1.2, it declares that “preferential rules of origin should be as transparent, simple, and objective as possible.” (b) The same paragraph calls for recognition of the principle that origin will be conferred by “substantial or sufficient transformation,” which could be defined through an ad valorem percentage criterion, a change in tariff classification, and/or a specific manufacturing or processing operation. (c) In § 1.3, it expresses a wish that when the value-added criterion is chosen, the level of value addition threshold should be kept at a low, reasonable level, and the methods for calculating value added should be simple (§ 1.4). (d) The “change in tariff classification” criterion should be fulfilled when, having imported inputs, LDCs have created a good that comes under a different classification subheading than the inputs (§ 1.5). (e) When recourse is made to the specific manufacturing or processing operation criterion, the productive capacity of LDCs should be taken into account (§ 1.6). (f) Finally, cumulation should be considered so as to allow goods originating in various LDCs to profit from preferential access (§ 1.7). 4.6.4.7 If No Negotiations, Then What? The Bali Declaration discussed in the previous sections is the only multilateral initiative so far to address the problems posed by preferential rules of origin. Otherwise, as stated earlier, the HWP does not include a negotiation of preferential rules of origin. True, the current ROO, in its Annex II, includes a common declaration with regard to preferential rules of origin, but does not move beyond that. In essence, this annex imposes

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a transparency obligation. Without denying the value of transparency, more is definitely required. Simplification of rules should be a priority and harmonization to the extent warranted would be a decisive step in this direction. The literature includes some imaginative proposals aimed at counteracting the nefarious effects caused by the plethora of complicated preferential rules of origin. Lloyd (1993), probably inspired by the negotiation of the WTO Agreement on Agriculture, proposed the introduction of a tariff equivalent that would be negotiable. By “tariffing” the current rules of origin, WTO members would be led to the table to negotiate tariff reductions instead of regulatory equivalence, a much more burdensome task. Alas, similar suggestions have fallen on deaf ears so far. The political willingness to move into this area and establish an easy-to-use, workable regime has been missing to date. 4.6.5 The Rise of Global Value Chains (GVCs) Questions regarding rules of origin would not arise at all if products where wholly obtained or produced in one country, as stated previously.89 Issues arise only if more than one country is involved in the production process. This is, alas, a very likely scenario in today’s world. Supply chains, or GVCs as they are frequently referred to, are being formed around the world, comprising different countries that produce parts of final goods. There is nothing new about specialization, though. Steil and Hinds (2009) put it aptly: This is Adam Smith’s famous pin factory example writ global. Just as division of labor in the manufacture of items as simple as pins can be shown to increase pin output per worker hundreds or even thousands of times, the global connectivity revolution is introducing startling productivity gains across a rapidly expanding array of goods and services—all driven by the simple idea, specialization, that Smith showed to be supply-side driver of the eighteenth century Industrial Revolution.

The difference now is that the pin factory is located in various jurisdictions. It is geographic location of its various components that supplies the “G” in “GVCs.”90 The picture of the origin of a Volvo car given in figure 4.1 is quite telling in this respect. Figure 4.1 is the natural outcome of the current explosion of outsourcing, or offshoring,91 or, less colloquially, trade in tasks. GVCs multiplied (and have kept multiplying) in recent years. Their origins trace to the 1980s.92 Tempest (1996), in one of the first papers in this context, showed how and why China, Indonesia, Japan, Malaysia, and Chinese Taipei were all participating in the production process of a Barbie doll, along with the US.93 In a similar vein, the WTO Annual World Trade Report of 1998 explains that a typical US car includes 30 percent Korean added value, 17.5 percent Japanese, 7.5 percent German, etc. We have come a long way since the Barbie doll example. The explosion of offshoring is, of course, the outcome of economically rational decisions. No one mandated particular

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production lines. Increasing competition around the world, partially as a result of the success that the GATT/WTO regime has had in liberalizing trade, has led to this form of production process.94 The explosion of GVCs is not, nevertheless, the result of liberalization of movement of production factors (due, in part at least to the reduction of barriers to trade) only. The increasing ability of firms to coordinate complex tasks from afar is also an important contributing factor.95 Information technology (IT) has certainly contributed to the rise of fragmentation in the production process across firms and countries. It is definitely no longer wine for cloth, the transaction that the political economist David Ricardo had in mind when constructing his theory of comparative advantage. The WTO World Trade Report (2014)96 goes so far as to state that “there is now no alternative to GVC participation. Attempting to source all or most components of a product domestically nowadays implies that many will not be competitively priced, and the product produced will generally not be competitive in world markets” (pp. 98–99). The explosion of GVCs97 has provoked a lot of discussion worldwide regarding the proper adaptation of the multilateral trade regime to this new reality. The range of questions asked is quite impressive, including the inclusion of preferential rules in the agenda (since many developing countries participate in supply chains); coordination of policies in order to facilitate trade; and to what extent the emergence of bargaining solutions (in the form of supply chains) makes the case for some positive integration at the WTO (e.g., a move toward adopting common policies necessary to facilitate the operation supply chains).98 In short, the whole negotiating process in the WTO would be affected had negotiators adopted a GVC perspective when debating trade liberalization. What emerges from this literature is that there is clearly a disconnect between the requests and aspirations of the business community and the WTO agenda as it was shaped in the context of the Doha negotiations. The former request an ambitious plan, aimed at cutting red tape at and behind the borders, and customized solutions that correspond to the specificities of trade transactions. The WTO has tried to respond through the enactment of the Trade Facilitation Agreement (discussed in chapter 1 of volume 2). Recently, it also issued a study called “Made in the World” and launched a corresponding initiative in order to commit resources to the study of supply chains.99 There is still, however, a lot that needs to be done for the WTO to keep pace with the current aspirations of the business community in this respect. Importantly, GVCs would greatly benefit from more rational, less complicated rules of origin. If negotiators do not achieve a similar outcome in Geneva, then maybe individual trading nations profiting from their participation in GVCs could find it to their advantage to simplify or rationalize their own national regimes.

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4.7 4.7.1

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Like Products Like Products and Beggar-Thy-Neighbor Policies

The reason why the obligation to accord MFN is restricted to like products only has to do with the type of beggar-thy-neighbor policies that the GATT framers wanted to outlaw. GATT outlaws some, but not all, protectionist policies. Recall from the brief discussion in chapter 1 that “protection” is a term that is hard to define.100 The presumption that a policy is protectionist is more correct across two like products (e.g., goods competing in the same relevant product market) than it is otherwise. This does not mean that beggar-thy-neighbor policies cannot take place through policies that concern unlike goods, though. An example could be helpful here. Home imposes a 2 percent import duty on cars (which it produces and where it is competitive), and a 52 percent import duty on wheat (which it does not produce).101 Home would be violating no GATT provision, although it is imposing a cost on its trading partners who, depending on Home’s power to affect the terms of trade, might have to bite the bullet and reduce the price of wheat (e.g., share their profits with Home). With the income made from its tariff setting, Home would be financing its own policies. GATT did not want to go as far as challenging the legitimacy of similar policies. The framers were well versed in the virtues of realism, as shown in chapter 1, and avoided slippery slopes that could endanger the whole negotiation. 4.7.2 Tariff Classification: The Dominant Criterion The term “like products” appears in various GATT provisions. The test for deciding on likeness is not the same across all GATT provisions, however. This section will discuss likeness with respect to border measures (e.g., tariffs).102 Tariff classification emerges as the dominant criterion to decide on likeness with respect to tariff treatment.103 The Panel on Japan–SPF Dimension Lumber provided an explicit acknowledgment of the relevance of tariff classification as the dominant criterion to establish likeness (§§ 5.11–12): … if a claim of likeness was raised by a contracting party in relation to the tariff treatment of its goods on importation by some other contracting party, such a claim should be based on the classification of the latter, i.e., the importing country’s tariff. The Panel noted in this respect that “dimension lumber,” as defined by Canada, was a concept extraneous to the Japanese Tariff … nor did it belong to any internationally accepted customs classification. The Panel concluded therefore that reliance by Canada on the concept of dimension lumber was not an appropriate basis for establishing “likeness” of products under Article I:1 of the General Agreement.

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This finding has been followed consistently in subsequent case law. GATT panels have further dismissed the relevance of some factors, arguing that they are irrelevant for the purpose of defining likeness. In a 1978 panel on EEC–Animal Feed Proteins, the question arose as to whether, by treating different protein products in different ways, the EU was violating its obligations.104 There was little doubt that the products at hand could be regarded as substitutable (that is, as belonging to the same relevant product market). The question, however, was whether such a criterion (substitutability) was still appropriate to decide likeness under Article I of GATT. The panel decided that this should not be the case (§ 4.20): The Panel noted that the general most-favored-nation treatment provided for in Article I:1 … did not mention directly competitive or substitutable products. In this regard the Panel did not consider animal, marine, and synthetic proteins to be products like those vegetable proteins covered by the measures.

The Panel on Spain–Unroasted Coffee, on the other hand, set aside the relevance of process-based distinctions in defining likeness (§§ 4.7–4.10): The Panel examined all arguments that had been advanced during the proceedings for the justification of a different tariff treatment for various groups and types of unroasted coffee. It noted that these arguments mainly related to organoleptic differences resulting from geographical factors, cultivation methods, the processing of the beans, and the genetic factor. The Panel did not consider that such differences were sufficient reason to allow for a different treatment. It pointed out that it was not unusual in the case of agricultural products that the taste and aroma of the end-product would differ because of one or several of the above-mentioned factors. The Panel furthermore found relevant to its examination of the matter that unroasted coffee was mainly, if not exclusively, sold in the form of blends, combining various types of coffee, and that coffee, in its end-use, was universally regarded as a well-defined and single product intended for drinking. The Panel noted that no other contracting party applied its tariff regime in respect of unroasted, non-decaffeinated coffee in such a way that different types of coffee were subject to different tariff rates. In light of the foregoing, the Panel concluded that un-roasted, non-decaffeinated coffee beans listed in the Spanish Customs Tariff … should be considered as like products within the meaning of Article I:1. (emphasis in the original)

Why was similar analysis necessary? The question whether two goods share the same tariff classification requires some thought: in order to decide, for example, whether “Nespresso” and “Lavazza” coffee pods share the same tariff classification, the judge first needs to be satisfied that he or she is dealing with coffee pods in the first place. The judge will have to ask what is a reasonable understanding of the term “coffee pod” and then subject Nespresso and Lavazza coffee pods to it. To this effect, such criteria as physical characteristics and end uses should be relevant. The comparator, thus, is the tariff classification, and the more detailed it is, the easier it will be for the judge to decide the case. To the extent that production or process methods (PPMs) are not featured in the classification, they are irrelevant.

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Recall that agreed HS classifications contain a maximum of six digits. The level of specificity is not symmetric across classifications. For example, tariff heading 030312, which comprises “Other Pacific Salmon,” specifies geographically the product category that it applies to. In parentheses, six different species of “oncorhynchus” (e.g., gorbuscha, keta, etc.) are mentioned. These are terms from marine biology that refer to specific categories of salmon. The judge will have a relatively easy time decising the tariff classification of similar goods upon request. The same is not true, however, with tariff heading 8406.10, “Turbines of Marine Propulsion.” The title at the four-digit level is “Stream Turbines and other Vapor Turbines.” Now this seems to be quite open-ended since both small boats and well liners use turbines of marine propulsion. In similar cases, the judge’s discretion is wider. Finally, as will be discussed in more detail in chapter 7, the term “like products” has a different meaning in Article III of GATT. There, likeness is relative in the sense that the issue is whether two goods are like one another. In this example, the issue is whether Lavazza and Nespresso coffee pods are like one another, regardless of whether they come under the same tariff classification. The latter criterion could be relevant, but it is not the quintessential element that two goods must share. Moreover, it could be the case that goods coming under the same tariff classification are not considered to be like for the purposes of Article III of GATT. Take, for example, tariff heading 0201.10 (Bovine Meat, Carcasses, and Half-Carcasses), and assume that mad cow disease has spread within one WTO member country. Importing states can legitimately impose a sales ban on bovine meat originating there, while allowing other carcasses and half-carcasses to circulate freely in its market. As will be shown in the coverage of EC–Asbestos in chapter 7, reasonable consumers would always distinguish between these two goods. For this reason, the two goods are unlike. Regardless of the intellectual legitimacy of this finding, this is standard case law nowadays. It follows that, while likeness has a universal dimension when discussed in the context of tariff treatment, it has a market-specific dimension when discussed in the context of Article III of GATT. This should not strike the reader as odd. The rationale for negotiating tariffs is different from the rationale for regulating the internal market. It follows that the same term, interpreted in light of the rationale of the relevant provision, could be understood in two different ways.105 There are, of course, agreed and unilateral tariff classifications. As we saw in the previous chapter, the HS provides for agreed tariff classifications up to the six digit-level: by virtue of Article 3.3 of HS, national classifications beyond the six-digit level can legitimately come into the picture, so long as they specify a six-digit classification. WTO members might prefer to use a trade (elaborate tariff classification) instead of a domestic instrument in order to advance social preferences. Should the response remain the same? The answer should be a function of the legality of similar classifications. Unilateral classifications are not necessarily GATT consistent

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and can be challenged before WTO panels for (to provide but one example) unlawfully distinguishing between two like products. If panels consent to their lawfulness—that is, if they find that they respect Article 3.3 of HS—then they can provide a benchmark for deciding likeness. There is no case law on this score. Intuitively, one could use EC– LAN Equipment (discussed later), and ask whether similar classification could have been expected by the trading nations at the moment when the tariff concession was negotiated. 4.8 4.8.1

Exceptions Special and Differential Treatment

Developing countries can benefit from preferential tariffs and nontariff measures, as discussed in chapter 5. 4.8.2

PTAs

WTO members can provide each other market access on preferential conditions if they comply with the obligations embedded in Article XXIV of GATT, the Enabling Clause (chapter 6), or both. 4.8.3

General Exceptions

GATT contains an exhaustive list of general exceptions that enable the WTO member invoking them to deviate from any obligation assumed under GATT, including MFN (see chapter 9). 4.8.4

National Security

A WTO member can invoke a threat to its national security in order to deviate from its obligations under GATT, including MFN (see chapter 9). 4.8.5 Waivers A WTO member may, in exceptional circumstances, request that it be exempted from its obligations under the WTO. To this effect, a member must submit a request for a waiver to the WTO membership (Article IX of the Agreement Establishing the WTO). Waivers are discussed further in chapter 9 since they constitute an exception not only to MFN, but also to other obligations assumed under GATT.

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Nonapplication

A WTO member may legitimately refuse application of GATT to another WTO member if it has invoked the nonapplication clause to this effect. This possibility is explored in chapter 9. 4.9

Concluding Remarks

MFN is legitimately called the cornerstone of the GATT/WTO: it is MFN that keeps the multilateral trading system together. There is inherent tension between MFN and the other quintessential GATT principle, reciprocity. MFN, by inviting free riding, reduces the scope for reciprocity. This is what has prompted some nations to insist on “conditional” MFN; e.g., the idea that tariff reductions, or conferral of trade advantages more generally, will benefit only those who are prepared to offer something in return. Similar efforts have failed. In the classic theory explaining trade agreements, though, one should not overemphasize this risk since negotiations across principal suppliers and, more recently, critical mass agreements have greatly reduced the scope for free riding. In the next two chapters, we will be discussing two institutions where reciprocity has a drastically different impact. It is totally irrelevant when it comes to concessions in favor of developing countries (chapter 5), and very much the linchpin of commitments in the context of PTAs (chapter 6).

5

Special and Differential Treatment for Developing Countries

5.1 The Legal Discipline and Its Rationale 5.1.1 The Legal Discipline The GATT/WTO provisions on special and differential treatment (Part IV, and the Enabling Clause, which both constitute additions to the original GATT) provide donors (typically, developed nations) with the possibility to provide a subset of the WTO membership, namely developing countries, with trade advantages that they do not have to extend to the remaining WTO members. Thus, these provisions constitute an exception to the Most Favored Nation (MFN) Clause since advantages granted to goods originating in developing countries will not be extended to like goods originating in developed countries. Furthermore, donors cannot expect reciprocity, since trade advantages granted to developing countries are one way preferences. 5.1.2 The Rationale for the Legal Discipline The idea behind the Enabling Clause is that equal treatment across unequal partners does not work. Most developing countries, as they are called nowadays, did not participate in the negotiation of GATT, as already shown in chapter 1. Only a few of the participants advanced proposals in favor of “special and differential” treatment. GATT, except for sporadic references (as in Article XVIII), did not concede this point. What, then, explains the change in attitude? Why was Part IV deemed necessary? In a nutshell, it is all due to the ideas prevailing in the late 1950s and early 1960s (at least in some corners), as well as the creation of new, independent states around that period that saw merit in these ideas, espoused them, and fought for their adoption at the multilateral level. The term “industrialization” was being used as a synonym for “development”—indeed, the pathway toward development that all nations had to take. Domestic subsidies could of course contribute towards this objective, but the treasuries of many interested in this endeavor were empty. Import substitution and export expansion were the remaining instruments necessary to achieve industrialization. There were legitimate doubts

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regarding the consistency of both instruments with the GATT. Those interested in industrializing their economy in this manner thus, needed to be granted exceptions from MFN. Many developing countries gained their independence around the time when similar ideas regarding industrialization flourished. These ideas did not fall on deaf ears. Upon joining GATT, as they almost all did, they brought these views to the world trading system, calling for the necessary adjustments. They requested the introduction of instruments to advance their quest for industrialization. It all boiled down to two points. First, developing countries should be benefiting from concessions that would not be extended to like products originating in developed countries. This would be done through the Enabling Clause. Second, developed nations, when making concessions, should not expect reciprocity from developing countries. Article XXXVI.8 reflects this point: “The developed contracting parties do not expect reciprocity for commitments made by them in trade negotiations to reduce or remove tariffs and other barriers to the trade of less-developed contracting parties.” All this is discussed in the rest of this chapter. 5.1.3

Discussion

5.1.3.1 MFN between Unequal Partners In chapter 1 we explained why the MFN clause was designed to be the cornerstone of GATT. The original GATT consisted of a relatively homogeneous group of 23 countries. At the very least, all participants shared the commitment to nondiscriminatory trade liberalization. Already, during the negotiation of the original GATT, Lebanon had argued in favor of introducing tariff preferences for developing countries, but its proposal was not accepted.1 Moreover, Lebanon did not sign the GATT, and this voice was lost. It was not the only one. In a similar vein, Irwin, Mavroidis, and Sykes (2008) noted that India (before partition) had a hostile reaction when it was presented with the Suggested Charter and was requested to comment upon it. Its criticism focused on MFN, arguing that this instrument was ill equipped to deal with countries at different stages of development.2 India’s voice was not totally ignored. The provision on infant industry [Article XXVIII(c) of GATT] was one response to this and similar requests. Besides a few sporadic provisions allowing special and differential treatment for developing countries, though, GATT did not reflect a comprehensive chapter dealing with issues of interest exclusively to developing countries. In the years subsequent to the advent of GATT, a number of countries acceded to independence and eventually joined GATT. Many of them were rather poor, developing countries. They were joining a GATT including provisions that, with few exceptions as noted previously, were not conceived to discriminate across the membership using development level as a benchmark for making distinctions. From the early days of their participation, developing countries, influenced by the writings of Prebisch (1950) and Singer (1950), and (1950a) that are described later in

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this chapter, aimed at changing this basic scaffolding by requesting the introduction of preferential tariffs for products originating in developing countries with no reciprocal obligation on behalf of developing countries to liberalize their markets.3 They believed that they could not compete for export markets on an equal basis with developed countries. In their view, the MFN tariff rate amounted to an impediment to their export trade, in that it provided for nondiscriminatory access to markets regardless of the level of development of the exporting country. They also thought that a few sporadic provisions here and there (like the provision on infant industry) felt short of advancing their concerns. They requested a comprehensive discussion on trade and development. Their request was answered. A comprehensive discussion on GATT and its contribution to development took place in 1958. The background for the discussion was the circulation of the Haberler report, discussed in the next section.4 5.1.3.2 The Background: Gottfried Haberler versus Singer/Prebisch Haberler had been requested by the GATT contracting parties to examine the validity of claims by the less-developed trading partners to the effect that the existing rules on trade liberalization would not necessarily work to their advantage. Exports of farm and textile goods were growing at a much slower pace than exports of industrial goods, and this was the reason for the anxiety of developing countries. They believed that they would never catch up with the developed world unless they could switch to producing industrial goods. Haberler concluded in his study that developing countries had some valid reasons to be worried. He examined both the short- and long-term trends in commodity prices and the factors influencing them. He concluded that the protectionist policies of developed nations in the farm sector, as well as their tariff escalation practices, were factors contributing to lack of growth in the export of textiles and farm products originating in developing countries. It is worth recounting in this respect that the US had obtained a waiver in 1955, which allowed it to grossly subsidize its farm production over the subsequent years and essentially shield domestic producers from the challenges of international competition.5 The Haberler report made a series of recommendations to address the issue, and reduction of the existing protectionism was one of the measures suggested. His main conclusions were that labor-intensive goods, like farm and textile goods, which are typically produced in developing countries’ markets, were facing formidable barriers to entry in the markets of developed countries. Haberler, nevertheless, was not advocating industrialization and import substitution. His report sensitized the trading partners to the fact that not all parties were gaining equally from the existing regime. His recommendations included a painful recipe for some developed nations: open up their textiles and farm markets. Developing countries seized the opportunity (without paying too much attention to the details in the Haberler report) and raised the volume of their voice in GATT, claiming that the imbalance had to be addressed. They argued that something needed to be done to

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address the concerns of those who were being left behind. Something needed to be done, but what was it exactly? Haberler’s report was not the only game in town. Hans Singer, a German professor of economics at Cambridge, and Raoul Prebisch, an Argentine economist, had been independently advocating for some time that the safest way toward development was to strive for industrialization through import substitution policies.6 The argument for import substitution was justified as the adequate response to what was termed “terms of trade pessimism”: exports of developing countries were progressing at a slower pace than total exports. No one denied that. But unlike Haberler, who thought that it was protectionism with respect to farm goods that caused the slow growth of exports, Singer and Prebisch argued that the slow growth of exports was due to the prevailing terms of trade between farm and industrial goods. Fast development required industrialization. This was the Prebisch-Singer thesis, also called the “Prebisch-Singer hypothesis.”7 Consequently, both Haberler and Singer and Prebisch were looking at the same picture, but drawing different conclusions. Exports of labor-intensive goods were growing slower than exports of industrial goods. They disagreed on the necessary treatment to correct this imbalance: Haberler was recommending that textiles and farm protectionism be dismantled, whereas Singer and Prebisch were advocating import substitution policies. Haberler was addressing the causes for slow growth of exports of farm goods. Singer and Prebisch moved to prescribe policies that should be followed to bridge the gap between the rates of growth of exports (industrial-, farm goods) without asking first what had given rise to the gap. The view that development essentially equaled industrialization (supported by the influence of terms-of-trade elasticity pessimism)8 resonated well with many developing countries. Note that during that time, liberal market economies were discredited in the eyes of many observers, especially in developing countries, and a strong argument in favor of government-driven economies was finding a receptive audience. Prebisch and Singer had a head start over Haberler in many quarters. Unsurprisingly, many developing countries espoused negotiating strategies aimed at achieving preferential access in developed countries’ markets. In a nutshell, their request would be framed in terms of nonreciprocal preferential access to developed countries’ markets, and, thanks to economies of scale resulting from nonreciprocal preferential access of their products (so the argument goes), they would gradually become more competitive in the production of industrial goods. Then and there, Haberler lost his intellectual argument to Singer and Prebisch, at least as far as developing countries were concerned. Haberler lost support among developed countries as well, this time for reasons of political economy. They found it easier to accept one-way preferences in areas of their choice, as will be explored later in this chapter, rather than a painful opening of their textiles and farm markets that would bring their governments into direct collision with powerful lobbies. The US had just been granted its farm waiver, as we saw earlier, and some of its

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southern states (the so-called textile belt) were clearly reluctant to open up to foreign competition. The EU, on the other hand, was taking its first steps toward integration and had already assigned itself the objective to become self-sufficient with respect to farm production. Haberler’s report was not inconsequential, though. Three committees were established in its aftermath: Committee I, which was supposed to prepare a new tariff negotiating round; Committee II, mandated to review the agricultural policies of governments; and Committee III, which would deal with the problems that developing countries were facing. Nothing tangible came from Committee II, and the request for one-way preferences dominated discussions in Committee III. 5.1.3.3 Import Substitution The Prebisch-Singer hypothesis persuaded many developing countries that adoption of import substitution policies was the pathway to development. To do that, some support was necessary, either in the form of tariffs or, as we saw in chapter 2, in the form of quotas [Article XVIII(c) of GATT], or, on occasion, through subsidization. The test in economic theory to support an industry is the so-called Mill-Bastable test. John Stuart Mill first explained that the absolute precondition for government support of an industry should be the presence of learning effects external to firms, e.g., knowledge that others can use as well. In addition, support should be temporary, as subsidized firms should become viable after a moderate amount of time. Charles Francis Bastable added that, once viable, formerly subsidized firms should be in a position to pay back to society the grants received.9 In practice, there have been various cases where import substitution policies were followed without meeting the Mill-Bastable test, and, alas, these cases led to wasteful expenditure in countries where the opportunity cost of similar actions was quite high. Early analysis of the issue cast doubt on the validity of import substitution policies. Studies conducted by Bhagwati (1982) and Krueger (1978) for the National Bureau of Economic Research (NBER)10 provided ample support for this claim. Theoretical papers included in the two studies actually supported the view that the focus should be on export policies, which, besides economies of scale, ensure that fewer quantitative restrictions will be in place. Empirical papers underlined the shortcomings of import substitution policies in terms of misallocation of resources.11 Subsequently, some analysts have presented empirical evidence regarding the merits of import substitution through infant industry support. Rodrik (2009) presents evidence of success stories from Latin American countries.12 Some empirical evidence suggests that it is the government’s role in enforcing conditionality that will distinguish winners from losers.13 Overall, while economists legitimately continue to look at import substitution policies with a considerable amount of skepticism, there are some examples that support the view that, under very restrictive conditions, similar interventions could be successful.

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5.2 Toward Special and Differential Treatment 5.2.1

Striving for a Two-Tier GATT

The discussions on the previous topic slowly found its way into GATT at the end of the 1950s and the beginning of the 1960s. Initiatives multiplied that were aimed at reforming GATT into a two-tier system that would allow developing countries to continue under the aegis of GATT without having to be bound by its quintessential provision, the MFN. First, a GATT Working Party on Commodities was established to review trends and developments in international commodity trade. The Singer-Prebisch thesis was reflected therein, as evidenced by the following quoted passage from the report in 1961: … in the long term, only the industrialization of the less-developed countries would enable these countries to overcome the present difficulties in their external trade; in turn, this industrialization and the economic development generally of the less-developed countries would only be achieved through an increase in their exports, including exports of manufactured and semi-manufactured goods. Direct investment and financial aid alone would not solve this problem.14

Almost naturally, and without asking too many questions to this effect, the discussions moved from the generic to the specific. During the Kennedy round of international trade negotiations (1962–1967), the Committee on Legal and Institutional Framework of GATT in Relation to Less-Developed Countries (one of the negotiating groups) worked on a chapter on Trade and Development. This chapter was finalized at a special session of the CONTRACTING PARTIES, held from November 17, 1964, to February 8, 1965. It was annexed to GATT as an amending protocol, and it now appears as Part IV. Part IV was hailed by developing countries as their only major benefit from the negotiations of the Kennedy round. Reductions of tariffs on products of interest to them were far short of the 50 percent level that had been accepted as the working hypothesis for the negotiations.15 Moreover, some of the products of interest to them had been totally excluded from the negotiation. 5.2.2 The Content of Part IV Part IV came into effect on June 27, 1966, and consists of three new legal provisions: • Principles and Objectives (Article XXXVI of GATT) • Commitments (Article XXXVII of GATT) • Joint Action (Article XXXVIII of GATT) A look at the wording of each provision leaves no doubt that these were meant to be “best-endeavors” clauses aimed at opening the door to discriminatory, preferential trade.

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5.2.2.1 Principles and Objectives Article XXXVI of GATT constitutes the formal recognition that market access for products of export interest to developing countries has to be improved. It stops short of prescribing specific measures that should be adopted to this effect. It does, on the other hand, provide the foundation for nonreciprocity (§ 8): The developed contracting parties do not expect reciprocity for commitments made by them in trade negotiations to reduce or remove tariffs and other barriers to the trade of less-developed contracting parties.

The Interpretative Note to this provision adds: It is understood that the phrase “do not expect reciprocity” means, in accordance with the objectives set forth in this Article, that the less-developed contracting parties should not be expected, in the course of trade negotiations, to make contributions which are inconsistent with their individual development, financial and trade needs, taking into consideration past trade developments.

During the Kennedy round, this provision was further interpreted as follows: There will, therefore, be no balancing of concessions granted on products of interest to developing countries by developed participants on the one hand and the contribution which developing participants would make to the objective of trade liberalization on the other and which it is agreed should be considered in the light of the development, financial and trade needs of developing countries themselves. It is, therefore, recognized that the developing countries themselves must decide what contributions they can make.16

It follows that developing countries were expected to make contributions only to the extent that when doing so, they did not endanger their development needs. Since only they would be the judge of their own situation, this provision did not mean much, and subsequent practice confirmed its irrelevance. 5.2.2.2 Commitments Article XXXVII of GATT is a general clause recommending various actions that developed countries should undertake to help promote issues of interest to developing countries. Chief among them was the inducement to reduce the gap between high barriers on processed goods and low barriers on primary products. This is, of course, what tariff escalation is all about. The validity of the tariff escalation argument is doubtful at best. In a scenario of high tariffs for processed goods and low tariffs for primary goods, the problem seems to be the high tariffs on processed goods, not the gap in the level of tariffs between processed and primary goods.17 Be it as it may, though, this provision seems to attach validity to the escalation argument more than it does to the high-tariff component. The remaining part of this provision deals with issues that were also further detailed in other agreements. For example, developed countries, when imposing countervailing duties

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(CVDs) or antidumping (AD) duties, or when introducing safeguard measures, should “have special regard to the trade interests” of developing countries. To this effect, they should “explore all possibilities of constructive remedies before applying such measures.” In the AD Agreement concluded during the Uruguay round, WTO members agreed to transform this provision into a binding legal obligation. It has since been consistently interpreted as an obligation to examine the feasibility of introducing price undertakings on dumped imports originating in developing countries before AD duties are eventually imposed.18 5.2.2.3 Joint Action Article XXXVIII of GATT was meant to provide the institutional vehicle that would make the principles reflected in the two aforementioned provisions operational. It does not, however, provide the definitive solution. It simply calls for institutional arrangements for furthering the objectives of Part IV. It further calls for collaboration to this effect with the UN and its organs and agencies. Finally, it expresses the view that some monitoring of the rate of growth of the trade of developing countries should be introduced. The response to the call for institutional arrangements to further the objectives of Part IV came with the advent of the Enabling Clause, discussed next.19 5.3 The Enabling Clause Enters the Frame 5.3.1 An Atypical Birth The Enabling Clause came to life in two steps. Initially, the GATT CONTRACTING PARTIES agreed in 1971 that those interested in treating goods originating from developing countries better than like goods originating elsewhere could benefit from a ten-year waiver. The waiver was necessary, of course, to legalize the deviation from Article I of GATT (MFN). Before the waiver lapsed, the Enabling Clause was agreed to in 1979, providing a permanent deviation from Article I of GATT.20 The waiver ran out but preferences would continue, thanks to the enactment of the Enabling Clause. The Enabling Clause reproduces the nonreciprocity idea, first embedded in Article XXXVI.8 of GATT.21 It was negotiated in one of the negotiating groups formed during the Tokyo round, the Negotiating Group on Framework.22 The Panel on EC–Tariff Preferences recounts the advent of the Enabling Clause in the following terms: During the Second Session of UNCTAD, on 26 March 1968, a Resolution was adopted on “Expansion and Diversification of Exports and Manufactures and semi-manufactures of Developing Countries” (Resolution 21 (II)). In this Resolution, UNCTAD agreed to the “early establishment of a mutually acceptable system of generalized, non-reciprocal and non-discriminatory preferences which would be beneficial to the developing countries” and established a Special Committee on

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Preferences as a subsidiary organ of the Trade and Development Board, with a mandate to settle the details of the GSP arrangements. In 1970, UNCTAD’s Special Committee on Preferences adopted Agreed Conclusions which set up the agreed details of the GSP arrangement. UNCTAD’s Trade and Development Board took note of these Agreed Conclusions on 13 January 1970. In accordance with the Agreed Conclusions, certain developed GATT contracting parties sought a waiver for the GSP from the GATT Council. The GATT granted a 10-year waiver on 25 June 1971. Before the expiry of this waiver, the CONTRACTING PARTIES adopted a decision on “Differential and More Favorable Treatment, Reciprocity and Fuller Participation of Developing Countries” (the “Enabling Clause”) on 28 November 1979.

5.3.2 The Main Features of the Enabling Clause The function of the Enabling Clause is to help WTO members that are developed nations accord trade advantages to developing countries without running the risk of seeing their own practices being challenged for violating MFN. National Generalized System of Preferences (GSP) schemes were the vehicle to make this happen.23 A GSP is a list reflecting concessions granted by donors to beneficiaries. GSP lists, of course, must respect the legal requirements imposed through the Enabling Clause—namely:24 1. The general principle that deviations from MFN are allowed for products originating in developing countries (§ 1). 2. Concessions (§ 2) can be expressed in tariff terms (§ 2(a)), as well as nontariff terms (§ 2(b)). 3. Distinctions can be made between developing countries and least-developed countries (LDCs), the latter being a subgroup of the former; and additional preferences can be granted to LDCs (§ 2(d)). 4. Measures must be designed to correspond to the “development, financial, and trade needs of developing countries” (§ 3(c)). 5. WTO members that have recourse to measures coming under the purview of the Enabling Clause must notify the WTO membership and consult with them, whenever appropriate (§ 4). 6. Donors should not expect reciprocity from beneficiaries (§ 5). LDCs should not, in general, be expected to make commitments that might jeopardize their development, financial, and trade needs (§ 8). The Enabling Clause further provides in § 2(c) the legal basis for developing countries to form preferential trade agreements (PTAs) between themselves, while respecting less onerous requirements than those established by Article XXIV of GATT.25 Finally, the possibility for graduation is established: developing countries are expected to participate more fully in the multilateral trading system as their economic situation improves (§ 7).26

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5.3.3 The Legal Nature of the Enabling Clause The Appellate Body (AB), in its report on EC–Tariff Preferences, held that the Enabling Clause became an integral part of GATT by virtue of Article 1(b)(iv) of GATT (1994).27 In the same report, it held that since the Enabling Clause permits WTO members to grant tariff preferences to a subset of the WTO membership, it constituted a legal exception to Article I of GATT (§ 99). The legal implication, in the AB’s view, is that the Enabling Clause takes precedence over Article I of GATT (§ 102). As to the allocation of the burden of proof, the AB, reversing the panel’s decision in this respect, held that it is insufficient for a complaining party, when challenging a measure taken pursuant to the Enabling Clause, to simply claim violation of Article I of GATT (§ 110). Due process considerations (§ 113) require that the complaining party “identify those provisions of the Enabling Clause with which the scheme is allegedly inconsistent, without bearing the burden of establishing the facts necessary to support such inconsistency” (§ 115; emphasis in the original). The soundness of this approach can be questioned, of course. It would probably have made better sense for the AB to go all the way and construct the Enabling Clause as a self-standing obligation, not as an exception to Article I of GATT. WTO members that want to do that anyway apply one set of tariffs to imports from developed nations and another on imports originating in developing countries. Complainants will carry a similar burden of proof, regardless of whether they attack violations of MFN or of the Enabling Clause. 5.3.4

Donors and Beneficiaries

5.3.4.1 No Obligation to Donate WTO members are permitted, but are not required, to provide preferences. If they decide to do so, though, then they must respect the Enabling Clause. The letter and the spirit of this clause both make it clear that preferences are granted by developed nations and can be granted only to developing countries, not to other developed countries. The Enabling Clause, however, does not lay down any specific criteria for which WTO members will be classified as developing countries. 5.3.4.2 Self-selection of Beneficiaries Several discussions have taken place within GATT/WTO that aim to provide some certainty as to the identity of donors and beneficiaries, but, alas, none of them has been conclusive.28 In practice, developing countries in the WTO are designated on the basis of the self-selection principle (which itself is an expression of the principle of sovereignty). Their declaration has ramifications for a host of issues, not simply eligibility for GSP advantages. Unilateral declarations to the effect that a WTO member is a developing country can, in principle, be challenged before a WTO panel. No formal challenge has been launched so far in this context.

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There are, nevertheless, instances where the legitimacy of developing-country status has been questioned, but no instance where the challenging party went as far as to submit a formal dispute to this effect. While negotiating on the implementation of the TradeRelated Aspects of Intellectual Property Rights (TRIPs) Agreement, for example, the US and the EU voiced their wish that WTO members like Singapore, Korea, and Hong Kong be considered developed nations, at least for the purposes of complying with TRIPs. These three southeast Asian countries disagreed. Subsequently, discussions took place in the TRIPs Council. During these discussions, the principle of self-selection as such was not questioned, and a mutually satisfactory solution was agreed to among the interested parties.29 To cite another example, during the discussions before the Dispute Settlement Body (DSB) regarding the adoption of the AB report on Korea–Various Measures on Beef, the EU delegate: … noted with surprise that Korea had been treated as a developing country for the purposes of the Agreement on Agriculture. Although this issue did not seem to have been in dispute, the EC was compelled to underline its disagreement with Korea’s self-characterization as a developing country.30

There may have been a disagreement, but the EU did not formally challenge this issue. WTO practice points to instances where, through negotiated solutions, the WTO membership has managed to mitigate what it considered to be unreasonable demands. China, for example, defends its developing-country status. The Chinese Protocol of Accession, though, states that the de minimis threshold for calculation of the Aggregate Measurement of Support (AMS)31, in accordance with Article 6.4 of AG, should be 8.5 percent, when the corresponding numbers are 10 percent for developing countries and 5 percent for developed countries. All these instances show that WTO members have opted for ad hoc agreements to resolve similar disputes instead of launching a formal complaint in accordance with Article 1 of the Dispute Settlement Understanding (DSU), whereby they would be contesting the developing-country status of another WTO member. The WTO World Trade Report (2014, p. 66) divides WTO members between “developed,” on the one hand, and “developing and emerging economies,” on the other. The term “developing and emerging economies” is further subdivided into “emerging economies,” “developing economies,” and “LDCs.” There is no doubt as to the identity of the LDCs, a subset of the developing-countries group as per § 2(d) of the Enabling Clause. The WTO recognizes as LDCs the countries that have been designated as such by the UN. The UN criteria for including a country among the LDCs are as follows: 1. A low-income criterion based on a three-year average estimate of the gross national income (GNI) per capita. The so-called Atlas method has been used to this effect, a

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mathematical formula used to reduce the impact of short-term exchange rate fluctuations. Graduation takes place if, following this method, the GNI per capita rises by 20 percent over a given three-year period: $992 GNI per capita was the threshold for inclusion of a country in the LDC category in 2011. If the GNI per capita of any country that had been originally included in the LDC category had risen above $1,190 for two of the three years between 2011 and 2014, then graduation would occur. 2. A human-capital-status criterion that involves a composite Human Assets Index (HAI) based on indicators of: (i) nutrition (percentage of population undernourished); (ii) health (mortality rate for children aged five years or under); (iii) education (gross secondary school enrollment ratio); and (iv) adult literacy rate. 3. An economic vulnerability criterion involving a composite Economic Vulnerability Index (EVI) based on indicators of (i) population size; (ii) remoteness; (iii) merchandise export concentration; (iv) share of agriculture, forestry, and fisheries in gross domestic product (GDP); (v) homelessness owing to natural disasters; (vi) instability of agricultural production; and (vii) instability of exports of goods and services.32 A country must satisfy all three criteria. In addition, large economies are excluded. No country with a population exceeding 75 million people may be included, regardless of its GNI per capita. There are currently 48 LDCs on the UN list, 33 of which are WTO members: Angola, Bangladesh, Benin, Burkina Faso, Burundi, Cambodia, Central African Republic, Chad, Democratic Republic of Congo, Djibouti, Gambia, Guinea, Guinea Bissau, Haiti, Laos, Lesotho, Madagascar, Malawi, Mali, Mauritania, Mozambique, Myanmar, Nepal, Niger, Rwanda, Senegal, Sierra Leone, Solomon Islands, Tanzania, Togo, Uganda, Vanuatu, and Zambia. Nine more LDCs are currently negotiating their accession to the WTO: Afghanistan, Bhutan, Comoros, Equatorial Guinea, Ethiopia, Liberia, São Tomé and Príncipe, Sudan, and Yemen. Geographically, 34 of the 48 are located in Africa, 13 in Asia Pacific, and 1 (Haiti) in the Caribbean. Argentina, Brazil, China, India, Indonesia, Korea, Mexico, Russia, Saudi Arabia, South Africa, and Turkey are designated as “emerging economies.” Note that Mexico and Turkey are Organisation for Economic Co-operation and Development (OECD) members (e.g., members of the “club of rich countries”). Three more OECD members (Chile, Israel, and Korea) are designated as “developing countries” in the WTO publication. All emerging economies present themselves as developing countries in the various WTO forums. On the other hand, several EU member states that are not OECD members have been designated as “developed economies” (Bulgaria, Cyprus, Latvia, Lithuania, and Romania). Finally, Bermuda, Faeroe Islands, Gibraltar, Greenland, Liechtenstein, and Saint Pierre and Miquelon have been designated as “developed economies.”

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5.3.4.3 Graduation Graduation from the LDC list is possible, as we discussed when we referred to the UN criteria for conferring LDC status. Since its inception, Botswana (1994), Cape Verde (2007),33 Maldives (2011), and Samoa (2014) have all been removed from the list.34 Graduation can, of course, occur from the list of developing countries to that of developed countries. In fact, this should not come as a surprise at all. Since development is an ongoing process, one would normally expect that the group of developing countries is dynamic, not static. No precise criteria have been established, though, that will explain under what conditions graduation will take place. Donors have removed beneficiaries from lists without always explaining the reason for doing so. No beneficiary that has been removed has challenged the legality of similar actions. As a result, neither as a matter of law nor as a matter of case law is it clear as to the criteria for graduation to developed-country status. 5.3.5

GSP Schemes

5.3.5.1 The Basic Obligation § 2(a) of the Enabling Clause states that the clause applies to Preferential tariff treatment accorded by developed contracting parties to products originating in developing countries in accordance with the Generalized System of Preferences

A footnote to this paragraph clarifies that preferences must be • Generalized • Nondiscriminatory • Nonreciprocal • Beneficial to developing countries The wording of the footnote leaves no doubt that all these properties must be cumulatively present in a GSP scheme. § 2(d) of the Enabling Clause further provides that the clause protects: “special treatment on the least developed among the developing countries in the context of any general or specific measures in favour of developing countries.” Finally, § 3(c) of the Enabling Clause holds that “… treatment accorded by developed contracting parties to developing countries be designed and, if necessary, modified, to respond positively to the development, financial, and trade needs of developing countries.”35 A donor, thus, can legitimately impose an MFN rate for widgets of 10 percent, a preferential rate of 5 percent, and a rate applicable to LDCs of only 2 percent. Additional preferences are often denoted with a “+”: we distinguish, thus, between GSP, GSP+, and preferences for LDCs.36

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The question that arises at that point is whether there is tension between § 2(d) and § 3(c): that is, can donors distinguish beneficiaries based on their “development, financial, and trade needs” beyond the statutory distinction operated between developing countries and LDCs? The response provided by WTO adjudicating bodies on this score is explored later in this chapter. 5.3.5.2 Preferences Requiring a Waiver Let’s kick-start this discussion with an idiosyncratic program, the US African Growth and Opportunity Act (AGOA), which is a scheme targeting beneficiaries geographically located in sub-Saharan Africa. It roughly aims at compensating performance; that is, the US aims at picking “winners” and providing them with extra preferences. Because of its idiosyncratic elements (e.g., not all countries in a similar position from a level-of-development perspective will participate), it required a waiver for the US to be lawfully positioned to compensate the designated beneficiaries. The US obtained a waiver that runs until September 30, 2015.37 The EU requested and obtained a waiver in order to provide Pakistan with necessary aid and thus help it with the problems that it faced as a result of the 2011–2012 floods that had affected extensive regions of the country. The form of the aid was principally exemptions from payment of customs duties.38 The granting of waiver dispenses the EU from the obligation to help other countries similarly situated in the future. The EU can behave as it did when Pakistan was hit by torrential floods, but does not have to do so. 5.3.5.3 Preferences for LDCs Donors have adopted asymmetric schemes when granting preferences to LDCs. The Chinese schemes, for example, are often a two-way street guaranteeing a return for China in terms of accessing the minerals market of beneficiaries. China’s dependency on raw materials explains why this is the case. New Zealand has been offering, since July 1, 2001, duty-free and quota-free (DFQF) access to all imports originating in LDCs. Japan, in December 2000, announced its 99% Initiative on Industrial Tariffs, which practically meant that, as of April 2001, the coverage of DFQF treatment for industrial products originating in LDCs and imported into Japan increased from 94 to 99 percent. Crucially, textile and clothing products—a product market of particular interest to LDCs—enjoyed DFQF treatment in the Japanese market. The EU’s Everything But Arms (EBA) is a bit more complicated.39 First, in February 2001, the European Council adopted Regulation (EC) 416/2001, granting DFQF access to imports of all products from LDCs (except for arms and ammunitions) without any quantitative restrictions (except for bananas, sugar, and rice, for a limited period). EBA was later incorporated into the GSP Council Regulation (EC) No. 2501/2001. The regulation foresaw that the special arrangements for LDCs should be maintained for an unlimited period of time and not be subject to the periodic renewal of the EU GSP.

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The EBA allows for LDCs that have graduated to profit from EBA for three years following graduation: Maldives, for example, profited from EBA benefits until the end of 2013, three years following its graduation from the LDC list.40 The treatment accorded to products originating in LDCs has been heavily negotiated during the Doha round, and the various innovations agreed to will be explored later in this chapter. Table 5.1 Preferences in favor of LDCs PreferenceGranting Country Australia Belarus

Brazil

Canada

China

Description

Beneficiaries

Coverage/Margin of Preference

Duty- and quota-free entry. Entry into force: July 1, 2003 Harmonized System (HS) of preference by the Eurasian Economic Community (EAEC); entry into force: May 2001 Duty-free and quota-free scheme for LDCs

LDCs

All products

WT/ COMTD/N/18

47 LDCs

Duty-free access for all products

WT/TPR/S/170

LDCs

WT/COMTD/ LDC/M/55

GSP–Least-Developed Countries’ Tariff Programme (LDCT); entry into force: 1 January 2003; extended until 30 June 2014 Asia-Pacific Trade Agreement (APTA)b— amendment to the Bangkok Agreement; entry into force: 1 September 2006

LDCs

Duty-free and quota-free access for products from LDCs covering 80 percent of all tariff lines to be granted by mid-2010 With the exception of over-quota tariff items for dairy, poultry, and egg products, Canada provides duty-free access under all tariff items for imports from LDCs. In addition to 1,697 products (with average margin of preference of 26.7 percent) available to all APTA members, tariff concessions granted exclusively to LDC members on 161 products with average margin of preference of 77.9 percent. On top of the Asia-Pacific Trade Agreement (APTA), unilateral special preferential tariffs (zero rated) are offered on additional 87 tariff lines

Bangladesh Lao PDR

References

WT/ COMTD/N/15/ Add.l and Add.2 WT/ COMTD/W/159 WT/ COMTD/N/22 Information received from the government of China

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Table 5.1 (continued) PreferenceGranting Country

Description

Beneficiaries

Framework Agreement on Comprehensive Economic Co-operation between ASEAN and China; entry into force: 1 January 2006

Cambodia

Framework Agreement on Comprehensive Economic Co-operation between ASEAN and China Entry into force: 1 January 2006

Lao PDR

Lao PDR

Framework Agreement on Comprehensive Economic Co-operation between ASEAN and China Entry into force: 1 January 2006

Myanmar

Myanmar

Coverage/Margin of Preference

References

Duty-free treatment on 418 tariff lines. On top of Framework Agreement on Comprehensive Economic Co-operation between ASEAN and China, unilateral special preferential tariffs (zero rated) are offered on additional 420 tariff lines Duty-free treatment on 330 tariff lines

Information received from the government of China

On top of Framework Agreement on Comprehensive Economic Co-operation between ASEAN and China, unilateral special preferential tariffs (zero rated) are offered on additional 300 tariff lines Duty-free treatment on 220 tariff lines

Information received from the government of China

On top of Framework Agreement on Comprehensive Economic Co-operation between ASEAN and China, unilateral special preferential tariffs (zero rated) are offered on additional 226 tariff lines

Information received from the government of China

Information received from the government of China

Information received from the government of China

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Table 5.1 (continued) PreferenceGranting Country

EU

Description

Beneficiaries

Forum on ChinaAfrica Co-operation

African countries, including LDCs, having diplomatic relations with China

Special preference tariff

Afghanistan, Maldives, Samoa, Vanuatu, and Yemen LDCs

GSP-EBA initiative; entry into force: 5 March 2001

EPAs

79 African, Caribbean, and Pacific (ACP) countries, 40 of which are LDCs

Coverage/Margin of Preference As of July 1, 2010, China grants zero-tariff to 4,762 tariff lines imported from 33 LDCs, which had completed the exchange of letters for that purpose. Another 8 LDCs will enjoy the same treatment once the exchange of letters is completed. The 4,762 tariff lines account for roughly 60 percent of China’s total tariff lines, and represented 98.2 percent of all LDC exports to China in value in 2008. Zero-tariff treatment will be expanded, with the aim of achieving the final objective of including 95 percent of China’s total tariff lines. Unilateral special preferential tariffs (zero rated) are offered on 286 categories of products. Since October 1, 2009, the EBA has been granting DFQF access for all products from all LDCs (except arms and ammunitions). The EU introduced revised rules of origin for the GSP as of January 1, 2011, simplifying rules specially for the LDCs. EPAs include provision for duty-free and quota-free market access. As of February 2011, a full EPA was signed by the 15 countries in the Caribbean Forum of ACP states (CARIFORUM), of which Haiti is an LDC. Interim EPAs are signed by the following LDCs: (i) Southern African Development Community (SADC): Lesotho and Mozambique; (ii) Eastern and Southern

References WT /COMTD/ W/164 WT/ COMTD/M/77 WT/ COMTD/ LDC/M/57

Information received from the government of China WT/COMTD/ N/4/Add.2 andAdd.4 WT/TPR/S/214/ Rev. 1 ec.europa.eu

WT/TPR/S/214/ Rev. 1 WT7COMTD/ LDC/W/ 46/ Rev. 1/Corr.l ,http://ec. europa.eu/trade/ index_en. Htm

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Table 5.1 (continued) PreferenceGranting Country

Description

Beneficiaries

Iceland

GSP–Tariff Preferences in Regard to the Importation of Products Originating in the World’s Poorest Developing Countries; entry into force: 29 January 2002

LDCs

India

APTA—Amendment to the Bangkok Agreement; entry into force: 1 September 2006

Bangladesh Lao PDR

Duty-Free Tariff Preference (DFTP) Scheme; entry into force: 13 August 2008 South Asian Free Trade Agreement (SAFTA)C; entry into force: 1 January 2006

LDCs

Bangladesh

Bhutan Maldives Nepal

Coverage/Margin of Preference Africa (ESA): Madagascar (signatures by Comoros and Zambia are pending). Interim EPAs are initialed with the East African Community (EAC), which includes four LDCs: Burundi, Rwanda, Tanzania, and Uganda. Essentially all products, with some exceptions in agricultural products (HS chapters: 4, 15, 18, 19, 21, and 22) and nonagricultural products (HS subheadings: 3502 and 3823, and all of HS 16, with the exception of subheadings 1603 to 1605) In addition to 570 products (with an average margin of preference of 23.9 percent) available to all APTA members, tariff concessions granted exclusively to LDC members on 48 products with average margin of preference of 39.7 percent DFTP Scheme announced in April 2008. Duty-free access on 85 percent tariff lines at HS six-digit level within a five-year time frame. In addition to tariff concessions on 2,940 lines at the HS six-digit level to all SAFTA members, special concessions exclusively granted to LDC members. Between 2006 and 2007, preferential rates were granted on 84.4 percent of all tariff lines at average rate of 10.6 percent (while 15 percent for non-LDC members)

References

WT/COMTD/ N/17 and Corr. l WT/ TPR/S/164

WT/COMTD/ N/22

WT/COMTD/ M/69

WT/COMTD/ IO WT/ TPR/S/182. Rev.l and WT/ COMTD/N/26

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Table 5.1 (continued) PreferenceGranting Country

Description

Beneficiaries

Bilateral agreement; entry into force: 13 May 2003

Afghanistan

Bilateral agreement; entry into force 2002: extended on 29 July 2006 for 10 years Bilateral agreement

Bhutan

Japan

GSP–Enhanced duty- and quota-free market access; entry into force: 1 April 2007

LDCs

Kazakhstan

HS of preference by the Eurasian Economic Community (EAEC); entry into force: May 2001 Presidential Decree on Preferential Tariff for LDCs; entry into force: 1 January 2000 APTA—Amendment to the Bangkok Agreement

47 LDCs

Entry into force: 1 September 2006 HS of preference by the EAEC Entry into force: May 2001 Preferential tariff treatment for LDCs; entry into force: 1 January 2001

Lao PDR

Korea

Kyrgyz Republic Morocco

Nepal

Coverage/Margin of Preference Tariff reductions on 38 HS six-digit lines, with margins of preferences of 50 percent or 100 percent of MFN tariff All products

Tariff exemptions for all goods subject to rules of origin. Imports of certain goods (vanaspati, copper products, acrylic yarn, and zinc oxide) are subject to annual quota. Duty-free access on 8,859 tariff lines (or 98 percent of the tariff line level), covering over 99 percent in terms of the import value from LDCs Duty free for all products

References WT/TPR/ S/182 .Rev. 1 WT/TPR/ S/182 .Rev. 1 and WT/COMTD/ N/28 WT/TPR/ S/182 .Rev. 1

WT/ COMTD/N/2/ Add. 14

WT/TPR/S/170

LDCs

Duty-free access is granted on 87 tariff items (HS six-digit)

WT/COMTD/ N/12/ Rev.l WT/TPR/S/137

Bangladesh

In addition to 1,367 products (with average margin of preference of 35.4 percent) available to all APTA members, tariff concessions granted exclusively to LDC members on 306 products with average margin of preference of 64.6 percent

WT/ COMTD/N/22

47 LDCs

Duty free for all products

WT/TPR/S/170

33 African LDCs

Duty-free access on 61 products (at the HS four- to ten-digit level)

WT/LDC/SWG/ IF/18 and G/C/6

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Table 5.1 (continued) PreferenceGranting Country New Zealand Norway

Pakistan

Sri Lanka

Switzerland

Tajikistan

Turkey Russia United States

Description

Beneficiaries

Coverage/Margin of Preference

GSP–Tariff Treatment for LDCs; entry into force: 1 July 2001 GSP–Duty- and quotafree market access; entry into force: 1 July 2002 South Asian Free Trade Area (SAFTA); entry into force: 1 January 2006

LDCs

All products

LDCs

All products

Bangladesh Bhutan Maldives Nepal

Special concessions available for leastdeveloped contracting states

South Asian Free Trade Area (SAFTA); entry into force: 1 January 2006 APTA–Amendment to the Bangkok Agreement; entry into force: 1 September 2006

Bangladesh Bhutan Maldives Nepal Bangladesh Lao PDR

Special concessions available for leastdeveloped contracting states

GSP–Revised Preferential Tariffs Ordinance; entry into force: 1 April 2007 HS of preference by the ECEA; entry into force: May 2001 GSP; entry into force: 31 December 2005 HS of preference by the ECEA GSP for leastdeveloped beneficiary developing countries (LDBDCs); entry into force: 1 January 1976, extended until 31 December 2010 (further extensions are currently being considered)

LDCs

In addition to 427 products (with average margin of preference of 14 percent) available to all APTA members, tariff concessions granted exclusively to LDC members on 72 products with average margin of preference of 12 percent Duty-free access for all products originating from all LDCs as of September 2009

47 LDCs

Duty free for all products

LDCs

Duties are eliminated for LDCs on the basis of the EU’s EBA Initiative Duty free for all products

47 LDCs 43 designated LDCsd

In addition to the standard GSP coverage of nearly 5,000 products, 1,450 articles exclusively available for LDC beneficiaries for duty-free treatment

References WT/ COMTD/27 WT/TPR/S/115 WT/TPR/S/138 WT/ COMTD/N/6/ Add.4 SAARC Secretariat website (www. saarc sec.org) WT/TPR/S/193 SAARC Secretariat website (www. saarc-sec.org) WT/ COMTD/N/22

TN/CTD/M/28 WT/ COMTD/N/7/ Add.2 and Add.3 WT/TPR/S/170

WT/TPR/S/192 WT/TPR/S/170 WT/COMTD/ N/l/Add.4 & Add. 5 WT/TPR/S/235 www.ustr.gov

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Table 5.1 (continued) PreferenceGranting Country

Description

Beneficiaries

AGOA

38 designated sub-Saharan African Countries (including 25 LDCsf)

Entry into force: May 2000, extended until 30 September 2015e Caribbean Basin Trade Partnership Act (CBTPA)

Uzbekistan

HS of preference by the ECEA

Coverage/Margin of Preference 1,835 products, including textiles and apparel,g available for duty-free treatment, in addition to duty-free treatment on products benefiting from GSP

References WT/COMTD/ N/l/Add.3

WT/TPR/S/235 WT/L/754 19 designated beneficiaries (including one LDC; i.e., Haiti) in Central America and the Caribbean

47 LDCs

Duty free for most products, including textiles and apparels. The Haitian Hemispheric Opportunity through Partnership Encouragement Act enhanced Haiti’s benefits under CBERA. The Haiti Economic Lift Program Act of 2010 further expanded Haiti’s benefits, including broadening duty-free access for Haitian textile and apparel exports Duty free for all products

WT/TPR/S/235 WT/L/753 www.ustr.gov

WT/TPR/S/170

Notes: a. This table, which represents a nonexhaustive list of market access initiatives undertaken in favor of LDCs, updates the information contained in the previous report by the Secretariat (WT/ COMTD/LDC/W/46/ Rev. 1). For those measures taken in favor of exports originating from LDCs prior to 2001, see the document WT/COMTD/LDC/W/38. The most recent update is WT/COMTD/LDC/W/58 of 10 September 2013. b. Members of the APTA are Bangladesh, China, India, Lao PDR, Korea, and Sri Lanka. c. Members of SAFTA, which superseded the SAPTA in 2006, are Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. d. Afghanistan, Angola, Bangladesh, Benin, Bhutan, Burkina Faso, Burundi, Cambodia, Central African Republic, Chad, Comoros, Democratic Republic of Congo, Djibouti, East Timor, Equatorial Guinea, Ethiopia, The Gambia, Guinea, Guinea-Bissau, Haiti, Kiribati, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Nepal, Niger, Rwanda, Samoa, São Tomé and Príncipe, Sierra Leone, Solomon Islands, Somalia, Tanzania, Togo, Tuvalu, Uganda, Vanuatu, Yemen, and Zambia. e. The Africa Investment Incentive Act of 2006, or AGOA IV, extended the third-country fabric provision from September 2007 until September 2012; added an abundant supply provision; designated certain denim articles as being in abundant supply; and allows lesser developed beneficiary sub-Saharan African countries to export certain textile articles under AGOA. Section 3 of the Andean Trade Preference Extension Act of 2008 (Public Law 110–436) removed the abundant supply provisions, and redesignated Mauritius as a lesser developed beneficiary sub-Saharan African country for AGOA apparel benefits. See more information about this at the official AGOA website (http://www.ustr.gov/trade-topics/trade-development/preference-programs/african-growth-andopportunity-act-agoa). f. Angola, Benin, Burkina Faso, Burundi, Chad, Comoros, Democratic Republic of Congo, Djibouti, Ethiopia, The Gambia, Guinea-Bissau, Lesotho, Liberia, Malawi, Mali, Mauritania, Mozambique, Rwanda, São Tomé and Príncipe, Senegal, Sierra Leone, Tanzania, Togo, Uganda, and Zambia. g. 25 sub-Saharan African countries, including 15 LDCs (Benin, Burkina Faso, Chad, Ethiopia, The Gambia, Lesotho, Malawi, Mali, Mozambique, Rwanda, Senegal, Sierra Leone, Tanzania, Uganda, Zambia), are eligible for AGOA apparel benefits.

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5.3.5.4 Preferences for Developing Countries Developing countries that do not qualify as LDCs will profit from preferences—the usual GSP preferences. The treatment of goods originating in these countries will be somewhere between the MFN rate and the margin of preference for LDCs. The Enabling Clause does not require anything more precise than that. 5.3.5.5 Additional Preferences for Developing Countries In EC–Tariff Preferences, the panel and the AB faced the following question: is the statutory distinction between developing countries and LDCs the only permissible distinction across beneficiaries that could serve as the basis for differentiating the level of preferences granted? Recall that the text of the Enabling Clause, on the one hand, makes a distinction between developing countries, and on the other, requests in § 3(c) that preferences “shall in the case of such treatment accorded by developed contracting parties to developing countries be designed and, if necessary, modified, to respond positively to the development, financial, and trade needs of developing countries.” So the question before the panel was whether the distinction between developing countries and LDCs was the only permissible distinction that could serve as a benchmark to differentiate the preference intensity, or, conversely, whether additional distinctions were permissible as well. The facts in this dispute were as follows: India and Pakistan both benefited from the EU GSP. However, Pakistan had received extra preferences because it qualified under the so-called Drug Arrangements, a scheme aimed at compensating those WTO members that had adopted active policies against drug production and trafficking. India had complained that by discriminating in favor of Pakistani imports, the EU was in violation of Article I of GATT, a claim upheld by the panel (§ 7.60). The panel went on to examine to what extent recourse to the Enabling Clause could be offered to justify the violation. In the panel’s view, the Enabling Clause requires that developed countries (donors) must, by virtue of the term “non-discriminatory” in footnote 3 of the Enabling Clause, give identical tariff preferences to all developing countries.41 Hence, in the panel’s view, the EU, by treating Pakistani imports better than Indian imports of like goods, was violating the Enabling Clause. The AB reversed the panel’s findings in this respect. It started its analysis (§ 157) by pointing out that the terms used in § 3(c) of the Enabling Clause made it plain that development needs are not necessarily identical in all developing countries (§ 162).42 As a result, a donor wishing to do justice to this provision might have to provide customized treatment to different beneficiaries. In this case, the scheme would not ipso facto (e.g., because of the differentiation) be judged discriminatory since, as the previously quoted passage from § 3(c) of the Enabling Clause makes plain, differentiation might be warranted—indeed necessary—in order to

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respect the “effet utile” of this provision, that is, in order to ensure that preferences are tailored to the needs of each individual beneficiary (§ 165). The differential treatment, in other words, was not a function of the identity of the beneficiary, but of factors endogenous to the beneficiary, which, nevertheless, could exist elsewhere as well. At the end of the day, what mattered was whether the same “medicine” was being prescribed for the same “disease.” As a result, additional preferences cannot be excluded outright (§ 169). It went on to rule that in granting such differential tariff treatment, however, preference-granting countries are required, by virtue of the term “non-discriminatory,” to ensure that identical treatment is available to all similarly-situated GSP beneficiaries, that is, to all GSP beneficiaries that have the “development, financial and trade needs” to which the treatment in question is intended to respond. (§ 173)

Applying its test to the specific case, the AB found that the Drug Arrangements were not WTO-consistent, but only because the EU had included in its scheme a closed list of beneficiaries (§§ 180 and 187). The following text from § 183 gives the core of the AB argument: What is more, the Drug Arrangements themselves do not set out any clear pre-requisites—or “objective criteria”—that, if met, would allow for other developing countries “that are similarly affected by the drug problem” to be included as beneficiaries under the Drug Arrangements. Indeed, the European Commission’s own Explanatory Memorandum notes that “the benefits of the drug regime … are given without any prerequisite.” Similarly, the Regulation offers no criteria according to which a beneficiary could be removed specifically from the Drug Arrangements on the basis that it is no longer “similarly affected by the drug problem.” Indeed, Article 25.3 expressly states that the evaluation of the effects of the Drug Arrangements described in Articles 25.1(b) and 25.2 “will be without prejudice to the continuation of the [Drug Arrangements] until 2004, and their possible extension thereafter.” This implies that, even if the European Commission found that the Drug Arrangements were having no effect whatsoever on a beneficiary’s “efforts in combating drug production and trafficking,” or that a beneficiary was no longer suffering from the drug problem, beneficiary status would continue. Therefore, even if the Regulation allowed for the list of beneficiaries under the Drug Arrangements to be modified, the Regulation itself gives no indication as to how the beneficiaries under the Drug Arrangements were chosen or what kind of considerations would or could be used to determine the effect of the “drug problem” on a particular country. In addition, we note that the Regulation does not, for instance, provide any indication as to how the European Communities would assess whether the Drug Arrangements provide an “adequate and proportionate response” to the needs of developing countries suffering from the drug problem. (emphasis in the original)

For its scheme to become WTO-consistent, the EU would have to modify its regulation so as to ensure that it reflects “criteria or standards to provide a basis for distinguishing beneficiaries under the Drug Arrangements from other GSP beneficiaries” (§ 188). It follows from this case law that WTO members can distinguish between recipients of preferences (developing countries) beyond the distinction between developing countries and LDCs included in the Enabling Clause, provided that their distinctions correspond to objective criteria. Whereas the panel had taken the view that the distinction between

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developing countries and LDCs was the exclusive operationalization of the generic standard to target aid to needs of development level, the AB felt that additional subdivisions were warranted. The AB, alas, did not provide any guidance as to how the term “objective criteria and standards” that it employed in EC–Tariff Preferences for the first time should be understood. Distinctions are possible, but there is no evidence—nor even an indicative list— concerning how distinctions should be drawn. Various questions legitimately arise. For example: how fine-tuned can similar distinctions be? Indeed, if § 3(c) of the Enabling Clause is taken seriously, then there could conceivably be customized solutions for each and every beneficiary. Development needs differ across countries, as it is highly unlikely that two countries have identical needs. On the other hand however, some sort of standardization is necessary, otherwise, donors risk all sorts of challenges when fine-tuning preferences that they grant to the effect that their schemes are discriminatory. The statutory distinction between LDCs and developing countries corresponds to the need for standardization. So do, in principle at least, the judge-made “objective criteria and standards.” Whereas there is relative clarity with respect to the former though, there is total obfuscation with respect to the latter.43 One might further legitimately ask why the AB did not bring into question the EU’s discretion to unilaterally draw up objective criteria and standards. It is at best debatable, nonetheless, whether donors have any incentives to adopt criteria that will promote development of the recipients and not simply advance their own social preferences. It might sound cynical, but was not the EU addressing (at least in part) its own domestic problems through the Drug Arrangements? Is it certain that by allowing donors to pick the areas of regulatory changes that beneficiaries must undertake first in order to be eligible for GSP+ benefits, they will do so by selecting policies that are beneficial to developing countries? By not addressing similar questions, the AB involuntarily opened the door that could lead to potential abuses: it allowed for unilateral definition by donors of “objective criteria and standards,” but it did not attach any conditions on what their content should look like. There is a risk that donors might be pursuing their own agenda through the granting of preferences. Similar policies would be running counter the explicit wording and spirit of the Enabling Clause, which calls for pro-development programs. There is the more nuanced risk that donors might undo the prioritization of development options that the recipients have decided for themselves, if the perks were too good to turn down.44 This is an area where some additional thinking is required before embarking upon the exercise as currently designed by the WTO adjudicating bodies. The EU regulation cited here, conditions GSP+ benefits on two criteria. First, the vulnerability criterion: a beneficiary meets this criterion by virtue of its size or the limited diversification of its exports.45 Second, beneficiaries must also be willing to ratify conventions, such as the International Convention on the Rights of the Child, the Freedom of Association and Protection of the Right to Organize Convention, or even the Convention on International Trade in Endangered Species (CITES). This could be a tall order for some

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developing countries, which might legitimately take the view that they have other priorities. Alas, these are nonnegotiable items as things stand, and they could be perceived to qualify as “objective criteria and standards.” The only discipline that the EU has to respect is quite weak. § 3(a) of the Enabling Clause provides that preferences “shall be designed to facilitate and promote the trade of developing countries and not to raise barriers to or create undue difficulties for the trade of any other contracting parties.” This is a condition that GSP schemes will routinely meet since any policy could, in principle, qualify as development related. It is doubtful, nevertheless, whether developmentrelated policies are indeed development friendly as well. This discussion will continue later in this chapter, with an exploration of the debatable effectiveness of GSP schemes. 5.3.5.6 Excluding Beneficiaries It is necessary to distinguish between exclusion from the LDC, the GSP, and the GSP+ list. Exclusion from the first two can legitimately occur only in the case of graduation. Exclusion from the GSP+ list can occur if the circumstances that gave rise to additional benefits no longer exist. Take, for example, the Drug Arrangements. Assume that because of the efforts of those implicated, drug trafficking is not an issue anymore. In this case, Pakistan will stop receiving the GSP+ benefits. We refer in what follows to some relevant practice of exclusion from GSP benefits. The examples cited underscore that donors often walk on a tightrope between legality and illegality when excluding beneficiaries from their GSP lists. With the exception of EC-Tariff Preferences, though, we observe no legal challenges against similar practice, probably because beneficiaries fear that if they did challenge similar practices they might be permanently excluded form benefits. After all, the GSP regime carries inherently discretion, and the AB only added to it through the introduction of the possibility to grant preferences on “objective criteria and standards.” The EU had originally included Sri Lanka in its list for GSP+ preferences. In a press release dated 15 December 2009, however, the Commission of the EU (DG Trade)46 announced that the EU would remove Sri Lanka from the list of GSP+ beneficiaries immediately. The EU justified its actions on the grounds that Sri Lanka had failed to implement three UN Human Rights Conventions—namely, the International Covenant on Civil and Political Rights (ICCPR), the Convention against Torture (CAT), and the Convention on the Rights of the Child (CRC).47 The EU also removed Myanmar from the list of beneficiaries following charges that Myanmar was violating the International Labour Organization (ILO) conventions on forced labor (Council Regulation 552/97). Following the decision by the Conference of the ILO to suspend its restrictive resolution on Myanmar in June 2012, the EU reinstated GSP benefits for Myanmar on 19 July 2013, with retroactive application as of 13 June 2012. The EU, on the other hand, has kept Maldives among the beneficiaries, although as of January 1, 2011, Maldives does not figure among the LDCs because it graduated, as stated

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previously. The EU justified its actions on the grounds that Maldives was benefiting from a generous transitional period.48 The US excluded Argentina from the list of its GSP beneficiaries for failure to enforce an arbitral award.49 The EU, probably unhappy with the expropriation of shareholders of Repsol (a Spanish energy company), eliminated Argentina from its list of beneficiaries in the new GSP, which came into effect in 2014. On the one hand, the overall number of beneficiaries was reduced in the new EU regulation from 176 to 89 since the EU took the view that by focusing on those in real need, its scheme would become more effective.50 On the other hand, the EU did not invoke any grounds for excluding some of the addressees (including Argentina), and it is questionable at the very least (if not altogether baseless) to claim that Argentina was excluded because it had graduated to the club of developed countries in the WTO. To date, none of the excluded beneficiaries has contested its exclusion from the list before a WTO panel.51 We have argued supra that the fear of the consequences in case of legal action is legitimate, of course, since the threat of punishing innocent bystanders must weigh in. Recall that donors do not have to confer trade advantages in the first place, and in the name of legality, they could eliminate their GSP lists altogether. That action would make complainants quite unpopular in many quarters. As a result, donors de facto enjoy substantial discretion in deciding who is in and who is out, as they do unilaterally decide on the criteria for inclusion. In the face of many schemes that are hardly compatible with the requirements for “generalized,” “non-discriminatory,” and “beneficial” GSP schemes, the fact that only one complaint has been launched so far testifies to the donors’ de facto discretion. 5.3.5.7 Evaluating the GSP Schemes: Is the Candle Worth the Flame?52 For various reasons, scholars have cast doubt on the efficacy of GSP schemes to address development concerns and help beneficiaries “graduate” to developed-country status. This part of the discussion should probably start by underscoring that the policy debate has shifted nowadays from an unambiguous “trade, not aid” perspective in the 1950s to “aid rather than (preferential) trade,” a point explored in more detail later in this chapter in an explanation of the Aid for Trade initiative.53 One thus might legitimately ask: If GSP schemes were fulfilling their intended function, why bother with the whole Aid for Trade endeavor? Even if the Aid for Trade initiative is perceived as a complement to and not as a substitute for GSP schemes, a complement was deemed necessary all the same. Therefore, the emergence of Aid for Trade, in and of itself, is reason enough to ask the question of what went wrong with GSP schemes. The following presents the main critique of this instrument. The basis of the discussion is the substantive antinomy between tariff preferences and the role of GATT. The point is that beneficiaries have the incentive to block GATT from fulfilling its role since otherwise, the value of their gift is reduced. Here is how it works.

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The margin of preferences in favor of developing countries (e.g., the difference between the MFN and the preferential tariff rate) has been affected over the years by MFN tariff liberalization. In the 1970s, MFN rates were much higher than they are now across all products. The reduction of MFN rates led to preference erosion. MFN tariff liberalization confirmed the transitional nature of GSP preferences. If GATT works as it should, then eventually there will be no room for tariff preferences anymore. To understand preference erosion, consider this example: Hoekman, Ng, and Olarreaga (2001) ran a simulation, and they assumed that any tariff rate greater than 15 percent should be treated as a tariff peak. In this vein, assuming that LDCs benefited from a 0 percent tariff rate on all tariff peaks, their exports would increase by 11 percent. If all GSP beneficiaries benefited from a 0 percent tariff rate on all tariff peaks, then LDC exports would increase by only 5 percent. If, however, the MFN rate for tariff peaks drops to 5 percent, then LDC exports would not increase at all. Because of preference erosion, developing countries have less of an incentive to liberalize trade on an MFN basis, as § 3 of the Enabling Clause would request them to do.54 They have the incentive to become the enemies of MFN tariff liberalization. Although, empirically speaking, preference erosion does not seem to be much of an issue for lowincome countries in high-income export markets,55 it is still an important issue for others concerned. The problem for them is that they cannot do much to stop others from unilaterally dropping their MFN rates—unless, of course, they form coalitions with the donors’ industry interested in keeping protection.56 The only thing they can do is refuse to drop their rates themselves, but this attitude would only have an effect on South-South cooperation. They can, on the other hand, block multilateral liberalizing initiatives such as “linear cuts.” Developing countries have taken a defensive stance when it comes to tariff reductions in both the Uruguay and the Doha rounds. Grossman and Sykes (2005), citing abundant empirical evidence to this effect,57 concluded that the candle is not worth the flame. They conclude that there is little support for the proposition that GSP schemes have had substantial positive welfare effects on recipients. Take the EU scheme, for example, which distinguished between nonsensitive, semisensitive, sensitive, and very sensitive products. Grossman and Sykes (2005) calculate that during the period of their investigation, developing countries received tariff reductions of roughly 100 percent (for nonsensitive), 65 percent (for semisensitive), 30 percent (for sensitive), and 15 percent (for very sensitive products), compared with the usual MFN rate for goods in each category.58 Of course, the export interest of most developing countries concentrates on the very sensitive category of products, the one that receives the smallest preference margin.59 Reductions of little interest to developing countries happened because beneficiaries did not negotiate the areas where tariff reductions would take place (discussed further later in this chapter). This is, of course, less of an issue for LDCs because of the DFQF programs that have been adopted, even though Bangladesh, for example, complained that when some donors decided not to extend preferences to 100 percent of

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tariff lines, items in their interest, like textiles, were left out. For some developing countries and LDCs, most of the trade is concentrated in a few tariff lines; hence, DFQF that stops short of covering 100 percent of tariff lines might have a dramatic impact on their export earnings (which will arguably be financing their quest for development). Dean and Wainio (2009) discussed the effects of US GSP on beneficiaries and concluded that high utilization rates should not hide the fact that preference margins for nonagricultural goods are low (preference erosion here is the direct result of low US MFN tariffs), whereas preference margins are low for agricultural goods, largely because of the exclusion of products that face high tariffs from GSP schemes. Their data support the view that the US is more generous toward its PTA partners than it is to its GSP beneficiaries. Candau and Jean (2009) concluded that the EU GSP scheme is quite important for subSaharan LDCs, but not for South Asian LDCs, essentially because of the constraints imposed by rules of origin on textile and clothing exports. In a similar vein, Kowalski (2009) concluded that the welfare impact of Canadian preferences is very small for developing countries. And Lippoldt (2009) concluded that the Australian GSP scheme has had unambiguously beneficial effects only for those developing countries in geographic proximity to the donor. Why is this so? One could imagine dozens of plausible explanations, but a key one is that GSP schemes simply do not reproduce a negotiation based on reciprocal concessions. Developing countries are not there to request the opening of the export markets that they are interested in. Rather, they wait for donors to draw up their GSP lists. § 4 of the Enabling Clause reads as follows: Any contracting party taking action to introduce an arrangement pursuant to paragraphs 1, 2 and 3 above or subsequently taking action to introduce modification or withdrawal of the differential and more favourable treatment so provided shall: a) notify the CONTRACTING PARTIES and furnish them with all the information they may deem appropriate relating to such action; b) afford adequate opportunity for prompt consultations at the request of any interested contracting party with respect to any difficulty or matter that may arise. The CONTRACTING PARTIES shall, if requested to do so by such contracting party, consult with all contracting parties concerned with respect to the matter with a view to reaching solutions satisfactory to all such contracting parties.

Donors do not have to secure agreement from beneficiaries in the areas where preferences will be granted, and they do not have to negotiate the margin of preferences with them either. If requested, they must consult; that is all they are required to do. Consultations do not guarantee adherence to the views expressed by beneficiaries. First, Hudec (1987) criticized the consequences of lack of reciprocity. He likened the system established in the Enabling Clause to some sort of “welfare obligation” that wealthier participants incurred voluntarily toward their poorer counterparts. Through similar payments, wealthier members would earn “moral credit,” while beneficiaries would de

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facto be exiting the realm of GATT obligations. Alas, in Hudec’s account, it was all “form without substance” since all the initiative to decide on the size of the cake was in the hands of donors.60 Then, Bagwell and Staiger (2014) reached a similar conclusion, stating that GSP schemes essentially drove many developing countries away from the negotiating table where useful bargains would be struck and left them waiting in the antechamber for the mercy of donors. Donors will negotiate with their domestic lobbies, and the opening of their markets is in response to the question “Where and how much would my lobbies want me to open up to international trade?” rather than “Where would developing countries want me to open up?”61 In this vein, Blanchard and Matschke (2014) provide empirical evidence to the effect that many of the donors’ decisions are driven by endogenous reasons: trade preferences follow investment patterns by donors in the wide sample of countries they examined. In fact, thus, quite often when granting preferences, they favor intra-industry trade, their own investors who have delocalized production, or both. Finally, subdividing beneficiaries into various categories, which are not necessarily linked to their development level, might entail various negative external effects. Let’s return to the EU GSP scheme for illustrative purposes. There are three classes of beneficiaries under this scheme, as noted earlier. The subdivision operated in the EU framework might lead to a race across developing countries to secure benefits, which might undo legitimate policy priorities62 (especially if one factors in political economy63), and might entail externalities of political nature as well. The alliance across developing countries might be damaged because of the resulting trade diversion if some developing countries race in to secure benefits under GSP+. Grossman and Sykes (2005) showed, when discussing EC–Tariff Preferences, that the EU was essentially paying Pakistan (and all beneficiaries of the Drug Arrangements) with India’s money. Similar payments drive a wedge between beneficiaries who might embark in a race between them to attract sympathy from donors. The empirical studies cited here prove that GSP schemes have not been very effective, nor have they been nondiscriminatory. The US GSP scheme excludes communist countries from its coverage, as well as countries that withhold the supply of vital commodity resources (aimed at OPEC countries), countries that injure US commerce by affording preferences to other developed countries, countries that do not enforce arbitral awards in favor of US citizens, countries that aid terrorism, countries that do not protect internationally recognized workers’ rights, and countries that do not act to prevent child labor.64 As a result, the list of beneficiaries might be a function of political decisions rather than development needs. The countries that got out of the vicious circle of underdevelopment are those that liberalized and enjoyed gains from trade. Sachs and Warner (1995) showed that developing countries with more liberal trade policies have achieved higher rates of growth and development than countries that are more protectionist.65

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Özden and Reinhardt (2003), in an empirical study, underscored this conclusion. Countries that gradually extricated themselves from GSP schemes subsequently undertook greater liberalization than those that chose to retain their eligibility to participate in them. It is a sort of wicked variation on the Jevons paradox: preferences were supposed to help beneficiaries graduate to nonbeneficiary status, but instead, they become “hooked” on the benefit granted, use it more than before (or as much as they can), and never graduate. The WTO gradually becomes irrelevant to them: They live in the WTO world, but outside its legal disciplines. A number of more recent studies point to the same result. Trefler (2004) showed how tariff cuts can increase the industry-level productivity of the country. Tokarick (2006) examined import protection in 26 developing countries; the sample used in this study was quite disparate and hence largely representative of the situation prevailing across all developing countries: Argentina, Brazil, Botswana, Malawi, China, India, Albania, and Romania were reviewed. The study’s main objective was to quantify the extent to which import protection implicitly acts as a tax on a country’s export sector. Tokarick found that such an effect was indeed the case, and concluded that a 12 percent tax had been imposed on exports of the 26 countries in his sample.66 Mostashari (2010) showed that tariff cuts by countries exporting to the US market are more important in explaining the success that these countries have enjoyed exporting to the US market than the US import tariff cuts themselves. GSP schemes are ineffective, discriminatory, and also sometimes very hard to use. The complexities associated with the administration of preferential schemes should not be underestimated either. Most of these complexities have been linked to the preferential rules of origin, which make evidence of the origin of a product a particularly cumbersome exercise.67 It is true that there has recently been a considerable easing of similar rules, as was pointed out in the previous discussion about rules of origin. However, there is still a way to go. Hudec (1987) took the view that GSP schemes were not all that beneficial to developing countries. They essentially blocked beneficiaries from adopting much-needed changes. In his view, developing countries would have been better off simply abandoning such schemes in exchange for nondiscriminatory access to the agricultural and textile markets of donors. He urged (p. 235): “Governments of developing countries will have to be persuaded that it is in their own national economic interest to respond with a fuller commitment to GATT law.” Developing countries, alas, turned a blind eye to this and similar calls. They preferred to continue with one-way preferences and have not changed this strategy, even in the face of evidence that similar schemes do not work. Hudec’s intuition that one-way preferences will have the opposite of the desired outcome, sadly, has been largely confirmed by subsequent practice and research.68

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To provide an evaluation of GSP schemes, one needs a benchmark. The response depends on the counterfactual, and that cannot be the situation before 1971. It must be a sophisticated analysis of exports by developing countries after 1971, with preferences (the real world) and without (the simulation). The economic studies referred to in this discussion provide ample evidence that the record is disappointing. 5.3.6

South-South Preferences

The WTO regime favors South-South cooperation in two ways: it allows developing countries to grant preferences to LDCs and to form PTAs on conditions that are less stringent than those included in Article XXIV of GATT, which governs the formation of PTAs when at least one constituent is a developed country. 5.3.6.1 Tariff Preferences In 1999, WTO members adopted a waiver that allows developing countries to provide preferential tariff treatment to products of LDCs, designated as such by the UN, without being required to extend the same tariff rates to like products of any other member.69 LDCs will benefit from one-way preferential treatment since they are not required to reciprocate. 5.3.6.2 PTAs between Developing Countries The Enabling Clause provides the basis for facilitating PTAs across developing countries that do not have to follow the requirements embedded in Article XXIV of GATT. § 2(c) of the Enabling Clause exempts the following from the usual GATT discipline: Regional or global arrangements entered into among less-developed contracting parties for the mutual reduction or elimination of tariffs and, in accordance with criteria or conditions which may be prescribed by the CONTRACTING PARTIES, for the mutual reduction or elimination of nontariff measures, on products imported from one another.

This provision does not explain the specifics of the test that will be applied when a PTA among developing countries is examined. Following the advent of the Transparency Mechanism (discussed in more detail in the next chapter), there is a standard procedure applicable to all PTAs, regardless whether they have been notified under Article XXIV of GATT, Article V of GATS, or § 2(c) of the Enabling Clause. The only difference is that, whereas it is the Committee on Regional Trade Agreements (CRTA) that is notified of the first two, it is the Committee on Trade and Development (CTD) that is notified of the latter. There are very few completed reports on the issue, such as the report concerning the Bangkok Agreement, and hence no meaningful conclusion can be drawn on the nature of multilateral review of South-South cooperation.70 To date, no direct legal challenge has been made to South-South preferences.71

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Table 5.2 Preferential arrangements notified under § 2(c) of the Enabling Clause RTA Name

Coverage

Type

Date of Notification

Notification

Date of Entry into Force

Andean Community (CAN) ASEAN–China

Goods

CU

1 October 1990

Enabling Clause

25 May 1988

Goods and

PSA and EIA

Enabling Clause and GATS Article V

1 January 2005

Services ASEAN–India ASEAN–Korea, Republic of

Goods Goods and Services

FTA FTA and EIA

21 September 2005(G) 26 June 2008(S) 19 August 2010

ASEAN Free Trade Area (AFTA) Asia Pacific Trade Agreement (APTA) Asia Pacific Trade Agreement (APTA)– Accession of China Common Market for Eastern and Southern Africa (COMESA) East African Community (EAC) Economic and Monetary Community of Central Africa (CEMAC) Economic Community of West African States (ECOWAS) Economic Cooperation Organization (ECO) Egypt–Turkey Global System of Trade Preferences among Developing Countries (GSTP) Gulf Cooperation Council (GCC) India–Afghanistan IndiaBhutan India–Nepal India–Sri Lanka

Goods

FTA

Goods

PSA

Goods

Korea, Republic of–India Lao People’s Democratic Republic– Thailand Latin American Integration Association (LAIA)

Enabling Clause

(G) 1 July 2007(S) 1 January 2010 1 January, 2010 (G) 1 May 2009(S) 28 January 1992

Enabling Clause

17 June 1976

Enabling Clause

1 January 2002

4 May 1995

Enabling Clause

8 December 1994

CU

9 October 2000

Enabling Clause

7 July 2000

Goods

CU

21 July, 1999

Enabling Clause

24 June 1999

Goods

CU

6 July 2005

Enabling Clause

24 July 1993

Goods

PSA

10 July 1992

Enabling Clause

17 February 1992

Goods Goods

FTA PSA

5 October 2007 25 September 1989

Enabling Clause Enabling Clause

1 March 2007 19 April 1989

Goods

CU

Goods Goods Goods Goods

PSA FTA PSA FTA

Goods and Services Goods

FTA and EIA PSA

Goods

PSA

PSA

30 October 1992 2 November 1976 30 April 2004

Goods

FTA

Goods

Enabling Clause

1 January 2003 8 March 2010 30 June 2008 2 August 2010 17 June 2002

Enabling Clause Enabling Clause Enabling Clause Enabling Clause

13 May 2003 29 July 2006 27 October 2009 15 December 2005 1 January 2010

26 November 1991

Enabling Clause

20 June 1991

1 July 1982

Enabling Clause

18 March 1981

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Table 5.2 (continued) RTA Name

Coverage

Type

Date of Notification

Notification

Date of Entry into Force

Melanesian Spearhead Group (MSG) MERCOSUR–India

Goods

PSA

3 August 1999

Enabling Clause

1 January 1994

Goods

PSA

Enabling Clause

1 June 2009

Pacific Island Countries Trade Agreement (PICTA) Pakistan–Malaysia

Goods

FTA

23 February 2010 28 August 2008

Enabling Clause

13 April 2003

Goods and Service

FTA and EIA

19 February 2008

01 January 2008

Pakistan–Sri Lanka

Goods

FTA

11 June 2008

Enabling Clause and GATS Article V Enabling Clause

5.4

12 June 2005

Special and Differential Treatment Other Than GSP

5.4.1 Typology There are numerous provisions in the covered agreements that qualify as special and differential treatment provisions, and this is how a document prepared by the WTO Secretariat72 classified them: • Provisions aimed at increasing trade opportunities • Provisions safeguarding the interests of developing-country members • Flexibility of commitments, of action, and use of policy instruments • Transitional time periods73 • Technical assistance74 • Provisions relating to LDCs only75 In essence, these provisions aim to improve the position of developing countries within the WTO, either by introducing “lighter” disciplines that are applicable to developing countries only, or by increasing the expertise of developing countries on WTO-related issues (what is usually referred to as “technical assistance” or “capacity building”). It is very difficult to assess the actual impact of these provisions, which on occasion might prove to be counterproductive. Indeed, price undertakings in the AD Agreement, a remedy that must be explored during the investigation of companies originating in developing countries, could be defended as a means for developing countries to charge the rents that otherwise would have become duties in the treasury of the WTO member. Through price undertakings, though, some price collusion across exporters is legitimized. Similar practices could lead to the cartelization not only of the destination market, but also of the exporting developing country, and the welfare implications could be nefarious.

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Some scholars have questioned the efficacy of these provisions. Rodrik (2001) has forcefully argued in favor of adding to the existing arsenal, pointing to the very limited usefulness (if not complete uselessness) of some of the existing provisions. Transitional periods often come and go, with no preparation for full implementation of whatever has been agreed. Awareness about export opportunities is often useless knowledge anyway. And, finally, the effectiveness of increasing technical capacity in developing countries has come under a lot of criticism. At the other end of the spectrum, views have been expressed about the dangers inherent in overextension of “special and differential” provisions. Hoekman (2005) warns that the WTO could become an irrelevant policy prescription for beneficiaries, and thus all gains from trade liberalization and participation in the negotiating process could be severely undermined were one to continue increasing the sphere of special and differential treatment ad nauseam. Low (2007) has expressed criticism of the current regime from a different angle. His well-founded reservations concern the one-size-fits-all approach adopted by the WTO. Developing countries present a very diverse group, which is becoming increasingly diverse over the years. The provisions echo the very basic distinction between developing countries and LDCs first reflected in the Enabling Clause, which is largely outdated now. This distinction was probably more or less acceptable in 1979, when one could usefully distinguish between two groups of developing countries. Nowadays, the developing-countries group comprises countries like Mexico, Vietnam, Senegal, India, and China. It is no longer sensible to continue with the current distinction when the development needs of the five countries selectively referred to in this discussion are drastically different. There has been an institutional acknowledgment that the implementation of these provisions is essential to the credibility of the commitments entered. The Bali Ministerial Declaration included a decision establishing a “Monitoring Mechanism on Special and Differential Treatment.”76 According to this decision, the mechanism would operate in “Dedicated Sessions” of the CTD and make recommendations regarding the status of implementation of all provisions relating to special and differential treatment. At the same time, action in favor developing countries, even when it concerns trade issues, does not necessarily come under the institutional aegis of the WTO. Various WTO members participate in numerous other initiatives outside the WTO aimed at improving the position of developing countries in the WTO. The Advisory Centre for WTO Law (ACWL) is the best-known initiative of the sort, and it aims at providing legal expertise to developing countries at nonmarket (e.g., subsidized) rates.77 5.4.2 Transparency Mechanism for Preferential Trade Advantages In 2010, the General Council of the WTO adopted the Transparency Mechanism for Preferential Trade Advantages,78 aimed at standardizing and clarifying the content of unilateral

Subsidies and Countervailing Measures Safeguards GATS TRIPs Understanding on Rules and Procedures Governing the Settlement of Disputes GATT 1994 Article XVIII GATT 1994 Article XXXVI GATT 1994–Article XXXVII GATT 1994–Article XXXVIII Enabling Clause Decision on Measures in Favour of Least-Developed Countries Waiver Preferential Tariff Treatment of LDCs Total

Agriculture Decision on NFIDCs Application of SPS Measures Textiles and Clothing Technical Barriers to Trade Trade-Related Investment Measures Implementation of Article VI of GATT 1994 Implementation of Article VII of GATT 1994 Decision on Texts Relating to Minimum Values and Imports by Sole Agents, Sole Distributors and Sole Concessionaires Pre-shipment inspection Rules of Origin Import Licensing Procedures

Agreement

1

7

2

33

3 6 5

50

14

3 1

1 4

1 4

19

2

14

2 1 1

2 3 2

1

155

1

1 7

24

3 8 8 7 4 7

2 15 6 11

3 2

1 6

0 0 4 16

8

2

1

14 5 5 6 16 4

2

4

2 1 1

3

Total by Agreement

8

2

7

1 1

(v) Technical assistance

1

1 2

2

1

(iv) Transitional time periods

(vi) Provisions relating to measures to assist least- developed country members

1

1 1

9

(iii) Flexibility of commitments, of action, and use of policy instruments

1

4 2 3 6

(ii) Provisions that require WTO members to safeguard the interests of developing country members

4 2 2 1

3

1

1

(i) Provisions aimed at increasing the trade opportunities of developing country members

Table 5.3 Special and Differential Treatment Provisions in Multilateral Agreements

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trade advantages granted by donors to beneficiaries. This document79 explains that it does not apply to bilateral deals, such as South-South PTAs (§ 1). In two annexes, it explains the content of notifications (tariffs, exceptions, rules of origin, etc.), whereas in § 3, it requests donors notify the WTO of unilateral advantages granted before their application or, at the very latest, within three months after a preferential trade advantage has been in force. 5.5 The Wider Picture: Trade and Development The discussion so far has referred to the period leading up to the launch of the Doha round. There were sporadic references to Aid for Trade, one of the few milestones of the Doha round, but overwhelmingly the discussion has examined the attitude of the world trading system toward concerns expressed by developing countries in the period up to and including the Uruguay round. Following the adoption of the Doha Development Agenda (DDA), the WTO took a decisive turn and embarked, along with partners, on a more comprehensive involvement in the trade and development agenda, if not the development agenda altogether. The WTO has, of course, some innate limitations due to its mandate. It can commit only so much to the overall development agenda. Development implicates many instruments other than trade liberalization, and for such other instruments, the WTO has no competence to say anything at all. This point will be discussed in more detail later in this section. The involvement of the WTO in development-related issues has widened over the years and extended beyond the so-called classic trade content with which it was originally endowed. In the minds of the original framers of GATT, the contribution of the world trading system toward development was unidimensional: nondiscriminatory trade liberalization. Following the discussions in the late 1950s, as explored previously, the rules of the trading system were amended so as to make room for discriminatory (preferential) trade for goods originating in developing countries and, in the aftermath of the Uruguay round, the discussion moved to nontrade development-related issues. 5.5.1

Early Years

In 1964, the International Trade Centre (ITC) was established with the aim of promoting trade of developing countries. The ITC later became a joint agency of the UN Conference on Trade and Development (UNCTAD) and GATT (and eventually the WTO). In 1998, the WTO, together with UNCTAD and the ITC, established the Common Trust Fund, with the expressed goal of financing technical capacity in developing countries. Scattered initiatives saw the light of day, but, by and large, the multilateral trading regime did not invest considerable resources into the trade and development agenda until

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the advent of the Doha round. Advertised as the “development round,” it was only normal that development-related issues would find their way into the negotiating agenda. 5.5.2 The DDA 5.5.2.1 The Mandate (and Its Caveats) § 51 of the Doha Ministerial Declaration reads The Committee on Trade and Development and the Committee on Trade and Environment shall, within their respective mandates, each act as a forum to identify and debate developmental and environmental aspects of the negotiations, in order to help achieve the objective of having sustainable development appropriately reflected.

Soon thereafter, the Trade Negotiations Committee (TNC) decided that the CTD should convene in special sessions to discuss all provisions relating to special and differential treatment, evaluating and complementing them, if need be: As reaffirmed by Ministers at Doha, provisions for special and differential treatment are an integral part of the WTO Agreements. The negotiations and other aspects of the work program shall take fully into account the principle of special and differential treatment for developing and least-developed countries as provided for in paragraph 50 of the Ministerial Declaration. The review of all special and differential treatment provisions with a view to strengthening them and making them more precise, effective and operational provided for in paragraph 44 of the Ministerial Declaration shall be carried out by the Committee on Trade and Development in Special Sessions.80

Without directly stating so, the feeling was that past efforts had simply proven inadequate, and a change was required to redress the ever-growing gap between developed and developing WTO members. Jawara and Kwa (2003) captured the feeling among developing countries when they noted (p. 269): Developed countries are benefiting from the WTO, as are a handful of (mostly upper) middle income countries. The rest, including the great majority of developing countries, are not. It is as simple as that.81

There are, of course, two important caveats. First, trade is only one component of a wider development agenda. Its contribution to GDP is asymmetric across countries, but it is never a perfect substitute for development, which is a function of many other policies as well. In the very appropriate words of the WTO World Trade Report (2014) at p. 5: Expanding trade may be essential for development, but it is hardly sufficient. Countries that have succeeded in transforming trade and economic growth into inclusive, sustainable and broad-based development—whether measured in terms of improving health, rising education, increasing opportunities for women, or decreasing poverty—have also pursued a range of policies that not only share the gains (and costs) of trade openness, but ensure that societies are equipped to benefit from global economic integration.82

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Second, the WTO is not a development agency. Hence, it can only do so much in the development context, where it must cooperate and coordinate with other institutions specialized for the task of development. By reason of its institutional mandate and the limits inherent in its content, the WTO can contribute toward the goal of development and poverty reduction only to a limited extent. 5.5.2.2 Capacity Building The WTO now devotes substantial resources toward capacity building. The Special Assistance Unit that was established in the GATT Secretariat back in 1979 was thought as the team of experts to deal with requests on technical issues. It was supposed to provide responses to technical issues, and help train the personnel of developing countries dealing with issues coming under the aegis of GATT. In the same year, it became the Technical Cooperation Division, which organizes regularly conferences in Geneva and missions in various developing countries. It is quite difficult to measure the success of similar initiatives. The WTO has, through the establishment of the Technical Cooperation Division Audit, attempted to estimate the impact of similar initiatives using a series of proxies. 5.5.2.3 Cooperation with Other Institutions The two most prominent initiatives aimed at providing technical assistance to developing countries are the Integrated Framework (IF) and the Joint Integrated Technical Assistance Programme (JITAP).83 The IF, or Enhanced Integrated Framework (EIF) as it became known beginning in 1997,84 is an interagency coordination mechanism for the delivery of technical assistance and promotion of economic growth and sustainable development, and more generally for helping lift LDCs from the poverty trap. It comprises five multilateral agencies—ITC, IMF, UNCTAD, the UN Development Programme (UNDP), and the World Bank (WB)—in partnership with bilateral donors and LDC beneficiaries. Note that only LDCs can take advantage of the IF facility. The WTO serves as coordinator of the IF and accommodates a secretariat with a view to taking maximum advantage of each agency’s expertise to ensure optimal coordination. Interagency coordination has been entrusted to the Inter-Agency Working Group (IAWG).85 The IF aims to place trade in the context of a wider development agenda. The revamped IF is currently under extension to the following countries: Cambodia, Madagascar, Mauritania, Burundi, Djibouti, Eritrea, Ethiopia, Guinea, Lesotho, Malawi, Mali, Nepal, Senegal, and Yemen. Almost all LDCs in total have benefited from it. The members of the WTO have approved the work of the IF. During the Doha Ministerial Conference, they decided to reinforce the IF, as illustrated by § 43 of the Doha Ministerial Conference Decision: We endorse the Integrated Framework for Trade-Related Technical Assistance to Least-Developed Countries (IF) as a viable model for LDCs’ trade development. We urge development partners to significantly increase contributions to the IF Trust Fund and WTO extra-budgetary trust funds in favor of LDCs. We urge the core agencies, in coordination with development partners, to explore the enhancement of the IF with a view to addressing the supply-side constraints of LDCs and the

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extension of the model to all LDCs, following the review of the IF and the appraisal of the ongoing Pilot Scheme in selected LDCs. We request the Director-General, following coordination with heads of the other agencies, to provide an interim report to the General Council in December 2002 and a full report to the Fifth Session of the Ministerial Conference on all issues affecting LDCs.86

More recently, echoing this decision and following active monitoring of its activities, the WTO decided to redirect the IF toward the preparation of poverty-reduction strategic papers and toward reducing the observed implementation gap (between IF prescriptions and follow-up at the national level).87 JITAP, on the other hand, is a multicountry capacity-building program implemented jointly by the ITC, UNCTAD, and the WTO. Following JITAP I, JITAP II was launched in February 2003, and originally covered 16 African countries,88 which included the original 8 JITAP countries plus an additional 8 countries selected on the basis of criteria determined jointly by the implementing agencies and the donors to the program. The 8 original JITAP countries89 have since graduated from the program as of December 31, 2005. JITAP aims at building capacity and strengthening the national knowledge base on the multilateral trading system. Its objective is to ensure: • More effective participation in trade negotiations • Better implementation of the WTO agreements • Informed formulation of trade-related policies • Improved supply capacity and market knowledge of exporting and export-ready enterprises to derive benefits from business opportunities resulting from better market access under the multilateral trading system In 2006, JITAP consolidated the implementation of the various modules in the remaining 8 countries.90 The JITAP Common Trust Fund Steering Group was to determine before the end of 2007 whether it was necessary to commission a future phase of JITAP. JITAP II ended in June 2007, with the nature and scope of its future phase not agreed between the agencies and the donors to the program. JITAP III never materialized. The donors felt that the IF and the new Aid for Trade initiative that was successfully negotiated during the Doha round would take care of the issues that JITAP was supposed to address. 5.5.2.4 Action for LDCs At the Doha Ministerial Conference in November 2001, trade ministers mandated the WTO CTD to identify which special and differential treatment provisions are mandatory, and to consider the implications of making mandatory those provisions that remained nonbinding. It is this meeting that gave birth to the Sub-Committee on LDCs. This body, in which all WTO members participate, focuses on the implementation of the WTO Work Programme for the LDCs, namely: • Market access for LDCs • Trade-related technical assistance and capacity-building initiatives for LDCs

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• Providing, as appropriate, support to agencies assisting with the diversification of the production and export base of LDCs • Mainstreaming into the WTO’s work, as appropriate, the trade-related elements of the LDC III Programme of Action, as relevant to the WTO’s mandate • Participation of LDCs in the multilateral trading system • Accession of LDCs to the WTO; and follow-up to WTO ministerial decisions/ declarations.91 The WTO Work Programme for the LDCs is the platform that essentially placed the WTO in the wider interinstitutional discussion on poverty reduction and development (where, notably, the WB participates). The presence of development-related issues in WTO negotiating documents multiplied. Indeed, a WTO document surveying the progress of the Doha round negotiations from a developing-countries angle states: … first, development issues suffuse all areas being negotiated, including in the market access and rule-making aspects of the negotiations. Second, a large number of proposals already on the table are aimed at addressing the development aspects of each subject. The possible gains to developing countries would largely depend on the outcome of the ongoing negotiations and manner in which the various proposals are operationalized after being adopted.96

At the Hong Kong Ministerial Conference (2005), the CTD adopted five decisions in favor of the LDCs, including a decision to grant duty-free and quota-free (DFQF) market access for at least 97 percent of LDC exports, which is discussed more later in this chapter. This decision was a milestone in improving market access opportunities for LDC exports. Most of the developed members of the WTO provide close to 100 percent DFQF market access to LDC products. Eventually, the number everyone agreed upon was 97 percent of all tariff lines. Of course, 97 percent is a meaningful number in principle, except that donors retain discretion to leave out the 3 percent of tariff lines that matter most to LDCs (and the corresponding domestic industry of the donor as well). Following the decision at the Sixth Ministerial Conference on Measures in Favor of Least-Developed Countries, the WTO CTD was mandated to annually review the steps taken to provide DFQF access to the LDCs. The first review was held on November 28, 2006. A number of developing countries, which are increasingly becoming key trading partners of LDCs, have either adopted or are in the process of granting a significant degree of DFQF access to LDC products.97 The CTD has also been quite active in implementing a number of development-related initiatives, such as the WTO Work Programme on Small Economies. The Doha Declaration mandated the WTO General Council to examine this issue and to make recommendations regarding measures that could improve the integration of small economies into the multilateral trading system. On 1 March 2002, the WTO General Council agreed that “[t]he question of small economies would be a standing agenda item

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of the General Council; The Committee on Trade and Development (CTD) would hold Dedicated Sessions on this question and report regularly to the General Council.”92 In a similar vein, § 55 of the Hong Kong Ministerial Declaration instructed the CTD to intensify its work on commodity issues in cooperation with other relevant international organizations and to report to the General Council with possible recommendations. Coordination with other (development) agencies in this area is also quite important. The UN (and its specialized agencies) adopted at the third UN Conference on LDCs (Brussels, 2001) the Brussels Programme of Action (BPOA) for the LDCs for the decade 2001– 2010.93 Among the various commitments, Commitment 5, entitled “Enhancing the Role of Trade in Development,” is most relevant to the WTO activities.94 The director-general (DG) of the WTO circulated a report explaining the WTO activities aimed at implementing Commitment 5.95 The WTO secretariat has been attaching special priority to LDCs when organizing technical assistance and training programs. During the period 2002–2009, LDCs have been associated with 40 to 45 percent of all trade-related technical assistance (TRTA) delivered by the Secretariat. An LDC Unit was established in the WTO Secretariat in early 2003, aimed at building more informed participation by LDCs in the multilateral trading system and in their effective participation in DDA negotiations. LDCs are being accorded a high degree of flexibility in all areas of negotiation, ranging from agriculture to nonagriculture, services, trade facilitation, rules, etc., which is expected to help them pursue their development objectives. LDCs are exempted from making any tariff-reduction commitments and are not expected to undertake any new commitments in service negotiations. Finally, the institutional dimension should not be neglected at all. The LDC Group, which was formed in 2001, has become an active constituency over the years and today represents an important player in the decision-making process of the WTO. Accession of LDCs to the WTO is being encouraged: there were already 30 LDC members of the WTO in 2001—that is, before the advent of BPOA. Since then, 6 LDCs have acceded to the WTO,98 and 9 LDCs are at various stages of their accession process. The LDC Accession Guidelines were adopted in 2002, aiming to facilitate the accession of LDCs to the WTO. The presence of all these initiatives notwithstanding, the situation regarding the participation of LDCs in world trade remains far from idyllic. Although the growth of LDC exports was already higher than the world average during 2000–2009, their share in world merchandise trade was just under 1 percent in 2009, which represents a 100 percent increase from 1999. The starting point that is, was very low indeed. Moreover, LDC exports continue to be characterized by concentration on a limited number of products, making them vulnerable to external shocks. Add to that that supply-side constraints constitute one of the major challenges for expansion of LDC trade, and the fact that market access opportunities have not been fully utilized due to certain nontariff measures (e.g., the difficulty for LDCs in meeting rules-of-origin requirements). Some steps have surely

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been taken, but a lot remains to be done if the objective is to contribute meaningfully to the development of LDCs. 5.5.3 Aid for Trade: Integrated, Not Simply Involved 5.5.3.1 The Jewel of the DDA The WTO webpage describes Aid for Trade as “part of overall development aid, but with the specific objective of helping developing countries, in particular the least developed, to play an active role in the global trading system and to use trade as an instrument for growth and poverty alleviation.” A WTO document reads: “Aid for trade is about assisting developing countries to increase exports of goods and services, to integrate into the multilateral trading system, and to benefit from liberalised trade and increased market access.”99 Aid for Trade is thus about integrating developing countries into the WTO. It is probably the most solemn admission that developing countries have been involved but have not been integrated into the multilateral trading system. It concentrates on trade policy and regulation, economic infrastructure, productive capacity building, and adjustment assistance (“supply-side challenges”). It is individual donors and multilateral agencies that will assume the financing, with the WTO limiting itself to a monitoring and evaluation role. It is probably the most prominent illustration of the DDA (and the fact that the WTO is now part of the worldwide discussion on trade and development). Why has integration failed so far, and why was Aid for Trade a necessity? We have already stated the main reason, in our view. The instruments used by the WTO were tariff preferences (not necessarily in areas of priority interest for developing countries and LDCs), and longer transitional periods to implement agreed obligations. Together, they made WTO policy irrelevant for the majority of developing countries. More than twothirds of the current WTO members are developing countries. Only a few of them follow the day-to-day activities of the WTO, and even fewer have implemented the various disciplines imposed. There are, of course, many other reasons that have hampered integration or, at the very least, made it hard for many developing countries (and especially LDCs) to profit from the Uruguay-round package. These include internal barriers, lack of knowledge about trading opportunities, the occasional excessive red tape, inadequate financing of trading operations, and poor infrastructure, and they have all proved formidable obstacles for those aspiring to trade. Moreover, various studies, including Finger and Schuler (2000), supported the view that the implementation of the Uruguay round was costly for LDCs100. Aid for Trade was perceived as one of the means to redress the situation. Nevertheless, the trading partners did not proceed to abolishing GSP schemes. Aid for Trade has been thought as more of a complement to, rather than a direct substitute for, existing special and differential treatment.

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There are four main areas where Aid for Trade101 is relevant, and they will be examined one by one in the next sections. 5.5.3.2 Capacity Building in Aid for Trade Participation of developing countries in trade negotiations has been severely damaged by scarcity of negotiating resources and lack of expertise. While there is not much that can be done to address the former in the short run, a lot can be probably done with respect to the latter. The various initiatives discussed previously have been revamped and reinvigorated thanks to additional resources made available through Aid for Trade. 5.5.3.3 Infrastructure Construction of roads, ports, airports, and energy networks, as well as upgrading of the existing telecommunications infrastructure, emerge as key issues in expanding the current participation of developing countries in world trade. 5.5.3.4 Increased Productivity Very often, developing countries cannot compete in product markets. Some of the Aid for Trade money is meant to address this type of concern.102 5.5.3.5 Adjustment Assistance As a result of the reduction of MFN tariffs worldwide, developing countries have suffered from preference erosion; that is, the margin of preference that they previously enjoyed has been gradually curtailed. Aid for Trade money could provide some short-term relief. Most important, it could go some of the way toward avoiding the risk that those who have suffered from preference erosion turn into enemies of trade liberalization as a result.103 The general idea is that donors and beneficiaries participate in designing the various projects to be financed, and it is to be expected that the latter actively participate in designing them. In that, Aid for Trade stands in marked contrast to the GSP schemes that were designed solely by donors, where beneficiaries, if they had a choice at all, could only choose between complying with the various requirements and benefiting from them, or not complying and foregoing the benefits. The amount committed so far (according to OECD data) is estimated at $25–30 billion per year, of which capacity building absorbs roughly $0.9 billion (in 2005); infrastructure, roughly $9.5 billion (2005); increased productivity, $12.1 billion (2005); and adjustment assistance, between $3–6 billion (2005–2008). According to the WB, Aid for Trade has increased by 21 percent in real terms between 2002-2005 (the baseline period) and 2007.104 For 2009, Aid for Trade commitments105 reached approximately $40 billion, a 60 percent increase from the 2002–2005 baseline period. Other official flows106 doubled, reaching $51 billion in 2009, probably a reflection of the donor response to the global economic crisis. Disbursements have been increasing at a rate between 11 and 12 percent for each year since 2006, and reached $29 billion in 2009. In total, 269 case stories were received from more than 150 countries (ranging from

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the smallest states, such as the Solomon Islands and Comoros, to the largest, such as China). Priorities have changed as well, with competitiveness and export diversification becoming the top target areas when requests for grants and loans have been tabled by potential beneficiaries since 2009.107 Grants and loans are provided to recipients either through bilateral channels [say, from the US Agency for International Development (USAID) to Ghana], or through multilateral channels [say, International Development Assistance (IDA) from the WB to Ghana]. Roughly 50 percent of money dispersed is grants and the remainder is loans. 5.5.3.6 The WTO’s Involvement What is the WTO role in all this? As we have already stated a few times but is always worth recalling, the WTO is not a development agency108 and cannot provide substantial financial assistance. Conversely, the WTO can and will exercise monitoring activities. Its experience from running the Trade Policy Review Mechanism (TPRM), that we discuss in detail in chapter 12, volume 2, could be quite relevant here. It will aim to bridge the gap between the aspirations of donors and requests by beneficiaries. The WTO will be working hand in hand with other institutions in this context, as indeed it has been doing while participating in the JITAP and the IF, as discussed previously. Monitoring will take place at three levels: 1. Global monitoring, carried out by the OECD [note: OECD Aid for Trade statistics come from the Creditor Reporting System (CRS)] 2. Donor monitoring, in the form of self-evaluations 3. In-country monitoring, also in the form of self-assessments These various threads will be woven together in an annual report and an Aid for Trade debate in the WTO General Council. A WTO Aid for Trade task force has been established to assist this endeavor.109 Two declarations by the TNC, adopted at the end of the Uruguay round (December 15, 1993), provide the foundation for this collaboration: namely, the Decision on Contribution of the WTO to Achieving Greater Coherence in Global Economic Policymaking; and the Decision on the Relationship of the WTO with the IMF. 5.5.3.7 Aid for Trade: Early Evaluations Studies have emerged that have questioned the efficacy of this instrument. Cadot, Fernandes, Gourdon, and Mattoo (2011) survey the literature on this score. Their conclusion is that the shift from measures of general nature to focused interventions is quite welcome. Beneficiaries are quite diverse, and measures of generic nature might be counterproductive to some. Their second major conclusion is that the effect of Aid for Trade on export performance of beneficiaries has yet to be established. Their views are an accurate reflection of the view literature has adopted on this score. Aid for Trade is viewed as

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a step in the right direction, but a step that needs to be strengthened and improved. Gamberoni and Newfarmer (2009) have constructed an index for potential demand for Aid for Trade money based on ten indicators for trade performance and trade capacity. They conclude that those who score the lowest receive most of the money. They also conclude that some have received much less money in relation to their needs. Hoekman and Nicita (2010) point to the problems that might eventually be posed by the absence of a central entity or global financial coordination mechanism, since the whole enterprise builds on existing mechanisms and coordination might prove to be a formidable task. Delpeuch et al. (2011), while not denying that there is an impact (probably indirect) on poverty reduction, find no evidence supporting the thesis that Aid for Trade has had a beneficial effect on trade. In a nutshell, a number of commentators make more or less the same point: Aid for Trade is not a perfect substitute for domestic reform, and its contribution to development should be viewed and appreciated within its limits. 5.5.4 Trade, Poverty, and Inequality Earlier in this section, it was stated that the WTO is not a development agency, but also that trade can be a contributing factor toward development. In addition, we also explained the various initiatives that the WTO has undertaken, either alone or with other institutions, in this respect. The following discussion shifts the focus to the interplay between trade, poverty, and inequality. Combating poverty is, of course, a development objective in and of itself. Inequality is a concern for different reasons. Trade creates both winners and losers, as demonstrated in chapter 1. Trade liberalization is not Pareto superior to autarky, and efficiency is measured in terms of Kaldor-Hicks (e.g., gains outweigh losses). Losses, nevertheless, should not be overlooked. Losers could help erode the support for trade liberalization, and for this reason alone, a look into the effect of trade liberalization on inequality is warranted. Bhagwati (2004) has eloquently stated that the “trade and poverty” debate rests on a two-step argument: namely, that trade leads to growth and growth leads to reduction of poverty. There have been some refinements on this basic story, but few would doubt that the basic message here is correct. Conversely, the jury is still out when it comes to discussing the impact of trade on inequality. 5.5.4.1 Why the Question? The WTO contract does not contain specific obligations regarding the fight against poverty. Nonetheless, the Agreement Establishing the WTO recognizes in its preamble that: Recognizing that their relations in the field of trade and economic endeavour should be conducted with a view to raising standards of living, ensuring full employment and a large and steadily growing

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volume of real income and effective demand, and expanding the production of and trade in goods and services, while allowing for the optimal use of the world’s resources in accordance with the objective of sustainable development, seeking both to protect and preserve the environment and to enhance the means for doing so in a manner consistent with their respective needs and concerns at different levels of economic development, Recognizing further that there is need for positive efforts designed to ensure that developing countries, and especially the least developed among them, secure a share in the growth in international trade commensurate with the needs of their economic development. (italics in the original)

The fight against poverty is, thus, somewhere in the equation, but it is definitely not the focus of specific disciplines assumed under the WTO. The fight against poverty, though, has a lot to do with the legitimacy of the WTO. Indeed, it would be paradoxical at best to claim on the one hand that trade liberalization promotes development, but on the other that it increases poverty. 5.5.4.2 Trade and Poverty Poverty-neutral growth is a theoretical possibility. Empirical work, however, conducted by Ravallion (2001) shows not only that the poor gain when an economy grows (as it does as a result of trade expansion), but, crucially, that the incomes of the poorer segments of the society do not grow at a slower pace than that of the overall economy. There are further papers that point to the same conclusion while controlling for reverse causation; e.g., they ask not only the question whether per capita income is raised as a result of trade liberalization, but also whether the opposite is true as well. Frankel and Romer (1999), and Irwin and Terviö (2002) strongly supported this conclusion. Mitra (2015), in a comprehensive survey of the literature on this score, found no dissident voices. 5.5.4.3 Trade and Inequality A somewhat related discussion is whether trade liberalization leads to income inequality within societies. The WTO is often criticized in some circles for contributing to income inequality (as measured by the Gini coefficient, or Gini Index, which measures the degree of concentration when distribution is unknown; hence, the higher the outcome—between 0 and 1—the more concentrated wealth is in the hands of a few). The relationship between per capita income and inequality has been graphically represented in the Kuznets curve. This is an inverted, U-shaped curve meant to depict the economist Simon Kuznets’s claim that as countries develop, income inequality worsens at first and then improves when countries reach a certain level of development. In John Rawls’s classic difference principle, inequality is compatible with justice only if it improves the lives of those at the bottom of the pyramid. The empirical papers discussed in the previous section strongly support this view. Goldberg and Pavcnik (2007) survey this issue. They conclude that one of the few uncontroversial insights of trade theory is that changes in a country’s exposure to international trade, and world markets more generally, affect the distribution of resources within the country and can generate

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substantial distributional conflict. Two trends emerge clearly from the data analysis. First, the exposure of developing countries to international markets as measured by the degree of trade protection, the share of imports and/or exports in GDP, the magnitude of capital flows (foreign direct investment in particular), and exchange rate fluctuations has increased substantially in recent years. Second, while inequality has many different dimensions, all existing measures for inequality in developing countries seem to point to an increase in inequality, which in some cases (pre–NAFTA Mexico, Argentina in the 1990s) is severe. This points to the need for accompanying measures, assuming of course willingness to promote social cohesion. This last point deserves an additional few words. The WTO does not take a particular stance on inequality. The fight against inequality can emerge, if at all, as a domestic social preference. Mitra (2015) reviewed both the theory and empirical papers concerning the relationship between trade and inequality a few years after the survey study by Goldberg, Koujianou, and Pavcnik, and concluded that the standard Stolper-Samuelson effects that benefit abundant factors and hurt the scarce factor are present in the context of trade liberalization (albeit mitigated). The abundant factors in developing countries are typically less skilled labor. Accepting $1.25/day of income as the poverty line, Mitra then asked the question of how many people India and China moved above the poverty line. India moved out of poverty a substantial part of the population, reducing the people below the poverty line from 59 to 32 percent between the 1980s and 2014. In the same time period, China moved even more people out of poverty, reducing the number of people earning less than $1.25/ day from 69 to 15 percent. The Gini coefficient at the same time moved in India from 32 to 34 in his calculation, whereas in China it moved from 28 to 42. Mitra, thus, concluded that China moved more people out of poverty while increasing inequality, whereas India moved fewer people out of poverty without increasing inequality in comparable terms to China. Both of them, nevertheless, respected the Rawlsian principle.110 The author did not assign a cause-and-effect relationship between trade and inequality, since the role of political institutions, for example, is difficult to quantify. Still, the time span of the research, as well as the sheer size of the economies involved, provide a good deal of food for thought on this score. 5.6

Institutions

In 1964, GATT undertook its first substantive initiative to provide an institutional infrastructure to its provisions regarding special and differential treatment: the GATT CONTRACTING PARTIES agreed on the establishment of the CTD. Its mandate was to review the application of the provisions of Part IV of the GATT. Article IV.7 of the Agreement Establishing the WTO, which describes the current mandate of the CTD, provides:

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The Ministerial Conference shall establish a Committee on Trade and Development … which shall carry out the functions assigned to them by this Agreement and by the multilateral trade agreements, and any additional functions assigned to them by the General Council. … As part of its function, the Committee on Trade and Development shall periodically review the special provisions in the multilateral trade agreements in favour of LDC members and report to the General Council for appropriate action.

The CTD is the depositary for all GSP schemes. It is also the forum where the notification of and the discussion about preferential arrangements under § 2(c) of the Enabling Clause take place.111 It supervises the implementation of provisions favoring developing countries (special and differential treatment). It issues guidelines for technical cooperation.112 It serves as a focal point for consideration and coordination of technical assistance work on development in the WTO and its relationship to development-related activities in other multilateral agencies. Finally, it adopts measures aiming to increase participation of developing countries in the trading system, paying particular attention to the position of LDCs. The CTD has thus evolved into a forum where the discussion on trade and development, in the widest possible connotation of the term “development”, takes place under the aegis of the WTO. Also, it has been active in promoting electronic commerce113 and Aid for Trade. 5.7

Concluding Remarks

In hindsight, we can safely conclude that the original measures in favor of developing countries were not properly designed. One-way preferences through GSP schemes were established through a political decision, with little support in economic theory. From a realpolitik perspective, it was quite feasible to bring similar measures under the aegis of GATT, since donors would be left alone to decide on the extent of preferences, and there was no need for them to undergo painful adjustments in sectors such as textiles and farm policies, where political economy did not promote liberalization. On the other hand, the binary distinction between developing countries and LDCs does not allow customized solutions, which are very necessary when it comes to addressing development-related issues. The AB report on EC–Tariff Preferences tried, in a way, to respond to this shortcoming by allowing for differentiation in GSP schemes beyond the statutory distinction between developing countries and LDCs. It did so, nevertheless, in a clumsy way, making it even easier for donors to advance their own agenda when designing or according preferences. What is missing, precisely, is coordination between donors and beneficiaries—some sort of basic agreement between them so that aid becomes effective. Aid for Trade is a first step in this direction since it provides a forum where donors and beneficiaries will meet and codecide, to some extent, the aid schemes.

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The passage from GSP only to GSP plus Aid for Trade is a step away from addressing the proximate cause and toward addressing the ultimate cause of lack of integration of developing countries in the multilateral trade order. It is, of course, an implicit acknowledgment that GSP schemes have failed, or, at the very least, that they have failed to do the job by themselves. The first evaluations of Aid for Trade point to a number of possible improvements that should be undertaken. Informed by similar research, the WTO will gain in institutional credibility if it understands the limits of its actions and ensures that its actions are in the right direction. Aid for Trade is also another bridge that the WTO has built to the Bretton Woods institutions and other institutions that deal with development policy. The WTO has, of course, a very limited mandate. It administers and promotes trade liberalization. This is, anyway, the WTO contribution to development. Trade, however, is one part—and not necessarily an important part—of overall development.

6

Preferential Trade Agreements

6.1 The Legal Discipline and Its Rationale 6.1.1 The Legal Discipline WTO members can treat goods originating in one or more WTO members better than like goods originating in the remaining WTO membership, and thus deviate from their obligation to accord most-favored nation (MFN) treatment, provided that they have satisfied the requirements included in Article XXIV of GATT. To this effect, they must conclude a preferential trade agreement (PTA)1 with one or more trading nations. PTAs can take the form of either a customs union (CU) or a free trade area (FTA). Regardless of the form chosen, PTA partners must liberalize “substantially all trade” between themselves, without raising the pre-PTA level of protection applied to nonparticipants. 6.1.2 The Rationale for the Legal Discipline Article XXIV of GATT was not a provision that was heavily discussed during the negotiations that led to the advent of GATT. This might look like a paradox today since hundreds of PTAs exist nowadays. In fact, there is not one WTO member that is not party to at least one PTA; the last bastion, Mongolia, negotiated an FTA with Japan in 2014. This was not the situation back in the 1940s, though, when GATT was negotiated. There were only a few bilateral arrangements around, and it is actually debatable whether a genuine FTA existed at that time. Indeed, as explored in chapter 1, the preferences that mattered most when GATT was being negotiated were imperial preferences, which are a far cry from any reasonable understanding of PTAs. Negotiating efforts, thus, rationally focused on addressing imperial preferences, the actual problem, and not PTAs. The negotiating record leads to the following conclusions: • The US delegation was instrumental in proposing the draft of what became Article XXIV of GATT. The US delegate (usually Harry Hawkins) proposed the first comprehensive written version of the provision.

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• To some, the inclusion of this clause might have seemed a total paradox, since the whole purpose of GATT was to do away with discriminatory trade. A number of trading nations, though, were in favor of introducing a provision on PTAs, albeit for different reasons. Some saw it as natural complement to the discipline on “frontier traffic” (e.g., trade between adjacent countries, which is now regulated in Article XXIV.3(a) of GATT); others as a necessary tool to legalize preexisting arrangements; others as tool for development; and some even took the view that similar schemes could function as insurance policies in case the multilateral order broke down. Indeed, there was no guarantee at the time of inception of GATT that the twenty-three original signatories would stick together in times of adversity, much less that others would join in. We can, thus, legitimately conclude that negotiators did not see eye to eye on why a clause allowing for PTAs should be included in GATT. • They also did not see eye to eye on why PTAs should be formed in the first place. • Chase (2006) has persuasively claimed that the extension of the original drafting of Article XXIV of GATT to also cover FTAs was very much a reflection of “secret” talks between Canada and the United States, who were envisaging the conclusion of an FTA. • PTAs would be reviewed multilaterally in order to ensure that the legal conditions imposed had been met. The nature of the multilateral review would come close to that of a merger authority: no CU or FTA would be consummated absent multilateral clearance. Let us now look closer at some of the rationales advanced for including this provision in GATT. 6.1.2.1 Frontier Traffic For many, the idea was that frontier traffic and CUs were two sides of the same coin. They would occur across geographically adjacent countries, and the only difference between them would be the intensity of the integration process. Whereas frontier traffic would be limited to sporadic preferences, CUs would provide meaningful liberalization with respect to “substantially all trade.”2 Frontier traffic is now regulated in Article XXIV.3(a) of GATT, which makes it clear that advantages concerning frontier traffic should not be put into question by the GATT system. In Article XXIV.3(b) of GATT, the GATT framers mentioned specifically that arrangements made by Yugoslavia and Italy to facilitate trade with the Free Territory of Trieste could not be challenged. The Free Territory of Trieste was established with the Treaty of Peace signed on February 10, 1947, between Italy and the victors of World War II (WWII). It was meant to ensure the peaceful existence of the ethnically and culturally mixed population that lived in that part of the world (in and around Trieste, in northern Italy, and what is Slovenia today). De facto as of 1954, and de jure as of 1975 with the signature of the Treaty of Osimo, the Free Territory of Trieste was divided between Yugoslavia and Italy. As a result, Article XXIV.3(b) of GATT is now of historic interest only.

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6.1.2.2 Preexisting Arrangements Two CUs participated in the negotiation of the original GATT, the Syro-Lebanese customs union (Syria and Lebanon) and Benelux (Belgium, Netherlands, and Luxembourg).3 6.1.2.3 Development Tool Georges Hakim, the Lebanese delegate to the GATT negotiation, argued: In certain regions small nations might find it impossible to develop industries even with the aid of tariff protection. For the development of modern industry a large market is required, and many small nations do not have a sufficient population to provide such a large market. One method of securing this market would be for the small nations of a certain region whose economies are complementary to form Customs Unions among themselves …. Instead of removing all tariff barriers between themselves, a group of countries may perhaps decide to reduce tariffs between themselves to half their normal level, while maintaining the normal tariffs as against other more industrialized countries. If the object of such a system of tariff preference is to develop the industry of a group of less developed countries by providing a wider market for each country’s products, no harm to world trade will result.4

This view was typical of developing countries at that time. 6.1.2.4 Insurance Policy CUs were also thought of as an insurance policy for those developing countries interested in securing market access for their exports. Mr. Frusquet, the Cuban delegate, should be credited with this view:5 Cuba had so greatly suffered in the past from trade restrictions such as high tariffs, quotas and internal subsidies in other countries that the national income from exports had fallen to the level of thirty years previously. … Cuba could not lightly abandon her special trade relations without definitive assurance of an equal or better economic position in the future.6

6.1.2.5 US-Canada Rapprochement Chase (2006), drawing on a series of archival records, explains the extension of the original provision (which was limited to CUs) to cover FTAs as well. He demonstrates that the US negotiators designed this provision in order to accommodate the previously mentioned trade agreement that they had secretly reached with Canada. References to FTAs were thus included in Article 44 of the Havana Charter (the corresponding provision to Article XXIV of GATT) and appeared for the first time only in 1948.7 The US-Canada FTA, alas, was never ratified. It follows from this discussion, as well as the many explanations cited here, that the negotiating history of Article XXIV of GATT does not reveal a dominant explanation for its inclusion in GATT.8 This is a setback for the interpreter, for it will have no guidance regarding the object of similar arrangements when called to interpret the provision dealing with consistency of PTAs with the GATT. As will be discussed later in this chapter, though, WTO panels have been only sparingly called to interpret this provision, and, when this

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happened, they wisely chose to abstain from providing meaningful interpretations of the key concepts. This is an issue that continues to be mainly discussed among the “principals” (i.e., the WTO members). 6.1.3

Discussion

6.1.3.1 PTAs and MFN There is an obvious tension between PTAs and GATT, an agreement that was meant to promote nondiscriminatory trade. The initial carve-out from MFN was, of course, quite narrow, since only CUs were allowed. CUs are a rather demanding form of integration, in that they involve a common external trade policy, an integration step most likely too far for those who cherish sovereignty (although the membership of this club has diminished). It was the extension to FTAs that opened the floodgates to MFN exceptions, since FTAs proliferate incessantly. Before the Treaty of Rome establishing the European Economic Community (EEC) was signed in 1957, GATT had been notified of only three FTAs.9 Over 500 exist today. 6.1.3.2 FTAs, CUs, and Beyond Article XXIV of GATT distinguishes between two forms of PTAs: FTAs and CUs. For an FTA to be GATT-consistent, its members must liberalize trade between themselves, whereas, for a CU to be GATT-consistent, its members must also agree on a common trade policy vis-à-vis the rest of the WTO membership. This is how Article XXIV.8 defines CUs and FTAs: A customs union shall be understood to mean the substitution of a single customs territory for two or more customs territories, so that (i) duties and other restrictive regulations of commerce (except, where necessary, those permitted under Articles XI, XII, XIII, XIV, XV, and XX) are eliminated with respect to substantially all the trade between the constituent territories of the union or at least with respect to substantially all the trade in products originating in such territories, and, (ii) subject to the provisions of paragraph 9, substantially the same duties and other regulations of commerce are applied by each of the members of the union to the trade of territories not included in the union;10 A free-trade area shall be understood to mean a group of two or more customs territories in which the duties and other restrictive regulations of commerce (except, where necessary, those permitted under Articles XI, XII, XIII, XIV, XV, and XX) are eliminated on substantially all the trade between the constituent territories in products originating in such territories.

FTAs and CUs do not exhaust the forms of market integration, as indeed the EU experience shows. Balassa (1967) provided a classification of “stages of integration” where FTAs and CUs were the two “shallowest” forms of market integration; next would come the common market, where impediments to free movement of factors of production (and not

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only trade restrictions) would be eliminated; then the economic union, where some form of harmonization of economic policies would occur; and finally, a complete economic integration, which would entail unification of monetary, fiscal, and social policies and where a central authority entrusted with the capacity to issue binding rules would be established. Balassa saw a sequence across the various stages.11 Sapir (2011) does not. In his view, there is no reason to believe that there is some form of automaticity in the integration process that leads from FTAs to CUs to the common market, etc. Indeed, the numbers here tell a story since only a handful of CUs have been noted by the WTO, and, for some of them, there are legitimate doubts as to whether they have established a genuine common external tariff. Moreover, to cite one example, MERCOSUR was established as a CU right away, without tinkering with an FTA project beforehand.12 6.2 Why Go Preferential? PTAs come at a cost. Viner (1950) was the first to explain why PTAs are welfare reducing in light of the resulting trade diversion (deflection).13 When Home and Foreign form a PTA, they create trade since they dismantle preexisting protections between them. They also divert trade, though, since intra-PTA trade might displace extra-PTA trade (trade deflection). The classic Vinerian analysis would want to calculate the trade created through the establishment of a PTA (since intra-PTA trade would be liberalized) and compare it to the trade diverted (since trade, if it becomes relatively more efficient, should be deflected from the worldwide most efficient source of supply to the intra-PTA most efficient source of supply). Of course, one might cast significant doubt on the appropriateness of such measurement since it assumes the counterfactual. What if countries refused to make the same MFN cuts if they were deprived of the possibility to go preferential? What if they refused to participate in the WTO altogether if they could not enjoy the benefit of entering into PTAs? This is not meant to put into question the classic Vinerian analysis. Indeed, Viner was interested in measuring the allocational impact of discriminatory integration. Realpolitik would suggest that there is no reason to believe that MFN cuts would be the appropriate counterfactual to preferences,14 but this was not Viner’s concern.15 Influenced by Viner’s analysis, economists initially viewed regional integration with a lot of skepticism.16 Influential papers such as Grossman and Helpman (1995) and Krishna (1998) added to the early criticism, as they established the incentive for PTA partners to choose integration in those sectors where the possibility for preference (and thus trade deflection) is at its maximum. The GATT legal test does provide some insurance against this possibility (through the requirement to liberalize “substantially all trade,” as

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discussed later in this chapter). Worse, the legal test was almost never respected in the first place. And costs do not stop here. PTA partners are missing incentives to agree, following establishment of a PTA, on MFN tariff cuts for fear of “preference erosion.” Bhagwati (2002), Krishna (1998), and Limão (2006a) have all contributed theoretical and empirical papers in this vein. Besides trade diversion generated through the establishment of PTAs, members of PTAs behave like enemies of nondiscriminatory trade liberalization in the future as well, since they are unwilling to cut tariffs on an MFN basis for fear of eroding the margin of preference that they have already granted to their PTA partners. They thus become, as Bhagwati and Panagariya (1999) put it, “stumbling blocks” (as opposed to “building blocks”), opposing MFN trade liberalization and frustrating the achievement of the basic WTO objective. In other words, trade diversion is here to stay as a result of the incentives of PTA partners.17 Bhagwati (2008) goes so far as to state (p. 88): It is hard to contemplate the consequences of PTAs with equanimity. The most important item in our policy agenda has to be to devise an appropriate response to their spread and the damage they impose on the multilateral trading system.18

Note, nonetheless, that a group of NAFTA negotiators (Carla Hills, Jaime Serra Puche, Michael Wilson) that were gathered in the Hoover Institute of Stanford University to celebrate the 20 years of NAFTA concluded the exact opposite: that it is because of successful conclusion of NAFTA that the deadlock of the Uruguay round was undone. Carla Hills, the USTR at the time the NAFTA and the Uruguay round were being negotiated provided the most compelling evidence to this effect.19 Against this background, one might naturally be tempted to ask, why go preferential? The number of PTAs in place is staggering, and their increase in the post—Uruguay round era (when tariffs were cut as never before) dramatic. The answer is far from easy, since explanations could be idiosyncratic and quite often, information about the true motives for going preferential might be private. Indeed, economists and political scientists have advanced various explanations why one might opt to go preferential,20 and if there is one characteristic they all have in common, it is that they are all idiosyncratic. This discussion can begin with the EU, the most advanced integration form seen nowadays. The EU integration process can be viewed both in its “internal” and “external” dimensions. The internal dimension concerns the integration process of the European states. Trade was part of the integration process, and in fact it contributed a lot to realizing the overarching objective: political union. The EU has not achieved it yet, but it has taken decisive steps in this direction. The external dimension of the EU integration process concerns the overall presence of the EU in international relations, and its role in substituting gradually its member states in the international arena. The EU has been an early champion of preferential trade, recently copied by various eager beavers. Trade policy was for years the only genuine EU common policy, and one cannot resist the temptation to ask

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the question whether PTAs were not part of a wider “I sign, ergo I exist” strategy: with every PTA signed, the EU was affirming its international persona, becoming more of a figure in international relations.21 Many other plausible explanations for signing PTAs have been advanced. PTAs are close to natural integration schemes across geographically proximate partners. Tinbergen (1962) was the first to explain that the formation of PTAs was in some ways quite natural. He developed the “gravity equation,” aimed at predicting trade in the absence of distortion. Trade flows would depend on the economic size and distance22 between two countries. Trade is an increasing function of the gross national products (GNPs) of both the exporting and the importing countries, and is negatively influenced by the physical distance between the countries. Gravity models have been successfully used to explain the formation of PTAs, especially between partners in geographic proximity to each other. Krugman (1991) and Summers (1991) have gone one step further, arguing that PTAs among countries in proximity should be encouraged, whereas PTAs among countries that are not geographic neighbors should be discouraged. In their analysis, the former are more likely to avoid the adverse possibility of welfare reduction and to lead to a larger improvement in welfare.23 In a way, the GATT provision on frontier traffic that we discussed earlier echoes this view. Perroni and Whalley (2001) have argued that smaller (and often) developing countries have on occasion had recourse to PTAs (and were even prepared to pay a heavy price for this) in order to secure access to larger markets. Their aim is to achieve a safe haven, and thus, PTAs could be seen as insurance agreements. To this effect, they were prepared to assume the role of “spokes” and link through PTAs with the main “hubs” of international trade. Originally, they thought of PTAs as insurance policies against the collapse of the trading system, as we saw earlier. More recently, they also saw them as the means to get a “first mover’s advantage” and establish preferential trade with hubs before other spokes did.24 Baldwin (1995) argued that the signing of PTAs between a hub and a spoke might create a domino effect, in the sense that other spokes might be willing to follow suit and sign similar arrangements with the hub because if they were left out, they would miss out on important market opportunities. Although it is difficult to explain all PTAs through this view, there is certainly a lot of empirical support for it.25 Krugman (1991) observes that a trading bloc could be formed in order to improve the terms of trade for its participants. In this view, a similar arrangement: [A trading bloc] will normally have more monopoly power in world trade than any of its members alone. The standard theory of the optimal tariff tells us that the optimal tariff for a country acting unilaterally to improve its terms of trade is higher, the lower the elasticity of world demand for its exports. So for a trading bloc attempting to maximize the welfare of its residents, the optimal tariff rate will normally be higher than the optimal tariff rates of its constituent countries acting individually.26

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Meade (1955), in similar vein, writing on customs unions, noted that (pp. 64–65) “the larger the trading area which is negotiating as a single unit the better the commercial policy treatment which it can hope to exact in its bargains from other countries, and the better therefore its terms of trade with the rest of the world are likely to be.” Meade was, of course, one of the key UK negotiators of the original GATT, and his discussion. Kowalczyk (1990) has shown, employing terms-of-trade and volume-of-trade analysis, that trade creation and diversion do not necessarily equate with welfare gains and losses. WTO members might be deriving important political benefits by association with their preferential partners, and this is most likely the case when associating themselves with the two main hubs, the EU and the US. This observation might also explain why those originally left out might wish to join in subsequently.27 The North American Free Trade Agreement (NAFTA) was beneficial to Mexico not simply because the US lowered its tariff barriers to Mexican goods and services, but also because Mexico benefited from other dynamic benefits, such as increased investment over the years as a result of rationalization of its policies and other factors.28Jaime Serra Puche, a key Mexican negotiator for NAFTA, went on record stating that Mexico aimed at two objectives while negotiating NAFTA. First, it wanted to reenter the “map of world investment,” since, in the pre-NAFTA years, it had been attracting almost no investment at all. Second, because it wanted to undo the perverse effects of GSP. Mexico was an important beneficiary. Puche cites the example of microphones. Mexico was exporting a quota of 100,000 microphones at preferential rates to the US. The quota was being reached quite fast, though, and factories had to close down for the remaining part of the year since they could not be exporting one additional unit at preferential rates. NAFTA preferential rates would operate as the “substitute” for GSP preferences.29 In a similar vein, Baltagi et al. (2008) discussed the relationship between PTAs and foreign direct investment (FDI). They concluded in an empirical paper regarding the European Union Association Agreements that the removal of trade barriers has led to substantial flows of FDI for those participating. Recourse to PTAs thus could be privileged because a country sees a PTA as a way to get investment/access to foreign technology that can increase its income or access to low-cost production of inputs that can increase its ability to export certain products. It could also be that trade is a component of a wider public policy package.30 Dynamic (indirect) benefits can be of a different nature as well. It could be, for example, that PTAs serve as signaling mechanisms. Mexico, by joining NAFTA, not only enjoyed trade and investment benefits, as mentioned earlier, but also signaled to the world that it was abandoning its policies of the past and was espousing a different model. Association with this particular hub (the US) was a strong signal to this effect. This, in turn, might have eased Mexico’s relationship with international organizations, financial markets, etc.

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Becoming a preferential partner in trade might open the door to all sorts of political cooperation. Obtaining political perks, which might be indirect or uncertain, could on occasion be the key motivation why spokes decide to go preferential with hubs. PTAs are part and parcel of wider foreign policy and might be motivated only (or mainly) by concerns of a political order. Thanks to leaked documents, for example, we know that India was pursuing closer ties with the Association of Southeast Asian Nations (ASEAN) with the goal of balancing China’s growing clout in Asia.31 In a similar vein, China has not signed any PTA with WTO members that have recognized Chinese Taipei.32 In light of this discussion, one might naturally ask whether it is meaningful at all to attempt to discipline a phenomenon when we are unclear as to what has caused it. The GATT legal regime turns a blind eye to the rationales for going preferential and disciplines PTAs anyway.33 And at the very least, some disciplining was necessary; otherwise, as Grossman and Helpman (1995) have observed, MFN could have become an “empty shell.” 6.3 The Legal Requirements for GATT-Consistent PTAs The legal and economic tests for giving the green light to a PTA are like two ships passing in the night. What stems from the previous discussion is that economists care about the welfare implications of PTAs. This is the question that the legal test embedded in Article XXIV of GATT does not ask. This is not to suggest that the current legal discipline is totally nonsensical. Article XXIV of GATT aims at avoiding PTAs à la carte. Absent the “substantially all trade” requirement that is discussed later in this chapter, for example, PTAs on only one good would be imaginable. This would, of course, signal the death of MFN, the cornerstone of GATT.34 The GATT regime also aims to ensure that intra-PTA trade liberalization will not be accompanied by new protection vis-à vis the rest of the world, regardless of the welfare implications. While respecting the legal obligations, though, a GATT-consistent PTA could be very costly since it could create very substantial trade diversions. This could easily be the case as far as early PTAs in the 1950s and the 1960s were concerned, when MFN tariffs were quite high and tariff cuts only to inefficient sources of supply could be meaningful. Indeed, nothing in the GATT regime stopped a GATT contracting party from entering into a PTA with inefficient producers. If it played by the book and liberalized all its trade totally toward its new PTA partners, it would be diverting a lot of trade in their direction at a moment when the rest of GATT would be called to pay 30 percent and 40 percent duties to enter its market.35 Recall that this was the habitual level of duties in the early years of GATT integration. This is much less of a threat nowadays, of course.

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6.3.1 An Exception to MFN Article XXIV.4 of GATT leaves no doubt that there is room for PTAs under the aegis of the multilateral framework: The contracting parties recognize the desirability of increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties to such agreements. They also recognize that the purpose of a customs union or of a free-trade area should be to facilitate trade between the constituent territories and not to raise barriers to the trade of other contracting parties with such territories.

The wording and the negotiating history make it clear that Article XXIV of GATT was meant to be an exception to Article I of GATT.36 The Appellate Body (AB) ruled in unambiguous terms that the party invoking Article XXIV of GATT to justify deviations from MFN trade carries the associated burden of proof (§ 58): First, the party claiming the benefit of this defence must demonstrate that the measure at issue is introduced upon the formation of a customs union that fully meets the requirements of subparagraphs 8(a) and 5(a) of Article XXIV. And, second, that party must demonstrate that the formation of that customs union would be prevented if it were not allowed to introduce the measure at issue.37

Nevertheless, the relationship between the two provisions (Articles I and XXIV of GATT) has proved to be a thorn of sizeable dimensions in GATT/WTO practice. In the words of the Panel on Turkey–Textiles (§ 2.2): The relationship between the most-favoured-nation (“MFN”) principle and Article XXIV of the GATT, which deals with free-trade areas and customs unions, has not always been harmonious.

Various issues have arisen in practice, and some of them have been responded to, whereas some have not. All of this will be explored later in this chapter. One thing is clear: the exceptional treatment is limited to PTA partners; it cannot be extended to nonparticipants in the PTA. To this effect, the Panel on Canada–Autos clearly stated (§ 10.55): In our view, Article XXIV clearly cannot justify a measure which grants WTO-inconsistent duty-free treatment to products originating in third countries not parties to a customs union or free trade agreement.

6.3.2

Notification Requirements

6.3.2.1 Who Notifies? Recall from the discussion in chapter 5 that it is the Committee on Trade and Development (CTD) that should be notified of arrangements across developing countries (south-south cooperation). We are consequently left with the following possible constellations for PTAs notified under Article XXIV of GATT:

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• Between developed countries, all of which are WTO members • Between WTO members, some of which qualify as developed and some as developing countries • Between a WTO member that qualifies as a developed country and a non-WTO member The Committee on Regional Trade Agreements (CTRA), of course, should be notified of PTAs in the first two categories. It is the last of these categories that legitimately raises issues. One would think that Article XXIV of GATT is a discipline to be observed between WTO members only. Article XXIV.5 reads: Accordingly, the provisions of this Agreement shall not prevent, as between the territories of contracting parties, the formation of a customs union or of a free-trade area or the adoption of an interim agreement necessary for the formation of a customs union or of a free-trade area … (emphasis added)

And yet, practice has developed in a different way. WTO members, whether developed or developing, notify the Committee on Regional Trade Agreements (CRTA), the CTD, or both about their PTAs with non-WTO members as well: EC–CARIFORUM (Bahamas is part of the agreement, but not a WTO member) is an example of the former, and Ukraine–Uzbekistan of the latter.38 One is tempted to argue that whenever a WTO member grants a benefit to a non-WTO member, it must immediately and unconditionally extend it to all WTO members. Article XXIV of GATT cannot be an exception to this rule since it exonerates only PTAs between WTO members from the obligation to observe MFN (Article XXIV.5 of GATT, cited earlier). Furthermore, review by the CRTA of similar arrangements (e.g., extension of benefits to non-WTO members that participate in a PTA) is not a watertight shield against eventual legal challenges by WTO members who have been denied similar benefits. Affected parties can always complain before a panel and request extension of benefits granted. This response would be all the more pertinent for schemes subjected to review after the advent of the Transparency Mechanism. No evaluation of the legal consistency of notified schemes has taken place since 2006. We will revert to this point later in this chapter. So far, though, no legal challenge against the legality of PTAs between WTO- and non-WTO members has been raised before a WTO panel. So what if a legal challenge is raised? Formally, it is still an open question whether, when signing PTAs with non-WTO members, WTO members have to automatically and unconditionally extend benefits to all other WTO members based on MFN, although the letter and the spirit of Article XXIV of GATT are, of course, violated through similar arrangements. The better arguments lie with an obligation to extend to the WTO membership all benefits granted to non-WTO members through the conclusion of PTAs. Still, the absence of legal challenges to this effect should not come as a shock. They are quite improbable since WTO members lack the incentive to challenge PTAs anyway, for the reasons explained later in this chapter. Moreover, the

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size of the problem is gradually diminishing. The WTO is becoming (if it is not already) a global institution, with a membership rivaling that of the UN. PTAs with non-WTO members is slowly becoming a sort of endangered species, on its way to extinction. 6.3.2.2 Notify Whom? The WTO must be notified of decisions by WTO members to enter into a PTA or of their intention to do so (Article XXIV.7 of GATT).39 Notifications will be submitted to the CRTA, where the compatibility of the notified scheme with the multilateral rules will be reviewed.40The CRTA41 is the successor to Article XXIV of GATT Working Parties, the organ that would examine the consistency of notified PTAs with the multilateral rules in the GATT years. Practice also evidences dual notifications simultaneously to the CRTA and the CTD. When MERCOSUR was established, only the CTD was notified of the scheme, since all participants (i.e., Argentina, Brazil, Paraguay, and Uruguay) considered themselves developing countries. It was later agreed between them and the rest of the WTO membership that the terms of reference of the Working Party should also include an examination of the consistency of MERCOSUR with Article XXIV of GATT as well: To examine the Southern Common Market Agreement (MERCOSUR) in the light of the relevant provisions of the Enabling Clause and of the GATT 1994, including Article XXIV, and to transmit a report and recommendations to the Committee on Trade and Development for submission to the General Council, with a copy of the report transmitted as well to the Council for Trade in Goods. The examination in the Working Party will be based on a complete notification and on written questions and answers.42

A number of developing countries raised concerns regarding the legality of this practice. In a joint communication, China, Egypt, and India pointed to the absence of a legislative framework enabling dual notifications and the ensuing uncertainty regarding both the impact of the various provisions and the role of the CTD and the CRTA should be acknowledged in this process.43 6.3.2.3 Notify What? The content of notification has been standardized for all PTAs, regardless of whether they are notified under the Enabling Clause or Article XXIV of GATT. An annex to the Transparency Mechanism explains the precise content of notifications and communications to the CRTA, while § 20 of the Transparency Mechanism makes it clear that cross-notifications are permissible. 6.3.2.4 Notify When? Article XXIV.7(a) of GATT addresses the timing of notification as well: Any contracting party deciding to enter into a customs union or free-trade area, or an interim agreement leading to the formation of such a union or area, shall promptly notify the CONTRACTING

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PARTIES and shall make available … such information … as will enable them to make such reports and recommendations to contracting parties as they may deem appropriate. (emphasis added)

The wording of Article XXIV of GATT suggests that the CRTA should be notified of any prospective action.44 The WTO Secretariat (the TPRM Division, Trade Policy Review Mechanism)45 will then prepare a factual presentation of the PTA to be circulated to all WTO members.46 It is quite common, however, for PTAs to be notified ex post facto—that is, after they have been officially signed, entered into force, or both. Indeed, the review typically takes place while the notified PTA is in force. For example, NAFTA was signed on December 17, 1992, entered into force on January 1, 1994, and a Working Party to examine its consistency with the GATT rules was established only on March 23, 1994. The EC–Visegrad Agreements (a former FTA between the EU on one hand and Hungary, Poland, and the Czech and Slovak Federal Republics on the other) entered into force on December 16, 1991, and the Working Party was established only on April 30, 1992. Consequently, Working Parties (and now the CRTA) have often been presented with a fait accompli. This is an important observation, especially in light of the de facto absence of retroactive remedies in the GATT/WTO legal system. Assume that a successful legal challenge (an unlikely occurrence, as explained later in this chapter) against a PTA. The remedy would be for the members of an FTA to bring their measures into compliance with their obligations under the WTO. This would not entail, though, compensation for past damages to affected WTO members (who paid the MFN rate when others did not). In practice, because of the belated notifications, the CRTA is de facto not understood by the WTO membership as the permission necessary for a PTA to lawfully enter into force. One WTO panel report at least (US–Line Pipe) has sided with this view. The General Council decision establishing the Transparency Mechanism47 regarding the content of notifications formally accepted that notifications can take place after the entry into force of the notified PTA: “The required notification of a PTA shall take place as early as possible; it will occur when practicable before the application of preferential treatment by the notifying member and, at the latest, three months after the PTA is in force.” The negotiating intent to notify prospective action thus has been officially defeated. One should not exaggerate the importance of this point, though. We have not experienced totally flimsy PTAs—such as preferential schemes in only one product market. There is some self-discipline, and discussions before the CRTA reveal that notified PTAs do liberalize a wide variety of product markets. While they might not always conform to the spirit of Article XXIV of GATT (indeed, it is almost impossible to make definitive statements regarding conformity with the letter of this provision, since, as we will see later in this chapter, key terms remain uninterpreted), PTAs typically are comprehensive in their coverage.

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6.3.3 Internal Requirement: Eliminate Duties with Respect to Substantially All Trade 6.3.3.1 Same Requirement for FTAs and CUs Recall from the definition of CUs and FTAs quoted earlier, that both preferential schemes must eliminate duties and other restrictive regulations of commerce (ORRC) with respect to substantially all trade (SAT) in products originating in the constituents of the PTA. 6.3.3.2 Substantially All Trade (SAT) It bears repetition that, as Grossman and Helpman (1995) have persuasively argued, the inclusion of this requirement serves a legitimate purpose: absent this requirement, WTO members might have an incentive to conclude preferential deals on commodities where the largest possible trade diversion could result. PTAs à la carte will thus be avoided (the “carte” here being, of course, finely customized to correspond to the maximum trade diversion across commodities of interest to the preferential partners). Roughly, this term should imply that comprehensive liberalization should take place for a PTA to be legally established. Nevertheless, the statutory language does not clarify how much should be liberalized for this legal requirement to be satisfied. This term, unlike other terms featured in Article XXIV of GATT, was not clarified through subsequent legislative action during the Uruguay round negotiations either.48 To make matters worse, it has not been interpreted by GATT/WTO panels. Inevitably, hence, we have to turn to practice, that is, the various Article XXIV Working Parties that have dealt with this issue, in order to discern its meaning. But even a cursory, helicopter view of practice leaves the impression that this is an area where trading partners found it impossible to agree on a particular meaning. In what follows, we provide an inventory of some representative views on this score. It has been suggested that the term SAT has a quantitative as well as a qualitative component, in the sense that it covers a certain percentage of trade and, at the same time, no major sector of a national economy can be excluded.49 During the deliberations before the EEC Working Party, the opinion was expressed to the effect that it is “inappropriate to fix a general figure of the percentage of trade which would be subjected to internal barriers.”50 In the same Working Party, various EU member states expressed the view that “a freetrade area should be considered as having been achieved for substantially all trade when the volume of liberalized trade reached 80 per cent of total trade.”51 The Working Party report on EFTA states that “the percentage of trade covered, even if it were established to be 90 per cent, was not considered to be the only factor to be taken into account.”52 Other Working Party reports reflect the view that the exclusion of a whole sector, no matter what percentage of trade is involved, is contrary to the spirit of both Article XXIV GATT and GATT itself.53

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Nothing has changed since these reports saw the light of day,54 and discussions in the context of the CRTA have hardly been illuminating. The GATT Analytical Index (vol. 2, p. 824, footnote 162) provides an exhaustive list of Working Party reports dealing with this issue. The inescapable conclusion is that trading partners did not manage to clarify this term. In a series of papers that the WTO Secretariat prepared for the CRTA,55 this conclusion has been reconfirmed: 50 years of practice notwithstanding, WTO members have failed to come up with a workable definition of SAT. Probably the most appropriate way to sum up practice in this field is offered by the Working Party report on EC–Agreements with Portugal,56 where the EU delegate noted that “there is no exact definition of the expression referring to the term ‘substantially all trade.’” After the conclusion of the Uruguay round, Australia tabled a proposal to clarify the term “substantially all trade.”57 Australia parted company with the oft-mentioned but nebulous idea that the term reflects both a quantitative and a qualitative element. Australia proposed that, to comply with this requirement, WTO members should be requested to liberalize 95 percent at the six-digit (tariff lines) level. In its response to questions from other WTO members,58 Australia accepted that the 95 percent figure was an arbitrary benchmark. In its view, nonetheless, coming up with a number was an appropriate device intended to move negotiations out of deadlock and provide a workable and reasonable rule of thumb. Australia was also mindful of the fact that in cases where trade is concentrated in only a few products, the 95 percent figure could exempt sizeable trade flows. This is why it also proposed an assessment of prospective trade flows under an arrangement at various stages. Australia did not manage to persuade enough WTO members.59 More recently, a General Council decision (implicitly, at least) suggests that the SAT requirement does not require liberalization of all trade involved.60 In its Annex 2, it requires that notifying WTO members provide information regarding the list of ineligible products, as well as the preferential trade volume affected in the last three years (prior to the notification). 6.3.3.3 Duties and Other Restrictive Regulations of Commerce Article XXIV.8 of GATT does not define this term any further, but, in a notorious parenthesis, it exempts from its coverage measures coming under the purview of Articles XI, XII, XIII, XIV, XV, and XX. There should be no doubt that the term “duties” refers to customs duties, and hence, interpretative issues arise only with respect to the term “other restrictive regulations of commerce.” Two issues arise: first, whether the list of measures mentioned in the parenthesis, and thus exempted, is exhaustive or not; and second, whether the exempted measures can help the interpreter define the full ambit of the term “other restrictive regulations of commerce.

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Practice suggests that inferences from the omission of Article XXI of GATT61 from the list reflected in the parenthesis can legitimately be drawn. The issue was discussed in the Working Party on EEC. The view of the EEC member states was that it would be difficult, however, to dispute the right of contracting parties to avail themselves of that provision which related, inter alia, to traffic in arms, fissionable materials, etc., and it must therefore be concluded that the list was not exhaustive.62

Similar voices have been raised in the context of other Working Party reports.63 The argument in favor of acknowledging the indicative character of the list has been reinforced by discussions regarding the exclusion of Article XIX of GATT. During the Uruguay round negotiations, a draft decision was tabled to clarify this issue: When an Article XIX action is taken by a member of a customs union or free-trade area, or by the customs union on behalf of a member, it [need not] [shall not] be applied to other members of the customs union or free-trade area. However, when taking such action it should be demonstrated that the serious injury giving rise to the invocation of Article XIX is caused by imports from nonmembers; any injury deriving from imports from other members of the customs union or free-trade area shall not be taken into account in justifying the Article XIX action.64

Had this proposal been accepted, it would have provided a much-needed clarification on this score and would have put to rest the relationship between Articles XIX and XXIV of GATT. The proposal was, alas, rejected. WTO adjudicating bodies have already faced the question whether a CU65 or an FTA66 could impose safeguards against their preferential partners. They responded in the affirmative, provided that they have respected “parallelism” between imports and injury. They can do so, that is, if they have counted preferential imports (e.g., imports originating in their PTA partners) when assessing injury. They cannot do this, however, if they have not counted preferential imports when assessing injury. Although the WTO adjudicating bodies explicitly declared that they were not influencing the relationship between the two provisions (Articles XIX and XXIV of GATT), de facto they did. Following these events, one can reasonably conclude that WTO practice supports the view that the list in the parenthesis of Article XXIV.8 of GATT is not exhaustive. Including the possibility for intra-PTA safeguards ipso facto suggests that the list featured in the parenthesis is of an indicative nature. Assuming that this is the case, the next question is what else should be included. The items included in the enlarged parenthesis should inform the interpreter about the other items that should be included. Yet, there is remarkable heterogeneity with respect to the subject matter of the provisions included in the parenthesis. Indeed, whereas the first five provisions mentioned deal with trade instruments, Article XX of GATT covers a wide range of domestic instruments. Should we understand the term “other restrictive regulations of trade” as extending to cover domestic instruments that restrict trade as well?

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The 1970 Working Party on EEC–Association with African and Malgasy States dealt with this issue. There, the opinion was raised that trade had not been substantially liberalized, in view of the continued imposition by certain parties to the convention (i.e., the Association of EEC with African and Malgasy States) of fiscal charges on imports from other members. In response, the members of the PTA argued that the provisions of Article XXIV, concerning the concept of a free-trade area, concerned only protective measures. The taxes referred to were of a fiscal character, not protective.67

Where should the line be drawn between “protective” and “fiscal”? Alas, this Working Party did not discuss (or explain) it any further. A series of PTAs now include standards on environmental protection, labor standards, human rights, and other issues.68 The question could arise whether members of a PTA could adopt, for instance, two sets of environmental policies: one applicable to its PTA partners and one applicable to the rest of the world. There are good arguments to support the thesis that the term “other restrictive regulations of commerce” should be confined to trade instruments. The purpose of Article XXIV of GATT is to reduce protection for a subset of the WTO membership; that is, WTO members participating in a PTA. Since quantitative restrictions (QRs) are illegal, and domestic instruments are nonnegotiable and have to abide by the nondiscrimination obligation as we saw in chapter 1, the only permissible (e.g., legal) protection in GATT is protection through tariff protection. Consequently, the only advantage that WTO members can give each other when forming a PTA should be a tariff advantage. For the rest, WTO members must respect the MFN obligation. Case law has repeatedly acknowledged that the very purpose of the discipline on domestic instruments is to safeguard the value of tariff concessions and not to protect.69 Since domestic instruments (policies) are not meant to protect, then it should be impossible for a member of a PTA to be allowed to give one subset of the WTO membership an advantage that it does not extend to the remaining membership.70 6.3.4

External Requirement: No New Protection

Broadly speaking, by virtue of the external requirement, WTO members should not raise their protection vis-à-vis the remaining WTO membership when entering a PTA. Contrary to what is the case with respect to the internal requirement, the conditions for meeting the external requirement are different for FTAs and CUs. 6.3.4.1 External Requirement That FTAs Must Meet With respect to FTAs, Article XXIV.5(b) of GATT reads that “… duties and other regulations of commerce … shall not be higher or more restrictive than the corresponding duties and other regulations of commerce existing in the same constituent territories prior to the formation of the free-trade area …”

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Article XXIV.5(b) of GATT does not explicitly state that WTO members participating in an FTA cannot modify their external protection when joining the FTA. FTAs aim at liberalizing trade within their constituents only, without addressing external protection at all. FTA members continue to unilaterally define their foreign commercial policy, even after they have joined an FTA. Note that the obligation enshrined in this legal provision does not refer to duties and other regulations of commerce as a whole, but rather to individual instruments. FTA members retain no flexibility to raise some levels and reduce other levels while keeping the overall balance intact (e.g., pre-FTA level of duties should be equivalent to the post-FTA level). FTA members must ensure that each and every individual duty (and other regulation of commerce) will not be more restrictive following establishment of the FTA. What is the level of comparison, though? Should it be the level of applied duties practiced before establishment of the FTA, or bound duties? The Understanding on the Interpretation of Article XXIV of GATT clarifies that prospective members of an FTA can raise duties from the applied to the bound level (assuming, of course, a discrepancy between the two levels). Since their MFN trade will be conducted at the bound level, members of the FTA can provide each other with an extra margin of preference (that is, the difference between the bound and the applied level). Article XXIV.5(b) of GATT, in contrast to Article XXIV.8 of GATT, refers to “other regulations of commerce,” not to “other restrictive regulations of commerce.” Article XXIV.5(b) of GATT contains neither an indicative nor an exhaustive list of other regulations of commerce. However, it should not be in doubt that, in light of the analysis in chapter 3, “other duties and charges” (ODCs) should be covered by this provision. The question is, of course, what else should be? Rules of origin are of particular interest in the FTA context, and hence a candidate for inclusion in this list. In addition, they have on occasion been discussed in the context of Article XXIV.5 of GATT, without, however, ever resorting to legal challenges before panels regarding their consistency with the multilateral rules.71 During discussions in the WTO, the opinion has been expressed that (unilateral or mutual) recognition under Sanitary and Phyto-sanitary Measures (SPS) or Technical Barriers to Trade (TBT) should also come under Article XXIV.5 of GATT, and there was even a formal proposal that all measures relating to recognition must be notified.72 No decision, however, was made in this respect. The lack of a decision is a blessing since, for the reasons mentioned earlier, protection to PTA partners cannot be afforded through domestic instruments. 6.3.4.2 External Requirement That CUs Must Meet With respect to CUs, Article XXIV.5(a) of GATT reads: “… duties and other regulations of commerce … shall not on the whole be higher or more restrictive than the general incidence of the duties and regulations of commerce applicable in the constituent territories prior to the formation of such union …” (emphasis added).

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The words in italics mark the difference between the text of Article XXIV.5(b) of GATT and that of Article XXIV.5(a) of GATT: “on the whole,” and “general incidence” invite a comparison of the general (and not item-by-item) situation before and after the formation of the CU. This was the intention of the drafters as well: The phrase “on the whole”… did not mean that an average tariff should be laid down in respect of each individual product, but merely that the whole level of tariffs of a customs union should not be higher than the average overall level of the former constituent territories.73 The Sub-Committee recommended that the words “average level of duties” be replaced by “general incidence of duties” in paragraph 2(a) of the new Article. It was the intention of the SubCommittee that this phrase should not require a mathematical average of customs duties but should permit greater flexibility so that the volume of trade may be taken into account.74

Disagreements appeared often among members of Working Parties as to whether bound or applied rates should be used in the context of Article XXIV.5(a) of GATT.75 This issue has been clarified with the entry into force of the WTO Understanding on the Interpretation of Article XXIV of GATT: The evaluation under paragraph 5(a) of Article XXIV of the general incidence of the duties and other regulations of commerce applicable before and after the formation of a customs union shall in respect of duties and charges be based upon an overall assessment of weighted average tariff rates and of customs duties collected. This assessment shall be based on import statistics for a previous representative period to be supplied by the customs union, on a tariff-line basis and in values and quantities, broken down by WTO country of origin. The Secretariat shall compute the weighted average tariff rates and customs duties collected in accordance with the methodology used in the assessment of tariff offers in the Uruguay Round of Multilateral Trade negotiations. For this purpose, the duties and charges to be taken into consideration shall be the applied rates of duty. It is recognized that for the purpose of the overall assessment of the incidence of other regulations of commerce for which quantification and aggregation are difficult, the examination of individual measures, regulations, products covered and trade flows affected may be required. (emphasis added)76

It follows that applied rates matter when a CU is established. But then, the question arises regarding the ambit of the comparison. The report of the 1983 Working Party on Accession of Greece to the European Communities reflects the view expressed by the EU: “Article XXIV.5 required only a generalized, overall judgment on this point.”77 By the same token, the report of the 1988 Working Party on Accession of Portugal and Spain to the European Communities includes the view of the EU that “Article XXIV.5 only required an examination on the broadest possible basis.”78 This view, however, failed to convince other members of the Working Party. One member could not accept the Communities’ contention that the extension of the tariff of the EC/10 to the EC/12 was compatible with their obligations under Article XXIV. 5(a) regardless of the effect on the tariffs of Spain and Portugal. Article XXIV.5(a) required a comparison with the pre-accession tariffs of the constituent territories and the relative size of those territories was not a relevant factor.79

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It is questionable, however, whether all these discussions concern Article XXIV.5 of GATT at all. The points made here, to the extent that they concern duties,80 are intimately linked with the amount of compensation due when CUs are formed. This requirement is discussed in Article XXIV.6 of GATT: If, in fulfilling the requirements of subparagraph 5(a), a contracting party proposes to increase any rate of duty inconsistently with the provision of Article II, the procedure set forth in Article XXVIII shall apply. In providing for compensatory adjustment, due account shall be taken of the compensation already afforded by the reduction brought about in the corresponding duty of the other constituents of the union.

Recall, first, that Article XXIV.6 of GATT deals only with customs duties, not other regulations of commerce. Assume that Home, Foreign, and Third are WTO members and decide to enter into a CU, and that before the formation of the CU, the tariff protection (to avoid any unnecessary complications, assume equivalence between bound and applied rates) of the automotive sector in the three countries was the following: Home—20 percent Foreign—30 percent Third—40 percent Home, Foreign, and Third bind customs duties on cars at 30 percent at the CU level. Arguably, they have met their obligations under Article XXIV.5(a) of GATT. They have not, however, necessarily met their obligations under Article XXIV.6 of GATT. When Article XXIV.5(a) of GATT is violated, Article XXIV.6 of GATT will be ipso facto violated as well. Compliance with Article XXIV.5(a) of GATT, nevertheless, does not automatically lead to compliance with Article XXIV.6 of GATT. Compliance with Article XXIV.5(a) GATT is, in other words, a necessary but not sufficient condition for compliance with Article XXIV.6 of GATT. Article XXIV.6 of GATT comes into play any time a member of a CU (in our illustration, Home) has to raise its pre-CU duty to the higher CU level. In this case, Article XXVIII of GATT will kick in. This means that WTO members, which qualify for initial negotiating rights (INRs) or principal supplying interest (PSI), will participate in the negotiations with the members of the CU. Negotiations will aim to compensate those WTO members that will have more difficult access to Home’s market following the establishment of the CU. The second sentence of Article XXIV.6 of GATT makes it clear that built-in compensation will be taken into account. An obligation to compensate will exist only if the built-in compensation does not suffice to take care of the injury suffered as a result of Home’s new, higher duties. Let us go through two factually different scenarios to illustrate this point. First scenario: Home is a small country with a low per capita income, whereas Third is a large country with a high per capita income. Neither Home nor Third produces cars.81 The fact that Third lowers its duties from 40 percent to 30 percent will, in all likelihood,

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overcompensate for the fact that Home raised its own duties from 20 percent to 30 percent. This is the notion of built-in compensation. Third will increase its imports of cars to such an extent that exporters will be compensated for their losses resulting from fewer exports to Home. Second scenario: Home is a large country with a high per capita income, whereas Third is a small country with a low per capita income. In this case, the amount of trade lost because Home had to raise its duties will, most likely, not be compensated by the fact that Third lowered its own duties. In such cases, there is nothing like sufficient built-in compensation. Hence, something needs to be done. Article XXIV.6 of GATT calls for compensation to be offered to the WTO members following negotiations in accordance with the procedures established in Article XXVIII of GATT.82 6.3.5 The Nature of Review 6.3.5.1 A Merger Authority, In Principle Recall from the previous discussion that, in principle, WTO members entering into a PTA, are required to notify the WTO of prospective actions. Article XXIV.7 of GATT provides that the organs examining the consistency of notified PTAs have the power “to make such reports and recommendations to contracting parties as they may deem appropriate.” In principle, thus, one cannot exclude the possibility that the CRTA concludes that a notified PTA is WTO-inconsistent. This conclusion is underscored by the explicit wording of Article XXIV.7(b) of GATT, which explains the powers of the CRTA when it reviews an interim agreement leading to the establishment of a CU or an FTA: If … the CONTRACTING PARTIES find that such agreement is not likely to result in the formation of a customs union or of a free-trade area … the CONTRACTING PARTIES shall make recommendations to the parties to the agreement. The parties shall not maintain or put into force, as the case may be, such agreement if they are not prepared to modify it in accordance with these recommendations. (emphasis added)

The combination of the obligation to notify prospective action and the wide powers conferred to GATT leads to the inescapable conclusion that the regime established was meant to function as a merger authority: PTAs would not be consumed absent permission from the institution. This is not at all what happened in