Rules of Origin panel ruling damages MFN principle

Geneva, 24 July (Chakravarthi Raghavan) - The World Trade Organization and its Dispute Settlement Body adopted 21 Sep the report of a panel on a dispute raised by India against the United States over the Rules of Origin measures applied on textiles imports, that is going to prove as damaging for the system, if not more, than the 1958 GATT panel ruling that wrongly judged wheat flour to be a primary product.

It has long been accepted, almost axiomatically, by trade law experts and commentators, that the problems facing the multilateral trading system (under the old GATT and in the 8-year-old WTO), in the efforts to ‘reform’ agricultural trade and cure it of its distortions and create a level playing field for developing countries, can all be traced to the original sin of a bad panel ruling dating back to 1958 on the definition of a primary product in respect of GATT Art. XVI, prohibiting export subsidies. Subsidies on exorts of primary products are to be avoided.

That 1958 panel ruling, ‘French Assistance to Exports of Wheat and Wheat Flour’, holding wheat flour to be a primary and not processed product, laid the ground work for all the problems and disputes about agricultural trade and the distortions caused by the various subsidies and support programmes and policies of the rich nations.

A subsequent challenge in 1980, leading to a 1983 panel ruling, in a dispute raised by the US arguing that wheat flour is a non-primary product, was not adopted. That 1983 panel report, in the dispute arising out of EC subsidies on exports of wheat pasta, had said that neither the US nor the EC had “finally contended that pasta was a primary product”; and the panel went on to rule that pasta was not a primary product, but a processed agricultural product.

Subsequent GATT rounds (including the Tokyo Round), and the 1994 Uruguay Round Agriculture Agreement setting the ground for a reform, have been unable to undo the mischief caused by the original bad ruling.

The latest panel ruling arising from the Agreement on Rules of Origin (ARO), has given interpretations that depart from the hitherto accepted views about non-discrimination among goods that are ‘like’, ‘directly competitive’ or ‘substitutable products’, and limiting the non-discrimination to the ‘same goods’, has now driven a coach-and-four through the fundamental Most-Favoured-Nation and Non-discrimination principles of international trade that predated even the GATT.

The ruling also changes the meaning of ‘international trade’ to rule out bilateral trade.

There are many other perverse findings and rulings, written in a clever way, by proceeding, not on the basis of the panel’s interpretation of a disputed rule and then judging the evidence produced, but by the panel couching an interpretation, without giving one, by using the term ‘in arguendo’ (accepting for the sake of argument), the meaning of a rule as put forward by the complainant, and then deciding that the complainant has not proved it by its evidence!

This perverse ‘in arguendo’ way of interpretation prevents the ruling being appealed before the appellate body. And in future disputes, this bad ruling can be cited and becomes new law!

India in its intervention said the report was fundamentally flawed, but complained that the way it has been drawn up made it impossible for India to go in appeal. Philippines the third party, while aggrieved that the ruling was not being appealed, expressed understanding for India’s plight.

The DSB adopted by the negative consensus rule, the report of the panel on the Rules of Origin - where India had challenged the US rules of origin and the changes effected in 1994 by the US in its long-standing practices and rules in respect of imports into the US of textiles and clothing products.

The US changed its rules about origin of textiles and clothing products, and what in trade parlance is called the ‘fabric formulation’ to attribute the origin of a good (a clothing product) that a country exports, on the basis of the origin of the fabric, and debit such an import against the quota of the fabric originating country for the Agreement on Textiles and Clothing.

The rule was challenged by a number of textile and clothing exporting countries, including the European Communities. Subsequently, the US changed the rules in a way that it would not apply or adversely hit the high-value exports of the EC to the United States.

The three-member panel was headed by the former Swedish ambassador to the GATT, Mr. Lars Anell, who had chaired and guided the Uruguay Round negotiations on Trade-Related Intellectual Property Rights, and helped formulate the infamous 1989 mid-term accord (forced on developing countries by the GATT Director-General Arthur Dunkel) to negotiate norms and standards in the Uruguay Round, and subsequently helped to formulate the ‘Dunkel text’ on TRIPS presented by Dunkel in 1991 December as part of a package.

The panel, with Anell as chair and Ms Mary Elizabeth Chelliah and Donald McRae as members, was named by the WTO Director-General (in a by-now common practice) since the parties could not reach an agreement on the panellists.

The report of the panel is so full of contradictions and violations of the fundamental principles of law and judicial norms, including the basic due process requirements for natural justice applicable to judicial and even administrative tribunals, ‘audi alteram partem’, that in any country governed by rule of law, the ruling would be set aside by a court of record.

The most egregious violation, and one that brings out the inadmissible role of the secretariat or of a panel, is in using material not brought on record by either party in hearings open to both, or in written submissions to which the other side can respond. This one cites a document of the WTO, of work in progress, in a committee on harmonising rules of origin.

It is bad enough that a treaty interpreter has sought to interpret the provisions of an agreement by reference to the socalled ‘negotiating history’ (when the Uruguay Round has no negotiating history approved by the plenipotentiaries who negotiated the treaty); but it is worse when the meaning of a rule is sought to be interpreted by reference to subsequent efforts (which have not even produced an agreement) in the ongoing process of work on harmonizing rules of origin.

In para 6.73 of the ruling, though presenting it as an en passant observation, the panel has cited a document, G/RO/52 of the WTO Committee on Rules of Origin, engaged in the process of harmonisation of the rules that the Marrakesh treaty mandated, where various countries have presented positions on how the harmonisation should take place, and several of them indicated support for a ‘fabric formation’ rule adopted by the US!

The published record of the panel does not show this document was cited by any of the parties before it. How then did the panel get the document to cite? Did it have any communication behind the back of the complainant with one of the parties, or did the secretariat provide it, or did the panellists ‘research’ and find it?

Even then, the rules of natural justice would require the panel to have asked the views of all the parties, and third parties on this. There is no record that this was ever done.

And in fact India made a pointed reference to this in its intervention at the DSB.

But the dispute settlement mechanism under the rules-based WTO is such that none of the procedural and substantive rights seem to prevail.

Unfortunately, even in the current review of the Dispute Settlement Understanding, and the chairman’s text on the basis of which (if Cancun so decides) further negotiations are to be held, this does not figure. India at one stage had made the suggestion that the secretariat or anyone else should not provide any briefing or notes to the panel, without making it available to all the parties, so that they could comment on them. This does not seem to be on the table in the DSU review.

In its intervention at the DSB, India viewed the ruling as “fundamentally flawed”, with a few “particularly egregious aspects” to which it drew attention and placed on record.

In terms of Art.2 (b) of the ARO, before the panel, India had contended that the US law (S. 334 of the UR implementation) brought more textiles and clothing items under quota, and thus strengthened the impact of the quota regime, put in place to protect domestic industry. This, in India’s contention, showed that the US was using the rules of origin in pursuit of a trade objective to protect its domestic textile industry.

The panel in para 6.84 said that “using rules of origin which render a quota regime more restrictive may be consistent with using rules of origin to implement and support such a (quota) regime.”

Then the panel went to say that that the requirement against discrimination between Members, stipulated in Art.2.d of the ARO, applied only “to goods that are the same”. The panel thus has restricted the product scope of non-discrimination obligation to “discrimination on the same good”.

India pointed out that the ordinary meaning of ‘the good concerned’ used in Art.2 (d) would be that the good is ‘affected’ by or ‘involved’ in the practice that is regulated in the practice, namely the discriminatory treatment between Members. However, the panel has interpreted it to apply only to the ‘same good’.  If such an interpretation is followed in the future, this provision will have “a narrower definition of the non-discrimination standard than that contained in similar non-discrimination provisions in other WTO agreements.”

As a result of the panel ruling, under Art.2 (d) of the ARO, Members may “discriminate” between other Members on the basis of goods that are “like”, “directly competitive” or “substitutable”.

The drafters of the ARO, India said, in no way intended thus to limit the effectiveness of Art. 2 (d).

In complaining over the methodology adopted by the panel, India told the DSB that in accordance with the GATT and WTO jurisprudence, the panel should have assessed the WTO-consistency of the measure based on the “conduct-oriented approach”, namely, Members refraining from adopting and maintaining rules of origin which establish conditions of competition with restrictive, disruptive or distorting effects on international trade. In such an approach, the incentives and disincentives created by the rules of origin themselves, and not their impact on the market place, would be the decisive factor in determining the WTO consistency.

The immediate impact of any rule of origin is to change the investment and other business plans of producers and investors engaged in international trade. Since market conditions constantly change, and rules of origin are only one of many factors that determine trade flows, a Member cannot foresee with any degree of accuracy, how producers and traders will react to a new rule of origin. Members can only control and foresee the conditions of competition they impose.

Yet the panel ignored all these and found that Art.2 (d) regulates not only the rules of origin adopted by members, but rather the reaction of producers and traders to these rules.

“There is simply no basis for such an interpretation in accordance with the jurisprudence of the WTO. If, as the panel assumed, one must examine the trade impact of a rule of origin, in order to assess its WTO-consistency, then a complaint could not be brought against a rule of origin immediately on its adoption, but only after several years, after its trade impact becomes apparent.”

On India’s complaint that the US rule had adverse impact on its trade, the panel said it was not convinced that “demonstrating an adverse effect on one Member’s trade would always and necessarily be sufficient to demonstrate a violation of the term ‘international trade’ in Art.2 ( c).”

The ordinary dictionary meaning of the term international would be “existing, occurring or carried on between two or more nations”. India and the US as two nations carry on trade, but the panel’s interpretation is that the adverse impact on India’s trade is not enough.

The WTO Agreement on SPS measures and the TBT Agreement all employ the terms ‘on international trade’, but their provisions have not been interpreted as requiring showing of effects on more than one Member state.

In a reference to the panel citing the ongoing work on harmonization and the positions of various WTO members, India complained that the panel had not given the parties an opportunity to comment on evidence that the panel had sought on its own initiative without the knowledge of the parties.

“Is it appropriate,” asked India, “for a panel to examine the negotiating positions of Members in order to ascertain the WTO-consistency of a challenged measure?”

The panel, India added, did not also give the parties an opportunity to comment on the information that it had researched on its own.

On the panel’s contentions about India not having adduced evidence on the basis of trade data about the effects of the US rule on international trade, India pointed out that in interpreting the rules of origin, India had said that a conduct-based approach should be applied. In such an event, the evidence produced by it was sufficient.

But if the panel was adopting a different approach on trade data, it had not asked India specifically to provide trade data to demonstrate the adverse trade effects. The panel had asked over 70 questions to the parties and third parties, but never once specifically asked India for the trade data.

“Only when the panel report was issued did India learn that the panel consistently found that India had failed to produce the necessary evidence....  If the panel had considered that trade data was necessary, it should have availed itself of the vehicle of asking questions of the parties, or its discretion under Art. 13 of the DSU, to seek the information it considered necessary.”

The panel had ignored the well-established principle of burden of proof applicable to WTO cases that had been enunciated by the Appellate Body. In holding that India had not established its claims by adducing evidence, the Panel said that India had not provided evidence of trade data, regarding:

·        which countries are under quota in the US with respect to relevant downstream goods (e.g. cotton bed linen);

·        which countries are important suppliers of relevant upstream goods (.e.g cotton fabrics); and

·        the price and quality of the upstream goods made by those countries and their production capacity.

Having laid out such a standard of evidence to be produced by India, the panel did not observe the same standard to the United States, when the US asserted “facts” or “asserted the affirmative of a particular defence.”

The panel for example accepted at face value, the US contention that at the time the rules of origin were implemented, and thereafter, six out of the ten world exporters of cotton fabrics accounting for 50% of world trade in cotton fabrics were countries that were not subject to quota on fabric or bed linen in the US.  The panel relied on this fact in determining that the evidence and argument adduced by India did not support the conclusion that the fabric formation rule necessarily, or in fact, brings more imports of made-up articles under quota in the US, by observing that origin could have shifted to those six countries that were not under quota.

But in a footnote 199, the panel said: “the United States has not however, provided any evidence in support of its statement.”

In its ruling, the panel adopted an interpretation of Art.2 of the rules of origin which acknowledged exclusively the discretion of a Member to determine the use of its rules of origin, without drawing the line at an abuse of the rule. Second, it adopted an interpretation of the non-discrimination provision of Art. 2 (d) of the ARO that narrows the scope of the non-discrimination provision in the WTO agreements, in particular Art.1 of the GATT. Third, it avoided making clear legal interpretations by couching its interpretation in arguendo and then making findings of fact based on these interpretations. The panel also failed to seek information from India it considered necessary for proper evaluation of the dispute.

As a result, the report of the panel does not form a proper basis for an appeal, India said in explaining why it was not appealing the ruling.

In its intervention, the Philippines echoed India’s complaints about the panel, and said the panel had set such the standard of evidence required from a complainant “at such an inordinately high level that it is doubtful whether any other outcome could have been possible.”

Also, in interpreting the scope of Art.2 of the rules of origin in terms of what a Member should not do during the transition period that the Harmonised Work Programme is being negotiated, the panel “virtually condones an overly expansive scope of measures that a Member could undertake during this transition period.”

“By doing so,” added the Philippines, “it would not surprise this delegation to find certain Members encouraged to further prolong the ongoing negotiations on the Harmonised Work Programme given the practically unlimited ambit they have in the interim period.”

[The work programme, mandated to be concluded by end 1998, is still continuing.  The US and a few others have been delaying and blocking the harmonisation process,]

In finding in favour of the US about the fabric formation rule, the panel seems to have put weight on the fact that the US is not the only country that uses such a rule, and notes with interest that within the framework of the Harmonized Work Programme, a significant number of members have indicated support for such a fabric formation rule for textile goods. It was the understanding of Philippines that on this matter the panel sought this information on its own initiative, without however affording the parties opportunity to comment on the information obtained.

“We are uncertain whether this approach undertaken by the panel in this instance is appropriate.”

The Philippines also found it disconcerting that the panel (para 6.84) had said that even if India had established to the panel’s satisfaction that under the fabric formation rule, more imports would be under restraint in the US, this would not prove that the fabric formation rule was being used to protect the US textile industry.

“This, along with other subsequent statements of the panel, seems to ignore the fact that, domestic policies are not formulated in a vacuum, but rather with concrete trade objectives in mind. However, more egregiously, the panel seems to imply that, even if India had provided the necessary factual evidence suggested by the panel as critical, it would not have been sufficient to meet the panel’s standard to prove inconsistence with Art. 2(b).”

Again, in examining the changes instituted by the US, in pursuance of its agreement with the EC, and testing the consistency of section 405 of the US law with Art. 2 (b), the panel had disregarded the ‘design, architecture and structure’ test. Rather, it examined the intentions of the EC and the US in entering into the agreement to settle their dispute. It then also makes the statement that “even if section 405 had the practical effect of favouring goods imported from the EC over competitive goods imported from other members, that effect might be incidental, rather than intentional... In other words, the mere effect of favouring EC imports over imports from other Members [does not] in itself justify the inference that creating such an effect is an objective pursued by the US.”

“This assumes that such policies are drawn up in a vacuum, without the benefit of a clear trade objective in mind, which as negotiators are aware, and as simple reality dictates, is simply not the case.”

Again, complained the Philippines, in para 6.113 the panel says that “there is no evidence that the EC requested the US to create exceptions frm the fabric formation rule so that it could enjoy an advantage, competitive or otherwise, vis-a-vis other Members.”

“Yet, two paras down, in para 6.115, the panel accepted that the US was persuaded by the EC that it would be appropriate to amend section 334 and return to the DP2 (dyeing, printing plus other two other finishing processes rules) for the relevant products.”

This suggests, to adopt the panel’s favourite line “even if” the US and EC had every right to settle their bilateral disputes, it cannot be ignored that the intension was de facto to favour imports of certain gods frm the EC, vis-a-vis closely related, if not essentially similar goods from other Members.

The panel’s interpretation of Art.2 (d) that it applies only to the ‘same’ goods, means that this is a narrow conception of the non-discrimination standard, and implies that Members may discriminate between other Members on the basis of goods that are ‘like’, ‘directly competitive’ or ‘substitutable’, just not goods that are closely related or are the same. – SUNS5392

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