US-China Trade Conflict: the WTO Verdict, the Holistic Approach in Interpreting Article XX and the Aftermath

Background

A World Trade Organization (WTO) Dispute Settlement Body (DSB) Panel handed a verdict in favour of China on 15 September 2020. The United States (US) had imposed additional tariffs of 25% on certain products from China on 20 June 2018. These products were listed as List 1. On 21 September 2018 the US had imposed additional tariffs of 10% on another list of products from China. These products were listed as List 2. While imposing the 10% tariff on the List 2 products the US stated that it would increase the tariffs to 25% on 01 January 2019. After delaying the increase, for which the US did not provide any reasons, the tariffs were increased to 25% on 09 May 2019.

The US claimed that a United States Trade Representative (USTR) Section 301 Report under the US Trade Act, 1974 showed that China’s acts, policies and practices amounted to ‘state-sanctioned theft and misappropriation of US technology, intellectual property, and commercial secrets’ which violates public morals prevailing in the US as it goes against the ‘standards of right and wrong.’ Hence, the US defended the imposition of tariffs under Article XX (a) of the General Agreement on Trade and Tariffs (GATT) citing that the tariffs were necessary for protecting public morals.¹

As per the Dispute Settlement Understanding (DSU), China had at first initiated discussions to resolve the dispute. Failing to resolve the dispute through discussions, China forwarded it to a DSB Panel claiming that the US tariffs on the products violated Article I:1, Article II:1 (a) and Article II:1 (b) of the GATT, 1994. China claimed that the US tariffs violated the Most Favoured Nation (MFN) principle and the scheduled bound rates submitted by the US to the WTO. The MFN principle requires WTO member states not to discriminate amongst trading partners and to afford all trade advantages equally to member states. The scheduled bound rate is a list provided to the WTO by its member states stating the tariff rates on different products. If a country goes above the bound rate, other member states can seek recourse through the DSU.

China had prima facie established a case under Article I:1, Article II:1 (a) and Article II: 1 (b) of GATT. The DSB Panel found in favour of China as the US’s imposition of additional duties on Chinese goods was a clear violation of the most favoured nation (MFN) principle and a violation of the scheduled bound rates submitted by the US.² Although the DSB Panel found the US interpretation of public morals under Article XX (a) conceptually right,³ under a ‘holistic approach’ taken by the DSB Panel, the US failed to prove how public morals were protected by the imposition of the tariffs.⁴ This blog looks into how the DSB Panel Report reached its conclusion on the issue of Article XX (a) under the ‘holistic approach.’

Holistic Approach in Examining GATT Article XX

In adjudicating on the US’s defence of the imposition of additional tariffs under Article XX (a), the DSB Panel undertook the two-tier test.⁵ At first it adjudged whether the measures taken fall under any of the exceptions of Article XX and if so, whether the measures are justified under the chapeau of Article XX.⁶

In determining the first test, the DSB Panel undertook a ‘holistic approach.’ The DSB Panel stated that the nature and purpose of Article XX (a) will be frustrated if a ‘holistic approach’ is not taken. The ‘holistic approach’ consists of finding out: (i) whether the measures fall under the ambit of Article XX (a); (ii) whether the measures are designed to protect public morals; and (iii) whether the measures are necessary to protect public morals.

The DSB Panel in determining the first issue under the ‘holistic approach’ undertook the measure set by the DSB Panel in EC – Seal Products.⁷ Following the EC – Seal Products test, the DSB Panel first examined whether the concern in question, ie the alleged state-sanctioned theft and misappropriation by the Chinese, indeed exists in that society. The DSB Panel found that the public morals objective as invoked by the US reflects societal interests ie theft and misappropriation of the US intellectual property that the US describes as highly important to it.⁸ Secondly, the DSB Panel determined whether such concern falls within the scope of ‘public morals’ as ‘defined and applied’ by a regulating member ‘in its territory, according to its own systems and scales of values.’⁹ The DSB Panel found the US’s interpretation of ‘public morals’ conceptually right.¹⁰ China raised a claim that the legal instruments which the US issued in the declaration of the additional tariffs imposed did not contain any reference to the protection of public morals. The DSB Panel stated that it is not necessary for the legal instruments implementing the additional tariffs to mention a public morals objective. China raised another objection stating that Article XX is only limited to non-economic measures. The DSB Panel rejected this interpretation as well stating Article XX (a) is not limited to non-economic measures only.¹¹

The DSB Panel next moved to the second stage of the ‘holistic approach’ to find whether the public morals objective is designed to protect public morals. The US argued that the measures have disincentivized China from continuing its conduct that the US found to be morally objectionable and thus meet the minimal threshold of being ‘designed to’ protect public morals for the purposes of Article XX (a).¹² The DSB Panel to a certain extent agreed with the US submission that the imposition of additional duties is capable of protecting public morals. But the DSB Panel was not convinced that the conclusion of the second stage of the ‘holistic approach’ is enough. Rather, the DSB Panel was of the view that the justification of Article XX (a) must be found under the necessity test ie the third stage of the ‘holistic approach’ as well.¹³

In the third stage of the ‘holistic approach’, the DSB Panel examined whether there is a nexus between the measures taken and the objectives that the US is seeking. The US in this case was unable to provide sufficient evidence to show the link between the imposition of tariffs and the public morals objective. Rather, the US after the declaration of tariffs on List 1 products, on 11 July 2018, gave three criteria on the basis of which some products can be excluded from the list if it is requested by US importers. The criteria are: (i) whether the particular product is available only from China and whether the particular product and/or a comparable product is available from sources in the US and/or in third countries; (ii) whether the imposition of additional duties on the particular product would cause severe economic harm to the requestor or other US interests; and (iii) whether the particular product is strategically important or related to certain Chinese industrial programmes. The USTR reviewed the requests for removal of tariffs on a case by case basis.¹⁴ The US failed to prove to the DSB Panel why the products that were initially thought to be benefitted from alleged Chinese practices of theft and misappropriation have been removed. The US also failed to prove how the removal of these products helps them to achieve the public morals objective.¹⁵ As far as the products on List 2 are concerned, the US also failed to show the DSB Panel that those products are a result of Chinese practices that are harming US public morals.¹⁶

The DSB Panel found that the US has failed to demonstrate how the ends justify the measures taken.¹⁷ Therefore, the US defence under Article XX (a) failed the necessity test.

As the US’s measures could not pass the first phase of the two-tier test through the ‘holistic approach’, the DSB Panel found it unnecessary to examine whether the measures are justified under the chapeau of Article XX.¹⁸ For this very reason, the DSB Panel also did not find it necessary to compare the ‘reasonably available alternative measures.’¹⁹

Decision and Aftermath

The DSB Panel concluded that the measures taken by the US violate Article I:1, Article II:1(a) and Article II:1(b) of GATT, 1994 resulting in the violation of the MFN principle and the bound rates for the US schedule.²⁰

As far as the verdict goes, the US can render it moot. Under the DSU it has 60 days to appeal to WTO Appellate Body but the Trump administration’s decision not to appoint new member has made the WTO Appellate Body toothless. This decision was taken a few years back as the current US administration in line with its trade protectionism policies blocked new appointments to the body. The major cause was that the US did not like how the WTO Appellate Body had ruled against it on issues of countervailing measures or in the trade conflict with the European Union (EU) regarding Airbus and Boeing. The WTO Appellate Body has to have seven members; presently there is only one. The US government’s decision not to appoint new members has made the forum paralyzed. But the verdict does give the US government some ammunition in its trade war with China. ‘This DSB Panel report confirms what the Trump administration has been saying for four years: The WTO is completely inadequate to stop China’s harmful technology practices’, US Trade Representative Ambassador Robert Lighthizer said in a statement after the verdict.

In reality, it can be said that the US, China and the WTO are all losers in this case. The US would certainly face more retaliatory measures from China as the present state of the WTO Appellate Body (AB) renders the WTO (AB) unable to hear any appeal including this one. China’s legal victory is hollow as the US would certainly not remove the additional tariffs. As the WTO Appellate Body remains paralyzed one would wonder at the utility of the WTO dispute settlement mechanism. The EU, however, could heave a sigh of relief over the WTO verdict. The current US administration has threatened to use Section 301 of the US Trade Act, 1974 against the EU in response to its imposition of taxes on digital companies in the region.²¹ It’s safe to say that this verdict would make the US think twice before taking such measures.

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References

1. WTO, United States – Tariff Measures on Certain Products from China (15 September 2020) WT/DS543/R [7.100].
2. ibid [7.86], [7.96].
3. ibid [7.140].
4. ibid [7.242].
5. See eg United States – Standards for Reformulated and Conventional Gasoline (WT/2/DS/R) [1996] 1 DSR 3, 22.
6. WTO (n 1) [7.110].
7. WTO, European Communities – Measures Prohibiting the Importation and Marketing of Seal Products (25 November 2013) WT/DS/400/R, WT/DS/401/R [7.383].
8. WTO (n 1) [7.169].
9. WTO (n 1) [7.140].
10. ibid.
11. ibid [7.133]-[7.137].
12. ibid [7.147].
13. ibid [7.151].
14. ibid [7.202]-[7.204].
15. ibid [7.212].
16. ibid [7.222].
17. ibid [7.229].
18. ibid [7.242].
19. ibid [7.235].
20. ibid [8.2].
21. ibid.