Concept Of Most Favoured Nation Treatment Under General Agreement On Tariffs And Trade
Most Favoured Nation principle is one of the most fundamental principles of the WTO. It requires member states to accord the most favourable tariff and regulatory treatment given to the product of any one member and/or non member at the time of export or import of “like products” to all other WTO members. Under the Most Favoured Nation rule, should WTO member state A agree in negotiation with state B, which needs not to be a WTO member, to reduce the tariff on the same product X to five percent, this same tariff rate must apply to all other WTO members as well. In other words, if a country gives favourable treatment to one country regarding a particular issue, it must handle all members equally regarding the same issue. The idea of Most Favoured Nation treatment has a long history. An embryonic version of an MFN clause has been traced as far back as 1417, but the origins of the Most Favoured Nation commitment in international commercial matters are generally considered to stem mainly from the seventeenth and eighteenth centuries. Prior to the GATT, a Most Favoured Nation clause was often included in bilateral trade agreements, and as such it contributed greatly to the liberalisation of trade. One of the President Woodrow Wilson’s Fourteen points in 1918 urged “ the establishment of an equality of trade conditions among all the nations consenting to the peace” which was explained to mean “ whatever tariff any nation might deem necessary for its own economic service, be that tariff high or low , it should apply equally to all foreign nations.”
The League of Nations Covenant likewise mentioned the goal of “equitable treatment for the commerce of all members” and the 1919 peace treaties contained Most Favoured Nation clauses. However despite MFN, various trade restrictions and discriminations did exist. At the end of the Second World War, one of the prime post-World War II objectives of the United States was the dismantling of trade preferences, especially the commonwealth system. The United States’ preoccupation with Commonwealth preferences was so intense that a United States representative in London in 1946 included Most Favoured Nation as one of its five basic principles for the development of an International Trade Organization and it is generally said that failure to achieve this result was one of the causes for the failure of the United States to accept the Havana Charter, thus causing the International Trade Organization to fail to materialize. However learning form their mistakes, the major powers of the world decided to include Most Favoured Nation clauses in the General Agreement on Trade and Tariff (GATT) and the incorporation of this clause in GATT has contributed to the stability of the world trade and hence, against this background, MFN principle must be observed as a fundamental principle for sustaining the multilateral free trade system.
The concept of MFN embodies the principle of non discrimination which is a basic and key concept of World Trade Organization. Discrimination between, as well as against, other countries was an important characteristic of the protectionist trade policies pursued by many countries during the economic crisis of 1930s. Historians now regard these discriminatory policies as an important contributing cause of the economic and political crises that resulted in the Second World War. Discrimination in trade matters breeds resentment among the countries, manufacturers, traders and workers. Such resentment poisons international relations and may lead to economic and political confrontation and conflict. In addition, discrimination makes scant economic sense, generally speaking, since it distorts the market in favour of products and services that are more expensive and/ or lesser quality. Eventually, it is the citizens of the discriminating country that ends up paying the bill for the discriminatory trade policies pursued. Not only this principle is justified by history and its potential for reducing trade frictions among countries, but also by its utility as a tool for building peace and security. Without it, countries might retreat into trading blocks, and those blocks might become armed fortress. Thus, unconditional MFN treatment was and remains a legitimate economic means to a noble political end. It reduces trade friction among countries, provides their people with the opportunity to generate jobs and income through trade, giving them a stake in the multilateral economic order, and thereby contributing to peace and stability. With unconditionally, the benefits of open trade would spread multilaterally. Each country would come to realise its stake in nurturing the global economy, given the production and consumption benefits from free trade.
The end consequence of this realisation would be heightened aversion to military conflict, which obviously would destroy the economic gains from trade. The peace and security logic in favour of unconditional MFN treatment is the most sophisticated of all rationales. Generally speaking, the more significant the stake a country has in the international economic order (i.e. the more prosperity its citizens derive from cross-border trade and investment relationships, and financial flows), the less likely it is to unsettle that order through violent conflict with other countries.
Economic Implications Of Most Favoured Nation Treatment
The most favoured nation has several positive economic implications, which are discussed below:
Increased Efficiency In The World Trade:
Firstly, most favoured nation treatment makes it possible for countries to import from the most efficient supplier, in accordance with the principle of comparative advantage. For example, if country A does not produce product X, and if country B can supply product X at a lower price than country C, country A can increase its economic efficiency by importing it from country B. If however, country A applies higher tariff rates to product X from country B than product X from country C, country A may end up importing product X from country C, even though country C is not as efficient a supplier. This distorts trade and, as a result, reduces the welfare of country A and the economic efficiency of the entire world. If, however, the most favoured nation principle is applied between the three countries, then country A will apply its tariffs equally to all exporting countries and will therefore necessarily import product X from country B because it is cheaper to do so. The most efficient result is thus attained.
Reduction Of The Cost Of Maintaining The Free Trade System:
Thirdly, MFN reduces the cost of maintaining the free trade system. The equal treatment demanded by the most favoured nation principle tends to act as a force for unifying treatment at the most advantageous level (which in trade means the most liberal). The establishment and maintenance of the most favoured nation rule enables WTO Members to reduce their monitoring and negotiating costs- the cost of watching and comparing treatment received with that given to third countries. In short, the most favoured nation rule has the effect of reducing the cost of maintaining the free trade system. Finally, as long as the most favoured nation rule is honoured, imports from all WTO Members are treated equally, which reduces the cost of determining an import’s origin and therefore improves economic efficiency.
Advantages For Smaller Countries:
MFN allows smaller countries, in particular, to participate in the advantages that larger countries often grant to each other, whereas on their own, smaller countries would often be not powerful enough to negotiate such advantages by themselves. Apart from that, Granting MFN has domestic benefits: having one set of tariffs for all countries simplifies the rules and makes them more transparent. It also lessens the frustrating problem of having to establish rules of origin to determine which country a product (that may contain parts from all over the world) must be attributed to for customs purposes. MFN restrains domestic special interests from obtaining protectionist measures. E.g., butter producers in country A may not be able to lobby for high tariffs on butter to prevent cheap imports from developing country B, because, as the higher tariffs would apply to every country, the interests of A's principal ally C might get impaired.
Article 1 Para 1 Of GATT
Article 1 of the GATT 1994, entitled ‘General Most Favoured Nation Treatment’, states in paragraph 1:
With respect to custom duties and charges of any kind imposed on or in connection with importation or exportation or imposed on the international transfer of payments for import or exports, and with respect to the method of levying such duties and charges, and with respect to all rules and formalities in connection with importation and exportation, and with respect to all matters referred to in paragraphs 2 and 4 of Article III, any advantage, favour, privilege, or immunity granted by any Member to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other Members.
Essential Requirements Of Article I: 1
Under Article I:1 there are three questions that must be answered to determine whether there is a violation of the MFN treatment obligation of Article I:1, namely:
• Whether the measure at issue confers a trade ‘advantage’ of the kind covered by ArticleI:1;
• Whether the products concerned are ‘ like products’; and
• Whether the advantage at issue is granted ‘immediately and unconditionally’ to all like products concerned.
Any Advantage… The MFN treatment obligation concerns ‘any advantage, favour, privilege or immunity’ granted by any member to any product originating in, or destined for, any other country with respect to1) custom duties; 2) charges of any kind imposed on exportation or importation (e.g. import, surcharges or consular taxes); 3) charges of any kind imposed in connection with importation or exportation (e.g. customs fees or quality inspection fees); 4) charges imposed on the international transfer of payments for imports or exports; 5) the method of levying such duties or charges, such as the method of assessing the base value on which the duty or charge is levied; 6) all rules and formalities in connection with importation and exportation; 7) internal taxes or other internal charges; and 8) laws, regulations and requirements affecting internal sale, offering for sale, purchase, transportation, distribution or use of any product. Under Article I:1, if advantages are granted to all other countries, including non-WTO members, then the member has to grant that advantages also to all WTO members. In other words, the MFN treatment obligation requires that any advantage granted by a member to any product from or for another country be granted to all like products from or for all other members. The Article I:1 casts a very wide net and it is of very wide applicability. Some case examples are:
• In US-MFN Footwear case, also referred to as US-Non Rubber Footwear case, the Panel found: “the rules and formalities applicable to countervailing duties, including those applicable to the revocation of countervailing duty orders, are rules and formalities imposed in connection with importation, within the meaning of Article I:1”.
• The Panel in US-Customer User Fee case stated: “The merchandise processing fee was a “charge imposed on or in connection with importation” within the meaning of Article I:1. Exemptions from the fee fell within the category of “advantage, favour, privilege or immunity” which Article I:1 required to be extended unconditionally to all other contracting parties”.
• In Canada-Autos case , the Appellate Body usefully clarified the scope of Article I:1 by ruling: “Article I:1 requires that “ any advantage, favour, privilege or immunity granted by any Member to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other members”. The words of Article I:1 refer not to some advantages granted “with respect to” the subjects that fall within the defined scope of the Article, but to “ any advantage”; not to some products, but to “any product”; and not to like products from some other Members, but to like products originating in or destined for “ all other” Members.”
• Similarly, in EEC-Imports of Beef case, the panel applied Article I:1 to European Communities regulations making the suspension of an import levy conditional on the production of a certificate of authenticity.
Like Products...ArticleI:1 concerns any product originating in or destined for any other country and requires that an advantage granted to such products shall be accorded to ‘like products’ originating in or destined for the territories of all other members. It must be noted that it is only when the products are like, the MFN treatment obligation applies and that discrimination is prohibited. Products that are not like may be treated differently. The concept of like products is used in various Articles of GATT but it is no where defined in the GATT 1994. The dictionary meaning of ‘like products’ suggests that like products are products that share a number of identical or similar characteristics. However, the Appellate Body noted in Canada-Aircraft case that the dictionary meanings leave many interpretative questions open. With regard to the concept of ‘like products’, there are three questions of interpretation that need to be resolved:
1. which characteristics or qualities are important in assessing ‘likeness’;
2. to what degree or extent must products share qualities or characteristics in order to be ‘like products’;
3. from whose perspective should ‘likeness’ be judged?
The Panel and Appellate Body has accepted that the concept of ‘like products’ has different meaning in the different contexts in which it is used. In Japan-Alcoholic Beverages II case, the Appellate Body illustrated the possible differences in the scope of the concept of ‘like products’ between different provisions of the WTO Agreement by evoking the image of an accordion. The Appellate Body said: The accordion of “likeness” stretches and squeezes in different places as different provisions of the WTO Agreement are applied. The width of the accordion in any one of those places must be determined by the particular provision in which the term ‘ like’ is encountered as well as by the context and the circumstances that prevail in any given case to which that provision may apply”. The meaning of the phrase ‘like products’ in Article I: 1 was addressed in a number of GATT working party and panel reports. In Spain- Unroasted Coffee case , the Panel has to decide whether various types of unroasted coffee ( ‘Colombian mild’, ‘other mild’, ‘unwashed Arabica’, ‘Robusta’ and ‘other’) were ‘like products’ within the meaning of Article I:1. Spain did not apply custom duties on ‘Columbia mild’ and ‘other mild’, while it imposed a seven percent customs duty on the other three types of unroasted coffee. Brazil, which exported mainly ‘unwashed Arabica’, claimed that the Spanish tariff regime was inconsistent with Article I:1. In examining whether the various types of unroasted coffee were ‘like products’ to which the MFN treatment obligation applied, the Panel considered:
• the characteristics of the products;
• their end-use and
• tariff regime of other members.
The panel stated as follows: “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 bean, and the generic factor. The Panel did not consider that such differences were sufficient reason to allow for a different tariff 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 the light of the foregoing, the Panel concluded that unroasted, non-decaffeinated coffee beans listed in the Spanish Customs Tariff…should be considered as “ like products” within the meaning of Article I:1”.
In addition to the three criteria used by the Panel in Spain-Unroasted coffee case, there is one more criteria that has assumed importance and that is consumers’ tastes and habits.
Advantage Granted Immediately And Unconditionally…… Article I: 1 requires that any advantage granted by a WTO members to imports from any country must be granted ‘immediately’ and ‘unconditionally’ to imports form all other WTO Members. Once a WTO Member has granted an advantage to imports from a country, it cannot make the granting of that advantage to imports of other WTO members conditional upon those other WTO Members. In a legal opinion of 1973 in the context of the accession of Hungary to the GATT, the GATT Secretariat noted that: “ the prerequisite of having a cooperation contract in order to benefit from certain tariff treatment appeared to imply conditional most favoured –nation treatment and would, therefore, not appear to be compatible with the General Agreement”. Some case examples are:
• In Indonesia-Autos case , the Panel found with respect to the requirement under Article I:1 that advantages are granted ‘unconditionally and immediately’, as follows: “ under the February 1996 car programme the granting of customs duty benefits to parts and components is conditional to their being used in the assembly in Indonesia of a National Car. The granting of tax benefits is conditional and limited to the only Pioneer company producing National Cars. And there is also a third condition for these benefits: the meaning of certain local content targets. Indeed under all these car programmes, custom duty and tax benefits are conditional on achieving a certain local content value for the finished car. The existence of these conditions is inconsistent with the provisions of Article I:1 which provides that tax and custom duty advantages accorded to products of one Member ( here on Korean products) be accorded to imported like products from other Members ‘immediately and unconditionally’ ”.
• In Canada-Autos case, the Appellate Body also discussed the concepts of ‘immediately and unconditionally’, and found: “The measures maintained by Canada accords the import duty exemption to certain motor vehicles entering Canada from certain countries. These privileged motor vehicles are imported by a limited number of designated manufacturers who are required to meet certain performance conditions. In practice, this measure does not accord the same import duty exemption immediately and unconditionally to like motor vehicles of all other Members, as required under Article I: 1 of the GATT 1994. The advantage of the import duty exemption is accorded to like motor vehicles from all other Members. Accordingly, we find that this measure is not consistent with Canada’s obligations under Article I: 1 of the GATT 1994”.
• In the Belgian –Family Allowances case, a dispute of 1952 concerning a Belgian Law providing for an exemption from a levy on products purchased form countries which had a system of family allowances similar to that of Belgium, the Panel held that the Belgian law at issue introduced a discrimination between countries having a given system of family allowances and those which had a different system or no system at all, and made the granting of the exemption dependent on certain conditions. The panel concluded that the advantage- the exemption from a levy-was not granted ‘unconditionally’ and that the Belgian law was, therefore, inconsistent with the MFN treatment obligation of Article I: 1.
Some Case Examples On The Concept Of MFN In Detail:
1998 Indonesia Car Case : In February and June, 1996, in an effort to develop “National Car”, the Government of Indonesia introduced differences between imports of car components in allocation of tax and custom duty benefits to these imports. The benefits took the form of duty and sales exemptions. The Indonesia Car panel held that the National Car programme blatantly violated Article I: 1.The Car Panel held identified four analytical questions:
I) whether there is an advantage created by a measure?
II) Whether the products affected by the measure are “like”?
III) Whether disputed matter is a type regulated by the MFN provision?
IV) Whether the advantage is offered to all like products unconditionally?
Only if the answer to all four questions is “yes”, there is a violation of Article I: 1. The Panel answered the first two questions in the affirmative without any difficulty. The Panel found that National Cars and their parts and components imported from Korea are “like” any motor vehicle and parts and components imported from other WTO members. As to the third question, the Indonesia Car Panel queried whether the custom and tax benefits of the February and June 1996 car programme are advantages of the types covered by Article I. It replied,
“The Custom duty benefits of the various Indonesia car programmes are explicitly covered by the wording of Article I. As to the tax benefits of these programmes, we note that Article I: 1 refers explicitly to all matters referred to in paragraphs 2 and 4 of Article III. We have already decided that the tax discrimination aspects of the National Car programme were matters covered by Article III: 2 of GATT. Therefore the custom duty and tax advantages of the February and June 1996 car programmes are of the type covered by Article I of GATT”.
On the fourth question, Panel found that Indonesia did not confer unconditionally to all like products the advantages from its custom duty and tax treatment measures. The panel held that GATT case law is clear to the effect that any such advantages (here tax and custom duty benefits) cannot be made conditional on any criteria that is not related to the imported product itself. The court held that it appears that the design and structure of the June 1996 car programme is such as to allow situations where another member’s like product is subject to much higher duties and sales taxes than those imposed on products imported from Korea. The Panel found that custom duties as high as 200% can be imposed on finished motor vehicles while an imported National Car benefits from a 0% customs duty. Further, no taxes are imposed on a National Car while an imported like motor vehicle from another member would be subjected to a 35% sales tax. The Panel further found that distinction as to whether one product is subject to a 0% duty and the other one is subject to 200% duty or whether one product is subject to 0% sales tax and the other is subject to a 35% sales tax, depend on whether or not Indonesia has made a deal with that exporting company to produce that National Car, and is covered by the authorization of June 1996 with specifications that correspond to those of the Kia car produced by the Korea. The Panel held that, in WTO/ GATT, the right of Members cannot be made dependent upon, conditional or even affected by, any private contractual obligations in place . The Panel held that existence of these conditions is inconsistent with the provisions of the Article I: 1 which provides that tax and customs duty benefits accorded to products of one Member (here on Korean products) be accorded to imported like products from other Members “immediately and unconditionally”. Therefore, the Panel held that February and June 1996 car programme which introduced discrimination between imports in the allocation of tax and customs duty benefits based on various conditions and other criteria not related to the import them, are inconsistent with the provisions of Article 1 of GATT.
Canada Auto Pact Case 2000: One of the few disputes in which MFN was a central issue for the Appellate Body to adjudicate is the Canada Auto Pact case . In January 1965, President Lyndon Johnson and Canadian Prime Minister Lester Pearson signed an agreement to liberalise trade in autos and autos part between two countries. Under the Auto Pact, Canada agreed to grant duty free treatment to vehicles and original equipment manufacturing parts (other than tires and tubes), but only if the importer of the cars or parts met the definition of a motor vehicles “manufacturer” set forth in the Auto Pact. There were three tests to be met before a person can be qualified as a “manufacturer”. First, the importer must have produced in Canada during the base year 1963-64 motor vehicles of the category it is importing. In other words, the importer had to have been established and made cars in Canada since before the Auto Pact entered into force. In effect, these importers were also foreign direct investors, such as General Motors of Canada, Ltd, Ford Motor Company of Canada Ltd, and Chrysler Canada Ltd- American Companies that imported cars into Canada that they made in the United States ( or elsewhere), and that also made cars in Canada. Secondly, the importer must comply with the ratio of (1) the sale value of it’s locally (Canadian) produced vehicles of that class of vehicle to (2) the sales it makes in Canada of that type of vehicle. The ratio is called production-to-sales ratio, because item (1) is the value of the importer’s local production, and item (2) is the value of its local sales. The production-to-sales ratio is expressed as follows:
The production is measured on annual basis. Under the Auto Pact, to receive duty-free treatment, an importer had to keep the ratio above a certain minimum threshold because the ratio is a gauge of the extent to which the importer is selling the cars it makes in Canada to Canadian consumers, i.e. selling its local production locally, and possibly also selling the cars it makes locally to foreign countries. Put succinctly, the ratio is a measure of an importer’s commitment to domestic countries. The production-to-sales ratio ensures that the importer does not get the entire vehicle it sells in Canada from abroad. Rather, the importer uses its local factories to source a sizeable percentage, if not all, of the local sales, and perhaps also to source exports from those factories. In sum, the production-to-sales ration is simply to design to ensure some production occurs locally. The Pact specifies the production-to-sales ratio by calling for comparison between the production-to-sales ratio in the current year with the production-to-sales ratio in a base year. The ratio in the current year must be equal to or greater than the ratio in the base year. Moreover, the Auto Pact specified that the ratio must never be less than 75-100 percent. Thirdly, the importer must achieve a minimum amount of Canadian value added (CVA) in its local production of vehicles. That is, the importer’s Canadian production facilities must not be mere assembly operations. There must be significant economic activity going on. Thus, included in the CVA are the costs of parts and materials that are of Canadian origin, Canadian labour costs, the manufacturing overhead costs, general and administrative expenses that occurred in Canada that are attributable to the production of vehicles, depreciation of machinery and permanent plant equipment located in Canada that is directly attributable to the production of vehicles and capital costs for land and buildings used in the production of motor vehicles. The specific CVA requirement was stated in terms of comparison: how much CVA exists in vehicle produced in the current year in comparison with the CVA that existed in the vehicles produced in a defined base year. The requirement was that CVA in current year had to be equal to or greater than the CVA in the base year.
Under the Pact, Canada agreed to abolish its tariffs on imports from the United States of certain finished vehicles, and on imports of certain parts for use as original equipment in vehicles to be produced in Canada. Canada agreed that auto parts could be imported duty free not only from the United States, but also from third countries. However, not everyone could benefit from the duty-free treatment for autos and auto parts-only qualifying person could and the qualifying persons were non other than the major American manufacturers, namely Ford, General Motors and Chrysler and/or their Canadian subsidiaries.
The principal legal issue that was raised in Canada Auto Pact case was the MFN treatment. In January, 1998, the European Union and Japan challenged the Auto Pact in the WTO, and in February 2000, a WTO Panel issued its final report, finding in favour of the complainants. Canada appealed and the issue before the Appellate Body was whether Canada violated MFN obligation by giving duty free treatment to motor vehicles imported from certain WTO Members, but not extending the advantages immediately and unconditionally to like products from all other Members. The Panel answered in the affirmative and so too did the Appellate Body. The EU and Japan argued successfully that the 1965 Auto Pact run afoul of the obligation laid down in article I: 1 of the GATT. The Complainants argued that Pact discriminates in favour of American car companies, and against all other car companies. Only the American companies can import cars and components duty free. In contrast, the Canadian customs authorities impose a duty on these imports by a Japanese or European car company. Thus, for example, Ford and General Motors need not pay any duty on imports, whereas Honda Canada, Inc and Toyota Canada, Inc must pay a duty on their imports. The Appellate Body agreeing with the Panel’s reasoning said that Article I: 1 applies to de facto as well as de jure discrimination. The Appellate Body said that it is true that Pact did not create de jure discrimination against import of auto and autos parts but that is not the only way to run afoul of the law. As long as there was de facto discrimination, that is enough for the violation of MFN obligation under the GATT. The Appellate Body found that Canada has granted an “advantage” in the form of duty- free treatment. This advantage accrues to some products (autos and auto parts) from some WTO Members (principally the United States). Canada has not accorded this advantage immediately and unconditionally to the like products that originate in all other Members. Quite the contrary, Canada has imposed a three- part test that effectively prevents the extension of advantage to all other Members.
1988 Japan Semiconductor Case; This is a case which illustrates unsuccessful effort to invoke the MFN obligations of Article I: 1. At the time of the facts of the case, Japan and U.S were largest producers and exporters of semiconductor chips in the world. Beginning in 1983, the American semiconductor industries began complaining that non-Japanese companies did not have good access to the Japanese semiconductor market. The semiconductor industries of U.S also complained that Government of Japan engaged in unfair trade practices vis-à-vis American companies, and Japanese companies were resorting to anti-dumping practices. In 1986, U.S Semiconductor Industry Association filed a petition with the United States Trade Representatives (USTR) asking for unilateral action under Section 301 of the Trade Act of 1974. The USTR accepted the petition and carried out an investigation. Owing to the investigation, the Japanese and American Government entered into negotiations. The result of the negotiation was the 1986 United States-Japan Arrangement Concerning Trade in Semi- Conductor Products. Under the Arrangement, the Government of Japan engaged to impress upon Japan producers and users of semiconductors the need to take advantage aggressively of increased market opportunities in Japan for foreign based firms seeking to improve their sales performance and position. Further, under the Arrangement, the Government of Japan agreed to provide support in the form of establishment of organization to provide sales assistance, quality assessment, research fellowship programmes and exhibition for foreign semiconductor products.
The Government also agreed to promote long-term relationship between Japanese semiconductor buyers and foreign producers, including joint development programmes. In exchange, the U.S Government asked American semiconductor producers to exploit the opportunity of increased market access in Japan. The U.S Government also agreed to suspend anti-dumping cases against Japanese chip manufacturers, after the Japanese Government agreed to monitor the cost and prices of semiconductor products exported to U.S. Further, both of them also agreed to monitor third country markets, saying that dumping should not occur in third country markets because American semiconductor producers used to compete with Japanese firms in the third country markets, and after the Arrangement, the American firms don’t have to compete with dumped products in these markets.
One issue which arose in 1988 Semi-conductor case was whether 1986 Arrangement violated the MFN principle embodied in Article I: 1 by preferring American semiconductor producers and exporters over all other non-Japanese producers and exporters. The European Economic Communities (EEC), which brought the case, alleged the violation of MFN principle and argued that the Arrangement amounted to “Buy American Policy” endorsed by Government of Japan in order to give preferential treatment to the American semiconductor producers. As for evidence in support of its argument, the EEC said the American semiconductor industry expected the market share of its sales in Japan would show a steady increase and rise to 20 percent by 1991, and that Japan recognised this expectation.
The GATT Panel ruled against the EEC’s argument, finding that the 1986 Arrangement did not violate the Article I MFN principle. The Panel reached to the conclusion that EEC’s evidence does not support its argument.
The panel held that there was nothing in the Arrangement to show that Japan promised to reserve 20 percent of the Japanese semiconductor market for American firms. The Panel gave four reasons for the finding: First, sales of non-American foreign semiconductors in Japan had been expanding steadily, just like sales of American semiconductors. Indeed, the growth of sales of semiconductors in Japan from non-American sources has been higher than that of sales of American semiconductors. Secondly, the Panel found that 1986 Arrangement uniformly applies to all foreign based semiconductor companies. Although the Panel found that there was only one such company not of American origin, there was nothing to prevent a non-American company from establishing itself in Japan on the same terms an American company. Thirdly, the Government of Japan implemented the Arrangement in an impartial manner. Fourth, the EEC’s argument that Japanese users and importers of semiconductor product would perceive the Arrangement as according preference to the U.S was a sheer speculation. Thus, Panel rejected the contention of EEC.
Further Illustration Of The Concept
As a further example of the broad type of measures covered by the MFN obligation, let us consider the following hypothetical illustration. Assume India imposes an MFN rate on turmeric spice of 5 percent. But, for turmeric from Thailand, India generally imposes a 10 percent rate. No Indian law or regulation sets out this 10 percent duty. Rather, the custom official at various Indian ports impose the 10 percent duty. Does Thailand can claim that India violate MFN principle. The answer is in the affirmative. Thailand can argue that Indian practice violates the MFN obligation of Article I: 1.This provision does not distinguish between laws and regulations, on the one hand, and practices on the other hand. Indeed, it speaks of the method of levying duties and charges.
As another hypothetical example, consider an agency and distribution law in Kuwait that mandates exclusivity. That is, any foreign company seeking to export its product to Kuwait must do so through a single Kuwait agent, and that agent has the sole right to distribute the product in Kuwait. Obviously, this law protects Kuwaiti holders of exclusive agreements from competing with one another, and with other foreigners, for agency and distribution rights. Would the Kuwait law violate Article I; 1? The fact that this law is a non-tariff measure is immaterial. The MFN obligation embraces all measures affecting imports, exports or payments.
The jurisprudence of Article I: 1 extends not only to de jure discrimination but also to de facto even if it is not manifest. In other words, any de facto discrimination, even if it is not manifest (i.e., potential or actual) is enough for concern. Thus, suppose the product at issue is flat screen TV sets between 35 and 40 inches, and that Kuwait imports these from Japanese manufacturers like Sony, and Korean producers like LG. If the Kuwaiti law somehow favours the Japanese exporters at the expense of the Korean exporters ( or vice versa), then that law violates Article I:1. Among the scenarios that could give rise to the violation would be the differences in the administration of the law by Kuwaiti officials. Suppose they permit sub-agreements with respect to Japanese imports, but not Korean imports. Therefore, manufacturers like Sony can obtain the services of various Kuwaitis in marketing the TVs, by calling on its exclusive representative to enlist sub-agents and sub-distributors. Through, sub-representation, Sony’s TVs are brought to the attention of Kuwaiti consumers more pervasively than LG’s TVs, which are marketed only by a central representative. This simply is a violation of MFN obligation. Thus, Article I:1 strikes not only at post-border, non-tariff measures, but also at de facto discrimination that is not yet manifest.
Other Provisions Reflecting MFN Principle
Apart from Article 1 Para1, there are other provisions in GATT 1994 that requires MFN or MFN-like treatment. These are:
• Article III Para 7: It provides for granting MFN status regarding internal quantitative regulations.
• Article V: It provides for granting MFN status regarding freedom of transit.
• Article IX Para 1: It provides for granting MFN status regarding marking requirements.
• Article XIII: It provides for non-discriminatory administration of quantitative restrictions.
• Article XVII Para 1: It provides for granting MFN status regarding state trading enterprises.
• Article XVIII Para 20: It concerns governmental assistance to economic development.
• Article XX (j): It concerns goods in short supply.
Exceptions To The Most Favoured Nation Principle
The GATT provides for certain exceptions to the Most-Favoured-Nation rule.
Regional Trading Agreements (Gatt Article XXIV)
Regional Trade Agreements (RTAs) have become in recent years a very prominent feature of the Multilateral Trading System (MTS). The surge in RTA has continued unabated since the early 1990s. Some 380 RTAs have been notified to the GATT/WTO up to July, 2007. Regional integration liberalizes trade among countries within the region, while allowing trade barriers with countries outside the region. Regional integration therefore may lead to results that are contrary to the Most-Favoured-Nation principle because countries inside and outside the region are treated differently. This may have a negative effect on countries outside the region, and thus lead to results contrary to the liberalization of trade.
Regional integration, thus, has a great impact on the world economy today and is the subject of frequent debate in a variety of forums, including the WTO Committee on Regional Trade Agreements. One of the most frequently asked question is whether these regional groups help or hinder the WTO’s multilateral trading system. The WTO Committee on Regional Trade Agreements is keeping an eye on the development. The regional trading groups such as the European Union (EU), the North America Free Trade Agreement (NAFTA), the Association of Southeast Asian Nations (ASEANS), the South Asian Association for Regional Cooperation (SAARC), the Southern Common Market ( MERCOSUR), the Common Market of Eastern and Southern Africa ( COMESA),etc have posed a great challenge to the Most Favoured Nation principle which have lowered or eliminated tariffs among the members while maintaining tariff walls between member nations and the rest of the world. The groupings that are important for the WTO are those that abolish or reduce barriers on trade within the group. The WTO agreements recognize that regional arrangements and closer economic integration can benefit countries. It also recognizes that under some circumstances regional trading arrangements could hurt the trade interests of other countries. Normally, setting up a customs union or free trade area would violate the WTO’s principle of equal treatment for all trading partners (“most-favoured-nation”).
But GATT’s Article 24 allows regional trading arrangements to be set up as a special exception, provided certain strict criteria are met (as mentioned above). In particular, the arrangements should help trade flow more freely among the countries in the group without barriers being raised on trade with the outside world. In other words, regional integration should complement the multilateral trading system and not threaten it. Article 24 of the GATT says that if a free trade area or customs union is created, duties and other trade barriers should be reduced or removed on substantially all sectors of trade in the group. Non-members should not find trade with the group any more restrictive than before the group was set up. On 6 February 1996, the WTO General Council created the Regional Trade Agreements Committee. Its purpose is to examine regional groups and to assess whether they are consistent with WTO rules. The committee is also examining how regional arrangements might affect the multilateral trading system, and what the relationship between regional and multilateral arrangements might be.
Waiver Of MFN Principle In Favour Of Developing Countries:
GATT provides for exception to the Most Favoured Nation principle in favour of the developing countries. Historically, developing countries were critical of the GATT because the trade of the developing countries were not growing as fast as developed countries within the framework of the GATT. Such dissatisfaction led to a study called the Haberler Report , which supported the perception that the export earnings of developing countries were not satisfactory. Later, the formation of United Nation Conference on Trade and Development (UNCTAD) spurred several initiatives within the GATT. First, in 1965, the GATT contracting parties adopted Part IV of the GATT to demonstrate a new concern for the interests of the developing countries. Second, in 1971, the GATT adopted two waivers for two types of preferences to favour developing countries: 1) a set aside of the MFN obligation to permit a “generalised system of preferences” ; and 2) permission for developing countries to exchange tariff preferences among themselves. In 1979, both waivers were made permanent through the so-called Enabling Clause. The Enabling Clause continues to guide WTO policy. The Enabling Clause settled a debate within the GATT and established the policy of special and preferential treatment for developing countries. At the same time, the Enabling Clause contains a so-called graduation clause (Para 7) which is the policy that eventually preferential treatment should end. Article XXXVI, which is incorporated in Part IV of the GATT, is a hortatory provision of “ Principles and Objectives” stating the need to raise standards of living in developing countries, the need for rapid and sustained expansion of their export earnings and increased access to world market for their products. Article XXXVI sets out the principle that developed countries do not expect reciprocity for their commitments to remove or reduce tariffs and other trade barriers.
To take an hypothetical example, assume that the United States grants duty free treatment to rice from Laos, which is not yet a WTO member. The United States does so because Laos is a less developed country in need of help. The United Sates makes the same decision, for the same reason, for rice imported by the United Sates from Cambodia, which is a WTO member. The normal MFN rate of 15 percent continues to apply to rice imported by the United States from Japan, which is also a WTO member. Would Japan have an MFN grievance against the American decision? The answer is “no”. The United States can grant duty-free treatment to developing countries under its Generalised System of Preferences program, whether they are WTO members or not by virtue of Paragraph 1 of Enabling Clause which provides for the general MFN waiver.
Apart from the above mentioned exceptions, there are other provisions in the GATT which can be construed as exceptions to the Most Favoured Nation rule. Article I: 2 provides for exception to the Most-Favoured-Nation principle regarding historical preferences which were in force at the time of the signing of the GATT, such as the British Commonwealth. Article XX, which provides for General Exceptions to the GATT, says that nothing in this Agreement shall be construed to prevent the adoption or enforcement by any contracting parties of measures:- necessary to protect public morals; necessary to protect human, animal or plant life or health; relating to the importations or exportations of gold or silver; necessary to secure compliance with laws or regulations which are not inconsistent with the provisions of the GATT; relating to the products of prison labour; relating to the conservation of exhaustible natural resources, etc. Article XXI, which provides for Security Exceptions to the GATT, says that nothing in this Agreement shall be construed :
a) to require any contracting party to furnish any information the disclosure of which it considers contrary to its essential security interests;
b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests- relating to fissionable materials or the materials from the materials from which they are derived; relating to traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a material establishment; taken in time of war or other emergency in international relations;
c) to prevent any contracting party from taking any action in pursuance of its obligations under the United Nations Charter for the maintenance of international peace and security. Article XIV provides for exceptions to the rule of non-discrimination in order to enable the member countries to deal with the balance of payment difficulties. Article XIX, which deals with Emergency Action on Imports of Particular Products ( Safeguard Measures), provides that if, as a result of unforeseen developments and of the effect of the obligations incurred by a contracting party under this Agreement, including tariff concessions, any product is being imported into the territory of that contracting party in such increased quantities and under such conditions as to cause or threaten serious injury to domestic producers in that territory of like or directly competitive products, the contracting party shall be free, in respect of such product, and to the extent and for such time as may be necessary to prevent or remedy such injury, to suspend the obligation in whole or in part or to withdraw or modify the concession.
The Most Favoured Nation (MFN) principle is a cornerstone of the multilateral trading system conceived after World War II. It seeks to replace the frictions and distortions of power-based (bilateral) policies with the guarantees of a rules-based framework where trading rights do not depend on the individual participants’ economic or political clout. Rather, the best access conditions that have been conceded to one country must automatically be extended to all other participants in the system. This allows everybody to benefit, without additional negotiating effort, from concessions that may have been agreed between large trading partners with much negotiating leverage. Although the formation of Regional Trading Blocks has eroded the fundamental importance of the concept to some extent, it is still the most fundamental obligation on which the entire foundation of GATT and WTO rests. The MFN principle must be observed as a fundamental principle for sustaining the multilateral free trade system. Regional integration and related exceptions need to be carefully administered so as not to undermine the Most Favoured Nation principle as a fundamental principle of the WTO.
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