Settling WTO disputes without solving the problem: Abusing compensation

Simon Evenett, Alejandro Jara

The WTO’s dispute settlement procedure was set up to help governments challenge policies that contravene WTO agreements. This column argues that two recent cases show that cases can be settled without resolving the problem and sometimes at the expense of other trading partners. This is an abuse of the system and a step backwards for the world trading system.

The WTO Dispute Settlement Understanding came into effect in 1995. After 400 disputes between WTO members had been addressed, the then Director-General of the WTO, Pascal Lamy, declared “The dispute settlement system is widely considered to be the jewel in the crown of the WTO” (Lamy 2009). He went on to argue that “No trade negotiator enters a negotiation without some assurance that the agreements he negotiates will be underpinned by a credible dispute settlement system” (Lamy 2009).

Once the Dispute Settlement Understanding procedures are invoked, a trade dispute moves on to legal (as opposed to diplomatic) territory. As Lamy observed: “All the political muscle-flexing and grandiloquence is discarded at the door once the case enters the WTO” (Lamy 2009). For many legal scholars, the creation of the understanding was an integral part of the move towards a rules-based world trading system (e.g. Jackson 1997). For economics scholars the Dispute Settlement Understanding plays an important role in making WTO accords self-enforcing (Bagwell and Staiger 2010). The question is whether it is desirable that WTO members can settle disputes by disregarding the disciplines and objectives of the Dispute Settlement Understanding and without addressing the root causes of a dispute?

How disputes are supposed to be settled at the WTO

The legal text of WTO’s Dispute Settlement Understanding1 has plenty to say about how disputes should be settled. Article 3.7 states: “The aim of the dispute settlement mechanism is to secure a positive solution to a dispute. A solution mutually acceptable to the parties to a dispute and consistent with the covered agreements is clearly to be preferred.”

Mutually acceptable solutions are to be contrasted here with outcomes that follow from legal rulings. Moreover, paragraph 4 of the understanding states “Recommendations or rulings made by the [Dispute Settlement Body] shall be aimed at achieving a satisfactory settlement of the matter in accordance with the rights and obligations under this Understanding and under the covered agreements.”

However, not every mutually acceptable solution between two disputants is acceptable. Paragraph 5 of the understanding states “All solutions to matters formally raised under the consultation and dispute settlement provisions of the covered agreements, […] shall be consistent with those agreements and shall not nullify or impair benefits accruing to any Member under those agreements, nor impede the attainment of any objective of those agreements.” (emphasis added). This is consistent with the general provision that “Recommendations and rulings of the [Dispute Settlement Body] cannot add to or diminish the rights and obligations provided in the covered agreements.”(paragraph 1 Article 3). Those rights include the rights of WTO members that are not parties to the dispute.

In order to safeguard transparency, and particularly the interest of third parties, Article 3.6 states that “Mutually agreed solutions to matters formally raised under the consultation and dispute settlement provisions of the covered agreements shall be notified to the Dispute Settlement Understanding and the relevant Councils and Committees, where any Member may raise any point relating thereto.”

The understanding states that in “[t]he absence of a mutually agreed solution, the first objective of the dispute settlement mechanism is usually to secure the withdrawal of the measures concerned if these are found to be inconsistent with the provisions of any of the covered agreements. The provision of compensation should be resorted to only if the immediate withdrawal of the measure is impracticable and as a temporary measure pending the withdrawal of the measure which is inconsistent with a covered agreement.”

In sum, a ruling approved by the Dispute Settlement Body does not determine how a dispute ends. A negotiation takes place between the parties to determine how and when the ruling will be complied. However, any settlement must meet at least three criteria:

it must be consistent with WTO agreements,

it should not be to the detriment of the rights of other members, and

compensation is only allowed if the immediate withdrawal of the offending measure is not practicable and its maintenance is temporary pending its withdrawal.

Two recent WTO disputes settled at the expense of third parties

During October 2014 two WTO disputes were settled in an extraordinary manner:

A complaint by Indonesia against the US ban on clove cigarettes, 2 and

and A complaint by Brazil against the US regarding subsidies on Upland Cotton.3

In both cases the US largely lost and the winning parties came close to retaliating against US commercial interests. In both cases the upshot is that offending measures have been maintained, albeit with some limitations.

In the upland cotton case the agreement supersedes a deal in 2010 that had temporarily settled the dispute by means of a US-financed Fund for Technical Assistance and Capacity Building. The latter settlement lasts until 30 September 2018 and includes, amongst others, the following elements:

A one-time payment of 300 million USD to the Brazilian Cotton Institute for specific activities.

The US shall not offer export credit guarantees for loans of longer than 18 months.

Brazil shall not initiate dispute settlement consultations with regards to such export credit guarantees and other current domestic support program or policy specific to upland cotton (a so-called peace clause).

In contrast, the details of the clove cigarettes settlement have not been provided by the parties, which itself is troubling. However, press sources4 indicate that the settlement provides that:

The US will not discriminate against clove-flavored cigars and cigarillos. The ban was against clove-flavored cigarettes and the Indonesian industry repackaged said products into cigars and cigarillos which are not banned.

The US will not pursue a WTO dispute against Indonesian export restrictions for certain mineral and mining products (the US had not yet triggered the dispute settlement procedures with regards to these high profile measures introduced earlier this year).

The US will consider adding ignition-wiring sets to the items covered under the (currently expired) trade preferences that it grants, reversing a petition to this effect that had been denied.

Both parties will negotiate a plan to better protect and enforce intellectual property rights in Indonesia. Recently the US had placed Indonesia on its “Priority Watch List” that singles out the egregious intellectual property rights offenders in its “Special 301” reports.

Now let’s apply the three tests derived from WTO rules (mentioned above) to the two settlements of complaints raised against the US. In the absence of additional evidence, we conclude:

In both disputes, the offending measures are maintained without a deadline for their derogation.

In the Upland Cotton settlement a monetary compensation is maintained but only to the benefit of the complaining party. Other interested and much weaker parties, such as Burkina Faso, Benin, Mali, and Chad, will still have to face the consequences of the US agriculture support found in breach of its WTO obligations.

In the clove-flavored dispute – according to the media – the compensation involves no correction to the offending measure but a promise to apply an opening-market measure (inclusion of other products in a trade preference scheme for developing countries) and a promise by the US not to challenge an export prohibition applied by Indonesia or take other action related to intellectual property right infringements (as if three wrongs make a right).

These are not the only cases where parties have settled a dispute in WTO while maintaining the offending measure. For example, in the Hormones cases,5 a settlement – apparently temporary – was reached by the EU with the US and Canada whereby the offending measure was not removed, but there was compensation in the form of a trade liberalising measure in the same sector, applied on a most-favoured-nation basis.

The settlement of both the Upland cotton and the clove-flavoured cigarettes disputes are suboptimal insofar as the measures found in breach are not corrected, and the offending country pays or removes the threat of bringing a dispute against the complaining party. Everyone is worse off except the stakeholders that continue to benefit from a protection or a subsidy. This surely is not what the drafters of the Dispute Settlement Understanding intended.

What these settlements mean for analysts of the world trading system

The settlement of these two disputes between larger trading nations calls for a re-examination of how WTO Dispute Settlement works in practice. When the Dispute Settlement Understanding was created, Jackson noted that many diplomats were worried about leaving state-to-state disputes in the hands of lawyers (Jackson 1997). Do these two settlements presage a shift in the balance between law and diplomacy in the resolution of trade disputes? Moreover, is the system less rules-based than it is characterised, with large players negotiating around trade rules while smaller players are compelled to comply with them?

Furthermore, if settlements such as these are allowed to stand, then to what extent can the WTO rules been seen as self-enforcing, or just the pretext for further deal-making that can come at the expense of third parties or compliance with other WTO rules? Much is at stake for the WTO – both in theory and in practice.

References

Bagwell, K, and R Staiger (2010), “The World Trading System: Theory and Practice.” Annual Review of Economics, 2:223-256.

Jackson, J (1997), The World Trade Organization: Constitution and Jurisprudence. The Royal Institute of International Affairs. London.

Lamy, P (2009), “WTO disputes reach 400 mark.” World Trade Organization.

Footnotes

[1] For the legal text see http://www.wto.org/english/docs_e/legal_e/28-dsu.pdf

[2] WTO document WT/DS406/17

[3] WTO document WT/DS267/46

[4] World Trade Online 6 October, 2014.

[5] WTO documents WT/DS26/29 and WT/DS48/26.