Earlier in September, a World Trade Organization (WTO) panel ruled that the unilateral tariffs imposed by the United States against Chinese goods were inconsistent with the United States’ WTO obligation under the General Agreement for Tariffs and Trade (GATT).
Background
The ongoing trade war between the United States and China particularly focuses on the issue of intellectual property rights (IPR) protection and the ability to take unilateral retorsion measures when a member state deems non-compliance to its Agreement commitments.
Title III of the Trade Act of 1974, or collectively known as section 301 permits the United States Trade Representative (USTR) to impose trade sanctions when it determines foreign practices to have violated U.S. trade agreements, or where foreign practices are deemed unjustifiable and imposes a burden or restrict U.S. commerce, including the failure to adequately protect IPR.
Under the applicable rules of the WTO, the USTR initiated in total thirty-three separate section 301 investigations, including a 2017 investigation against China over IPR protection. The 2017 investigation concluded that China’s practices in technology transfer, technology licensing terms, and the acquisition of U.S. technologies and protection of trading secrets were unreasonable, or at the least, discriminatory, and burdened or restricted U.S. commerce.
Based on the 2017 Report, the United States imposed two batches of duties, the first being the twenty-five per cent taxes imposed on June 6, 2018, and the second additional duties of ten per cent on September 21, 2018, which was later increased to twenty-five per cent on January 1, 2019.
Although this is not the first time that a member state of the WTO has taken unilateral action against another member state in raising its tariffs, such actions are scrutinized, if they were implemented in a manner which was not found to be congruent with the WTO trading rules.
In this dispute, China had accused the United States of violating its commitments under the Most-Favoured-Nation (MFN) obligation as provided in GATT Art I:1 and under its tariff bindings as provided under GATT Art II: 1(a) and (b). The United States responded by claiming that the issue had been resolved through a “settlement” or that the contested tariffs were justified under the GATT exception allowing WTO members to take measures “necessary to protect public morals”. Moreover, the United States also argued that the January 2019 tariff increments fell outside the ambit of the panel.
The United States “Mutually Satisfactory Solution”
The WTO encourages member states to dispute settlements through negotiations. In its report, the Panel rejected the United States’ position that the issue at hand had been resolved under a “mutually satisfactory solution” as the U.S. and China “have reached their own solution” through ongoing interactions (tit-for-tat retaliatory tariffs imposed by both countries) and bilateral negotiations. According to the Panel, there was no “mutually satisfactory solution” because China disagreed with the solution. Moreover, mutually agreed solutions must be officially notified to the WTO, which was not done in this case. Even the December 2019 Phase One Trade Agreement between the U.S. and China failed to change the Panel’s conclusion.
Most-Favoured-Nation (MFN) Violation and Increases in Unlawful Tariff
The Panel found that the challenged measures were inconsistent with the United States’ MFN obligation requiring the U.S. to treat products from China no less favourably than the comparable products from other countries. By targeting China with additional duties, the U.S. breached its MFN obligation. The Panel also found that the U.S. had increased tariffs beyond what was allowed by its schedule of concessions under GATT Article II:1(a) and (b).
All WTO members are bound by their tariff schedules as annexed to the GATT (“bound rates” are the highest tariff rates a member may impose on foreign products), and WTO members may not apply tariffs over the rates specified in their schedules. The U.S. did not appear to dispute China’s claims but mostly sought to justify its tariffs under the General Exceptions provision of the GATT.
On the jurisdictional issue of the January 2019 tariff increase, the Panel held that both China’s complaint and the tariffs measures originally challenged anticipated such an increase. Numerous WTO disputes have dealt with the issue of measures changing throughout the adjudication process, and panels and the Appellate Body have found amendments to an original measure within the scope of the claims.
Art XX (a) – “Public Morals” Justification
In defence, the United States argued that the challenged measures were justified under the GATT’s “public morals” exception. GATT Article XX (a) allows WTO members to take measures “necessary to protect public morals” so long as the measures are applied in a non-discriminatory fashion and are not a disguised means of restricting trade. The U.S. contended that practices documented in the 2017 Report violate the public morals prevailing in the U.S. and that some of these actions are subject to criminal penalty.
The U.S. also considered such unfair competitive practices “as a threat to the preservation of its democratic political and social institutions.” Thus, the U.S. asserted that the elimination of such conducts preserves public morals and that the measures were necessary as they encouraged China to agree to enter into negotiations with the U.S. and aimed at influencing China’s policies and practices.
China, in contrast, argued that criminalizing conduct is not, by itself, sufficient to prove a public morals objective, and “public morals” should be limited to non-economic concerns and do not encompass economic policy concerns. China contended for measures to be “designed” to protect public morals, they shall be “applied to goods that embody content or conduct offensive to public morals.” China also maintained that the measures were unnecessary because any benefit was significantly outweighed by the measures’ trade restrictiveness.
The Panel rejected the U.S.’s “public morals” justification. The Panel adopted the holistic analytical method considered by prior WTO adjudicators, namely, (1) determine whether the claimed policy is a “public morals” objective within the meaning of Article XX (a), (2) assess whether the measure is “designed” to protect that public morals objective, and (3) determine whether measures are “necessary” to protect public morals based on a process of “weighing and balancing” different factors.
The Panel agreed with the United States that “public morals” denote a standard of right and wrong, which could be ascertained by factors including “prevailing social, cultural, ethical and religious values.”
It recognized the deference that WTO Members enjoy when defining “public morals.” The Panel concluded Art. XX in general, and the “public morals” exception, may include economic concerns, counter to China’s argument. It recognized that the public morals the U.S. identified appeared to be highly important. According to the Panel, the U.S. “must demonstrate how the additional duties are apt to contribute to the public morals objective.”
After examining the selection and exclusion processes of products to be covered by the challenged measures, the Panel concluded the U.S. failed to explain the relationship between the measures and the public morals objective is pursued.
Rejecting the U.S.’s assertion that the measures were necessary to address Chinese industrial policies, including Made in China 2025, the Panel found that the products subject to additional tariffs were not closely related to the industries identified in the Section 301 Report and suggested the measures were based on other economic considerations rather than the public morals objective. The Panel, in footnote 456, implicitly voiced its disapproval of imposing unilateral retaliatory tariffs under the “public morals” exception instead of using the multilateral authorization of the WTO.
Implications for the Phase One Deal and Other WTO Cases
Many observers believe that this Panel Report is unlikely to yield any substantive result should the U.S. appeal the Report to a now dormant Appellate Body. An appeal by the U.S. would effectively prevent the Panel’s findings from becoming binding because it would delay indefinitely its adoption by WTO members per the normal procedure. Therefore, it appears to be a long way before the U.S. removes additional tariffs found inconsistent with the WTO obligations but that are nevertheless left intact in the Phase One Agreement.
On the jurisprudence of the “public morals” exception, and more specifically, on using this exception to address industrial policies, the Panel seemed to suggest that the mere assertions that products falling within certain industries believed to benefit from the challenged industrial policies are insufficient.
Another WTO dispute brought in March 2018 by the U.S. against China—but now suspended—specifically challenged China’s laws, regulations, and measures relating to IPR protection, inter alia, patent enforcement restrictions and forced technology transfer. Although both issues are identified in the Section 301 Report, the Section 301 Report was not referenced in China — IPR II. Interestingly, China — IPR II is not referenced in the Panel Report or in the Addendum that summarized parties’ and third parties’ arguments either. The concurrent WTO proceeding may have served yet another venue for addressing concerns highlighted in the Section 301 Report.
The Phase One Agreement and Chinese legislation, regulations, and judicial interpretations seem to have addressed some issues identified in the Section 301 Report. In the Phase One Agreement, China undertook to enhance intellectual property rights protection and refrain from forcing technology transfer. China amended its Technology Import and Export Regulation in 2019, removing patent enforcement and transfer restrictions that are concerned in the Section 301 Report. The new Foreign Investment Law and its implementing regulation explicitly forbid forced technology transfer.
More recently, the People’s Supreme Court of China further specified the scope of trade secrets and factors to consider in trade secret cases. However, as noted earlier, the Panel did not opine on the potential impacts of its Report on the Phase One Agreement. So far, the Phase One Agreement continued to be intact and it will likely remain so unless one of the Parties decides to abrogate it.
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