D. Arguments of the Third Participant - Mexico

1. "Directly Competitive or Substitutable Products"

(a) Potential Competition

92. Mexico contends that Korea overlooks that the Panel made an express ruling concerning "direct competition" ⁶⁸ and applied all of the criteria established by the panel, and endorsed by the Appellate Body, in Japan - Alcoholic Beverages. These criteria are: physical characteristics, common end-uses, tariff classifications and the market-place.

93. Mexico also considers that Korea's assertions regarding the "potential competition" criterion are contradictory. Korea sometimes accepts, through the "but for" test, that potential competition may be a necessary element in analysis under Article III:2, while at other times it objects to that criterion.

94. In Mexico's view, Korea places considerable emphasis on the irrelevancy and danger of speculating on the possible future evolution of a market. It is difficult to believe that Korea really thinks that the complainants and the third party in this dispute have any interest in such speculation or that they would invest considerable resources merely to obtain a hypothetical, advisory opinion. Mexico seeks only to be able to export tequila to Korea without having to face a discriminatory tax regime.

(b) Evidence from other Markets

95. According to Mexico, the Panel analyzed evidence from the Japanese market because the Korean market "still has substantial tax differentials"⁶⁹, and, in those circumstances, the Japanese market was relevant. The Panel did not evade its obligation to examine the Korean market since that market was also analyzed.

(c) Grouping of the Products

96. Mexico is of the view that Korea has misunderstood the Panel's intention in proceeding primarily with an examination of the relationship between diluted soju and the imported beverages. The Panel simply based its examination on diluted soju and, when it detected a relevant difference between the two types of soju, highlighted that difference.

97. The Panel did not improperly group the imported beverages nor did it ignore differences between them. The Panel based its comparison on the characteristics common to all of them and, in any event, also noted relevant distinctions between the beverages where appropriate.

2. "So As to Afford Protection"

98. Mexico contends that Korea's arguments under this heading are wrong because the Panel mentioned not only the difference in tax burden between the domestic beverages and the imported beverages, but also noted that the structure of the Liquor Tax Law itself was discriminatory.

3. Application of Article III:2 of the GATT 1994

99. Mexico considers that, since this is a dispute concerning alleged failure to comply with obligations in the GATT 1994, Korea's measures are presumed to nullify or impair benefits accruing under that Agreement and, consequently, under Article 3.8 of the DSU, the burden of refuting the allegations is incumbent upon Korea and not on the appellees or the third party. Contrary to Korea's assertions, the complaining parties and Mexico submitted several pieces of evidence, including: evidence on the physical similarities of the spirits; evidence on the tariff classification of tequila and soju; and evidence from the market-place, in the form of the Dodwell Study, which also covered the relationship between tequila and soju.

100. Mexico agrees with the Panel's rejection of Korea's arguments that the appropriate end-use to be considered in this case was consumption of the beverages with or without meals. As regards admixtures, Mexico considers that the existence of soju cocktails is evidence that soju is not only drunk straight, but is also drunk mixed.

101. Korea argues that it has greater authority than the Panel to analyze its own market. In Mexico's view, this claim is not only difficult to defend, but is also contradictory. If the Koreans have a special authority not possessed by others, why did Korea entrust analysis of the Korean market to non-Korean companies, such as A.C. Nielsen?

 III. Issues Raised In This Appeal

102. This appeal raises the following issues:

IV. Interpretation and Application of Article III:2, Second Sentence, of the GATT 1994

103. The first issue that we have to address is whether the Panel erred in interpreting Article III:2, second sentence, of the GATT 1994.

104. Article III:2 provides:

105. The meaning of the second sentence of Article III:2 is clarified by paragraph 2 of Ad Article III, which reads:

106. Article III:1 provides:

107. In our Report in Japan - Alcoholic Beverages, we stated that three separate issues must be addressed when assessing the consistency of an internal tax measure with Article III:2, second sentence, of the GATT 1994. These three issues are whether:

A. "Directly Competitive or Substitutable Products"

108. The Panel concluded its examination of the first issue arising under Article III:2, second sentence, as follows:

109. According to the Panel, the "key question" with respect to the first issue arising under Article III:2, second sentence, "is whether the products are directly competitive or substitutable." ⁷³ (emphasis in the original) The Panel stated that "an assessment of whether there is a direct competitive relationship between two products or groups of products requires evidence that consumers consider or could consider the two products or groups of products as alternative ways of satisfying a particular need or taste." ⁷⁴ The determination of whether domestic and imported products are directly competitive or substitutable "requires evidence of the direct competitive relationship between the products, including, in this case, comparisons of their physical characteristics, end-uses, channels of distribution and prices." ⁷⁵ The Panel reasoned, furthermore, that the "focus should not be exclusively on the quantitative extent of the competitive overlap, but on the methodological basis on which a panel should assess the competitive relationship." ⁷⁶ "[Q]uantitative analyses, while helpful, should not be considered necessary." ⁷⁷ Similarly, "quantitative studies of cross-price elasticity are relevant, but not exclusive or even decisive in nature." ⁷⁸ A determination of the precise extent of the competitive overlap can be complicated by the fact that protectionist government policies can distort the competitive relationship between products, causing the quantitative extent of the competitive relationship to be understated.⁷⁹ The Panel cautioned that "a focus on the quantitative extent of competition instead of the nature of it, could result in a type of trade effects test being written into Article III cases." ⁸⁰

110. The Panel noted that assessment of competition has a temporal dimension.⁸¹ It considered that panels should look at "evidence of trends and changes in consumption patterns and make an assessment as to whether such trends and patterns lead to the conclusion that the products in question are either directly competitive now or can reasonably be expected to become directly competitive in the near future." ⁸² The Panel stated:

111. According to Korea, the Panel misinterpreted the term "directly competitive or substitutable product" by, inter alia, "relying on 'potential' competition, comparing the Korean market to the Japanese market and undertaking the wrong product comparisons." ⁸⁴

1. Potential Competition

112. Korea argues that the Panel took an unacceptably broad and speculative approach to the role of potential competition, which is not permitted by the wording, context and object and purpose of Article III:2, second sentence.⁸⁵ Korea agrees that this provision is not intended to exclude products that are not directly competitive or substitutable because of the contested measure itself. However, the Panel's overly broad approach has opened the door to speculation about how the market could evolve in the future, irrespective of the tax measure in question.⁸⁶

113. Contrary to Korea's assertions, the Panel has not relied on potential competition in order to overcome the absence today of a "directly competitive or substitutable" relationship between the domestic and imported products on the basis that such a relationship might develop in the future. The Panel concluded that "there is sufficient unrebutted evidence in this case to show present direct competition between the products".⁸⁷ (emphasis added) This legal finding is not a speculative one concerning the future, but is based firmly in the present. The reference to "a strong potentially direct competitive relationship" does no more than buttress the Panel's finding of "present direct competition".⁸⁸

114. The term "directly competitive or substitutable" describes a particular type of relationship between two products, one imported and the other domestic. It is evident from the wording of the term that the essence of that relationship is that the products are in competition. This much is clear both from the word "competitive" which means "characterized by competition" ⁸⁹, and from the word "substitutable" which means "able to be substituted".⁹⁰ The context of the competitive relationship is necessarily the marketplace since this is the forum where consumers choose between different products. Competition in the market place is a dynamic, evolving process. Accordingly, the wording of the term "directly competitive or substitutable" implies that the competitive relationship between products is not to be analyzed exclusively by reference to current consumer preferences. In our view, the word "substitutable" indicates that the requisite relationship may exist between products that are not, at a given moment, considered by consumers to be substitutes but which are, nonetheless, capable of being substituted for one another.

115. Thus, according to the ordinary meaning of the term, products are competitive or substitutable when they are interchangeable⁹¹ or if they offer, as the Panel noted, "alternative ways of satisfying a particular need or taste".⁹² Particularly in a market where there are regulatory barriers to trade or to competition, there may well be latent demand.

116. The words "competitive or substitutable" are qualified in the Ad Article by the term "directly". In the context of Article III:2, second sentence, the word "directly" suggests a degree of proximity in the competitive relationship between the domestic and the imported products. The word "directly" does not, however, prevent a panel from considering both latent and extant demand.

117. Our reading of the ordinary meaning of the term "directly competitive or substitutable" is supported by its context as well as its object and purpose. As part of the context, we note that the AD Article provides that the second sentence of Article III:2 is applicable "only in cases where competition was involved". (emphasis added) According to Korea, the use of the past indicative "was" prevents a panel taking account of "potential" competition. However, in our view, the use of the word "was" does not have any necessary significance in defining the temporal scope of the analysis to be carried out. The Ad Article describes the circumstances in which a hypothetical tax "would be considered to be inconsistent with the provisions of the second sentence". (emphasis added) The first part of the clause is cast in the conditional mood ("would") and the use of the past indicative simply follows from the use of the word "would". It does not place any limitations on the temporal dimension of the word "competition".

118. The first sentence of Article III:2 also forms part of the context of the term. "Like" products are a subset of directly competitive or substitutable products: all like products are, by definition, directly competitive or substitutable products, whereas not all "directly competitive or substitutable" products are "like".⁹³ The notion of like products must be construed narrowly⁹⁴ but the category of directly competitive or substitutable products is broader.⁹⁵ While perfectly substitutable products fall within Article III:2, first sentence, imperfectly substitutable products can be assessed under Article III:2, second sentence.⁹⁶

119. The context of Article III:2, second sentence, also includes Article III:1 of the GATT 1994. As we stated in our Report in Japan - Alcoholic Beverages, Article III:1 informs Article III:2 through specific reference.⁹⁷ Article III:1 sets forth the principle "that internal taxes ... should not be applied to imported or domestic products so as to afford protection to domestic production." It is in the light of this principle, which embodies the object and purpose of the whole of Article III, that the term "directly competitive and substitutable" must be read. As we said in Japan - Alcoholic Beverages:

To continue with Potential Competition

⁶⁸Panel Report, paras 10.95, 10.97 and 10.98.

⁶⁹Panel Report, para. 10.45.

⁷⁰The provisions of Article III:2, second sentence, of the GATT 1994 include paragraph 2 of Ad Article III and, by specific incorporation, the term "so as to afford protection" which appears in paragraph 1 of Article III.

⁷¹Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 24.

⁷²The "products" referred to by the Panel are diluted soju, distilled soju, whiskies, brandies, cognac, rum, gin, vodka, tequila, liqueurs and admixtures. Panel Report, para. 10.98.

⁷³Panel Report, para. 10.39.

⁷⁴Panel Report, para. 10.40.

⁷⁵Panel Report, para. 10.43.

⁷⁶Panel Report, para. 10.39.

⁷⁷Panel Report, para. 10.42.

⁷⁸Panel Report, para. 10.44.

⁷⁹Panel Report, para. 10.42.

⁸⁰Ibid.

⁸¹Panel Report, para. 10.47.

⁸²Panel Report, para. 10.48.

⁸³Panel Report, para. 10.50.

⁸⁴Korea's appellant's submission, para. 22.

⁸⁵Korea's appellant's submission, paras. 26 and 31.

⁸⁶Korea's appellant's submission, para. 28.

⁸⁷Panel Report, para. 10.98. Likewise, the Panel also stated that "the evidence overall supports a finding that the imported and domestic products at issue are directly competitive or substitutable" (para. 10.95). (emphasis added)

⁸⁸Panel Report, para. 10.98.

⁸⁹Lesley Brown (ed.), The New Shorter Oxford English Dictionary, Vol. I, p. 459 (Clarendon Press, 1993).

⁹⁰Lesley Brown (ed.), op. cit., Vol. II, p. 3125.

⁹¹Appellate Body Report, Canada - Certain Measures Concerning Periodicals ("Canada - Periodicals"), WT/DS31/AB/R, adopted 30 July 1997.

⁹²Panel Report, para. 10.40.

⁹³Panel Report, Japan - Alcoholic Beverages, supra, footnote 16, para. 6.22, approved by the Appellate Body at p. 23 of its Report.

⁹⁴Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 20, and Canada - Periodicals, supra, footnote 91, p. 21.

⁹⁵Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 25.

⁹⁶Canada - Periodicals, supra, footnote 91, p. 28.

⁹⁷Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 23.

⁹⁸Ibid, p. 16, with references to earlier Panel Reports.