1. Potential Competition (Cont.)

120. In view of the objectives of avoiding protectionism, requiring equality of competitive conditions and protecting expectations of equal competitive relationships, we decline to take a static view of the term "directly competitive or substitutable." The object and purpose of Article III confirms that the scope of the term "directly competitive or substitutable" cannot be limited to situations where consumers already regard products as alternatives. If reliance could be placed only on current instances of substitution, the object and purpose of Article III:2 could be defeated by the protective taxation that the provision aims to prohibit. Past panels have, in fact, acknowledged that consumer behaviour might be influenced, in particular, by protectionist internal taxation. Citing the panel in Japan - Customs Duties, Taxes and Labelling Practices on Imported Wines and Alcoholic Beverages ("1987 Japan - Alcohol")⁹⁹, the panel in Japan - Alcoholic Beverages observed that "a tax system that discriminates against imports has the consequence of creating and even freezing preferences for domestic goods."¹⁰⁰ The panel in Japan - Alcoholic Beverages also stated that "consumer surveys in a country with ... a [protective] tax system would likely understate the degree of potential competitiveness between substitutable products".¹⁰¹ (emphasis added) Accordingly, in some cases, it may be highly relevant to examine latent demand.

121. We observe that studies of cross-price elasticity, which in our Report in Japan - Alcoholic Beverages were regarded as one means of examining a market¹⁰², involve an assessment of latent demand. Such studies attempt to predict the change in demand that would result from a change in the price of a product following, inter alia, from a change in the relative tax burdens on domestic and imported products.

122. Korea itself recognizes that potential demand may be taken into account in determining whether products are "directly competitive or substitutable". Before the Panel, Korea acknowledged that this term is not intended to exclude products that are not directly competitive or substitutable because of ("but for") the contested measure itself. At the oral hearing before us, Korea accepted that this "but for" test would permit account to be taken "not only [of] the direct price increasing effect of a tax differential but also [of] other elements that could show an impairment of competitive opportunities because of the tax differential, that distribution costs had been higher, etc." ¹⁰³

123. We note, however, that actual consumer demand may be influenced by measures other than internal taxation. Thus, demand may be influenced by, inter alia, earlier protectionist taxation, previous import prohibitions or quantitative restrictions. Latent demand can be a particular problem in the case of "experience goods", such as food and beverages, which consumers tend to purchase because they are familiar with them and with which consumers experiment only reluctantly.¹⁰⁴

124. We, therefore, conclude that the term "directly competitive or substitutable" does not prevent a panel from taking account of evidence of latent consumer demand as one of a range of factors to be considered when assessing the competitive relationship between imported and domestic products under Article III:2, second sentence, of the GATT 1994. In this case, the Panel committed no error of law in buttressing its finding of "present direct competition" by referring to a "strong potentially direct competitive relationship".¹⁰⁵

2. Expectations

125. In the course of its reasoning on potential competition, the Panel referred to the "settled law that competitive expectations and opportunities are protected" ¹⁰⁶ and noted our statement in Japan - Alcoholic Beverages that "Article III protects expectations not of any particular trade volume but rather of the equal competitive relationship between imported and domestic products".¹⁰⁷

126. Korea takes the view that "expectations" exist only for products which are already "like" or "directly competitive or substitutable" and that it was improper for the Panel to consider that there could be expectations regarding products that are not currently "directly competitive or substitutable", but which might become so in the near future.¹⁰⁸

127. As we have said, the object and purpose of Article III is the maintenance of equality of competitive conditions for imported and domestic products.¹⁰⁹ It is, therefore, not only legitimate, but even necessary, to take account of this purpose in interpreting the term "directly competitive or substitutable product".¹¹⁰

3. "Trade Effects" Test

128. The Panel expressed concern 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." ¹¹¹

129. Korea complains that this is a misunderstanding of the "trade effects" test.¹¹² In our view, when the Panel referred to a "type of trade effects test", it was simply expressing its scepticism about the consequences of placing undue emphasis on quantitative analyses of the competitive relationship between products. This is clear from the sentence immediately following the sentence containing the reference to a "type of trade effects test":

130. Thus, the Panel stated that if a particular degree of competition had to be shown in quantitative terms, that would be similar to requiring proof that a tax measure has a particular impact on trade. It considered such an approach akin to a "type of trade effects test".

131. We do not consider the Panel's reasoning on this point to be flawed. ¹¹⁴

4. Nature of Competition

132. The Panel makes numerous references to the "nature of competition".¹¹⁵ Korea considers that, through the use of the term "nature of competition", the Panel has inserted a "vague and subjective element" which is not found in Article III:2, second sentence.¹¹⁶ Korea argues that this reference to the "nature of competition", therefore, amounts to another failure properly to interpret the term "directly competitive or substitutable".

133. We believe that the Panel uses the term "nature of competition" as a synonym for quality of competition, as opposed to quantity of competition. The Panel considered that in analyzing whether products are "directly competitive or substitutable", the focus should be on the nature of competition and not on its quantity:

134. In taking issue with the use of the term "nature of competition", Korea, in effect, objects to the Panel's sceptical attitude to quantification of the competitive relationship between imported and domestic products. For the reasons set above, we share the Panel's reluctance to rely unduly on quantitative analyses of the competitive relationship.¹¹⁸ In our view, an approach that focused solely on the quantitative overlap of competition would, in essence, make cross-price elasticity the decisive criterion in determining whether products are "directly competitive or substitutable". We do not, therefore, consider that the Panel's use of the term "nature of competition" is questionable.

5. Evidence from the Japanese Market

135. The Panel considered that, in assessing whether products are directly competitive or substitutable, it was appropriate to look at "the nature of competition in other countries".¹¹⁹ It stated:

136. According to Korea, the Panel's approach constitutes an impermissible broadening of the scope of Article III:2, second sentence. Moreover, Korea believes that if evidence from other markets were to be admitted, more than one other market ought to be reviewed. In this case, as there was "considerable evidence available as to what is taking place within the Korean market" ¹²¹, Korea considers that there was no reason to rely on evidence drawn from another market when making conclusions about the Korean market.

137. It is, of course, true that the "directly competitive or substitutable" relationship must be present in the market at issue¹²², in this case, the Korean market. It is also true that consumer responsiveness to products may vary from country to country.¹²³ This does not, however, preclude consideration of consumer behaviour in a country other than the one at issue. It seems to us that evidence from other markets may be pertinent to the examination of the market at issue, particularly when demand on that market has been influenced by regulatory barriers to trade or to competition. Clearly, not every other market will be relevant to the market at issue. But if another market displays characteristics similar to the market at issue, then evidence of consumer demand in that other market may have some relevance to the market at issue. This, however, can only be determined on a case-by-case basis, taking account of all relevant facts.

138. In the present case, the Panel did not err in referring to the Japanese market in its reasoning.

6. Grouping of the Products

139. Before embarking on its assessment of whether the imported and domestic products at issue are directly competitive or substitutable, the Panel considered how it would carry out that assessment. It stated:

With respect to the imported products, the Panel said:

140. Korea argues that the Panel erred in failing to examine distilled soju and diluted soju separately and also in examining all of the imported products together. Korea's argument is based, in large part, on allegedly significant differences between the products that the Panel grouped together. Korea is concerned that by considering the products together, the Panel overlooked important differences between them. Korea believes that, in so doing, the Panel was able to conclude that all the products at issue were directly competitive or substitutable, whereas had the imported products been examined individually, this result would not have been possible.

141. We consider that Korea's argument raises two distinct questions. The first question is whether the Panel erred in its "analytical approach". The second is whether, on the facts of this case, the Panel was entitled to group the products in the manner that it did. Since the second question involves a review of the way in which the Panel assessed the evidence, we address it in our analysis of procedural issues.

142. The Panel describes "grouping" as an "analytical tool". It appears to us, however, that whatever else the Panel may have seen in this "analytical tool", it used this "tool" as a practical device to minimize repetition when examining the competitive relationship between a large number of differing products. Some grouping is almost always necessary in cases arising under Article III:2, second sentence, since generic categories commonly include products with some variation in composition, quality, function and price, and thus commonly give rise to sub-categories.¹²⁶ From a slightly different perspective, we note that "grouping" of products involves at least a preliminary characterization by the treaty interpreter that certain products are sufficiently similar as to, for instance, composition, quality, function and price, to warrant treating them as a group for convenience in analysis. But, the use of such "analytical tools" does not relieve a panel of its duty to make an objective assessment of whether the components of a group of imported products are directly competitive or substitutable with the domestic products. We share Korea's concern that, in certain circumstances, such "grouping" of products might result in individual product characteristics being ignored, and that, in turn, might affect the outcome of a case. However, as we will see below, the Panel avoided that pitfall in this case.

143. Whether, and to what extent, products can be grouped is a matter to be decided on a case-by-case basis. In this case, the Panel decided to group the imported products at issue on the basis that:

144. As the Panel explained in the footnote attached to this passage ¹²⁸, the Panel's subsequent analysis of the physical characteristics, end-uses, channels of distribution and prices of the imported products confirmed the correctness of its decision to group the products for analytical purposes. Furthermore, where appropriate, the Panel did take account of individual product characteristics.¹²⁹ It, therefore, seems to us that the Panel's grouping of imported products, complemented where appropriate by individual product examination, produced the same outcome that individual examination of each imported product would have produced.¹³⁰ We, therefore, conclude that the Panel did not err in considering the imported beverages together.

145. With respect to diluted soju and distilled soju, the Panel did not "group" these products as such. Rather, it concentrated on diluted soju in assessing the competitive relationship between the domestic and imported beverages. The Panel considered that distilled soju was an "intermediary" product, with respect to physical characteristics, end-uses and prices, between diluted soju and the imported products. On that assumption, it reasoned, a fortiori, taking the view that if diluted soju was shown to be competitive with the imported products, the intermediate product, distilled soju, would also necessarily be "directly competitive or substitutable" with them. ¹³¹ We do not consider the Panel's reasoning on this point to be objectionable.

To continue with So As To Afford Protection

⁹⁹Japan - Customs Duties, Taxes and Labelling Practices on Imported Wines and Alcoholic Beverages, adopted 10 November 1987, BISD 34S/83. The panel in Japan - Alcoholic Beverages, supra, footnote 16, cited para. 5.9 of this panel report.

¹⁰⁰Panel Report, Japan - Alcoholic Beverages, supra, footnote 16, para. 6.28. This passage was expressly approved by the Appellate Body in its Report in this case (p. 25).

¹⁰¹Ibid.

¹⁰²Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 25.

¹⁰³Response by Korea to questions at the oral hearing.

¹⁰⁴Panel Report, paras. 10.44, 10.50 and 10.73.

¹⁰⁵Panel Report, para. 10.98.

¹⁰⁶Panel Report, para. 10.48.

¹⁰⁷Supra, footnote 20, p. 16, with references to earlier panel reports.

¹⁰⁸Korea's appellant's submission, para. 33, citing, in part, the Panel Report, para. 10.48.

¹⁰⁹Supra, para. 119.

¹¹⁰Moreover, as we noted earlier, the Panel concluded that there was evidence of "present direct competition" between the imported and domestic products. (Panel Report, para. 10.98, emphasis added)

¹¹¹Panel Report, para. 10.42.

¹¹²Supra, para. 9.

¹¹³Panel Report, para. 10.42.

¹¹⁴We note, moreover, that the Panel cites correctly the "trade effects" test in para. 10.42 of the Report, the very paragraph in which it refers to a "type of trade effects test".

¹¹⁵See Panel Report, paras. 10.42, 10.45, 10.66, 10.76, 10.78 and 10.92.

¹¹⁶Korea's appellant's submission, paras. 37 and 38.

¹¹⁷Panel Report, para. 10.44.

¹¹⁸Supra, para. 120.

¹¹⁹Panel Report, para. 10.45.

¹²⁰Panel Report, paras. 10.45 and 10.46.

¹²¹Panel Report, para. 10.46.

¹²²Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 25, and Canada - Periodicals, supra, footnote 91, p. 25.

¹²³Panel Report, Japan - Alcoholic Beverages, supra, footnote 16, para. 6.28, with reference to Working Party Report on "Border Tax Adjustments", L/3464, adopted 2 December 1970, BISD 18S/97, p. 102, para. 18, approved by the Appellate Body Report, Japan - Alcoholic Beverages, supra, footnote 20, p. 25.

¹²⁴Panel Report, paras. 10.51 and 10.54.

¹²⁵Panel Report, paras 10.59 and 10.60.

¹²⁶The Panel mentions the product category of "whiskies" which include several subcategories of types of whisky such as Scotch (premium and standard), Irish, Bourbon, Rye, Canadian, etc., all of which differ. Panel Report, para. 10.59.

¹²⁷Panel Report, para. 10.60.

¹²⁸Panel Report, footnote 375. See also Panel Report, footnotes 382 and 399.

¹²⁹See Panel Report, paras. 10.67, 10.71, 10.72, 10.85 and 10.94 and footnotes 385, 386, 387 and 408.

¹³⁰We note that the panels in 1987 Japan - Alcohol and in Japan - Alcoholic Beverage, followed the same approach. This approach was implicitly approved in our Report on Japan - Alcoholic Beverages.

¹³¹Panel Report, 10.54.