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World Trade
Organization

WT/DS103/R WT/DS113/R
17 May 1999
(99-1924)
Original: English

Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products

Report of the Panel

(Continued)


5. Protected Markets and Export Subsidies

4.446 Canada did not deny that its milk production sector enjoyed a level of protection through tariffs. That was a right negotiated and set out in its WTO Schedules, Schedules which had been accepted by the Complainants. Nor did Canada deny that such protection could lead to higher prices for milk which benefited milk producers, but only with respect to the domestic market. The very purpose of tariffs was that the targeted domestic industry would enjoy higher domestic prices. This was accepted as a basic feature of the WTO system and was true for all WTO Members that maintained tariffs, including the two Complainants. Canada argued that the submissions of the Complainants failed, in particular, to recognize: (i) that sales of milk for export use in Canada were based on the commercial practices of producers and their reactions to world market signals; (ii) that the logical conclusion of their arguments would be to deem the existence of export subsidies wherever exported products were subject to tariff protection in their home market, thus prohibiting most such exports and undermining one of the most fundamental features of the WTO system; and (iii) that the selling of products at differing prices for domestic and export markets was a common international practice that had never been treated as an export subsidy for GATT/WTO purposes.

4.447 Canada argued that nothing in the WTO Agreements revealed a common intention to treat sales of a product in different markets at differing prices as implying the existence of a subsidy for the lower-priced good. Canada maintained that if the Complainants' arguments were to succeed, the basis of the consensus on the negotiated use of tariff protection for sensitive sectors, as captured in the GATT 1947 and the WTO Agreements, would be undermined. In character, a tariff was simply a tax and, as such, represented an incontestable government intervention in support of a domestic industry. The result of accepting the Complainants' line of reasoning would be that an export subsidy would be found every time a product was exported at its world market price from a market protected by tariffs at any level, since the very point of any tariff was to raise by government intervention the price of a good from its world market level. Given the absolute prohibition in the SCM Agreement on export subsidies, the Complainants' arguments, taken to their logical conclusion, would lead to an absolute prohibition on the exportation of any product at world market prices from a domestic market protected by tariffs. This could not have been the intention of the drafters of the WTO Agreements.

4.448 Moreover, Canada argued that the right to export while maintaining tariffs was clearly built into the "tariffication" decision incorporated in the results of the Uruguay Round. WTO Members agreed that all non-tariff barriers, including quantitative restrictions maintained under GATT 1947 Article XI(2)(c)(i), would be converted into equivalent tariffs. The condition under Article XI for the maintenance of such quantitative restrictions was that domestic production of the product in question had to be restricted. This limited any potential for production for export purposes. By converting Article XI quantitative restrictions into tariffs under Article II of the GATT 1994, this condition was removed. Thus, WTO Members had agreed that under the new WTO regime, Members maintaining the new equivalent tariffs would not have to restrict their domestic production. Canada argued that this shift clearly contemplated new production in addition to domestic needs, e.g., production for export while maintaining Article II tariffs. Thus, the new "tariffied" tariffs were to be treated in exactly the same way as all other tariffs had been since 1947 - there was a common expectation that the product subject to the tariff could be exported.

4.449 Canada argued that far from an anomaly, the sale of goods into domestic and export markets at differing prices was a common practice for many WTO Members. For example, the peanut market in the United States had a structure similar to the Canadian milk market. The United States peanut market was protected from external competition by high tariffs (155 per cent ad valorem on shelled peanuts and 192.7 per cent ad valorem for peanuts in shell) and domestic competition was limited through quotas. 308 There was no quota for production for export of peanuts. Any additional quantity produced by a farmer above the specified quota had to be "sold for whatever can be obtained on the international market". 309 As a result, the United States had a 25 per cent share of the world peanut market. The domestic prices for peanuts for edible use were about twice as high as the world market price. 310

4.450 Canada recalled that the use of differing prices for export sales of dairy products was also part of the marketing system used in California. At the November 1997 meeting of the Committee on Agriculture, Canada had asked the United States whether it could confirm that milk marketing plans established by the State of California provided lower prices for dairy components to be used in the manufacture of yoghurt, soft fresh cheese (fromage frais), uncreamed, creamed, or partially creamed cottage cheese, sour cream, sour half-and-half, or light sour cream which was sold for use outside the boundaries of the United States, than for dairy components to be used for manufacturing similar products for sale within the United States. The United States confirmed Canada's understanding of the matter.

4.451 Canada argued that even if the enabling authority of the producer boards were to be eliminated, producers would operate on the basis of economic differences between the domestic market and the world market. As a matter of very simple economic reality, so long as there was a level of border protection maintained by Canada, dairy product prices in Canada would continue to exceed world price levels. Such differences in pricing were linked to the level of border protection maintained and other general economic conditions in the Canadian market. In these circumstances, producers would seek to exploit these tariff-generated differentials in their commercial relations with Canadian processors. This would occur independently of any legislative framework.

4.452 New Zealand argued that compliance with export subsidy commitments by a Member whose domestic market was protected by tariffs did not prohibit it from exporting at world market prices. A Member that protected its domestic market by high tariffs could export in accordance with its export subsidy commitments. It could also, of course, export without the use of export subsidies. In this respect, New Zealand noted that Canada's export data indicated that Canada did export dairy products: in 1997/98, 4 per cent of cheese and 21 per cent of "other milk products" exports were exported from outside Special Classes 5(d) and (e). 311

4.453 New Zealand argued that there was no blanket prohibition under the WTO of differential pricing between domestic and exported agricultural products. What the WTO required was that any such difference result from private and not from government action. The objection of New Zealand in this case was that through the actions of governments and their agencies Canada was using export subsidies to bridge the gap between its high domestic prices and lower world market prices in excess of its scheduled allowance. The subsidy existed because, in accordance with the relevant definitions of export subsidy, a government was involved in a scheme which required milk producers to supply lower priced milk to exporters of dairy products as an incentive for them to undertake exports which would, in the absence of the export subsidy, be unlikely. The removal of government from such a scheme, and not just the pretence of removal of the kind Canada asserted in this case, would mean that the Agreement on Agriculture would not apply. Exporters would be free to export without limit based on commercial considerations rather than export subsidies.

4.454 New Zealand emphasized that it was not indeed suggesting that Canada did not have the right to export dairy products. Canada, like any Member, was perfectly free to export dairy products provided that it did so in accordance with its WTO obligations. It could export up to its export subsidy commitment levels. And it could export whatever quantity it wanted without the use of subsidies at all. What New Zealand was denying was Canada's claim that it was allowed to use export subsidies which came within Article 9.1 of the Agreement on Agriculture in excess of its export subsidy commitments or to use export subsidies not covered by Article 9.1 that had the effect of circumventing or threatening to circumvent those commitments.

4.455 In respect of Canada's arguments on Article XI (paragraph 4.448), New Zealand noted that it was not surprising that Canada cited no authority for what it claimed the WTO Agreements "contemplated" as a result of tariffication, nor could it. Tariffication was not concerned with whether a country was an exporter or an importer or both. Tariffication was not about the right to export. It was concerned with market access barriers. However, it certainly was not within contemplation that having liberalised agricultural trade with the converting of quotas into tariffs, Members would now be free to use export subsidies inconsistent with the express requirements of the Agreement on Agriculture. New Zealand argued that Article XI did not in fact prevent producers from producing any quantity of product and it did not prevent that product from being exported. What Article XI did do was to require that in those countries which chose to put in place quantitative restrictions on imports, the proportion of imports could not fall below the level which would have pertained had the quantitative restrictions not existed.

4.456 The United States submitted that this broader question, raised by Canada, went beyond the scope of the case, and need not be addressed by this Panel. The United States was not contesting in this dispute either Canada's right to set tariffs or to pursue supply management in its dairy sector. The question presented by the Complainants was not only a different one, but was also much narrower, i.e., whether Canada's Special Milk Classes Scheme constituted an export subsidy subject to the reduction commitments contained in the Agreement on Agriculture. The question whether, in the absence of any other governmental action, exports at prices below tariff protected domestic prices constituted an export subsidy, was not before the Panel.

4.457 The United States contended that Canada was confusing the issue by suggesting that the position of Complainants meant that a country with high tariffs and high domestic prices necessarily engaged in differential pricing and therefore bestowed an export subsidy. Canada asserted that such price differences were simply a result of existing tariff protection. Although this, in part, could be the case, it would be unreasonable to assume that the WTO Members were unaware of protective tariffs or supply management systems when they concluded the SCM Agreement and the Agreement on Agriculture or when they adopted GATT 1994. The United States argued that there could be many circumstances where a WTO Member could have a lower price for export of agricultural products and a higher price for domestic use without implicating any of a Member's WTO obligations. The answer to this question depended in substantial part on the level and nature of government involvement in the export of the agricultural products. Canada was wrong in assuming that the price differential occasioned by the existence of a tariff barrier necessarily resulted in both a financial contribution and a benefit to the exporter. The situation where merely a protective tariff existed stood in sharp contrast to one where in addition to a tariff, a Member had constructed a scheme, such as the Canadian Special Milk Classes Scheme, where both the quantities exported and the export prices were determined largely by the intervention of governments.

4.458 The WTO Agreements on Agriculture and Subsidies imposed specific disciplines on export subsidies. What was noteworthy was that none of the relevant Agreements provided an exemption from the export subsidy disciplines when differential pricing resulted from government action. The only provision that implicitly addressed this issue was Paragraph (d) of the Illustrative List of Export Subsidies in the SCM Agreement. Paragraph (d) provided an exemption from its coverage where any benefit that would otherwise result from the provision of a good at a lower price by the government was negated by the availability of such goods on as favorable terms and conditions on the world market. Canada did not satisfy the requirements of that exemption. Moreover, even if Canada did meet those requirements, it would only be exempted from the disciplines of that provision, not the additional restrictions on export subsidies included in the Agreement on Agriculture and the SCM Agreement.

4.459 If Canada merely maintained tariff protection for its milk producers and the Canadian federal and provincial governments otherwise were not involved in the regulation of prices and exports of dairy products, the United States would not have requested the formation of this Panel. A situation in which tariff protection alone resulted in differential pricing for domestic and export manufacturers involved no financial contribution or benefit in the sense of the SCM Agreement. The mere imposition of tariffs, including any price differential that might result, had never been considered to constitute an export subsidy. In addition, where only tariffs existed, there was always the possibility that the world markets into which the goods were sold could reflect either prices at a higher or lower level than existed domestically. This was because domestic prices were not simply a function of the level of tariffs. The extent of competition within the domestic market, including the number of producers, the availability of alternative products, the level of production, the elasticity of demand, and other economic factors also had a direct bearing on domestic price levels. Thus, the existence of a price differential could not be assumed to exist and even where a differential existed it could not be assumed to result solely from the imposition of a tariff on imported goods.

4.460 The United States argued that Canada could not isolate the Special Milk Classes Scheme from the environment in which it operated, and particularly from the supply management system. It was convenient, but not convincing, for Canada to argue that the Special Classes did not provide for the establishment of domestic prices at levels higher than those applicable to exports, when the supply management system clearly established those prices. This was not a particularly pertinent issue. What was dispositive respecting the existence of the subsidy was that the governments in Canada had set in place a mechanism through which processors were provided lower priced milk. Whether the higher price for domestically-sold milk was fixed under the Special Classes or by some other government intervention was simply not relevant.

B. Importation of Milk

1. Outline

4.461 The United States recalled that in implementing its Uruguay Round market access commitments, Canada established a tariff-rate quota for fluid milk and cream (hereinafter "fluid milk") with an in-quota level of 64,500 tonnes. Part I, Section IB of Canada's Schedule, provided that fluid milk encompassed in tariff item number 0401.10.10, which entered within the tariff-rate quota at the MFN rate of 17.5 per cent, beginning in 1995. 312 The rate of duty applicable to entries within the tariff-rate quota receiving MFN treatment would decline to 7.53 per cent at the end of the six-year implementation period. Fluid milk imports outside of the 64,500 tonne tariff-rate quota bore an initial rate of duty equal to 283.3 per cent, declining to 241.3 per cent in 2001. The United States claimed that for all intents and purposes, the over-quota tariff rate precluded imports of fluid milk outside of the tariff-rate quota. 313

4.462 The United States maintained that Canada, in addition, imposed unjustified constraints on access to the tariff-rate quota that impeded market access at even the lower, in-quota tariff rate. Canada only permitted cross-border retail purchases of C$20, or less, by residents of Canada for their own personal use to qualify for entry within the tariff-rate quota. By confining the scope of fluid milk entries that were eligible for the lower in-quota rate, Canada granted imports of fluid milk treatment less favorable than that provided for in the appropriate Part of Schedule V and, thus, had acted inconsistently with its obligations under Article II:1 of the GATT 1994. Because Canada administered the tariff-rate quota through a general permit restricting any single import entry to a value of C$20 and subjected such entries to a personal use restriction, Canada's licensing procedures introduced additional trade impediments that were inconsistent with its obligations under Article 3 of the Agreement on Import Licensing Procedures ("the Import Licensing Agreement").

4.463 The United States claimed that it was clear that Canada imposed unjustifiable limitations, including both a dollar value and personal use restriction, on fluid milk imports under its General Permit for dairy products. The United States submitted that those restrictions were not justified by the language in Canada's schedule and were inconsistent with its obligations under Article II:1(b) of the GATT 1994 and Article 3 of the Import Licensing Agreement.

4.464 Canada claimed that its current treatment of fluid milk imports was fully consistent with the terms and conditions of the tariff item for fluid milk (HS 0401.10.10) in its Schedule. Canada noted that the United States did not argue that it had not received the level of access that it had negotiated. Rather, it was a particular type of access that was now the subject matter of this dispute. Canada denied that the continuation of its limited concession on consumer imports of packaged fluid milk, granted in respect of its residents who engaged in cross-border shopping, was a general concession on fluid milk including commercial and bulk trade in fluid milk.

4.465 Canada stressed that the agreed record of negotiations between Canada and the United States throughout the Uruguay Round of negotiations conclusively proved that the United States was well aware of the nature and meaning of Canada's concession and the terms and conditions under which it had been granted. The claims of the United States were in conflict with the clear and common understanding of the negotiators from both Canada and the United States of Canada's offer in the Uruguay Round negotiations with respect to access to fluid milk.

4.466 Canada further denied that the Import Licensing Agreement required Canada to impose import controls where none were required. Such controls would only cause inconvenience to cross-border shoppers.

4.467 Canada claimed that in making this claim, the United States was seeking to obtain through dispute settlement a broader and different type of access for trade in fluid milk than that agreed upon in negotiations.

To continue with Article II:1 of GATT 1994


308 American Peanut Coalition (APC) testimony before the Trade Subcommittee of the Ways and Means Committee of the US House of Representatives, 12 February 1998 p. 3 (Exhibit 23): "Congress moved to decouple farm income support from production decisions in the Federal Agriculture Improvement and Reform Act of 1996 (the "FAIR" Act). This 'freedom-to-farm' bill eliminated deficiency payments and marketing loans and replaced them with transition payments for virtually all farm commodities. This was in keeping with the concept of 'decoupled income support' in the 'green box' of permitted policies that were exempt from reductions in the Uruguay Round. As a result of the 1996 Farm Bill, farmers now have the freedom to farm almost everything, except peanuts. Only farmers who own or lease a production quota can legally grow peanuts to be sold for edible use." The APC further noted at p. 4: "In spite of the peanut programme, the US is a significant exporter of peanuts, having a 25% share of the world market. This occurs as a result of the fact that US peanuts grown outside of the peanut quota are required to be exported or put to non-edible uses."

309 The United States Government Accounting Office GAO/RCED-93-18, Making the Peanut Program Responsive to Market Forces, "Appendix II: GAO's, Technical Economic Analysis of the Peanut Program", p.60. (Canada, Exhibit 24)

310 Ibid., pp.62-63. In 1989, the quota support price for peanuts was $0.3318 per pound (in 1991 dollars). The world price for US peanuts was $0.1853 per pound (in 1991 dollars). In 1998, those prices were in the order of $0.45 per pound on world markets and $0.65 on US domestic markets.

311 Canada's answer to Question No. 1 by the Panel, 20 October 1998.

312 The United States noted that imports from the United States within the tariff-rate quota received preferential duty rates under terms of the North American Free Trade Agreement.

313 "The Canadian Dairy Industry: Institutional Structure and Demand Trends in the 1990s". (United States, Exhibit 25)