(c) The rise in unemployment

4.348 During the period of investigation, the number of dairy farms declined by approximately 20 per cent, from 28,219 in 1993 to 22,725 in 1996. This decline occurred even though Korea sought to assist the domestic industry by providing long-term loans of up to 300 million Won ¹⁴¹ per farm to improve the industry's competitiveness. Unemployment rose despite the fact that virtually all 28,219 dairy farms obtained long-term loans. ¹⁴²

(d) Debt-to-equity ratio and capital depletion

4.349 Prior to the increased imports of SMPP in 1993, the domestic industry derived profit from selling raw milk, and producing milk powder.As a result of the circumvention of the 220 per cent agreed tariff rate on milk powders, and the import into Korea of SMPP at a 40 per cent tariff rate, loss began to accumulate rapidly in the Korean livestock cooperatives.The table below shows the losses accruing to livestock cooperatives from production of milk powder, and its overall contribution to their annual debt.

(e) Inability to invest in research and development

4.350 The continued loss by cooperatives caused by SMPP further exacerbated and accelerated the underinvestment in new facilities at a time when the cooperatives needed to upgrade facilities and equipment to remain competitive.Their inability to attract investment is what led Korea to provide financial assistance through the Livestock Development Fund ¹⁴³ under the Dairy Cow Competitiveness Enhancement Programme.

4.351 Because the livestock cooperatives were unable to operate at a reasonable profit level, they could not make the necessary investments in research and development. Thus, the domestic industry produces only two types of milk powder (skimmed and whole) and has not been able to expand into the production of the other diverse forms of milk powders and milk powder preparations which are produced by exporting nations.

(f) Loss of market share

4.352 The share of the domestic market occupied by both domestic raw milk and milk powder producers fell during the period of investigation from 91.1 per cent to 85.4 per cent, with only a slight increase in the first half of 1996 attributable to below cost sales of domestic milk powder made as a defensive measure to alleviate the financial burden.

4.353 Given the unique nature of agricultural sectors generally and the Korean dairy industry specifically, Korea considered that the decline in market share for both raw milk and milk powder during the period of investigation indicated serious injury to the domestic industry. ¹⁴⁴

4.354 When the market share figures of raw milk and milk powder are disaggregated, the proportion of the consumption of milk powder in Korea taken by SMPP increased dramatically.

4.355 It is important to note that any increase in market share of SMPP must be correlated to the rate of increase in milk powder consumption in Korea.In this regard, total consumption of milk powder increased by 34.3 per cent in 1994, 14.1 per cent in 1995, and 14.5 per cent for the first six months of 1996. ¹⁴⁵ Given the low prices of imported SMPP and their functional substitutability with Korean raw milk and milk powder, an increase in Korean consumption effectively only benefits suppliers of the cheaper imported SMPP.As the increase in imports of SMPP displaces both domestically-produced raw milk and milk powder, it is to the direct detriment of the Korean cooperatives and dairy farmers.

(g) Consumption

4.356 The consumption of domestic raw milk (including milk powder) was 1,844,463 tonnes in 1993, 1,947,128 tonnes in 1994, 1,947,965 tonnes in 1995, and 984,934 tonnes during the first half of 1996, reflecting a distinct decreasing trend from 5.6 per cent in 1994, to 0.0 per cent in 1995, and to -2.0 per cent during the first half of 1996.Consumption of domestic milk powder decreased relative to the total milk powder consumption during the period of investigation.The domestic milk powder consumption rate was 40 per cent in 1993, 30 per cent in 1994, 23 per cent in 1995, and 28 per cent in the first six months of 1996. ¹⁴⁶

4.357 The consumption of white milk (only produced from Korean raw milk), the predominant end use of raw milk fell, with the exception of 1994, during the investigation period, from 1,287,000 tonnes in 1993, to 1,374,000 tonnes in 1994, to 1,319,000 tonnes in 1995, and to 610,000 tonnes for the first six months of 1996.The fall in consumption resulted in a decline of market share of white milk by nearly 10 per cent from 63 per cent to 53.7 per cent between 1993 and the first six months of 1996. ¹⁴⁷

4.358 On the other hand, the consumption of flavoured and fermented milk (which primarily use the cheaper imported SMPP) increased during the investigation period.Flavoured milk increased from 123,000 tonnes in 1993, to 176,000 tonnes in 1994, to 255,000 tonnes in 1995, and to 133,000 tonnes for the first six months of 1996, representing an increase rate of 43.5 per cent in 1994, 44.6 per cent in 1995, and 10 per cent in the first six months of 1996.The market share of flavoured milk increased from 6 per cent to 4.7 per cent during the period of investigation.The consumption of fermented milk surged from 466,000 tonnes in 1993, to 525,000 tonnes in 1994 to 539,000 tonnes in 1995 to 297,000 tonnes in the first six months of 1996.The annual increase rate was 4.7 per cent in 1994, 2.8 per cent in 1995, and 7.3 per cent in the first six months of 1996.The market share of fermented milk increased from 22.8 per cent in 1993 to 26.2 per cent in the first six months of 1996.Korea determined that the import of the cheaper SMPP was the primary reason for the processing companies to increase the production of flavoured and fermented milk and curtail the production of white milk that can only be produced from domestically-produced raw milk. ¹⁴⁸

4.359 Korea considered that the data above indicated that consumption of downstream products made from Korean raw milk and milk powder were declining, resulting in an overall decline in the consumption of domestic raw milk and milk powder.

(h) Productivity and capacity utilization

4.360 Korea asserted that capacity utilization is an example of an injury criterion which is relevant to industrial goods but is not necessarily useful in assessing serious injury to an industry in the agricultural sector.In the case of industrial goods such as autos, a high capacity utilization ratio of plants would be regarded as a positive indicator for the industry. This, however, is not the case in the raw milk/milk powder industry.

4.361 Korea emphasized that capacity utilization of both the raw milk and milk powder sectors was fully considered in the serious injury determination. Korea fails to understand the basis on which the European Communities claim that there is "no examination of capacity utilization" in view of the fact that the interim investigation report explicitly dealt with that issue. ¹⁴⁹

4.362 After considering capacity utilization for the milk powder sector, Korea determined that this element did not accurately reflect the condition of the domestic industry because the unused portion of raw milk became larger as SMPP replaced raw milk, livestock cooperatives' and processing companies' intake of the unsold raw milk quantity for conversion into milk powder increased, thereby increasing the milk powder industry's capacity utilization; however, despite the increase in capacity utilization, the raw milk converted into milk powder became unsaleable inventory.Thus, capacity utilization was not a suitable criterion for injury determination purposes and the investigating authority placed less emphasis on this factor than other injury elements.

4.363 In connection with capacity utilization of raw milk, the investigating authority found that the rate of utilization was 100 per cent, since all cows had to be milked.Here again, however, like the milk powder sector, high capacity utilization does not signal a healthy industry. Raw milk had been substituted for by cheaper SMPP imports and the excess (i.e, unsold) raw milk, due to its perishability, was turned into unsaleable milk powder inventory. Accordingly, after due consideration, Korea discounted capacity utilization in determining the existence of serious injury to the domestic industry.

(i) Production

4.364 Korea considered the raw milk and milk powder production data in its injury analysis and concluded that it was not an appropriate measure for determining the state of the domestic industry.It is true that raw milk production rose by 3-4 per cent during the investigation period.However, the excess raw milk was not consumed and thus became milk powder inventory.

4.365 The demand for flavoured and fermented milk products also increased, but such products were largely made from the cheaper imported SMPP which displaced the domestically-produced raw milk and milk powder.

4.366 In response to a question by the Panel ¹⁵⁰, Korea further clarified certain aspects of the injury investigation concerning the calculation of the manufacturing costs for the domestic industry:

4.367 The figures of the production costs of raw milk were calculated by adding the costs for feed, hired labour, depreciation, family labour, interest, and for miscellaneous items such as veterinary services and medicines, and by subtracting income from by-products. The annually published and publicly available "Annual Report of Livestock Production Cost Survey" by NLCF contains detailed figures for the production costs of raw milk. These figures are as follows:

4.368 Data for production cost of Korean milk powder was calculated by the total manufacturing cost over amount of production of milk powder produced by the NLCF, which appear in pages 46 and 54 of the OAI Report. Total cost of manufacturing consists of raw material cost, labour cost and other expenses as is shown in the following Table, reproduced from pages 46 and 54 of the OAI Report.

4.369 With regard to the exclusion of certain products from the final measure Korea in answer to a question by the Panel ¹⁵¹ made the following arguments:

4.370 The precise amount of products excluded and the methodology used to exclude them are set out on page 7 of the OAI Report. The European Communities obtained a copy of the OAI Report at the KTC's Public Hearing on 20 August 1996. The European Communities provided the Government of Korea with a translation during the consultations. Thus, the European Communities has already had access to the figures at issue.

4.371 Based on the analysis of the exporters' responses, the OAI concluded that certain items falling under the same HS code number as that of the SMPP should be excluded from the application of the safeguard measure on the ground that:

• they were not simple mixtures of whey powder or starches with milk powder prepared solely for the purpose of evading comparatively high tariffs;
• they were commonly traded products, and not exclusively targeted at countries with high negotiated tariffs such as Korea; and
• the import volume was very small.

4.372 Also in response to a question of the Panel ¹⁵² Korea offered the following clarification on the relation between SMPP imports and milk powder imports:

4.373 Korea's notification of 24 March 1997 and the OAI Report provide the import figures for SMPP at the second paragraph of section IV.2.It also provides the equivalent figures for imports of milk powder in paragraph V.2.2 of the same Notification.

4.374 The volume of total imports of milk powder and SMPP increased by approximately 90 per cent over the investigation period, and within that total increase, SMPP's share increased from 17.8 per cent to 96.6 per cent. Therefore, the conclusion that the increase in imports of SMPP far outweighs the decrease in imports of milk powder is evident.

4.375 The Panel also asked ¹⁵³ Korea to clarify its arguments on the composition of the domestic industry and to summarize how the serious injury factors were considered for the whole domestic industry. The following constitutes Korea's response:

4.376 Article 2-1 of Korea's Regulation on Relief of Injury to Domestic Industry Caused by Imports states:

4.377 The OAI Report in delineating the domestic industry states:

4.378 The OAI's position is also reflected in the Notification of 24 March 1997. ¹⁵⁴ In making this conclusion, the OAI considered overlapping commercial use among raw milk, milk powder, and SMPP, and resulting commercial competition among those products.The detailed analysis is also set out in the OAI Report.

4.379 In determining whether the whole domestic industry was suffering serious injury by reason of increased imports of SMPP, the competent authorities considered the relevant factors set out in Article 4.2(a) for the whole domestic industry. In instances where a factor was not relevant to a particular sector of the domestic industry (because it was not of an objective and quantifiable nature having a bearing on the state of that industry), the competent authorities explained the basis for disregarding this factor or the reason why this factor still provided an indication of injury to the whole domestic industry.

4.380 Korea evaluated the following factors as summarized in its first submission and explained in, inter alia, the OAI Report and the 24 March Notification:

The competent authorities also considered additional relevant factors indicating serious injury including:

4.381 Based on their evaluation of the above factors, the competent authorities considered that the whole domestic industry s suffering serious injury.

To continue with Additional arguments by th e European

¹⁴¹ Approximately US$220,000 based on October 1998 exchange rates.

¹⁴² Source: MAF. The objective of the loan programme was not to �consolidate� or �rationalize� the industry, since Korea provided financial assistance to keep dairy farms in the business. The long-term loans were not provided, for example, to encourage the dairy farmers to relocate and find other livelihood, given that the loans were earmarked solely for dairy business purposes and that the farmers had to repay the loans even if they ceased to operate in the dairy business.

¹⁴³ Funds are established and operated by the government to provide assistance to specific sectors which cannot attract investments.

¹⁴⁴ For reference, see the recent US International Trade Commission report in Wheat Gluten, Inv. No. TA-201-67, USITC Pub. No. 3088 (Mar. 1998) at I-16 and II-25, where the US ITC found serious injury even though the overall increase in the market share of imports was 8.8 per cent.

¹⁴⁵ Source: MAF.

¹⁴⁶ See, Notification IV.3.3. The consumption of domestic milk powder increased in the first half of 1996 because the price fell from a high of 5,388 Won/kg in 1995 to a low of 4,994 Won/kg in the first six months of 1996. The fall in the price is attributable to an acute rise in inventory from 6,565 tonnes in 1995 to 14,994 tonnes in the first half of 1996, an increase of 342.7 per cent, caused by the single largest increase between 1995 and 1996. The sharp increase in inventory amount compelled the cooperatives to sell milk powder at below production cost. Source: MAF.

¹⁴⁷ Source: MAF

¹⁴⁸ Source: MAF

¹⁴⁹ See, Exhibit Korea-5. A copy of the interim investigation report was publicly available to everyone and was distributed to all attendants of the public hearing, including the Agriculture Counsellor A C Van Arnhem of the Netherlands Embassy.

¹⁵⁰ The Panel recalls that the question was: "In Korea's first submission, you refer to "production costs of raw milk." Could you please provide evidence on how these calculations were performed. Could you also do the same for "production costs of Korean milk powder"."

¹⁵¹ The Panel recalls that the question was: "In paragraph 51 of Korea's oral statement to the first meeting of the Panel, you appear to refer to some products which would have been excluded from the application of the final safeguard measure. Is this statement accurate? Were any of these products (or any other products) excluded by Korea when it conducted its investigation, in particular, for the injury analysis? If so, please explain the methodology Korea used in doing so as well as the criteria it used to perform such assessment."

¹⁵² The Panel recalls that the question was: "Please provide supporting evidence that the increased SMPP "far outweighed" the drop in imports of milk powder paying the agreed tariff rate."

¹⁵³ The Panel recalls that the question was: "Please provide the panel with a detailed explanation of the factors you used to identify one single domestic industry (composed of raw milk and milk powder). In addition, Article 4.1(a) provides "'serious injury' shall be understood to mean a significant overall impairment in the position of the domestic industry". Please provide a summary and clarification as to how the factors considered led to a determination of serious injury to the whole of the domestic industry."

¹⁵⁴ G\SG\N\10\KOR\1\Suppl.1, page 7.

¹⁵⁵ OAI Report at Section V, Notification at Section IV.2.

¹⁵⁶ OAI Report at Sections VI.2 (a) and (b), Notification at Section IV.3.4.

¹⁵⁷ OAI Report at Sections VI.2 (a) and (b) (sales were compared for the livestock cooperatives given the non-availability of sales for individual dairy farmers), Notification at Section IV.3.9 and 10.

¹⁵⁸ OAI Report at Sections VI.2 (a) and (b), Notification at Section IV.3.1.

¹⁵⁹ OAI Report at Section VI.2 (a), Notification at Section IV.3.2.

¹⁶⁰ See, Exhibit Korea-5 for the discussion of this in the OAI's Interim Report circulated at the public hearing. Further, the Notification of 1 April 1997 made it plain that capacity utilization was unhelpful in analyzing the serious injury to both the raw milk and milk powder sectors, and so was discounted.

¹⁶¹ OAI Report at Section VI.2 (a) and (b) (the profits and losses were compared for the livestock cooperatives given the non-availability of profits and losses for individual dairy farmers), Notification at Section IV.3.10.

¹⁶² OAI Report at Sections VI.2(a)(2) and (b)(5), Notification at Section IV.3.6.

¹⁶³ OAI Report at Section VI.2 (a) and (b), Notification at Section IV.3.5 (inventory in the raw milk sector was estimated by examining inventory in the milk powder sector).

¹⁶⁴ OAI Report at Sections VI.2(a)(3) and (b)(4).

¹⁶⁵ OAI Report at Sections VI.2(b)(3), Notification at Section IV.3.7 (given the non-availability of sales transaction price for raw milk, sales transactions of milk powder were used as a surrogate).

¹⁶⁶ OAI Report at Section VI.2, Notification at Section IV.3.10.