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Korea - Definitive Safeguard Measure on Imports of Certain Dairy Products

Report of the Panel

(Continued)


G. Claim under Article 4.2(b) of the Agreement on Safeguards

(a) Claim by the European Communities

4.516 The European Communities claim that Korea violated Article 4.2(b) of the Agreement on Safeguards because it failed to show the existence of a causal link between the increased imports and the serious injury to the domestic industry. The following are the EC arguments in support of this claim:

(i) The inadequacies of Korea's analysis under the first sentence of Article 4.2(b) of the Agreement on Safeguards

4.517 In the EC view, Korea's attempted demonstration of causal link was as follows:

(a) It described the rising market share of SMPP out of total domestic consumption (domestic raw milk (including milk powder), imported milk powder, and SMPP) and the even more rapidly rising market share when compared with domestic and imported milk powder and SMPP.(Paragraph V.1.1 of the 1 April 1997 Notification).

(b) It recalled the stable level of prices for imported SMPP and the allegedly falling prices for domestic milk powder using the same figures as in Paragraph IV.3.7 of the Notification (which are discussed in Section C.3(c)(ix) above) and claimed that as the share of imported products in total consumption increased, the sales price of domestic milk powder dropped and that therefore increased imports of the products subject to investigation caused the price of domestic milk powder to drop. (Paragraph V.1.2 of the 1 April 1997 Notification).

(c) It next described the slow increase in the share of livestock co-operatives' raw milk collection in Korea increased (from 40.56 per cent in 1990 to 41.14 per cent in 1991, 40.19 per cent in 1992, 41.36 per cent in 1993, 42.80 per cent in 1994, 44.30 per cent in 1995, and 45.30 per cent for the first four months of 1996) and alleged that this was because milk processing companies reduced purchases of domestic raw milk and purchased more imported products. It concluded that increased imports of the products subject to investigation had an adverse effect on the "white market milk" sector.

(d) It finally alleged that the price difference between the imported and domestic products forced domestic producers to decrease their price to the point of sales below cost, and to stockpile excess inventory of unsold milk powder.For good measure it alleges that increasing competition from imported products caused the number of dairy farmers to decrease.

(a) The rising market share of SMPP

4.518 It is true that the market share of SMPP as measured by Korea was rising.The figures given are however, in the EC view misleading because the total production used to calculate market share (the denominator of the fraction in the calculation) included in each case imported milk powder. Much of the increase of imports of SMPP was at the expense of imported milk powder.Including imported milk powder in the denominator means that a simple substitution of SMPP for imported milk powder with no loss of sales or market share for domestic products would give a result showing an increase of market share for SMPP.A more accurate presentation is that given by Korea in Paragraph IV.3.4 of the 1 April 1997 Notification.

(b) The falling prices for domestic products

4.519 The price of imported SMPP was stable during the reference period as was the price of domestic milk powder except for what Korea itself describes the temporary phenomenon at the beginning of 1996.Korea's claim that increased imports of SMPP coincided with falling price of domestic products and its deduction that the first caused the second are in the EC view demonstrably false.

4.520 The European Communities recalled Korea's precise reasoning:

"Analysis showed that as the share of imported products in total consumption increased, the sales price of domestic milk powder dropped from 5,354 Won/kg in 1993 to 4,994 Won/kg for the four months of 1996. Thus, increased imports of the products subject to investigation caused the price of domestic milk powder to drop."

Korea's case is that increased market share for SMPP caused a decrease in the price of domestic milk powder.It is not arguing that low prices for SMPP caused a decrease in the price of domestic milk powder.This is logical to the extent that it did not identify low prices for SMPP as an injury factor in its examination or its conclusion in Paragraph IV.4 of its Notification of 1 April 1997. To have established low or falling prices for imported SMPP as an injury factor, Korea would have had to carry out a price investigation which it did not for its own reasons.

4.521 It is true that the share of imported products (that is SMPP) increased. However, this increase occurred throughout the period whereas the sales price of domestic milk powder only dropped at the end of the period.Therefore Korea's statement that they dropped at the same time is incorrect.

4.522 According to Korea's own figures, the price in 1995 was 5,388 Won/Kg, which represents an increase over 1993 and 1994.The whole decrease on which Korea is relying occurred in the first four months of 1996, during what it has itself termed a "temporary phenomenon".The deduction of causality which relies purely on the supposed simultaneity of the effects described is therefore incorrect and unjustified. In fact in the EC view the correct conclusion is the opposite: that is there is no causal relation between the increase in market share of imported SMPP and the decrease in price in domestic milk powder which occurred at the beginning of 1996.

(c) The increase in the share of livestock co-operatives' raw milk collection in Korea

4.523 The figures given by Korea on this point show a slowly but steadily rising proportion of raw milk collection by co-operatives from 1990 to 1996.This establishes the opposite of what Korea seeks to prove because increases in imports of SMPP did not affect a trend which already existed before their liberalization.

(d) Imports forced domestic producers to decrease their prices to below cost and reduce the number of dairy farmers

4.524 The prices of domestic milk powder as well as imported SMPP were stable except for the temporary phenomenon at the beginning of 1996.The fact that domestic sales came to be made below cost is entirely due to the increase in the cost of production which obviously has nothing to do with imports (but was due to government imposed price increases for raw milk from dairy farmers).

4.525 There is a suggestion for the first time in Paragraph V.1.4 of the Notification that a "price difference" between imported SMPP and domestic milk powder was relevant to the analysis of the causal link.This is inconsistent with all the previous arguments of Korea and in particular with its failure to identify the prices of SMPP or even a price difference between SMPP and domestic milk powder as an injury factor.

4.526 Also, imports had no effect on the number of dairy farmers since they received guaranteed and rising prices for their milk and increased their production and productivity.The reduction in numbers was due to healthy consolidation and the increase in the size of farms in accordance with Korean government policy.

(ii) The problems of the domestic industry were due to other factors - second sentence of Article 4.2(b) of Agreement on Safeguards

4.527 The European Communities consider that any problems the domestic industry may have had were due to other factors than imports of SMPP and most notably the high and increasing price guaranteed to Korean dairy farmers for their milk by the Korean Government.Korea claims to examine these factors in Paragraph V.2 of its Notification of 1 April 1997. However, in the EC view, Korea's examination of other factors that could have caused or contributed to any problems of the domestic industry is incomplete, the European Communities also believes Korea should have considered the extent to which Korean domestic industry itself imported SMPP and benefited therefrom.Korea's assumption that such imports by the domestic industry could be considered to cause injury to that same domestic industry requires at the very least a justification - which Korea has nowhere provided.

(a) Milk quality scandal

4.528 Korea deals with this issue in Paragraph V.2.1 of its Notification of 1 April 1997 as follows:

"After examining the facts related to the controversy which occurred from October to November 1995, it was acknowledged that this incident did reduce the demand for market milk, though only temporarily. It was determined that the controversy ceased to be a cause of reduced market milk demand in January 1996. The quality dispute affected only three months of consumption out of an investigation period totalling 42 months. No evidence was submitted by any of the parties concerned which demonstrated that the injury caused by the quality dispute was as serious or persistent as that caused by increased imports."

However, in the EC view there was a much greater and more persistent effect on consumption of milk in Korea and stocks than claimed by Korea.The rise of inventory occurred at exactly the time the milk quality scandal erupted and that therefore the milk quality scandal was the major cause of the increase in milk powder stocks in Korea in early 1996.

4.529 The European Communities note that even Korea admits that there was an effect both on consumption and stocks.It rejects the analysis of these effects by other parties but fails to make any analysis itself or to make any allowance for them in its own determination and in particular to examine how it might have effected the state of stocks and sales of milk powder in the first four months of 1996 on which Korea relies so heavily throughout its Notification (a price decrease and increased sales of milk powder by domestic producers which Korea describes as a "temporary phenomenon").

(b) Effect of reduced imports of milk powder

4.530 Korea examines this issue in Paragraph V.2.2 of its Notification of 1 April 1997.It constitutes in effect an attempt to deal with the objections to Korea's presentation of the "increasing market share of SMPP".

"It has been noted that the increase in imports of the products under investigation contributed to a reduction in imports of milk powder from 14,843 tons in 1993, 11,581 tons in 1994, 7,576 tons in 1995, to 583 tons in the first half of 1996. However, it has also been noted that there is an important difference between the imports of the products under investigation and those of milk powder. The milk powder imported by ROK in 1993-1994 was to supplement the shortage of domestic raw milk and milk powder, and was allocated to users at reasonable prices."

Thus, Korea admits a simultaneity between the decline of imports of milk powder and the increase in imports of SMPP but attempts to show that the imports of milk powder were not damaging while imports of SMPP were.However, it is fundamental to Korea's safeguard measure (see Paragraph III.1 of the Notification of 1 April 1997) that SMPP is a "directly competitive product" for raw milk and milk powder and that it was used for the same purposes.If imported milk powder was apt to "supplement the shortage of domestic raw milk and milk powder" then so should imported SMPP.

4.531 Korea also alleges that milk powder "was allocated to users at reasonable prices", and suggests that SMPP was not.However, Korea's Notification is noteworthy for its absence of any price analysis and the Korea's injury determination in Paragraph IV.3.4 of the Notification of 1 April 1997 makes no reference to low prices for SMPP.Korea cannot therefore rely on differences of prices which it has not investigated in its consideration of causal link.

(c) Review of demand

4.532 In paragraph V.2.3.6 of the Notification of 1 April 1997 Korea examines demand. The European Communities disagree that the demand trends for processed products can be dismissed as Korea does in that paragraph V.2.3.6.A substantial part of the increased imports may well have been used for processing into other dairy products such as ice cream, confectionery, yoghurt, cheese because of increased demand for these products.Korea admits that production and consumption of certain dairy products increased during the investigation period, but has declined to give precise figures, so this cannot be comprehensively verified.Instead Korea rather peremptorily concludes that, "no connection could be established between the effect on these dairy products and injury to domestic industry". 235 The logic behind this conclusion is not clear, since it is based on the prior assumption that the raw milk and milk powder industry has suffered serious injury.

(d) Review of government price decisions

4.533 The brevity of Korea's examination of this issue in Paragraph V.2.4 of the Notification of 1 April 1997 belies its importance.It can be quoted in full:

"The price of raw milk is determined by the government by taking into account production costs, influence on domestic commodity prices, domestic supply and demand, etc. The price set by the government is not an obligatory price but rather a base price for contracts between dairy farmers and milk processing firms. Therefore, this did not affect the domestic industry adversely. If the government had not set a base price and the livestock cooperatives had refused to collect raw milk, dairy farmers would have been directly injured."

4.534 The point about government price increases for raw milk is that they are likely to increase costs and supply beyond what the market for milk powder can bear and will give rise to precisely the difficulties of increasing stocks and pressure on margins for processing companies that are in evidence here.That is why the issue should have been examined seriously by Korea.

4.535 The European Communities do not know what Korea means by the term "base price".It has always understood the price set by the Korean Government to be always followed in practice. However, Korea has itself stated elsewhere in the same Notification that the price of raw milk "is maintained at a stable level fixed by the government" and that the price of raw milk was also increased twice during the investigation reference period. 236

4.536 The European Communities submit that the last sentence of this Paragraph V.2.4 appears to be an admission that dairy farmers have not been injured since the government has set a base price and the livestock cooperatives have not refused to collect raw milk.

(e) Other factor - Imports of SMPP by the domestic industry

4.537 Korea did not consider the effect of imports of SMPP by the domestic industry during the period of investigation.This is an essential condition for establishing a causal link. Since Korea failed to address this issue it cannot be determined whether, even if it is assumed that injury was suffered by the Korean industry, a causal link can be established between increased imports and the condition of the domestic industry.

4.538 The European Communities submit that any problems that domestic industry may have been suffering are not caused by imports of SMPP but by other factors and in particular by the inevitable conflict between a government policy of fixing and regularly increasing the domestic price for raw milk paid to dairy farmers causing increased production and a higher cost of milk for milk processors and co-operatives with insufficiently rising domestic demand. By wrongly attributing these problems to imports of SMPP on the basis of an inadequate and incomplete investigation of causal link, Korea has violated Article 4.2(b) second sentence.

(b) Response by Korea

4.539 Korea responds to the EC arguments as follows:

(i) Consideration of causation

4.540 Korea established a clear and strong causal link between the increased imports of SMPP and the serious injury suffered by the domestic industry. 237 This link relies on an understanding of the relationship between the supply of raw milk and the production of milk powder.Korea found that the increased imports of the cheaper SMPP replaced raw milk and domestic milk powder in a number of key uses.Demand for domestic products decreased as a result of an increase in the import of cheaper SMPP, which in turn suppressed the sales price of domestic products.Further, the reduction in demand for domestic products resulted in more raw milk having to be collected by the livestock cooperatives to be turned into milk powder.As the demand and price of milk powder had been suppressed by the imports of SMPP, both losses and inventory increased, with the consequent inability to operate at a reasonable level of profit, increase of debt, and failure by the cooperatives and farmers to invest in the dairy industry.

4.541 Korea determined that increased imports of SMPP gained a significant proportion of the Korean milk powder market at the expense of domestic milk powder. 238

Milk Powder Market Share of SMMP

1993 1994 1995 1996 (1-6)
Total Consumption in the Milk Powder Market (tonnes) (A) 30,181 40,532 46,254 23,532
Imports of SMPP (tonnes) (B) 3,217 15,561 28,007 16,320
SMPP's Share of the Milk Powder Market (%)(B/A) 10.7 38.4 60.669.4

4.542 Korea also determined that increased imports were significantly undercutting the prices of domestic producers. 239

Price Comparison Between Domestic Products and SMPP

1993 1994 1995 1996 (1-4)

Price of Raw Milk 240 (Won/kg) (A)

4,100 4,100 4,100 4,560
Price of Domestic Milk Powder (Won/kg) (B) 5,354 5,296 5,388 4,994
Price of SMPP in Korea (Won/kg) (C) 2,590 2,500 2,530 2,971
Difference (C-A) -1,510 -1,600 -1,570 -1,589
Difference (C-B) -2,764 -2,796 -2,858 -2,023

This wide price differential between domestic milk powder and imported SMPP forced Korean producers to lower their price of domestic milk powder to levels that eventually could not even cover costs.

4.543 In addition to the suppression of prices for both raw milk and domestic milk powder and the attendant losses connected with this suppression, SMPP imports increasingly displaced domestic inputs in the production of downstream products.During the investigation period, Korea determined that consumption of flavoured and fermented milk, which use the cheaper imported SMPP, increased at the expense of white milk, which can only be made from domestic raw milk 241.

Change in Market Share for Milk Products

1993 1994 1995 1996.1-6
White Milk 63.0% 61.4% 57.8% 53.7%
Flavoured Milk 6.0% 7.9% 4.2% 4.7%
Fermented Milk 22.8% 23.5% 23.6% 26.2%

Prior to the market liberalization in 1993, the production of flavoured milk remained constant. It is only after the surge in imports of SMPP into the Korean market that the production of flavoured milk increased at the expense of white milk. Looking at the production ratio of Korean white milk and comparing it to the increase in production of flavoured milk, the effect of SMPP imports on consumption of domestic raw milk is pronounced. 242

1990 Changes in Market Share of White Milk
and Flavoured Milk

1990 1991 1992 1993 1994 1995 1996.1-6
White Milk 92.9% 92.4% 92.4% 91.3% 88.6% 83.8% 82.1%
Flavoured Milk 7.1% 7.6% 7.6% 8.7% 4.4% 16.2% 17.9%

Indeed, the usage rate of imported SMPP by the five leading processing companies which manufacture final dairy products using SMPP showed a significant increase: 243

Usage Rate of Smpp by Processing Companies

Year Usage Rate
1993 3%
1994 23.8%
1995 29%
1996 (1-4) 53.3%

The impact of SMPP's replacement of domestic raw milk and milk powder can also be witnessed in the decreased profitability of the livestock cooperatives, which are owned by dairy farmers.Their decreased income had repercussions on other elements affecting the overall health of the domestic industry, including, for example, profitability, inventory, employment and the inability to invest in research and development.

4.544 Further, during the period of investigation, imports of SMPP increased at a more rapid rate than the decline in imports of skimmed and whole milk powder.

Differences in the Volume of Imported
Milk Powder nd SMPP

(Unit : tonnes)

Year Imported Milk Powder SMPP 244 Difference
1993 14,843 3,217 -11,626
1994 11,581 15,561 3,980
1995 7,576 28,007 20,431
1996 (1-6) 583 16,320 15,737

4.545 Against this background, Korea reached the conclusion that serious injury to the Korean dairy industry had been clearly caused by the increased imports in that:

(a) Korean market share of raw milk and milk powder decreased;

(b) Market share of Korean white milk (which can only be made from domestic raw milk) declined, while market share of flavoured and fermented milks (which can, and did, use imported milk powder) increased;

(c) Under normal market conditions, milk processing companies purchase raw milk and domestic milk powder as inputs for the production of end products. Because raw milk is perishable, excess raw milk not sold to the domestic market, or used by the processing companies, must be sold to the cooperatives for conversion into milk powder. During the investigation period, the processing companies increasingly replaced raw milk and domestic milk powder with much cheaper SMPP. As a result, excess raw milk was converted into unsaleable milk powder which remained in inventory and accumulated to high levels;

(d) As inventory levels increased, the livestock cooperatives were compelled to sell the milk powder stock at prices below their production costs and saddled with a heavier debt load that in turn contributed to the higher leverage ratio and further depletion of capital;

(e) The membership of the NLCF increased during the investigation period.This increase was a direct result of the increase in imports of SMPP, since, as these replaced Korean raw milk, farmers that had previously sold raw milk directly to processing companies were now unable to do so because they were faced with stiff competition from the cheaper imported SMPP.In order to find an outlet for the raw milk, they had to sell to cooperatives, and in order to sell to cooperatives, they had to be members of those cooperatives;

(f) As Korea has no developed export market for the accumulated milk powder, and in any case would be price-uncompetitive when compared to the subsidized or dumped milk powder available in the world market, there was no effective outlet for this inventory, thus only having a suppressive effect within Korea;

(g) The losses incurred by Korean milk powder producers were substantial and increased over the investigation period.These losses were in large part attributable to price suppression and displacement of raw milk and milk powder by the imports of the cheaper SMPP;

(h) As a direct result of the above, average household debt of dairy farmers doubled during the investigation period, and despite the long-term loans (which were unrelated to an increase or decrease in production) provided to virtually all dairy farmers, employment of Korean dairy farmers fell by approximately 5,500 households.The decrease in the number of farms was propelled by the cooperatives' inability to compensate fully the dairy farmers for their raw milk, because SMPP was replacing domestic products, causing a rise in inventory and decreasing profits. During difficult periods, including during the investigation period, the livestock cooperatives are required to purchase raw milk from dairy farms and pay 70-80 per cent in cash and the remainder in milk powder, further exacerbating the harm to operating margins of the dairy farms; 245

(i) The severe revenue problems suffered by the cooperatives were in large part passed onto the farmers.These problems caused disinvestment and severely limited investment in dairy production techniques and R&D in the milk powder sector, which produces only two types of milk powder, as compared to the multitude of milk powder types produced by the major exporting countries.

To continue with Other potential causal factors analysed


235 Notification of 1 April 1997, p.17, para. 2.3.6.

236 Notification of 1 April 1997, p. 10, para IV.3.7.

237 See, Notification V.

238 See, Notification V.1.1.

239 See, Notification V.1.2.

240 The price of raw milk was calculated by taking into account that 10 units of raw milk are used to produce one unit of milk powder.

241 Source: MAF

242 See, Notification V.1.3.

243 Source: MAF

244 See, Notification IV.2.

245 See, Exhibit Korea-1.