(ii) Other potential causal factors analysed and discounted

4.546 In addition, Korea considered other factors which could have been a cause of the serious injury noted above. ²⁴⁶ Korea undertook an extensive analysis of the effect of the �milk quality� controversy on inventory.It rejected the analyses suggested by both the KFIA ²⁴⁷ and the exporters, and used its own, which led it to conclude that the effect of the controversy lasted three months and ceased to be a cause of reduced raw milk demand by January 1996. ²⁴⁸

4.547 Korea also considered whether the increase in imports of SMPP during the period under investigation had led to a decrease in the overall imports of milk powder. ²⁴⁹ Imports of milk powder were within the import framework for milk powders negotiated by Korea as part of the Uruguay Round.Under this framework, milk powder (as opposed to SMPP) was subject to an agreed tariff rate of 220 per cent which permitted its import to be controlled in an agreed and transparent manner.However, imports of SMPP circumvented this structure and were able to be imported at a much lower tariff rate than milk powder.The increased imports of SMPP far outweighed the drop in imports of milk powder paying the agreed tariff rate, and so there was no reason to conclude that the effect of the increase in imports of SMPP was offset by the decrease in milk powder.

4.548 In relation to demand, Korea considered whether the serious injury was caused by changes in domestic demand, and concluded that such changes did not cause serious injury.The European Communities dispute Korea's conclusion that "no connection could be established between the effect on these dairy products and injury to the domestic industry ²⁵⁰." However, it is clear that there is no necessary connection between an increase in production and consumption of products using SMPP on the one hand, and injury to the domestic industry on the other.As noted above, no individual criteria of serious injury can be determinative on its own, and must be considered in conjunction with all other relevant criteria.

(c) Additional arguments by the European Communities made at the first meeting of the Panel with the parties

4.549 At the first meeting of the panel with the parties, the European Communities further advanced their arguments under Article 4.2(a) as follows:

(i) Invocation of new arguments

4.550 The European Communities based their analysis of the lack of causal link first on the reasons given by Korea in its Notification of 1 April 1997 and second on a consideration of factors which Korea had failed to consider or make allowance for.

4.551 In the EC view Korea in its First Written Submission seeks to rely on a completely different reasoning in order to try to establish causation.There is little similarity between Korea's First Written Submission on this point and Section V.1 of the Notification and Korea is clearly trying to justify its measure ex post. Most notable are arguments for the first time about the increasing membership of the NLCF, the unavailability of any export market, "price suppression", the "displacement" of domestic milk and milk powder by imported SMPP, the doubling of dairy farm debt and finally disinvestment and limited investment in Research and Development. The European Communities submit that the safeguard measure must be judged in the basis of the reasons given in the Notification and that ex post rationalizations are not admissible.

4.552 In particular the European Communities take issue with Korea's contention that it determined that increased imports were significantly undercutting domestic production.There was no investigation of this matter and no consideration of the proper relationship between the prices of imported SMPP and domestic milk powder.

4.553 In any event, The European Communities believe that the new reasoning also does not establish any causal link. However, regarding the notion that imports forced an increase in the membership of the NLCF and therefore injury, the European Communities note with interest the affirmation by Korea that the membership of the NLCF now accounts for 99 per cent of dairy farmers and that the NLCF has committed itself to pay the Korean Government recommended prices. Assuming this to be true, the European Communities do not see how it helps to establish causality. This high membership demonstrates that the dairy farmers are shielded from any possible adverse effects.The cause of the increased stock levels of NLCF members would seem to be sales to it by dairy farmers. This would therefore represent one part of the Korean industry (dairy farmers) causing injury to another part (co-operatives) and establishes no direct link with imports.

(ii) The consequences of the "pus milk" scandal

4.554 In the EC view the real cause of the increase in stocks in late 1995-1996 was, the "pus milk" scandal.At the end of 1995, the Korean public reduced its milk consumption when certain dairies started to accuse others of supplying "pus milk" from cows with mastitis.There was no doubt no truth in these allegations but they were made and did have an effect.The European Communities submitted a press Article describing the background to this issue.

4.555 Korea is fairly brief on this matter in its First Written Submission.Its explanation is worth quoting:

No detail is given of the analyses which led to this conclusion.

4.556 The Notification of 1 April 1997 had stated that the KFIA had failed to take account of the seasonal variations. The graph below, submitted by the European Communities, show a clear seasonal variation in milk consumption in Korea with a substantial decrease in winter. It also shows that milk consumption was increasing in each period.In 1995-96 there is a sudden dramatic drop which exceeds the previous seasonal variations and brings consumption back to levels of three years earlier. It is easy to understand why this, against a background of increasing dairy production and inflexible supply due to de facto assured prices would have led to the increase of stocks.

4.557 The European Communities therefore maintain that the situation of the Korean industry could not be considered to be one of "significant impairment" necessary to establish "serious injury" and in any event had nothing to do with rising imports of SMPP but was instead the result of the "pus milk scandal" in conjunction with rising and inflexible production caused by high quasi-guaranteed prices.

4.558 The European Communities submitted a graph (reproduced below) illustrating their conclusion on this matter.It shows the development of imports of SMPP and the evolution of stocks. Increased stock levels is a problem which arose from November 1995.It shows no correlation at all with imports of SMPP but very much so with the "pus milk scandal".

(d) Rebuttal arguments made by the European Communities

12.559 The European Communities made the following arguments in rebuttal:

4.560 Korea's measure cannot be justified on the basis of reasons which were not considered by the investigating authorities and are not reflected in Korea's 24 March Notification.In any event those put forward by Korea in its First Written Submission do not establish a causal link between imports of SMPP and the injury allegedly suffered by the Korean domestic industry. In particular, the European Communities recall that Korea did not demonstrate any causal effect between prices of imported SMPP and those of domestic milk powder or raw milk.

4.561 Furthermore, as regards the effects of the milk quality scandal, the European Communities note that Korea alleges to have relied on three econometric models to dismiss the importance of the quality scandal in explaining the situation of its domestic industry.Having examined the information included in the "OAI Report" which Korea has referred to, the European Communities consider that such information does not provide the explanation that Korea claims and that it has therefore not established that the "Pus Milk" Scandal did not cause or contribute to the injury.

4.562 First of all, the calculations of those models are based on production of milk, not on consumption. ²⁵¹ The European Communities assume that production refers to white milk since only this, and not production of raw milk would approximate to consumption of white milk, because of the short shelf life of white milk.It is also remarkable that Korea considers that "there are various factors that can influence milk consumption, such as, among others, the change of consumption patterns, weather, etc." This statement is used to explain away the relevance of the milk quality scandal, but these factors are nowhere considered when examining the impact of imports of SMPP.

4.563 But the most important point is that Korea's deductions from its own figures and models ²⁵² involve completely circular reasoning. Each of the three graphs deriving from the econometric models shows a decrease in milk production lasting through June 1996 (and possibly beyond, as no figures are given beyond that date): in June 1996 a decrease of between 13,000 and 17,000 tonnes of milk production is still evident (depending on which model is considered). These results are dismissed by the statement, "The gap shown from February 1996 is attributable to factors other than quality dispute." ²⁵³ Which other factors? Were these investigated? And where are the results of such investigation given?

4.564 The OAI Report also notes that "The investigation authority drew this conclusion on the basis of the nature and short duration of the quality dispute." ²⁵⁴ The issue at stake is not the duration of the dispute, but the duration of its remaining in the public consciousness so as to affect consumption of milk - this is likely to be considerably longer than the dispute itself, but Korea failed to conduct any research to establish the length of this latter period of time. Thus Korea's conclusion that the "Pus Milk" Scandal did not have a lasting effect on stocks is not supported by its own models and is derived from and peremptory statement that it was of short duration.As stated above the reasoning is circular.

4.565 The European Communities affirm that Korea's attempted ex post justifications are not based on the investigation and therefore not admissible. In addition the further information Korea has supplied to attempt to dismiss the "Pus Milk" Scandal as a factor shows circular reasoning and simply confirms that this factor was not properly considered.

(e) Rebuttal arguments made by Korea

4.566 Korea makes the following rebuttal arguments:

4.567 Based on its examination of the dairy industry, the Korean authorities concluded that the ease with which imported SMPP could replace domestic raw milk and milk powder meant that SMPP was an effective substitute for domestic raw milk and milk powder in most industrial uses. This was evidenced by the increased amount of SMPP used by the major food processing companies. Given this fundamental fact, the Korean authorities then examined the price at which the SMPP was imported into Korea and found that it considerably undercut the domestic price of both raw milk and milk powder.This price undercutting not only caused a drop in the consumption of domestic milk powder but also reduced raw milk consumption.Conversely, the market share of SMPP in uses such as flavoured and fermented milks increased dramatically at the expense of domestic milk powder and raw milk.Also, the absolute increase in imports of SMPP far outweighed any drop in the imports of milk powder.

4.568 The price undercutting caused an increase in inventory of milk powder.A further consequence of the imports of cheap SMPP was that the percentage of raw milk collected from dairy farms by livestock cooperatives for conversion into milk powder increased as processing companies which traditionally purchased raw milk from dairy households opted to buy the cheaper imported SMPP. The increase in inventory, combined with the relatively limited shelf-life of milk powder, caused the market price of milk powder to become depressed still further.

4.569 Strong competition from cheap imported SMPP also caused a drop in the revenue and profitability of the dairy households, the cooperatives, and the processing companies.The dairy households now had more limited sales opportunities for their raw milk, which out of necessity had to be turned into milk powder, thus increasing the supply of milk powder and inventory, and depressing its price.The losses on sales of milk powder affected the revenue and profitability of the processing companies and the cooperatives, and as the cooperatives are owned by the Korean dairy farmers, these farmers bore part of their losses.

4.570 Decline in profitability of the entire domestic industry also caused an increase in unemployment and a drop in the level of investment in dairy farming, including, inter alia, research and development.

4.571 In particular, Korea considers that the investigation demonstrated the existence of a causal link ²⁵⁵ based on the Korean authorities' examination of the following:

(i) Substitution of domestic product by SMPP

4.572 The authorities examined the extent to which cheap SMPP imports replaced domestic products and stated that:

Source :	Written answers of users provided to the KTC
Note :	1. The total amount of raw milk, milk and skimmed milk
	2.The share is computerized by using the figures calculated in terms of domestic raw milk

To continue with Effect of the increased import of SMPP

²⁴⁶ See, Notification at Paragraph V.2

²⁴⁷ See, Notification at Paragraph V.2.1.a.

²⁴⁸ See, Notification at Paragraph V.2.1.

²⁴⁹ See, Notification at Paragraph V.2.2

²⁵⁰ See, Notification at V.2.3.6.

²⁵¹ See, the OAI Report, Exhibit Korea-14, p. 68-70.

²⁵² See, the OAI Report, graph on p. 70.

²⁵³ See, the OAI Report, p. 69.

²⁵⁴ Id.

²⁵⁵ Korea again reminds the Panel that the EC has accepted that the competent authorities published (a) "a report setting forth their findings and reasoned conclusions reached on all pertinent issues of fact and law" and (b) "promptly, in accordance with the provisions of Article 3, a detailed analysis of the case under investigation as well as a demonstration of the relevance of the factors examined."

²⁵⁶ OAI Report at 66.

²⁵⁷ OAI Report at 28.