(h) Profits and losses

7.70 The Korean authorities' consideration of this factor appears at page 41 of the OAI Report for the raw milk segment of the industry and page 49 for the milk powder segment of the industry. Regarding the raw milk segment the Korean authorities found that various livestock cooperatives had declining profits during the period, to the point where by the first semester of 1996 they were reporting losses of 17,546 million Won. Korea explained in the OAI Report that this analysis was carried out on the livestock cooperatives with the following reasoning: "since the livestock cooperatives, which are comprised of dairy households producing raw milk, distribute their profits to their members, the livestock cooperatives' profits and losses are directly linked to the raw milk producers' income." ⁴³⁹

7.71 First, we note that the livestock cooperatives' business is not only the collection, distribution and sale of raw milk but also the processing of this raw milk into downstream dairy products for subsequent sale. Thus, the profits or losses of the livestock cooperatives do not reflect exclusively their activities in the raw milk sector but also other activities.

7.72 Second, the raw milk producers' profits or losses do not derive only from their investment in the livestock cooperatives, but also from the sale of raw milk to the livestock cooperatives. In its first submission ⁴⁴⁰ Korea presents data on the profit margins for raw milk producers based on the difference between the reference sale prices and the production cost of raw milk. However, as admitted by Korea, ⁴⁴¹ this analysis was not performed at the time of the investigation.

7.73 Third, we also gather from Korea's description of its analysis that it examined only some of the livestock cooperatives. However, there is no explanation of why this was done. Lacking any such explanation it is not possible for us to assess whether the selection of the livestock cooperatives rendered an objective picture of the situation of the whole domestic industry.

7.74 Taken together the flaws in Korea's consideration of profits and losses in the raw milk segment of the industry outlined above lead us to find that this factor was not adequately considered for the purpose of Article 4.2.

7.75 Regarding the milk powder sector of the industry, we again find flaws in Korea's consideration of profits and losses. In examining the profits and losses of the milk powder sector the Korean authorities examined only two livestock cooperatives and four milk processing companies. Again, there is no explanation of why the an examination of only these companies would constitute an objective and representative picture of the situation of the whole domestic industry. Footnote 15 of the OAI Report contains a reference to the proportion of annual production by the chosen cooperatives and companies where the data have been deleted. Without any such explanation Korea has not demonstrated that it had considered the objectivity and representativeness of the sample. Thus, we find that for the purpose of Article 4.2 Korea has not adequately considered the profits and losses of the whole domestic industry.

(i) Employment

7.76 The analysis of changes in the levels of employment for the domestic industry was also performed by the Korean authorities first for the raw milk producers and then for the milk powder producers. Regarding the analysis of the employment in the raw milk sector, the Korean authorities chose to analyse whether there was a decrease in the number of dairy households. The reasons for this choice were explained to the Panel as follows:

This explanation was made in the oral statement at the second meeting of the Panel with the parties, and not in the OAI Report. We commend Korea for devising a surrogate methodology to measure the employment in the raw milk industry and not simply dismissing this factor as irrelevant or not quantifiable. Nevertheless, this deviation from normal practice should have been explained at the time of the decision in the OAI Report. Lacking this explanation in the OAI Report we find that this factor was not adequately considered for the purpose of Article 4.2.

7.77 Regarding the analysis of employment for the milk powder producers, the Korean authorities, explained in the OAI Report, that:

In the light of this explanation in the OAI Report, we find that, for the purpose of Article 4.2, Korea has adequately considered this factor for milk powder production.

(j) Inventory

7.78 Regarding this factor, Korea considered inventories of domestic milk powder only, since raw milk is not susceptible of stockage. ⁴⁴⁴ There are two references to the inventory levels throughout the OAI Report (pages 38-39, and 46). We note that the figures at pages 38-39 are slightly different from those at page 46. Nevertheless, they both show an accumulation of stock for the period under investigation. ⁴⁴⁵ We find, however, that there is no reasoning as to why such levels of inventory are indicative of serious injury or why they are negative for the domestic dairy industry. Again this explanation is made in the second submission of Korea, where it is stated:

The increased inventory incurred a significant amount of costs. Even if depreciation is disregarded, the cost of inventory amounted to 17.3 billion Won (approximately US $21.6 million) during the investigation period.The inventory costs during the first six months of 1996 alone were 5.8 billion Won (approximately US $7.3 million), and the domestic producers were compelled to incur the full inventory cost... ⁴⁴⁷"

Thus, it is clear from the statement made in Korea's second submission that the level of inventories of milk powder found by the Korean authorities has negative consequences for the milk powder sector of the industry and could indicate that the domestic industry is injured. However, this reasoning provided in Korea's second submission is not discernible in the OAI Report, and it is only after it has been explained in the second submission that the precariousness of the situation of the domestic industry regarding this factor becomes evident. Thus, we find that this factor was not adequately considered for the purpose of Article 4.2.

(k) Price

7.79 This factor is not explicitly mentioned in the list of factors included in Article 4.2, however, Korea considered it in its investigation. The Korean authorities examined prices for milk powder and found that they were lower in the first half of 1996 than they were in 1993 at the beginning of the period of investigation. ⁴⁴⁸ We note that milk powder prices had risen to a high level as recently as 1995. Taking into account the entire OAI Report, we consider that Korea has established that lower prices for milk powder are indicative of serious injury for the milk powder industry ⁴⁴⁹. However, while there is an analysis of prices for the milk powder industry, we note that there is no explanation of the relationship between the price levels for milk powder and the serious injury alleged to be suffered by the whole domestic industry.

7.80 Indeed, Korea did not examine prices of raw milk in its investigation. In this regard Korea stated in its submissions that "there is no reliable way of arriving at an accurate or appropriate transaction price for raw milk in Korea" ⁴⁵⁰ and "that any impact of declining domestic milk powder prices adversely affected the entire domestic industry, since raw milk producers own the livestock cooperatives." ⁴⁵¹

7.81 We are of the view that conclusions about the prices of milk powder only, do not constitute a consideration of prices to the whole domestic industry which was defined as producers of raw milk and milk powder. The fact that it is the producers of raw milk who own the cooperatives does not exempt the Korean authorities from examining the particular conditions of the raw milk producers as this is a different segment of the industry from milk powder production. For this reason we find that Korea's consideration of the prices was incomplete as it only took into account one segment of the domestic industry. Thus, we find that this factor was not adequately considered for the purpose of Article 4.2.

7.82 Moreover, we note that even if actual transaction prices for raw milk in Korea were unavailable or it was not feasible to collect them given the large number of producers, there were several other avenues available to the Korean authorities that would have allowed them to calculate or construct an approximation of raw milk prices. ⁴⁵² Such indicators, even if not one hundred per cent accurate could have enabled the Korean authorities to identify the existence of trends, either positive or negative, in the prices for raw milk. The choice of methodology to determine prices rests with the investigating authorities, but given that there were various options available in this case we find that the Korean authorities should have made an effort to determine the prices for raw milk, instead of dismissing this factor as not being quantifiable.

(l) Debt to equity ratio and capital depletion

7.83 These are two additional economic indicators that do not appear in the illustrative list of Article 4.2, which were considered by the Korean authorities. These factors were evaluated exclusively with regard to the livestock cooperatives. The results, presented at pages 43 and 44 of the OAI Report, only give information on a portion of the livestock cooperatives. It is impossible for us to assess if the data presented reflect the position of the whole domestic industry. Thus, we fail to see in the OAI Report any explanation as to why these two factors reflect serious injury, especially serious injury to the whole Korean domestic industry producing raw milk and milk powder. Thus, we find that this factor was not adequately considered for the purpose of Article 4.2.

(m) Production cost

7.84 The Korean authorities only examined the production cost of livestock cooperatives in the production of milk powder. In this examination the Korean authorities found:

The difference between the sales price and the manufacturing cost was 196 won in 1993. However, it recorded -132 won in 1994 and the negative margin grew larger to -472 won in 1995 and further to -1,184 won in the January-to-April period of 1996." ⁴⁵³

The Korean authorities concluded that there was a widening negative gap between the cost of manufacturing milk powder and its sale price. These sales below cost would indicate that livestock cooperatives were going through a difficult period. However, as this factor was only evaluated for a portion of the domestic industry (livestock cooperatives producing milk powder) it is not possible for us to assess the situation with regard to the whole domestic industry. We do not consider this factor to provide adequate support for the conclusion that there is serious injury to the domestic industry as defined by the Korean authorities. Thus, we find that this factor was not adequately considered for the purpose of Article 4.2.

(n) Conclusion

7.85 For the reasons described above, we find that Korea's determination of serious injury to the domestic production of raw milk and milk powder does not meet the requirements of Article 4.2 of the Agreement on Safeguards.

7.86 Article 2.1 permits the application of a safeguard measure only if, inter alia, there has been a determination of serious injury pursuant to Article 4.2. Since we find that Korea's determination of serious injury does not meet the requirements of Article 4.2, the application of the safeguard measure at issue would necessarily also violate Article 2.1of the Agreement on Safeguards. We note that in its request for establishment of a panel, the European Communities claims generally that Korea violated Articles 2.1, 4.2(a), 4.2(b), 5.1 and 12.1 to 12.3 of the Agreement on Safeguards. However, in its submissions, the European Communities did not argue specifically, nor did it submit any evidence, in support of its claim under Article 2.1, other than those relating to "under such conditions" (as discussed in Section F supra. ⁴⁵⁴ Therefore, we do not reach any conclusion on the issue of whether Korea's determination of serious injury violates the provisions of Article 2.1 of the Agreement on Safeguards.

2. Korea's examination of the causal link between increased imports and serious injury

7.87 We have already determined above that Korea's injury determination did not meet the requirements of Article 4.2 of the Agreement on Safeguards. We concluded that Korea did not address all injury factors listed in Article 4.2 of the Agreement on Safeguards. In addition, we concluded that when addressing factors listed in Article 4.2 of the Agreement on Safeguards, the OAI Report did not contain any reasoning, analysis or evidence in support of its findings and sometimes it limited its analysis to only one segment of the relevant domestic industry. Having reached these conclusions with regard to Korea's assessment of the injury factors, it is not necessary for us to reach any findings on whether Korea demonstrated that increased imports "caused" serious injury to the domestic industry producing like or directly competitive products. However, keeping in mind the conclusions of the Appellate Body in Australia - Salmon ⁴⁵⁵, we would like to offer some general comments relevant to an analysis of a causal link between increased imports and injury, in the context of the Korean investigation.

7.88 We recall the provisions of Articles 2 and 4.2 of the Agreement on Safeguards:

7.89 In performing its causal link assessment, it is our view that the national authority needs to analyze and determine whether developments in the industry, considered by the national authority to demonstrate serious injury, have been caused by the increased imports. In its causation assessment, the national authority is obliged to evaluate all relevant factors of an objective and quantifiable nature having a bearing on the situation of that industry. In addition, if the national authority has identified factors other than increased imports which have caused injury to the domestic industry, it shall ensure that any injury caused by such factors is not considered to have been caused by the increased imports.

7.90 To establish a causal link, Korea has to demonstrate that the injury to its domestic industry results from increased imports. In other words, Korea has to demonstrate that the imports of SMPP cause injury to the domestic industry producing milk powder and raw milk. In addition, having analyzed the situation of the domestic industry, the Korean authority has the obligation not to attribute to the increased imports any injury caused by other factors.

7.91 For instance, the KTC needs to explain how the developments with respect to factors considered by the KTC to demonstrate serious injury, were caused by the imports of SMPP. This is to say that the KTC, in its analysis of the increased market share of SMPP for example, should have tried to explain how the imports of SMPP effectively displaced the domestic production of like or directly competitive products.

7.92 To take one example using only one factor for only one year we note that the OAI Report ⁴⁵⁶ states that the most important increase of import of SMPP occurred from 1993 to 1994 (384 per cent). However, we know that during the first year under investigation (1994), domestic demand for raw milk and milk powder increased significantly. The OAI Report ⁴⁵⁷ indicates: "... the large increase of dairy production in 1994 resulted from the drastically increased demand for market milk and fermented milk due to the quite warm winter". The Korean authorities found ⁴⁵⁸ that from 1993 to 1994, total demand of raw milk increased by 9.6 per cent while domestic production only increased by 3.2 per cent. We consider, therefore, that in 1994, to meet the increased demand in raw milk it was necessary to increase imports of raw milk substitutes. The reasons for this are: first, raw milk supply (in the short term) is very rigid, as it depends upon the number of milk cows (head) which cannot be increased rapidly and; second, the import tariff on milk powder had been increased to a very high level (220 per cent) which constrained imports of milk powder. This situation therefore implied that the only way for Korea to respond to the increased demand was to import more of the low-tariff SMPP (39 to 40 per cent). In other words, in 1994 domestic demand for raw milk in Korea was larger than domestic production of raw milk. This had the effect of decreasing the production of milk powder (which is made from raw milk) ⁴⁵⁹ and decreasing milk powder inventories ⁴⁶⁰. It seems clear to us, that at least for 1994, the imports of SMPP cannot have caused injury to the domestic industry producing like or directly competitive products in Korea. On the contrary the increasing imports of SMPP were the result of the increasing needs for raw milk and milk powder substitutes by the Korean industry faced with the incapacity of the domestic production to fulfill the increasing demand for such products. In the OAI Report there is no analysis of the interaction of these various elements. However, any adequate causation assessment had to be performed for the overall injury determination.

7.93 As to other factors that may have caused injury to the domestic industry producing like or directly competitive products, we know, from the OAI Report, that domestic demand for raw milk was affected by other factors. For example, it is said in the footnote to page 16 of the OAI Report: "Considering ..., data on cheese import was excluded but imports of cheese, which has direct influence on consumption of domestic raw milk, also has largely been increasing since import liberalization in 1995...". As we mentioned before (see paragraphs 15.62 and 15.63 supra), this footnote must refer to an exclusion of data on imported basic material for cheese, as the text that is expanded upon does not mention cheese as a finished product but rather imported basic materials for cheese. In other words, it would be these imports of basic materials for cheese that would have a direct influence on consumption (demand) for raw milk.

7.94 Korea recognizes that the domestic production of cheese has decreased. ⁴⁶¹ This decrease of cheese production directly affected the consumption of and demand for raw milk. However, the OAI Report does not contain any evaluation or analysis of the impact of this factor (i.e. increased imports of cheese or increased imports of basic material for cheese, and their impact on the reduced demand for cheese and consequently the reduced demand for domestic raw milk in making cheese).

7.95 The same line of reasoning holds for the other dairy products that use raw milk or milk powder as inputs which, according to Korea, also decreased. Therefore, the demand for raw milk and milk powder should have decreased as well. On page 14 of the OAI Report, the KTC notes that the domestic production of white milk, condensed milk, cheese and lactic-acid-producing beverages went down during the period of investigation. We know from Korea's domestic regulation ⁴⁶² that SMPP cannot substitute for raw milk in the production of white milk, condensed milk, cheese, and lactic-acid-producing beverages. If the domestic production of these products went down as well, factors other than imports of SMPP must have caused the reduction of domestic production of these products which, in turn also must have had an impact on the reduced consumption of raw milk and milk powder. In compliance with the provisions of Article 4.2 of the Agreement on Safeguards, the causal link between increased imports of SMPP and the factors it found to demonstrate injury must also be assessed by the national authority.

7.96 This should not be construed to mean that the Panel interprets the Agreement on Safeguards as imposing on the importing Member any appropriate method either for collecting data or for considering and weighing all the relevant economic factors upon which the importing Member will decide whether there is need for a safeguard restraint. The relative importance of particular factors including those listed in Article 4 of the Agreement on Safeguards is for each Member to assess in the light of the circumstances of each case. Korea remains free to determine an appropriate method of assessing whether the state of its domestic industry was caused by imports of SMPP and how this analysis was performed. Korea also remains free to choose the method of assessing whether any serious injury to its domestic industry was caused by such other factors.

To continue with Claims under Article 5.1 of the Agreement on Safeguards

⁴³⁹ OAI Report, page 41

⁴⁴⁰ See para. 12.343, supra.

⁴⁴¹ In its request for interim review, Korea submits that it "has never made any attempt to argue that [an analysis of the profits and losses of the raw milk producers] was conducted during the investigation".

⁴⁴² See para.12.513, supra.

⁴⁴³ OAI Report, page 48

⁴⁴⁴ OAI Report, page 38

⁴⁴⁵ See para. 12.323, supra.

⁴⁴⁶ See para.12.460, supra.

⁴⁴⁷ See para.12.462, supra.

⁴⁴⁸ OAI Report, page 47.

⁴⁴⁹ This reasoning can be found in the causation section of the OAI Report at page 62.

⁴⁵⁰ See para.12.504, supra.

⁴⁵¹ See para.12.449, supra.

⁴⁵² For example, Korea could have performed: (1) an analysis based on sampling of the raw milk producers, a methodology which was used by Korea elsewhere in its analysis; (2) a construction of the prices for raw milk based on the cost of production of raw milk producers, for which data appear to be on the record; on (3) a construction of the prices by making adjustments to the cost of raw materials reported by the milk powder producers.

⁴⁵³ OAI Report, page 53.

⁴⁵⁴ See the Appellate Body report on Japan - Measures Affecting Agricultural Products (WT/DS/76/AB/R), paras. 118 to 131.

⁴⁵⁵ Australia - Salmon, para. 223.

⁴⁵⁶ OAI Report, page 32.

⁴⁵⁷ OAI Report, page 14.

⁴⁵⁸ OAI Report, page 39.

⁴⁵⁹ OAI Report, pages 58-60.

⁴⁶⁰ OAI Report, page 17.

⁴⁶¹ See the negative data in the OAI Report, page 14.

⁴⁶² See Food Industry Handbook, referred to in the OAI Report, ge 26.