UNITED STATES - TRANSITIONAL SAFEGUARD MEASURE ON
COMBED COTTON YARN FROM PAKISTAN

AB-2001-3
 

Report of the Appellate Body

(continuation)

V. Definition of the Domestic Industry

82. The United States defined the domestic industry as the producers of yarn who produced it for sale on the merchant market, thereby excluding from the scope of its definition the vertically integrated fabric producers who produce yarn for their own internal use. Pakistan claimed before the Panel that the United States violated Article 6.2 of the ATC because it did not investigate the entire domestic industry producing yarn.

83. The Panel found that:

Inconsistently with its obligations under [Article] 6.2, the United States excluded the production of combed cotton yarn by vertically integrated producers for their own use from the scope of the "domestic industry producing like and/or directly competitive products" with imported combed cotton yarn.⁵⁵ (emphasis added)

84. The United States appeals this finding of the Panel. The United States submits that 
Article 6.2 permits a definition of the domestic industry on the basis of products that are not only like but also directly competitive with the imported product. According to the United States, yarn sold on the merchant market and yarn produced by vertically integrated fabric producers for their own internal consumption are like, but they are not directly competitive with each other. The United States argues that, by rejecting its definition of the domestic industry, the Panel failed to give full meaning and effect to the term "and/or" in Article 6.2 and reduced the word "and " to inutility. The United States also argues that the Panel should have interpreted the definition of the domestic industry within the four corners of the ATC without having recourse to the wider context of other agreements of the WTO containing a definition of the domestic industry.
 

85. We begin our analysis of this issue with the definition of the domestic industry as stated in the relevant part of Article 6.2 of the ATC, which provides:

Safeguard action may be taken under this Article when, on the basis of a determination by a Member, it is demonstrated that a particular product is being imported into its territory in such increased quantities as to cause serious damage, or actual threat thereof, to the domestic industry producing like and/or directly competitive products. (footnote omitted, emphasis added)

86. A plain reading of the phrase "domestic industry producing like and/or directly competitive products" shows clearly that the terms "like" and "directly competitive" are characteristics attached to the domestic products that are to be compared with the imported product. We are, therefore, of the view that the definition of the domestic industry must be product-oriented and not producer-oriented, and that the definition must be based on the products⁵⁶ produced by the domestic industry which are to be compared with the imported product in terms of their being like or directly competitive.⁵⁷ 

87. We also consider that the term "producing" in Article 6.2 means producing for commercial purposes and that it cannot be interpreted, in itself, to be limited to or qualified as producing for sale on the merchant or any other segment of the market. The definition of the domestic industry, in terms of Article 6.2, is determined by what the industry produces, that is, like and/or directly competitive products. In our view, the term "producing", in itself, cannot be given a different or a qualified meaning on the basis of what a domestic producer chooses to do with its product.

88. We now turn to the next two components of the definition of the domestic industry under Article 6.2 of the ATC, namely, like products and directly competitive products.

89. We note that there is no disagreement between the participants⁵⁸ that yarn imported from Pakistan and yarn produced by the producers of the United States, regardless of whether they are vertically integrated fabric producers or independent yarn producers, are like products. The United States has made it clear in its arguments⁵⁹ that its exclusion of yarn produced by vertically integrated fabric producers from the definition of the domestic industry was not because they are not producing a like product, but because they are not producing a directly competitive product. It is, therefore, not necessary for us to address the meaning of the term "like products" for the purposes of this appeal.

90. Before we examine the term "directly competitive" in the specific context of Article 6.2 and the facts of this particular case, we consider it useful to recall our interpretation of this term on previous occasions. 

91. We have interpreted the term "directly competitive " in Korea - Alcoholic Beverages⁶⁰ and Japan - Taxes on Alcoholic Beverages.⁶¹ We are cognizant of the fact that these two reports interpreted this term in the context of the Interpretative Note Ad Article III:2 of the GATT 1994. We will refer to this aspect later. The key elements of the interpretation of the term "directly competitive" in our Report in Korea - Alcoholic Beverages are:

(a) The word "competitive" means "characterised by competition". The context of the competitive relationship is necessarily the marketplace, since that is the forum where consumers choose different products that offer alternative ways of satisfying a particular need or taste. As competition in the marketplace is a dynamic and evolving process, the competitive relationship between products is not to be analyzed exclusively by current consumer preferences⁶² ; the competitive relationship extends as well to potential competition.⁶³

 (b) According to the ordinary meaning of the term "directly competitive", products are competitive or substitutable when they are interchangeable or if they offer alternative ways of satisfying a particular need or taste.⁶⁴ 

(c) In the context of Article III:2, second sentence, the qualifying word "directly" in the Ad Article suggests a degree of proximity in the competitive relationship between the domestic and imported products. The word "directly" does not, however, prevent a consideration of both latent and extant demand.⁶⁵ 

(d) "Like" products are a subset of directly competitive or substitutable products: all like products are, by definition, directly competitive or substitutable products, whereas not all "directly competitive or substitutable" products are "like".⁶⁶ 

92. The United States argues that the Panel's over-reliance on our Report in Korea - Alcoholic Beverages is mistaken for two reasons. First, that dispute involved interpretation of a different phrase ("directly competitive or substitutable"), of a different provision and agreement (Article III:2 of the GATT 1994), and in a different factual setting. In particular, the word "substitutable" is not used in juxtaposition with "directly competitive" in Article 6.2 of the ATC. Second, the Appellate Body emphasized, in that case, the importance of the marketplace in judging the competitive relationship between products because that is the forum where consumers choose between different products. According to the United States, a proper reading of the Appellate Body's reasoning reveals that if a domestic product does not enter the marketplace at all, it cannot be regarded as being "directly competitive" with the imported product, even though the two products may admittedly be "like products".

93. We are not persuaded by these arguments of the United States with respect to the relevance and interpretation of our Report in Korea - Alcoholic Beverages. 

94. With respect to the first argument of the United States, a careful reading of our Report in that case would show that we used the terms "directly competitive" and "directly substitutable" without implying any distinction between them in assessing the competitive relationship between products.⁶⁷ We do not consider that the mere absence of the word "substitutable" in Article 6.2 of the ATC renders our interpretation of the term "directly competitive" under Article III:2 of the GATT 1994 irrelevant in terms of its contextual significance for the interpretation of that term under Article 6.2 of the ATC.

95. We now turn to an examination of the term "directly competitive" in the specific context of Article 6.2 of the ATC and the dispute before us. We must bear in mind that Article 6.2 permits a safeguard action to be taken in order to protect a domestic industry from serious damage (or actual threat thereof) caused by a surge in imports, provided the domestic industry is identified as the industry producing "like and/or directly competitive products" in comparison with the imported product. The criteria of "like" and "directly competitive" are characteristics attached to the domestic product in order to ensure that the domestic industry is the appropriate industry in relation to the imported product. The degree of proximity between the imported and domestic products in their competitive relationship is thus critical to underpin the reasonableness of a safeguard action against an imported product. 

96. According to the ordinary meaning of the term "competitive", two products are in a competitive relationship if they are commercially interchangeable, or if they offer alternative ways of satisfying the same consumer demand in the marketplace. "Competitive" is a characteristic attached to a product and denotes the capacity of a product to compete both in a current or a future situation. The word "competitive" must be distinguished from the words "competing" or "being in actual competition". It has a wider connotation than "actually competing" and includes also the notion of a potential to compete. It is not necessary that two products be competing, or that they be in actual competition with each other, in the marketplace at a given moment in order for those products to be regarded as competitive. Indeed, products which are competitive may not be actually competing with each other in the marketplace at a given moment for a variety of reasons, such as regulatory restrictions or producers' decisions. Thus, a static view is incorrect, for it leads to the same products being regarded as competitive at one moment in time, and not so the next, depending upon whether or not they are in the marketplace.

97. It is significant that the word "competitive" is qualified by the word "directly", which emphasizes the degree of proximity that must obtain in the competitive relationship between the products under comparison. As noted earlier, a safeguard action under the ATC is permitted in order to protect the domestic industry against competition from an imported product. To ensure that such protection is reasonable, it is expressly provided that the domestic industry must be producing "like" and/or "directly competitive products". Like products are, necessarily, in the highest degree of competitive relationship in the marketplace.⁶⁸ In permitting a safeguard action, the first consideration is, therefore, whether the domestic industry is producing a like product as compared with the imported product in question. If this is so, there can be no doubt as to the reasonableness of the safeguard action against the imported product. 

98. When, however, the product produced by the domestic industry is not a "like product" as compared with the imported product, the question arises how close should be the competitive relationship between the imported product and the "unlike" domestic product. It is common knowledge that unlike or dissimilar products compete or can compete in the marketplace to varying degrees, ranging from direct or close competition to remote or indirect competition. The more unlike or dissimilar two products are, the more remote or indirect their competitive relationship will be in the marketplace. The term "competitive" has, therefore, purposely been qualified and limited by the word "directly" to signify the degree of proximity that must obtain in the competitive relationship when the products in question are unlike. Under this definition of "directly", a safeguard action will not extend to protecting a domestic industry that produces unlike products which have only a remote or tenuous competitive relationship with the imported product. 

99. We will now examine whether, in this case, yarn produced by the vertically integrated fabric producers of the United States for their own captive consumption is directly competitive with the imported yarn for the purposes of Article 6.2 of the ATC. The United States argues that such yarn is not directly competitive because it is not offered for sale on the market except when the captive production is "out of balance"⁶⁹ , and even then only in de minimis quantities. In addition, vertically integrated fabric producers are not dependent on the merchant market for meeting any of their requirements of yarn except to a de minimis extent. In the United States' view, these factors are clearly reflected in the very low and stable rate of yarn sold or purchased by vertically integrated fabric producers to or from the merchant market over the last several years.⁷⁰

 100. We are unable to subscribe to this static view which makes the competitive relationship between yarn sold on the merchant market and yarn used for internal consumption by vertically integrated producers dependent on what they choose to do at a particular point in time. 

101. If the competitive relationship between the two products is properly considered, it will be clear that they are "directly competitive" within the meaning of that term in Article 6.2. Our view is illustrated by the following considerations:

(a) The vertically integrated fabric producers compete with the independent fabric producers who purchase their requirements of yarn in the merchant market. It is, therefore, unlikely that vertically integrated fabric producers would make their "make-or-buy" decisions with respect to their input of yarn without considering the opportunity cost of doing so.⁷¹ The low and stable rate of their relationship with the merchant market for yarn observed in the past does not imply that the opportunity cost does not enter into their calculations.

(b) Individual vertically integrated fabric producers may enter the merchant market to different degrees for selling their production or buying their requirements of yarn.⁷² One may do it for two percent, another for five percent and yet another for 10 or more percent depending on their own individual commercial decisions at a particular point in time. A force majeure, or any other serious difficulty, may suddenly compel a vertically integrated fabric producer to rely heavily on the merchant market for its requirement of yarn. Likewise, the competitive conditions in the fabric market may compel a producer to offload a greater part of its yarn production in the merchant market. The low and stable rate of sales and purchases of yarn by vertically integrated fabric producers, observed in the past, is, therefore, not a sufficient reason to conclude that such yarn is not directly competitive with imported yarn sold on the merchant market. 

(c) The approach of the United States would lead to constant variations in the size of the domestic industry. In addition to the variations resulting from the ad-hoc sale and purchase decisions mentioned above, the size of the domestic industry would depend on ownership or control of yarn plants. The yarn produced by an independent domestic producer would cease to be directly competitive the moment that producer is taken over by a fabric producer, to the extent the latter transforms this yarn into fabric.⁷³ Likewise, if a vertically integrated fabric producer were to sell its plant producing yarn and that plant were to become an independent producer, the yarn that was previously regarded as non-directly competitive would suddenly become directly competitive.

(d) The approach of the United States would lead to another result which, in our view, cannot be justified. The domestic captive production of yarn by vertically integrated fabric producers would be excluded from the determination of serious damage (or actual threat thereof). However, a safeguard action taken against imported yarn would benefit the vertically integrated fabric producers with respect to the totality of their yarn production, not only with respect to the yarn they sell in the merchant market, but also with respect to yarn they produce for their own consumption.

(e) Finally, the approach of the United States would have major consequences for the justification and scope of the safeguard action. The exclusion of domestic captive production of yarn from the definition of the domestic industry would imply that if a fabric producer imports such yarn from a foreign plant that it owns, such import would also have to be excluded from the calculation of the surge in imports and from the application of the safeguard action. In the case before us, the safeguard action applies to all imports. The United States points out that, in this case, this issue does not arise as there are no imports of captively produced yarn from Pakistan; all the imports from Pakistan are destined for the merchant market. This may have been so until now, but the situation may well change in the future. Captively produced imports which had been exempt from the safeguard action could be sold on the merchant market if their prices were lower than those on the merchant market. This would undermine the effectiveness of the safeguard measure.

102. The United States also argues that our ruling in United States - Hot-Rolled Steel supports its contention that the captive segment of the market can be separated from the merchant market segment because we observed that captive production was "shielded from direct competition".⁷⁴ We did not hold, however, that captive production can be excluded from either the definition of the domestic industry or from the injury analysis. We said that, while an injury analysis can be carried out segment-by-segment before assessing damage to the domestic industry as a whole, an analysis of the captive segment of the market cannot be excluded. Our observation that captive steel production was "shielded from direct competition" did not mean that steel produced in the captive market segment is not directly competitive with imported steel destined for the merchant market. Our ruling in United States - Hot-Rolled Steel, therefore, does not support the argument of the United States.

103. For all these reasons, we do not accept the contention of the United States that yarn produced by the vertically integrated fabric producers of the United States is not "directly competitive" with yarn imported from Pakistan. 

104. We now turn to the interpretation of the connectors "and/or" in Article 6.2, on which the participants disagree.⁷⁵ We note that the definition of the domestic industry adopted by the United States in this case would be consistent with Article 6.2 only if we were to find: (i) that captively produced yarn is not directly competitive with imported yarn; and (ii) that the connectors "and/or" in Article 6.2 permit defining the domestic industry on the basis of a product which is not only like but also directly competitive with the imported product. We have reached the conclusion that captively produced yarn is directly competitive with imported yarn sold on the merchant market. We, therefore, do not need to address the interpretation of the connectors "and/or" in Article 6.2. 

105. For all these reasons, we find that combed cotton yarn produced by vertically integrated fabric producers for their internal consumption is "directly competitive" with combed cotton yarn imported from Pakistan. Accordingly, we uphold the Panel's finding, in paragraph 8.1(a) of its Report, that the United States acted inconsistently with Article 6.2 of the ATC, by excluding from the scope of the domestic industry the production of combed cotton yarn by vertically integrated producers for their own internal use.

55. Panel Report, para. 8.1(a). See also, Panel Report, para. 7.90.

56. In United States – Lamb Safeguard, we also found that the product defines the scope of the definition of the domestic industry under the Agreement on Safeguards. In that case, the "like" product at issue was lamb meat. (Appellate Body Report, supra, footnote 41, paras. 84, 86-88 and 95)

57. At this stage, we analyze the terms "like" and "directly competitive" in isolation. For the interpretation of the connectors "and/or" in Article 6.2, see, infra, paragraph 104.

58. Panel Report, para. 7.41.

59. United States' appellant's submission, paras. 33 ff.

60. Appellate Body Report, supra, footnote 20, paras. 108-124.

61.  Appellate Body Report, WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R, adopted 1 November 1996, DSR 1996:I, 97, at 117-118.

62. Supra, footnote 20, paras. 114-115.

63. Ibid., paras. 115 and 117.

64. Supra, footnote 20, para. 115.

65. Ibid., para. 116.

66. Ibid., para. 118.

67. See, ibid., paras. 114-116.

68. Appellate Body Report, Korea – Alcoholic Beverages, supra, footnote 20, para. 118; Appellate Body Report, Canada – Certain Measures Concerning Periodicals, WT/DS31/AB/R, adopted 30 July 1997, DSR 1997:I, 449, at 473. In these cases, we stated that "like" products are perfectly substitutable and that "directly competitive" products are characterized by a high, but imperfect, degree of substitutability.

69. United States' response to questioning at the oral hearing.

70. According to the United States, approximately two percent of captive consumption is purchased from the merchant market and approximately one percent of captive production is sold on the merchant market. (United States' appellant's submission, para. 80)

71. Panel Report, para. 7.58.

72. See also, ibid., para. 7.64(b).

73. See, ibid., para. 7.64(a).

74. United States' statement at the oral hearing; Appellate Body Report, supra, footnote 40, paras. 198 and 207.

75. See, supra, paras. 19, 20, 38 and 84.

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