Tariffs as a Proxy in a Larger Economic (and Moral?) War

By July 2018, the United States and China had each fired off the first shots in a tariff war that would escalate over the next year (see TradeVistas’ timeline here).

With higher tariffs on $60 billion in its exports to the United States and staring down the barrel of tariffs on another $200 billion, China requested the establishment of a WTO dispute settlement panel. Specifically, China sought for a panel to review whether U.S. tariffs – imposed unilaterally and without WTO authorization – violated the United States’ basic obligations to provide most favored nation treatment to China according to the U.S. schedule of tariff commitments in the WTO.

The dispute was triggered by the issuance of a March 2018 report describing the findings of an investigation by the Office of the U.S. Trade Representative under Section 301 of the Trade Act of 1974 into China’s unfair acquisition of U.S. intellectual property and technologies. In its first line of defense, the United States contends that most of the practices it reviewed as part of this investigation are not covered by existing WTO disciplines and therefore the measures it took (the tariff increases on imported goods from China) are “fundamentally not about WTO rights and obligations.”

Fast forward past the legal proceedings, the WTO panel to hear China’s claim issued its final report to the United States and China in June and it was made public on September 15.

The United States argued that, even if the panel finds it violated its WTO commitments to China, it was justified on the grounds that the tariffs were necessary to protect public morals.

It lost the argument. Here’s how. (Disclaimer: this is not a legal brief but rather a plain reading of the panel report.)

Going on the Moral Offense

USTR did initiate a WTO case against China focused on those practices it determined are covered by WTO disciplines and therefore could be addressed through WTO dispute settlement. But the United States also claims that the bulk of China’s practices contained in the scope of its Section 301 investigation are not addressed by WTO disciplines.

Further, the United States argues that China’s practices such as requirements upon foreign companies to transfer their technologies or license on non-market terms, and cyber-enabled theft, “undermine U.S. norms against theft and coercion and undermine the belief in fair competition and respect for innovation, all of which are key aspects of U.S. culture.” In other words, combatting them is a matter of protecting “public morals”.

First Things First

There’s an order in which a WTO panel considers the constituent parts of a case. In this case brought by China against the United States, the panel first reviewed whether the U.S. measures in question (several tariff increases covering different sets of products from China) were inconsistent with U.S. obligations. If so, the panel considers whether the inconsistency is justified as “necessary to protect U.S. public morals” under Article XX(a) of the General Agreement on Tariffs and Trade 1994 (GATT 1994).

The United States did not refute China’s case that the tariff measures are inconsistent with U.S. market access obligations (under Articles I:1 and II:1(a) and (b)). Therefore, the WTO panel found in favor of China on this point and moved on to consider the U.S. argument that the WTO-inconsistent tariff measures were necessary to protect U.S. public morals, within the meaning of GATT Article XX(a).

Making a Moral Case

Article XX(a) was part of the original GATT 1948 but it was not invoked even once in the subsequent almost 60 years.

It has since been argued by WTO members to justify measures designed to prevent money laundering, organized crime and gambling within a Member’s territory (a dispute between Antigua and the United States over Internet gambling), by China (unsuccessfully) to prevent the distribution of foreign movies and other audio-visual entertainment, and by the European Union to restrict imports of seals and seal products, a case in which the panel accepted that animal welfare falls under public morals but struck down the form of the measure under dispute.

Brazil sought to use the public morals exception to exempt certain domestic companies that produce television equipment from paying taxes as part of its public morals objective of “bridging the digital divide” in Brazil.

The Sum of the Parts

There’s a certain amount of deference given to WTO members to define public morals, which shift in nature and importance within societies over time.

Because the exceptions in Article XX are seen as limited and conditional, the burden lies with the WTO member invoking the exception to prove the measure indeed falls within the scope of the exception.

On the basis of this justification, WTO panels apply several “tests”: Has the WTO member justifying a measure under this exception demonstrated that the measure protects public morals? Is the measure “necessary” to achieve the stated public morals objective? Is the measure being applied in a manner that constitutes “arbitrary or unjustifiable discrimination” within the meaning of Article XX?

In this case, according to the panel, the onus was on the United States to explain how its tariff measures contribute to its public morals objective as well as how the scope of WTO-inconsistent tariffs do not apply beyond what is necessary within the meaning of Article XX(a) of GATT 1994.

A Means to the End

At its core, the United States argued that tariff increases were necessary to induce a change in China’s cost-benefit analysis – in other words, the economic stakes needed to be high enough that China would be convinced to discontinue its alleged technology and intellectual property theft. Tariffs were necessary because previous forms of diplomatic and trade negotiation engagements had demonstrably failed.

The United States also argued that a ban on imports of Chinese products into the United States would represent an overly trade restrictive measure; in contrast, tariff increases are not overly trade restrictive.

Not Necessarily So

Part of the panel’s job is to judge whether the measure is a genuine means to an end. In this case, did the tariffs contribute to the public morals objective and, even if so, were WTO-consistent or less trade-restrictive alternatives available to achieve the same outcome?

Simply saying the tariffs were necessary isn’t a sufficient defense. Some quantitative or qualitative assessment must be presented to form the basis of a conclusion by the panel.

Immoral Goods?

In an interesting and important angle to the case, the European Union argued in a third-party brief that Article XX(a) requires that the risk to public morals manifest itself either in the content of the goods themselves or in the methods in which the goods were obtained or produced – that demonstrating so affords a sufficient nexus between the public morals objective and the measure restraining imports of those products.

Related to this focus on the products ensnared in the measure, China argued that the goods subject to increased tariffs went well beyond the scope of products that “may have” received the benefit of technology transfer or intellectual property theft. In their view, the measure was overly trade-restrictive and not related to protecting public morals.

In its rebuttal, the United States countered that the text of Article XX(a) does not require a direct correlation or “embodiment” between the products subject to the measure and the public morals being protected. Although the tariff measures included Chinese goods that benefit from “unfair and immoral Chinese technology transfer policies,” tariffs on goods not directly involved in these practices were included as well to reach a scope of tariff penalties more broadly commensurate with the estimated overall harm to the U.S. economy of China’s practices.

The United States also found itself defending the use of a common form of public consultation. USTR amended the scope or provided exclusions from the tariffs on the basis of public comments. However, the panel found it unclear how or whether public moral concerns factored into those decisions or whether any such exclusions would “undermine or run counter to the stated U.S. public morals objective.”

Case Not Made

Ultimately, the panel viewed the U.S. explanation for the nexus between the nature of the measure (the specific tariffs applied to specific lists of goods) and the public morals objective as insufficient. The panel ruled against the United States – in other words, the measure did not appear to be “necessary” to achieve the public morals objective.

Having concluded that necessity wasn’t proven, the panel did not compare the U.S. use of tariffs with any alternative measure or assess whether U.S. tariffs on goods from China constituted “arbitrary or unjustifiable discrimination” or “a disguised restriction on international trade”. Case over.

Moral Dilemma

The WTO panel ruling in this case may have no practical effect. The United States could appeal the outcome, but the WTO Appellate Body does not have a sufficient number of appointed members to operate, so if the United States does not agree to adopt the panel decision as it currently stands, the case is stuck in a legal limbo.

Meanwhile, tariffs on goods from China remain, and tariffs on U.S. goods to China remain. If the United States did appeal and lost, the WTO panel could authorize China to retaliate – normally in the form of tariffs. But such authorization would merely formalize the action China has already taken without WTO permission – a hypocritical outcome at best.

More important than the dueling tariffs, the United States is aggrieved that China used the WTO as a shield for its “unfair and trade-distorting technology transfer policies and practices not covered by WTO rules” and that China committed the same WTO offense of applying tariffs on U.S. imports without awaiting the outcome of its case or receiving authorization to do so. That’s having your cake and eating it too.

In concluding comments, the panel observed that the “wider context in which the WTO system currently operates reflects a range of unprecedented global trade tensions,” perhaps an oblique acknowledgement that the issues the United States raised are indeed beyond the reach of current multilateral agreements.

USTR Ambassador Robert Lighthizer thinks so. In a press statement issued the day the WTO panel report went public, Lighthizer said the panel decision, “shows that the WTO provides no remedy for [China’s] misconduct.”

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