1. The issue
Since the jurisprudence on US–Tuna was overturned by the Appellate Body's US–Shrimp decision in favour of the United States, lending legitimacy to action against other nations because of their refusal to conform to the production processes and methods (PPMs) unilaterally specified by a member of the WTO, there has been concern that this has opened the door to all kinds of punitive measures such as the use of trade action, including against the United States itself for not having signed on to the Kyoto Protocol. Thus, in his 2004 book, In Defense of Globalization, in the context of an extended critique of the legitimization of such unilateral assertions of PPM requirements and the faultlines opened up by the US–Shrimp decision (2004: 153–158), one of us (Bhagwati) argued:Footnote 1
The shrimp–turtle decision … is a dangerous ruling because of the possibility, which bothered the authors of the 1991 GATT report on trade and the environment, that it opens up a Pandora's box. Consider that this finding applies fully to the United States, which has failed to sign the Kyoto Protocol on global warming, whereas almost all other nations have. The United States is therefore producing traded products using PPMs that other nations can claim damage the environment.
Not doubting that the US could be targeted for trade action because of its failure to ratify the Kyoto Protocol, the analysis then moved to the politics of such trade action:Footnote 2
We would in effect be talking about a virtual embargo, as most products use energy in their manufacture! The United States is protected only by its size and its ability as a hegemon to browbeat other nation-states into not passing such legislation [or using executive to take the trade action]. But that leaves a gaping incoherence and cynicism in the world at the inherent asymmetry and injustice of a WTO Dispute Settlement Mechanism that implicitly, even if perhaps unwittingly, favors the powerful.
Since then, this idea – admittedly not developed with the sophisticated legal analysis that is clearly necessary and which we offer here – has been taken up by others. In particular, Joseph Stiglitz, our colleague at Columbia University, has now proceeded to ask for joint trade action against the United States by the EU and Japan, among others.Footnote 3 And the French Prime Minister, Dominique de Villepin, never far behind in tweaking the American nose, has even followed in Bhagwati's footsteps and proposed such action by the European Union.Footnote 4 It would appear that Peter Mandelson, the EU Trade Commissioner, has dismissed the French proposal as a ‘probable breach of trade rules’ and, exactly as Bhagwati had suggested, as ‘not good politics’.Footnote 5
Clearly, the matter needs sophisticated legal analysis, as also a realistic assessment of the politics, of a Kyoto-based action against the United States. In what follows, therefore, we first explore what kind of action the European Union could legally, that is, in conformity with its WTO obligations, undertake against the United States (Section 2), and then move to discuss the policy dimension of an (eventual) US response (Section 3). In Section 2, consequently, we assume that the European Union has decided to move in this direction. In Section 3, on the other hand, we ask the question whether the European Union should be contemplating such actions in the first place: for, even if an action were legally possible, which we will argue could be the case under current WTO jurisprudence, it still does not follow that what is legally possible is also politically prudent. We also offer some critical comments on the evolving WTO jurisprudence that has made actions like the proposed EU measures against US exports possible, stressing that they pose increasing dangers, not to the rich, but to the poor countries.
We should enter the caveat however that we do not pronounce here on the issue of whether the United States should ratify the Kyoto Protocol; this is not our concern.Footnote 6 We pronounce on the much narrower issue of whether they could be ‘punished’ for non-ratification.
Legal analysis
The legal (WTO-conferred) rights of the European Union
The legal analysis of an action by, let us say, the EU cannot proceed with clarity unless we first note that the European Union's action could, in principle at least, use either trade or domestic instruments. By virtue of its adherence to the WTO, every member state has bound both its trade and domestic instruments (affecting trade);Footnote 7 but the disciplines imposed on these two categories of instruments are not identical. Hence we proceed with the possibility of action using each of them, in turn.
Trade instruments
The European Union has two possible avenues. First, it could add new tariff lines and impose new higher tariffs on US products that have been produced in violation of the commitments undertaken under the Kyoto Protocol. Or, second, it could impose a countervailing duty (CVD) against such US products.
Pursuing the first alternative, the European Union would notify the WTO Secretariat of its new tariff lines. The Secretariat would, in turn, circulate the tariff lines to the WTO Membership, which would have 90 days to object to them. Assuming objection by one WTO Member, a rather reasonable assumption under the circumstance, the Secretariat will not include the new tariff lines in the EU schedule, and the matter will end up before a WTO panel in case the European Union insists on implementing the new (higher) tariff rates. Eventually, the issue before the WTO panel would be whether two otherwise like products, one of which, nevertheless, has been produced in conformity with the various disciplines embedded in the Kyoto Protocol, and one not, continue to be like products as per Art. I of GATT (which reflects the most favoured nation clause). We discuss likeness infra in Section 2.2.Footnote 8
The second option, however, is definitely not promising. The disciplines on subsidies embedded in the WTO Agreement on Subsidies and Countervailing Measures (SCM) are applicable to pecuniary subsidies only. A subsidy exists only if a government has made a financial contribution or has incurred a cost. Obviously, the failure to ratify the Kyoto protocol does not amount to a financial subsidy by the government of the United States. The argument that the United States policy amounts to a ‘hidden subsidy’ is irrelevant and cannot justify an EU action under the SCM agreement. But we can also argue, additionally, that the EU cannot derive any support for action under the SCM agreement even if we consider the implications of the recent US–FSC litigation.Footnote 9 Here, the Appellate Body was confronted with an argument by the United States to the effect that its tax exemptions for overseas income were necessary in order to remove a competitive disadvantage that burdened the US companies; absent this device, US companies would have to pay US income tax for income made overseas, whereas EU companies did not have to do so. So, evidently, the United States was incurring a financial cost in the sense that it was foregoing tax revenue; and the question therefore was whether this practice was in violation of the SCM disciplines.
The Appellate Body argued that, in the absence of an agreed, uniform world tax law, every WTO Member was free to exercise its own preference in taxation. The various SCM disciplines would apply to national tax systems irrespective of whether they look alike or whether substantial regulatory diversity across them is observable. In other words, each WTO Member can unilaterally decide what income to tax and under what conditions. Once they have made such a choice and decide which income is due (taxable), then and only then the SCM disciplines will apply. Assuming they forego income they have decided should be taxable in the first place, they have ipso facto conferred a subsidy within the meaning of the SCM Agreement. Both the United States and the European Union know they cannot exempt economic operators from paying taxes. The former decided to tax overseas income, the latter did not. This was a sovereign choice not open to challenge by the SCM Agreement. By subsequently exempting overseas income from taxable income, the United States therefore violated its obligations under the WTO.
In other words, the WTO legal regime cannot request from the United States that it tax a particular source of income. It can, however, decide whether a subsidy has been conferred after the United States has revealed its preference as to what constitutes taxable income (assuming that it has exempted a source of taxable income from tax imposition). The first choice nevertheless, concerning what constitutes taxable income, belongs to the United States, and the United States only.
By the same token, the United States remains free, as a matter of WTO law, to decide whether it should (or not) join the Kyoto Protocol. The United States revealed its preference by not ratifying it. In light of this revelation, the Kyoto Protocol disciplines are simply irrelevant to US law. It is thus inconceivable that, as a matter of WTO law, a pecuniary subsidy can be found to exist, since there is no obligation to follow the Kyoto Protocol in the first place. If no subsidy can be found to exist, this means that no CVDs can ever be lawfully imposed since, for this to be done, the investigating authority must cumulatively demonstrate that (a) a subsidy is being provided, and (b) that it has been causing injury to its domestic industry producing the like product. Since no subsidy can be shown to exist, no CVDs can be lawfully imposed. Going down the subsidy argument for taking action against the United States therefore will not work.Footnote 10
Domestic instruments
The European Union however could, conceivably, afford a different treatment on products produced in a Kyoto Protocol-compatible manner, and on products produced in violation of such disciplines, by using its domestic instruments to this effect. The dominant discipline in this respect is Art. III GATT, which requires all WTO Members to treat all like products (domestic and foreign) in a non-discriminatory manner. The crucial issue here is whether a pair of products (Kyoto-compatible, Kyoto-incompatible) should be viewed as like products.
The Kyoto Protocol imposes caps on emissions, and leaves it to the discretion of its signatories to decide how the agreed caps will be achieved. By moving into environmentally friendly production, it is hoped that greenhouse effects (and the ensuing global warming) will be reversed. The Kyoto Protocol thus intervenes in the process of production; it raises the longstanding question of PPMs and what the WTO requires concerning them. In what follows, we will attempt to clarify the status of case law as it now stands on this score, including the US–Shrimp decision of the Appellate Board. We will ask the question: what are the current disciplines on domestic instruments regulating PPMs?Footnote 11
At the outset, we must distinguish between cases where the process of production has been incorporated in the final product, and cases where this is not the case.
The leading case in the first category is EC–Asbestos. The European Union, we recall, distinguished between asbestos-containing and asbestos-free construction material, allowing the sale of the latter and banning the sale of the former throughout markets under its sovereignty. Canada complained, arguing that the two products were like and therefore differential treatment was not justified. In a dramatic overturning of the Panel decision, the Appellate Body decided that the two products were unlike. The key to understanding the Appellate Body's opinion is the manner in which it construed physical characteristics: the process of production is, in the Appellate Body's view, part of the physical characteristics of a product (probably because the process, in this case, is incorporated in the final product). Physical characteristics, thus construed, become the dominant criterion when deciding whether two products are like. A ‘reasonable’ consumer, in the eyes of the Appellate Body, when confronting two construction materials knowing that one of them contains asbestos and one does not, and further knowing the negative health externalities stemming from consumption of the asbestos-containing product, will not treat the two as like products, the difference in physical characteristics mandating this outcome.
Recall that the Appellate Body, in treating the two products as different or ‘unlike’, did not go by any econometric analysis of whether this was so (in which case the elasticity of substitution between them must be less than infinite) but confined itself to an assertion that such would be the reaction of a ‘reasonable’ consumer. Since the two products were deemed unlike, the Appellate Body found that the European Union was not violating its obligations under Art. III GATT by allowing the sale of asbestos-free, while banning the sale of asbestos-containing construction, materials.
With respect to transactions where the process of production has not been incorporated in the final product, we observe that the leading case is US–Shrimp. In this case, the United States imposed a sales ban on all shrimp fished in a manner that would lead to the incidental taking of the life of sea turtles. The United States mounted no defense under Art. III GATT, had it done so, it would have had to elaborate on the distinction between like and unlike products based on their process of production. The dispute was litigated instead under Art. XX GATT, which is the clause including all exceptions to general obligations (such as non-discrimination) assumed under the GATT contract. So, we were in the presence of a domestic instrument (sales ban) enforced at the border. The Appellate Body, overturning the Panel in this case as well, held that the US measure at hand (sales ban) related to the protection of exhaustible natural resources (sea turtles). Following a change in US legislation so as to allow flexibility in its application,Footnote 12 the Appellate Body found that the United States was in full compliance with their WTO obligations.Footnote 13 In a previous case (US–Gasoline), the Appellate Body had held that clean air as well was an exhaustible natural resource.
What would have been the outcome had the case been litigated under Art. III GATT? The GATT Working Party on Border Tax Adjustments is helpful in this respect.Footnote 14 This Working Party dealt with the coverage of Art. III.2 GATT. Applied to the specifics of the case before us, we hypothesize that the European Union wishes to impose a carbon tax against imports from the United States, because US products have been produced in disrespect of the EU environmental norms.Footnote 15 If at all, the preparatory work of Art. III GATT, suggests that the intent of the negotiators was to include only taxes which directly hit products. The problem is that it is far from easy to distinguish between direct and indirect taxes. Additionally, the WTO judge does not have to use preparatory work to interpret the GATT; there is no legal compulsion to this effect: Art. 32 VCLT provides him with substantial leeway to this effect. However, the Working Party on Border Tax Adjustments is a decision that has been adopted by the GATT CONTRACTING PARTIES. As a result, it should, by virtue of Art. XVI of the Agreement establishing the WTO, guide the WTO judge. In this vein, the WTO judge should note that
the Working Party concluded that there was convergence of views to the effect that taxes directly levied on products were eligible for tax adjustment. Examples of such taxes comprised specific excise duties, sales taxes and cascade taxes and the tax on value added. It was agreed that the TVA, regardless of its technical construction (fractioned collection), was equivalent in this respect to a tax levied directly – a retail or sales tax. Furthermore, the Working Party concluded that there was convergence of views to the effect that certain taxes that were not directly levied on products were not eligible for tax adjustment. Examples of such taxes comprised social security charges whether on employers or employees and payroll taxes.Footnote 16
The term border tax adjustment is defined in §4 of the report
as any fiscal measures which put into effect, in whole or in part, the destination principle (i.e. which enable exported products to be relieved of some or all of the tax charged in the exporting country in respect of similar domestic products sold to consumers on the home market and which enable imported products sold to consumers to be charged with some or all of the tax charged in the importing country in respect of similar domestic products).Footnote 17
The GATT contracting parties took this exercise, that is the coverage of Art. III.2 GATT, quite seriously; the Secretariat was asked to compile a document where it included cases of border tax adjustments.Footnote 18 Nevertheless, beyond the noted convergence on some taxes, the GATT contracting parties did not go any further.Footnote 19
We noted that the distinction between direct and indirect taxes is awkward. Even if maintained, nevertheless, a carbon tax on imported products – which is the equivalent of the burden imposed on domestic producers who are called to satisfy the Kyoto Protocol disciplines would, in principle, be consistent with the destination principle. There is one important argument against this thesis: the WTO judge, in EC–Asbestos, relied on the process of production (as relevant criterion to define likeness) in a case where the process had been incorporated in the final product. This is unlikely to be the case when US products are being produced in disrespect of the Kyoto Protocol-disciplines. If Art. III GATT is limited to transactions such as those coming under the purview of EC–Asbestos, then a regulatory distinction that would justify a carbon tax would not be possible.
In this case, the European Union would have recourse to Art. XX GATT, and try to justify its measures making arguments à la US–Shrimp. Note that in US–Shrimp, the Appellate Body did not even enter the discussion whether the process of production had been incorporated in the final product (it was evidently not); moreover, it fully applied the destination principle, since it implicitly recognized the right of the United States to regulate under what conditions products will be sold in its market.Footnote 20
The EC–Tariff Preferences jurisprudenceFootnote 21 could also be of relevance to our analysis here. In this case, the Appellate Body was facing a challenge against EU legislation according to which one-way preferences granted to developing countries were conditioned on the prior adoption of policies (in this instance, the adoption of anti-drug-production policies) favoured by the donor. The Appellate Body held that, assuming such policies are based on objective criteria, such discriminatory preferences can be lawfully accorded. Unfortunately, we do not know what kind of policies can constitute objective criteria, since the Appellate Body did not elaborate on this issue any further. It is not inconceivable that the signing or otherwise of Kyoto Protocol would be treated by the Appellate Body as providing such an objective criterion for discriminatory action against Kyoto-non-signatory nations, even though this category includes only the developed nations, the United States and Australia, and the EU Tariff Preferences case was decided in the context of preferences accorded to a subset of developing countries. At least, this case opens the door a little wider for those seeking to restrict or reduce preferentially the market access of products from member nations that do not satisfy a unilaterally specified PPM requirement. It must be concluded that regulatory distinctions based on the process of production are likely to be held as WTO compatible even in cases where the process of production has not been incorporated in the final product, assuming of course, that the various other conditions discussed above have been complied with.
To conclude (as a matter of law)
To recapitulate: the European Union cannot impose a CVD under the SCM agreement against US imports because the United States has not signed the Kyoto Protocol. This much is clear. Can it however introduce new tariff lines providing advantages to products originating in countries ratifying the Kyoto Protocol? This option might be of little practical importance, of course, since EU tariffs are quite low anyway. Setting such concerns aside however, it seems that there is no bar to WTO Members according preferences when sub-classifying tariff lines to products using the PPMs they prescribe. There has never been a dispute discussing under what conditions this can lawfully be the case. There are good arguments to assume however that the WTO jurisprudence on EC–Tariff Preferences could be of relevance here. Assuming that under objective criteria we understand that the donor has no intention to discriminate in favour of a particular origin, and simply wants to promote particular transactions (based on its own preferences), then the underlying rationale of EC–Tariff Preferences could be imported in this context as well. We underscore nevertheless, that this is our evaluation of the situation, since no such dispute has ever been submitted to the WTO.
Can the European Union impose say a carbon tax (or even, ban sales of) on Kyoto Protocol-incompatible goods?Footnote 22 Recall our discussion above: irrespective of whether the production process has been incorporated in the final product, regulatory distinctions based on the production process can be perfectly legitimate, assuming the various conditions included in the relevant GATT provisions have been respected. In case of incorporation of the production process, the issue seems quite straightforward: a reasonable consumer test (whereby ‘reasonable’ means ‘informed’) would lead to the conclusion that a consumer (in the eyes of the Appellate Body) who is aware of the environmental (and eventually health)Footnote 23 hazard that global warming might represent, will treat the two goods (Kyoto Protocol-compatible, Kyoto Protocol-incompatible) as unlike goods.
In case the production process has not been incorporated in the final product, then the regulator might have to look for a regulatory objective in the list of Art. XX GATT and couch the regulatory intervention in these terms. Since clean air has been acknowledged to be an exhaustible natural resource, the European Union could argue that reduction of global warming contributes to this objective. If such argument prevails, all the European Union will have to demonstrate is that its carbon tax relates to its protection (of clean air). Assuming the fight against global warming is not considered synonymous with promoting clean air, the European Union will have to seek refuge in Art. XXb GATT, and show that its measures are necessary to protect the environment. The necessity test is more demanding than the relating to test, since only the reasonably available least-restrictive measure will pass the test and not simply any measure that relates to the stated objective. Still, the discussion will, in all likelihood, focus on the magnitude of the carbon tax, and not on the decision to tax differentially.
Policy analysis
The policy issue
So, the European Union has at least one option (domestic instruments) that it can use with substantial confidence that it is not violating its WTO obligations when punishing countries that have not adhered to the disciplines of the Kyoto Protocol. We now turn to the question of whether the European Union should, as a matter of policy prescription, make use of this legal possibility.
Does the European Union sincerely believe that the United States will be forced to join Kyoto Protocol because of EU trade countermeasures? There are good arguments that suppose that such actions, if undertaken, would be counter-productive. Recall first, that the European Union, when it had the opportunity to impose substantialFootnote 24 countermeasures against the United States (US–FSC), it decided not to do that: countermeasures are costly (at least in the short run) to the country imposing them. Are the EU leaders prepared to assume the economic (and other) cost? History points in the opposite direction.
As for the political rationale for an EU action, this clearly lies in the hope that the reaction of the United States to this ‘gaiatsu’ (foreign pressure) would be to ratify the Kyoto Protocol. But remember that gaiatsu did not work with Japan and India when the United States used Special 301 legislation to target them with 100% tariffs on selected products because they were declared ‘unfair traders’ by the unilateral determination of the USTR. It is hardly likely therefore that, even if the EU were to survive a US referral of the EU action to the WTO Dispute Settlement Mechanism, the reaction in the United States would be anything except one of outrage. Indeed, that is exactly how Australians (another country that could be facing EU trade counter-measures) have reacted. Thus, the Australian Prime Minister John Howard said: ‘This is a thoroughly silly proposal and utterly out of touch with reality … Mind you, [de Villepin] comes from a country that is known for imposing high trade barriers against other countries like Australia.’Footnote 25 The Daily Telegraph (15 November 2006) carried the headline alleging hypocrisy and double standards against France, exactly the way predicted by those who did not wish ‘values’-related PPMs to be legitimated for denial of market access in GATT jurisprudence. The outrage at the French, of all people, trying to claim the higher moral ground was typical: ‘The country that spent 30 years testing its nuclear weapons in our region wants to punish Australia for not signing off on a voluntary greenhouse agreement.’ The story was accompanied by a photograph of a mushroom cloud from a French nuclear test in the South Pacific in 1971, with a headline: ‘Back off, Frogs’. Indeed, moral arguments and trade actions in support thereof by governments whose own moral record leaves a lot to be desired are deeply resented and, especially when directed against powerful nations like the United States, are likely to precipitate strong and damaging reactions.
In fact, despite the present resurgence of global warming concerns in the United States, it is hardly likely that the US public and politicians will approve of a virtual ban, or tariffs, on exports of nearly all US exports just because the United States has not ratified the Kyoto Protocol (which happens, in many thoughtful analysts' view, to have a number of objectionable design features). One should note that the blue-ribbon Task Force of the Council on Foreign Relations, led by former CIA Director and MIT Professor John Deutsch and former Energy Secretary James Schlesinger, on National Security Consequences of US Oil Dependency, produced a Report (2006) that does not even consider the possibility of foreign tariff retaliation as a way to push the United States into ratifying Kyoto, leave aside welcoming it as politically helpful to the business of getting the US to reduce its energy dependence. So, one may well imagine how the United States Congress will react if such an EU action was undertaken. The reaction would well be to retaliate, not just with ‘moral’, values-related PPMs that could be advanced against the EU but on several other dimensions: there is no dearth of contentious issues that divide the EU from the US from time to time. Paula Dobriansky of the State Department, representing the United States at the Nairobi Conference on the Environment in November 2006 therefore brushed off the French proposal politely but firmly. Peter Mandelson is surely right when he claims that the proposal is not ‘good politics’.
If the European Union really wants to bring the US government to the table of negotiations once again and persuade them to ratify the Kyoto Protocol, it should better look into other avenues. Imposing counter-measures will yet again unnecessarily politicize the WTO ambiance at a rather difficult (for the WTO) moment: the Doha round is stalling and the last thing needed at this juncture is yet another confrontation (and to make it worse, this time from, in principle, trade un-related issues).
We would like to thank Bernard Hoekman, André Sapir, and an anonymous referee for very helpful comments. Remaining errors are of course our own.
