What WTO Rules, if any, govern China’s use of “Local Content” Rules? And will they Constrain China’s 2025 goals?

There is no specific provision in the WTO Rules that expressly deal with legality of Local Content measures per se. However, such measures may violate several provisions in the WTO Agreements. Under the present case of Local Content rules of China for the realization of china 2025 goal, we will examine each WTO rule that may be attracted in its implementation.

 

  1. NATIONAL TREATMENT: GATT ARTICLE III

The most important provisions affecting local content measures of China in advancing its objectives of the goal 2025 are laid down in the GATT 1994. That Agreement consists of the ‘original’ GATT 1947 as well as numerous other documents adopted from 1948 until the WTO came into being in 1995.[1] One of the very core principles of the original GATT laid down in its Article III is that of National Treatment in the sense that imported products may not be discriminated against vis-à-vis their domestic counterparts. Local content measures most often and likely to violate at least one of the paragraphs of Article III because by their very nature of Local Content measures, they condition a benefit on the use of goods of national origin and thus discriminate goods according to their territorial origin. In the following, we shall discuss paragraphs 1, 4 and 5 of the provision. Note that if the benefit granted to the national product is a tax advantage, Article III:2 will apply, which provides for indiscriminate taxes on domestic and imported goods[2]. According to Article III:8 (a), the rules of Article III do not apply to government procurement. This essential exception will be discussed later under the separate heading of government procurement.

 

  1. Paragraph 1 of Article III

Article III:1 of the GATT provides that internal measures ‘should not be applied to imported or domestic products so as to afford protection to domestic production’. The provision is not applied as a stand-alone provision. Rather, it functions as a principle that informs the rest of Article III.[3] The core analysis of whether a local content measure is in violation of GATT Article III is therefore deferred to the other paragraphs of the provision.

 

  1. Paragraph 4 of Article III

Article III:4 reads:

The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use. The provisions of this paragraph shall not prevent the application of differential internal transportation charges which are based exclusively on the economic operation of the means of transport and not on the nationality of the product.

 

The Appellate Body analyses an alleged violation of the provision by way of a three-prong test:

  1. The imported and domestic products at issue are ‘like products’;
  2. the measure at issue is a ‘law, regulation, or requirement affecting their internal sale, offering for sale, purchase, transportation, distribution, or use’; and
  • the imported products are accorded ‘less favourable’ treatment than that accorded to like domestic products.[4]

 

The first element concerning ‘like’ products is usually the focal point in Article III cases. This is not the case with respect to cases concerning local content because such measures de jure condition a benefit on the use of local goods and thus discriminate in favor of such goods compared to identical imported goods.[5] This is particularly clear where the measure requires a very specific item of local content (say use of nationally produced solar panels).

 

The second element concerns whether the requirement or advantage is derived from a ‘law, regulation or requirement’ that affects the internal sale, offering for sale, purchase, transportation, distribution or use. The Panel in US – FSC 21.5 clarified that this requirement concerns the form of the measure, not its content:

In considering these issues, we first consider the form of the measure in question. We agree with the views expressed in previous GATT and WTO panel reports that Article III:4 applies also to measures in the form of conditions that must be satisfied in order to obtain an ‘advantage’ from the government[6].

 

Local content requirements always come in the form of conditions in order to obtain an advantage. As illustrated by our examples such requirements can be both mandatory (and e.g., imposed by a statute) and voluntary schemes (such as the promise to use local content in a bid for a concession granted by the government), which private companies adhere to in order to receive a benefit.[7] In Turkey – Rice, the Panel held:

The domestic purchase requirement can clearly be considered as a ‘requirement’, within the meaning of Article III:4 of the GATT 1994, as it is a condition that importers may voluntarily accept in order to obtain an advantage from the Turkish government, i.e., the ability to import rice at reduced tariff rates.[8]

 

Consequently, when private companies voluntarily accept to adhere to local content requirements when entering into contractual relations with a government, there is evidence pointing to that there is a government measure covered by Article III:4. This was also the conclusion by the GATT Panel in Canada – FIRA concerning situations involving a private contractual obligation between an investor and a foreign government.[9]

 

However, only WTO Members are bound by GATT obligations. In other words, only measures that are attributable to the state[10] can be relevant requirements. If the measure is an act by the state such as a law this is clearly the case. The situation is more complex if the contract is not concluded with a governmental agency, but with a State-Owned Enterprise (SOE) such as Petrobras or BNDES. The measure will still be a measure by the state if the entity is considered part of the state itself or if the measure is otherwise attributable to the state.

 

The first difficulty thus is to determine whether SOEs are considered part of the state.[11] We can find some orientation for that question from the interpretation of the term ‘government or public body’ in the case law on Article 1 of the SCM Agreement.The key issue here is when SOEs are considered ‘public bodies’. In US – AD CVD (China), the Appellate Body examined whether SOEs were public bodies and held that the determination had to focus on ‘whether the entity is vested with or exercises governmental authority’.[12] Interestingly, however, the Appellate Body worded the test differently when applying it to the facts in the case, relying on whether the entity was vested with authority to perform a governmental function:[13]

 

evidence of government ownership, in itself, is not evidence of meaningful control of an entity by government and cannot, without more, serve as a basis for establishing that the entity is vested with authority to perform a governmental function. Accordingly, such evidence, alone, cannot support a finding that an entity is a public body.[14]

 

If a panel was to determine the SOE is not considered a ‘public body’, it is deemed to be a private body or entity. However, the measure could still be otherwise attributable to the state because the SOE or private company could still have acted on the instructions of the government.

 

The third element of the analysis of Article III:4 of the GATT concerns whether the imported product is treated ‘less favourably’. The GATT Article III concerns both de jure and de facto discrimination.[15] In local content cases, the discrimination is always de jure as the measure discriminates on the basis of the origin of the product, explicitly conditioning the grant of a benefit on the use of local content and thereby treating the imported product less favourably than the local one. This element will therefore nearly automatically be fulfilled in cases concerning local content. The Appellate Body has moved the analysis of this element beyond mere formalism, so that it concerns whether different treatment is to the detriment of the product at issue, actually changing the conditions of competition. In local content cases, the formally different treatment will no doubt modify the conditions of competition to the detriment of the imported products – in fact, that is why those requirements are set up in the first place. Most local content requirements thus run into conflict with Article III:4 of the GATT.

 

 

  1. Paragraph 5 of Article III

Paragraph 5 of Article III of the GATT reads:

No contracting party shall establish or maintain any internal quantitative regulation relating to the mixture, processing or use of products in specified amounts or proportions which requires, directly or indirectly, that any specified amount or proportion of any product which is the subject of the regulation must be supplied from domestic sources. Moreover, no contracting party shall otherwise apply internal quantitative regulations in a manner contrary to the principles set forth in paragraph 1.

 

The provision is further explained in an ‘Ad Article’ contained in Annex I to the GATT. Ad Article III:5 provides:

Regulations consistent with the provisions of the first sentence of paragraph 5 shall not be considered to be contrary to the provisions of the second sentence in any case in which all of the products subject to the regulations are produced domestically in substantial quantities. A regulation cannot be justified as being consistent with the provisions of the second sentence on the ground that the proportion or amount allocated to each of the products which are the subject of the regulation constitutes an equitable relationship between imported and domestic products.

 

The provision clearly imposes two tests for internal quantitative regulations in its two sentences.[16] As to paragraph 5 first sentence, the GATT Panel in US –Tobacco established two analytical steps. First, it analysed whether there was an ‘internal quantitative regulation relating to the mixture, processing or use of products in specific amounts or proportions …’[17] Second, whether it ‘requires, directly or indirectly, that any specified amount or proportion of any product which is the subject of the regulation must be supplied from domestic sources’.[18] Without going into much analysis, the Panel found a clear violation of paragraph 5 in the case it had to decide. The analysis of paragraph 5 first sentence in EEC – Animal

Feed Proteins followed the same analytical structure, but left equally little guidance as to future interpretation.[19]

As for the second sentence of the provision, which has to be read together with Ad Article III:5, the GATT Panel in US –Tobacco exercised judicial economy, but the GATT Panel in EEC – Animal Feed Proteins did, in passing, make some remarks on it. The Panel held that since the EEC measure was within the scope of paragraph 1 and the second sentence referred to paragraph 1, the measure should be analysed under paragraph 1.[20] Given the protectionist elements of the measure, it found the measure to violate both paragraphs 1 and 5.[21]

 

 

  1. TRIMS (TRADE-RELATED INVESTMENT MEASURES)

The TRIMs Agreement negotiated during the Uruguay Round has its historical roots in the Canada – FIRA GATT case.[22] It was designed to prevent trade restrictive and distorting effects of investment measures[23] and specifically regards local content requirements as prohibited trade-related investment measures, as is highlighted on the WTO’s own web page concerning ‘Trade and Investment’.[24] The TRIMs Agreement is rather short. The provisions that are relevant for our purposes, namely Article 2 and the Annex, read as follows:

 

Article 2:1 Without prejudice to other rights and obligations under GATT 1994, no Member shall apply any TRIM that is inconsistent with the provisions of Article III or Article XI of GATT 1994.

Article 2:2 An illustrative list of TRIMs that are inconsistent with the obligation of national treatment provided for in paragraph 4 of Article III of GATT 1994 and the obligation of general elimination of quantitative restrictions provided for in paragraph 1 of Article XI of GATT 1994 is contained in the Annex to this Agreement.

 

Annex

1 TRIMs that are inconsistent with the obligation of national treatment provided for in paragraph 4 of Article III of GATT 1994 include those which are mandatory or enforceable under domestic law or under administrative rulings, or compliance with which is necessary to obtain an advantage, and which require:

  • the purchase or use by an enterprise of products of domestic origin or from any domestic source, whether specified in terms of particular products, in terms of volume or value of products, or in terms of a proportion of volume or value of its local production; or
  • that an enterprise’s purchases or use of imported products be limited to an amount related to the volume or value of local products that it exports.

 

When it comes to substantive obligations,[25] the negotiating parties did not add much to the existing state of the law, as can be seen by the explicit limitation of the scope of the agreement to investment measures related to trade in goods (Article 1) and the references to the obligations of the GATT (Article 2) and its exceptions (Article 3). However, the wording of the TRIMs Agreement clarifies that performance requirements imposed on investors to allow them to invest or operate in the host country[26] – relevant for our purposes are local content requirements attached to permits to invest or establish oneself – do not escape scrutiny under the relevant GATT provisions. Additional clarity is provided by the illustrative list in the Annex to the Agreement. If a measure falls within the illustrative list, it automatically violates the correlating GATT provision. This understanding was confirmed by the Panel in Canada – Renewable Energy:

 

Article 2.2 of the TRIMs Agreement does not impose any obligations on Members, but rather informs the interpretation of the prohibition set out in Article 2.1. In particular, Article 2.2 explains that the TRIMs described in the Illustrative List of the Annex to the TRIMs Agreement are to be considered inconsistent with Members’ specific obligations under Articles III:4 and XI:1 of the GATT 1994.[27]

 

 

  • GOVERNMENT PROCUREMENT

Even though most local content measures thus run into conflict with the substantive obligations under Article III of the GATT (and the TRIMs Agreement), several governments apparently considered them justified as measures of government procurement. Government procurement is regulated by the

Plurilateral Agreement on Government Procurement (GPA).[28] As mentioned, it is excluded from the scope of the national treatment obligation by Article III:8(a) of the GATT (also applicable within the context of the TRIMs Agreement):

The provisions of this Article shall not apply to laws, regulations or requirements governing the procurement by governmental agencies of products purchased for governmental purposes and not with a view to commercial resale or with a view to use in the production of goods for commercial sale.

 

Government procurement is also exempt from the normal obligations relating to State Trading Enterprises (STEs) by virtue of Article XVII:2 of the GATT:

The provisions of paragraph 1 of this Article shall not apply to imports of products for immediate or ultimate consumption in governmental use and not otherwise for resale or use in the production of goods for sale. With respect to such imports, each contracting party shall accord to the trade of the other contracting parties fair and equitable treatment.[29]

 

Defining the exact scope of Article III:8(a) is hence crucial for the determinationof the legality of local content measures. To date, the scope of the provision has only been analyzed in Canada – Renewable Energy.

Both the wording of Article III:8(a) and Article XVII:2105 of the GATT as well as the fact that the drafters saw the need to provide for specific exemptions, or in the words of the Appellate body ‘derogations’,[30]106 for each obligation suggest an exclusion of government procurement from the obligations under Article III and Article XVII:1 – not the entire GATT. This is quite contrary to the popular understanding that government procurement is only subject to the substantive obligations in the GPA. The Appellate Body in Canada – Renewable Energy, however, made this point very clear:

Article III:8(a) therefore establishes a derogation from the national treatment obligation of Article III for government procurement activities falling within its scope. Measures satisfying the requirements of Article III:8(a) are not subject to the national treatment obligations set out in other paragraphs of Article III.Article III:8(a) is a derogation limiting the scope of the national treatment obligation and it is not a justification for measures that would otherwise be inconsistent with that obligation.[31]

 

 

  1. THE SCM AGREEMENT

Local content measures can also run afoul of the SCM Agreement. That Agreement regulates subsidies and countervailing measures in trade in goods. Article 3.1(b) of the SCM Agreement provides the most explicit prohibition against local content measures in the WTOAgreements:

 

3.1.  Except as provided in the Agreement on Agriculture, the following subsidies, within

the meaning of Article 1, shall be prohibited:

(b) Subsidies contingent, whether solely or as one of several other conditions, upon the

use of domestic over imported goods.

 

The prohibition is backed up by a special remedy in Article 4.7 of the SCM Agreement demanding withdrawal of the subsidy without delay if a panel found the subsidy to be prohibited. Panels specify a time period for withdrawal of the subsidy and have generally granted ninety days to do so.[32] This deviates from the ‘normal’ implementation period laid down in Article 21.3 of the DSU that provides for a ‘reasonable period of time’ of a maximum of fifteen months. Also, the DSB normally gives recommendations of bringing the measure into conformity with the WTO Agreements, whereas SCM Article 4.7 dictates what the WTO Member must do in order to be in compliance with the WTO Agreements.[33]

Unlike some of the obligation outlined above under the GATT and the TRIMs, the SCM Agreement applies to government procurement with respect to goods.[34] This makes the SCM Agreement particularly valuable for cases concerning local content measures in the field of government procurement against countries that are not parties to the GPA or have exempted local government, so that the measures are neither subject to Article III of the GATT because of Article III:8(a) of the GATT nor to the GPA. In order to challenge a measure under the SCM Agreement, the measure must be proven to constitute a subsidy, as defined in SCM Article 1.1. In order to establish that a measure is a subsidy, it has to grant a ‘financial contribution’, confer a ‘benefit’[35] and be specific.[36] According to Article 2.3, subsidies falling under Article 3 need not pass the specificity test in Article 2, so that we will only be concerned with the first two prongs. These remaining two elements are analysed separately – thus, a benefit conferred under a local content scheme does not automatically constitute a ‘financial contribution’. Given the numerous and diverse issues that are posed by the various types of local content measures.

 

 

 

  1. CONCLUDING OBSERVATIONS ON THE GATT/TRIMS LEGALITY OF LOCAL CONTENT MEASURES

Our analysis has shown that most local content measures described in our taxonomy would run afoul of the national treatment obligation in Article III:4 and/or 5 of the GATT. To the extent a measure falls within the ambit of the derogation in paragraph 8(a), it still violates the GPA where the WTO Member has signed on to the GPA. There are however a few loop holes: certain WTO Members have not signed on to the GPA or have exempted certain local governments. In those instances, the exact scope of the paragraph 8(a) derogation becomes vital because the provision will then shield measures imposed by those entities from the application of the national treatment provisions. In Canada – Renewable Energy, the Appellate Body and Panel have however narrowed the scope of this derogation significantly. Local content measures for renewable energy generation equipment have thus been carved out from the ambit of the derogation where governmental agencies purchase electricity conditioned on compliance with the content requirement and then resell the electricity. Similarly not covered by Article III:8(a) of the GATT may be many of what could be called ‘secondary purchases’, i.e., private companies’ local sourcing of products to comply with a local content requirement in a tender requiring local content, which may thus be in violation of Article III of the GATT if the local content requirement can be attributed to the state. Finally, the Appellate Body’s interpretation of ‘governmental purposes’ qualifies only very few measures as government procurement in the sense of consumption of the government, such as the purchase of computers, paper clips, autos, and perhaps even solar panels on the roof tops of government buildings if the electricity they generate is for governmental consumption only. Some may even argue that the procurement of buses or trams for public transport would not fall under the strict definition of governmental purposes.This might go too far, however, as public transport is arguably provided by the government to recipients in the discharge of public functions.

[1] The precise content of the GATT 1994 is set out in the Introductory Note of Annex 1A to the WTO Agreement. Throughout the article, we use the term ‘GATT’ as meaning GATT 1994 if nothing else is indicated.

[2] GATT Agreement.

[3] See Japan – Taxes on Alcoholic Beverages Appellate Body Report, WT/DS8/AB/R,WT/DS10/AB/R, WT/DS11/AB/R (4 Oct. 1996) [hereinafter Japan – Alcohol Appellate Body Report], para. 37.

[4] Korea – Various Measures on Beef Appellate Body Report, WT/DS161/AB/R, WT/DS169/AB/R (11 Dec. 2000) [hereinafter Korea – Beef Appellate Body Report], para. 133.

 

[5] The panel in Turkey – Measures Affecting the Importation of Rice Panel Report, WT/DS334/R (21 Sep. 2007) [hereinafter Turkey – Rice Panel Report], para. 7.214 hence regarded as showing that origin was used as the sole criterion for distinguishing the products as sufficient for showing likeness. The panel in China – Measures Affecting Trading Rights and Distributional Services for Certain Publications and Audiovisual Entertainment Services Panel Report, WT/DS363/R (19 Aug. 2009) [hereinafter China – Audiovisual Services Panel Report], at paras. 7.1446–7.1447, however, additionally demanded evidence that there can or will be domestic and imported products that are like.

 

[6] United States – Tax Treatment for ‘Foreign Sales Corporations’ 21.5 Panel Report, WT/DS108/RW (20 Aug. 2001) [hereinafter US – FSC 21.5 Panel Report], para. 8.139.

 

[7] See Japan – Measures Affecting Agricultural Products Panel Report, WT/DS76/R (27 Oct. 1998) [hereinafter Japan – Agricultural Products II Panel Report], n. 346. See also Canada – Certain Measures Affecting the Automotive Industry Panel Report, WT/

 

[8] Turkey – Rice Panel Report, supra n. 73, at para. 7.219.

[9] See Canada – FIRA, supra n. 21, at para. 5.6.

 

[10] It should be mentioned that the WTO allows for autonomous customs territories to become members even if they are not states.

 

[11] This is not analysed separately for GATT Art. III:2 as fiscal measures can only be imposed by governments, see Petros C. Mavroidis, Trade in Goods 237 n. 91 (Oxford U. Press 2007).

 

[12] See United States – Definitive Antidumping and Countervailing Duties on Certain Products from China

Appellate Body Report, WT/DS379/AB/R (11 Mar. 2011) [hereinafter US – AD CVD Appellate

Body Report], para. 345.

 

[13] See ibid., para. 346.

 

[14] Ibid., para. 346.

[15] See, e.g., Canada – Certain Measures Affecting the Automotive Industry Appellate Body Report, WT/DS139/AB/R, WT/DS142/AB/R (31 May 2000) [hereinafter Canada – Autos Appellate Body Report], para. 150. In Canada – Autos the Appellate Body cited to an early GATT case from 1958, see Italian Discrimination Against Imported Agricultural Machinery Panel Report, L/833 BISD 7S/60 (adopted 23 Oct. 1958) (GATT) [hereinafter Italy – Agricultural Machinery Panel Report] para. 12, which does not mention de facto discrimination explicitly. See also by now classic contribution on de facto discrimination in Lothar Ehring, De Facto Discrimination in World Trade Law: National and Most Favoured-Nation Treatment – or Equal Treatment? 36 J.World Trade 921–977 (2002).

[16] Holger P. Hestermeyer, Article III, in WTO – Trade in Goods para. 89 (Rüdiger Wolfrum et al. eds., Martinus Nijhoff 2011).

 

[17] See US – Tobacco Panel Report, supra n. 70, at para. 67.

[18] Ibid., para. 68.

 

[19] See EEC – Animal Feed Proteins, supra n. 66, at paras. 4.5–4.6.

[20] See ibid., para. 4.6.

[21] See ibid., para. 4.8.

[22] See http://www.wto.org/english/tratop_e/invest_e/invest_e.htm.

[23] See the Preamble to the TRIMs Agreement.

[24] See http://www.wto.org/english/tratop_e/invest_e/invest_e.htm.

[25] As to procedure, the TRIMs Agreement reaffirms obligations under Art. X of the GATT. Importantly, it provides for a notification of TRIMs in force at the time of entry into force of the WTO Agreement and their elimination (Art. 5). The Agreement also sets up the Committee on Trade-Related Investment Measures (Art. 7).

[26] See R. Schlegelmilch, WTO: Why Still no Multilateral Rules for Foreign Direct Investment? 6 Int’l.

Trade L. & Reg. 78, 82 (2000).

[27] Canada – Measures Affecting the Renewable Energy Generation Sector Panel Report, WT/DS412/R,

WT/DS426/R (19 Dec. 2012) [hereinafter Canada – Renewable Energy Panel Report], para. 7.119.

[28] Annex 4 to the WTO Agreement.

[29] Ad Art. XVII:2 provides: ‘The term ‘goods’ is limited to products as understood in commercial

practice, and is not intended to include the purchase or sale of services.’

 

[30] The Appellate Body might have chosen this peculiar term due to its wish to explicitly ‘not

pre-determine’ the question of the burden of proof. See Canada – Renewable Energy Appellate

Body Report, supra n. 4, at para. 5.56.

[31] Ibid., para. 5.56.

[32] K. Adamantopoulos, Article 4 SCMA, in WTO – Trade Remedies para. 11 (R.Wolfrum et al. eds.,

Martinus Nijhoff 2008).

[33] The ‘normal’ recommendations are laid down in DSU Art. 19.

[34] Article. 1.1(a)(1)(iii).

[35] The two elements are determined individually, see Appellate Body Report, Brazil – Export

Financing Programme for Aircraft, WT/DS46/AB/R (2 Aug. 1999) [hereinafter Brazil – Aircraft

Appellate Body Report], para. 157.

[36] See Arts 1, 2 of the SCM Agreement.

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