Chapter 10 : Non-discrimination and MFN

Chapter 10: Non discrimination and the most-favored nation clause

Section I: Introduction
A. Policies underlying the MFN principle
B. The history of MFN
C. The non-discrimination obligation in customary international law
A. Policies underlying the MFN principle
The unconditional most-favored-nation (MFN) provision is the cornerstone of the
international trade rules embodies in the GATT. The basic rationale is that if every
country observes the principle, all countries will benefit in the long run through the
resulting more efficient use of ressouces.
Five significant benefits singled out by economists:
1. It ensures that each country will satisfy its total import needs from the most
efficient sources of supply, allowing the operation of comparative advantage
2. The MFN protects the value of bilateral concessions and spreads security
around by making them the basis of a multilateral system
3. the commitment to the MFN clause mobilizes the power of large countries behind
the main interest and aspiration of the small ones which is to be treated equally. It
represents the only way to realize the idea of sovereign equality of nations. It
guarantees access to new comers to international masrkets.
4. from the domestic-political point of view, the MFN commitment makes for more
straightforward and transparent policies and for greater simplicity of
administration of protection (e.g. no special rules of origin necessary)
5. MFN serves as a general constraint on the delegated discretionary powers of the
executive branch in trade matters.
Problems from the general application of the MFN principle:
- small countries may drag their feet in reducing tariffs and
- attempt to free-ride the MFN principle
MFN: has been described as the cental policy of the GATT and the post World War II
trade system. It is captioned in Article I of the GATT.
GATT has 2 major non-discrimination principles:
- MFN principle of non-discrimination (Chapter 10)
- National treatment principle (Chapter 12)
Future questions & controversies in connection to the MFN principle:
- MFN system eroded by the exceptions:
i.
the customs unions and free trade agreements
ii.
Generalized system of preferences (GSP)
Conditional and unconditional MFN; Code conditionality

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conditional MFN: when a country A grants a privilege to country C while owing

MFN to country B, then country A must grant the equivalent privilege to B but
only after B has given to A some reciprocal privilege to pay for it.
- US pursued a conditional MFN approach prior to World War I and changed to
unconditional MFN in 1923.
- Advantages of unconditional approach over the conditional:
i.
it is very difficult to negotiate for reciprocal concessions from a
third party beneficiary of benefits. When A grants a privilege to C,
and B knows that knows that MFN obligations require that
privilege to go B also, albeit after payment there is no incentive
for B to be the forthcoming in a bargaining process with A.
ii.
unconditional MFN can help spread trade liberalization faster
Note: the GATT MFN is unconditional.
A different type of MFN concept has arisen in connection to various codes, i.e. side
agreements on trade matters (negotiated in the Tokio round)
In some of these agreements, certain members have taken the view that the benefits of
the code treatment would only be granted to countries that became members of that
agreement (e.g. the injury code in the safeguards agreement). This situation is not the
same as the conditional MFN, since it does not require a particular negotiation of
reciprocal benefits. There is a difference between traditional conditional MFN code
conditional MFN. Under the WTO agreements there are now 2 plurilateral
agreements with limited membership:
- Government procurement Agreement
- Tokio Round Civil Aircraft Agreement
B. The history of MFN
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The origin of the concept has been traced back to the 12th century, but the phrase
most-favored-nation comes from the end of 17th century. The role of the MFN
provision was to link commercial traties through time and between states.
The trend towards the use of MFN coincided with the decline of mercantilism
The unconditional form of the MFN clause garanteed equal treatment without
requiring direct reciprocal concessions was used exclusevly until the end of the
18th century. Conditional MFN (equal treatment upon adequate compensation)
was inaugurated by the US in 1778.
The position of the US as a newcomer to the world commerce largely accounts for
its novel interpretation of the MFN clause (i.e. conditional MFN). With colonial
ties to the British Empire, the US has difficulties establishing an equal footing for
trade with other nations.
The divergent interpretations of the MFN principle during the late 19th century
were largely a manifestation of the economic relationship between the US
Europe. World War I altered this relationship dramatically: US no longer stood to
Europe as an underdeveloped nation. The Us policy changed reflecting its broader
and more important export interest.

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C. The non-discriminatory obligation in customary international law
Sometimes it was argued that countries are obligated under customary international law
to extend nondiscriminatory treatment to other nations. In the 50s, Eastern European
scholars argued that the Us principle of state equality prohibits the discrimination to
which those countries were subjet at that time.
The idea: the MFN clause is treaty-based (see the draft articles of the UN International
Law Commission 1978).
Section 10.2 The most-favored-nation obligation in the GATT
A. Introduction
B. The scope of the MFN obligation
(1) the concept of like product for tariff purposes: Japan spruce-pin-fir (SPF)
dimension lumber (1989), Spain tariff treatment of unroasted coffee (1982),
Germany treatment of imports of sardines (1953)
(2) the extent of the MFN obligation: Canada autos (2000)
C. GATT and the MFN exceptions
A. Introduction
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the problems are the scope & meaning of GATT Article I:1 and the exceptions to
the MFN principle
the MFN principle is a central and fundamental obligation of international trade
policy, but it is not without interpretative problems. The scope of the clauses
covrage:
o customs duties & any other import/export charges
o methods of levying the duties & charges
o rules & formalities in connection with the importation or exportation
o internal taxation and sales regulation
the definitional problems:
o what are the rules & formalities in connection with importation and
exportation? What are the import/ export charges?
o What is an advantage?
o What is a like product ?

B. The scope of the MFN obligation

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discussed in EC Bananas / AB (1997). EC claimed that there were 2 separate

regimes for importing bananas: (i) the ACP bananas; and (ii) the erga omnes
regimes for all other imports of bananas. According to the EC the nondiscrimination obligations applied only within each of these separate regimes.
The AB did not agree: the essence of the non-discrimation obligations is that
like products should be treated equally, irrespective of their origin. As no
participant disputes that all bananas are like products, the non-discrimination
provision applies to all imports of bananas, irrespective of weather and how a

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Member categorizes or subdivides these imports for administrative or other

reasons.
The idea is that non-discrimination obligations apply to all imports of like
products, except when these obligations are specifically waived or are otherwise
not applicable as a result of the operation of specific provisions of GATT 1994,
such as article XXIV.
(1) the concept of like product for tariff purposes: Japan spruce-pin-fir (SPF)
dimension lumber (1989), Spain tariff treatment of unroasted coffee
(1982), Germany treatment of imports of sardines (1953)

Japan spruce-pin-fir (SPF) dimension lumber (1989)

- Canada complained that Japans tariffs on certain lumber cut to specific
dimensions (dimension lumber) violated the MFN clause of GATT Article I:1.
The problem was that lumber of some species was tariff-free (0%), while lumber
of other species was taxed at 8%.
- The Panel firstly examined the legal framework. The GATT left wide discretion to
the contracting parties in relation to the structure of national tariffs and the
classification of goods. The adoption of the Harmonized System has brought a
large measure of harmonization in the field of classification of goods, but this
system did not entail obligations as to the detailed classification.
- The Panel was of the opinion that a tariff classification going beyonf the HS is a
legitimate means of adapting the tariff scheme to each contracting partys trade
policy interest. However, such differentiations may lend to abuse insofar as they
may serve to circumscribe tariff advantages to like products originating in
different countries (leading to discrimination).
- A contracting party that claims that it is prejudiced by such practices bears the
burden of establishing that such tariff arrangement has been diverted from its
normal purpose so as to become a means of discrimination in international trade.
- Canada claims that the dimension lumber is a standard form of measurement,
quality-grading and finishing. Japan replied that dimension lumber was only a
one particular type of lumber among many other possible presentations. Apart
from thickness and the rgade of finishing, customs treatment of lumber according
to the Japanese Tariff was determined exclusively on the basis of biological
general or species. Dimension lumber was not identified as a particular category
in the framework of the Japanese tariff classification.
- The Panel concluded that reliance by Canada on the concept of dimension
lumber was not an appropriate basis for establishing the likeliness of products
under Article I:1 of the GATT.
Spain tariff treatment of unroasted coffee (1982)
- Prior to 1979, Spain classified all unroasted, non-decaffeinated coffee under one
tariff heading. In 1979, Spain subdivided its classification into 5 parts: three of
them with a 7%, two of them duty-free. Brazil, the main supplier of the type of
coffee subjected to the duty, complained in GATT. Panel concluded that the tariff
regime as applied to Spain was discriminatory.

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Idea: Spain considered that the differences in tariff classification for various types
if unroasted coffee was jusitifed by organoleptic differences resulting from
geographic factors, cultivation methods, the processing of the beans and the
genetic factor. Panel said that such differences are not sufficient to allow for a
different tariff treatment. Panel stated that unroasted coffee was mainly sold in the
mixed form (combining various types of coffee), the end-use of coffee: drinking.
In addition, no other contracting party applied different tariffs for different types
of un-roasted, non-decaffeinated coffee.

Germany treatment of imports of sardines (1953)

- in 1952 RFG imposed three types of duties for three types of sardines: 14%, 20%
and 25%.
- Parties disputes whether those types of sardines were like products or not for
the purposes of Articles I and XIII. Panel did not decide on the like products
issue (the history negotiations suggested that the parties had not considered them
to be like products).
- The Panel focus on the issue whether Norways anticipated benefits under GATT
had been nullified or impaired
- The Panel concluded that Norway had reasons to assume, during the negotiations
that the preparations of clupeae (sardines) in which they were interested would
not be less favorable treated than other preparations of the same family. Panel
took the following circumstances in the account:
o The varieties of clupeae are closely related and are considered by many
interested parties as directly competitive
o Both parties (Germany and Norway) agreed that the question of equality
was discussed during the Torquai negotiations
o It was reasonable to assume that the Norwegian delegation in assessing the
concessions offered by Germany regarding the preparations of clupeae and
in offering counter concessions, had taken into account the advantages
resulting from the continuation of the system of equality which had
prevailed ever since 1925
- As the measures taken by Germany nullified the validity of Norways
assumptions and substantially reduced the value of concessions obtained by
Norway, the Panel found that Norway was justified in claiming that it had
suffered an impairement of a benefit accruing to it under the GATT.
Canada auto (2000)
- the measure at stake is the duty-free treatment provided by Canada to imports of
automobiles, buses and specified commercial vehicles (motor vehicles) made
by certain manufacturers (e.g. GM, Ford, Chrysler, Volvo), under:
o the Customs Tariff
o the Motor Vehicles Tariff Order, 1998 (MVTO 1998)
o Special Remission Orders (SROs)
- the MVTO had its origins in the agreement Canada US (the Auto Pact). Under
the MVTO the import duty exemption was available to certain manufacturers of
motor vehicles based on 3 conditions:

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o manufacturer produced in Canada motor vehicles of the class imported

during the base year
o the ration of net sales value of the vehicles produced in Canada to the net
sales of all vehicles of that class sold for consumption in Canada must be
equal or higher than the ration in the base year and the ratio shall not in
any case be lower than 75:100
o the Canadian added value in the manufacturers local production (occurred
in Canada) must be equal or greater than the amount of Canadian added
value in the local production of motor vehicles of that class during the
base year (CVA requirements)
Through the Special Remission Orders (SROs), Canada has also designated
certain companies eligible to import motor vehicles duty-free
Problem : the new importers cannot qualify for the duty-free rate or the remission
of duties. Canada has not designated any additional manufacturers to be eligible
for the import duty exemption under the MVTO 1998. No new SROs. The MVTO
specifically excludes vehicles imported by a manufacturer whaich did not qualify
before 1 January 1988.
The issue at stake is whether the import duty exemption accorded by this
measure is consistent with Canadas obligations under GATT 1994 Article I:1.
The import duty exemption is granted by Canada to some, but not all, motor
vehicles. The Canadian Customs tariff provides a MFN tariff rate of 6.1%. The
MVTO 1998 and SROs modify this rate by providing the import duty exemptions
for motor vehicles imported by certain manufacturers:
o MVTO 1998: accords the import duty exemption in the form of the
reduced rate of customs duty
o SROs accord the duty exemption in the form of a fully duty remission
The measure on its face imposes no formal restriction on the origin of the
imported vehicles. However, in practice, a motor vehicle imported in Canada is
granted an advantage only if it originates in one of a small number of countries in
which an exporter of motor vehicles is affiliated with a manufacturer/importer in
Canada that has been designated as eligible to import motor vehicles duty free
Since 1989, no new manufacturer has bee able to qualify for the import duty
exemption (the list of eligible manufacturers is closed)).
In determining whether the measure is consistent with Article I:1 of the GATT, the
AB starts its analysis with the wording of Article I:1. The elements that are not
disputed by the parties:
o The import duty exemption is an advantage/privilege/favor/immunity
granted by a Member
o Only some, not all the motor vehicles imported from certain members are
accorded the duty exemption
o The interpretation of unconditionally: advantages conditioned on a
situation or conduct
one main issue in dispute: has the import duty exemption also been accorded to
like motor vehicles from all other Member states, in accordance with Article I:1?
o Article I:1 addresses not only de jure discrimination, but also de facto
discrimination

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o The wording of Article I:1: any advantage, any product

originating and all other Members
Canada has granted an advantage to some producuts from Members that Canada
has not accorded immediately and unconditionally to the like products
originating/ destined for the territories of all other Members. The measure was not
consistent with Canadas obligations under Article I:1 of the GATT 1994.

C. GATT and the MFN exceptions

The most significant 2 exceptions to the MFN clause are:
- Article I:2 dealing with tariff preferences in force when the GATT 1947 was
drafted. It has become less significant over the years, since colonial preferences
have disappeared. However, the preferences have been replaced & expanded
under the Generalized System of Preferences (GSP).
- Article XXIV: customs unions and FTAs.
Less important exceptions to GATTs preference to non-discriminatory preference:
- Article VI: AD/CVD
- Article XIV: permits discrimination in certain cases in the application of quotas
justified by balance of payment grounds
- Article XIX: country affected by another countrys Escape Clause may suspend
concessions
- Article XXI: deviations from MFN permitted for national security reasons
- Article XXIII: allows a country to be authorized to suspend concessions made to
another party that has nullified or impaired its benefits under the GATT 1947.
Section 10.3 The MFN obligation in US Law
A. The Trade Act of 1974
B. US implementation of the Tokio and Uruguay round agreements and MFN
C. US and Communist countries
A. The Trade Act of 1974
US specifies MFN treatment for most imports. For tariff purposes, the only countries that
did not receive MFN: Cuba and North Korea.
Exceptions to the MFN rule:
- the GSP for developing countries
- more extensive preferences for African, Caribbean and Andean countries
- various free US free trade agreements, i.e. Preferential Trade Agreements (e.g.
NAFTA)
Departures from the MFN principle:
- balance-of-payments (BOP) authority
- the retaliatory authority

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B. US implementation of the Tokio and Uruguay round agreements
and MFN
Tokio round: a whole series of side agreements on trade issues. The agreements usually
had procedural & governance provisions that only applied to the signatories. Nonsignatory members were treated differently. Two of the side agreements obligated only
the parties to apply the provisions of the Code to other parties:
- Subsidies Code
- Government procurement code
C. US and Communist countries
Idea: during the Cold War the US restricted its trade with the Communist countries:
- exports to those countries: main target of US export controls based on national
security concerns
- imports: the US did not provide MFN to imports from the Communist countries
US and the Soviet Union:
- Us granted the MFN to the Soviet Union in 1937
- US withdrew the MFN in 1951
- 1972: US Soviet Union enetered into a trade agreement that provided that
imports into the US will benefit from the MFN. Provisions of the MFN and
Communist countries were the most controversial. The agreement of 1972 never
came into effect.
US and China:
- the annual waiver process was particularly controversial , although the MFN has
continued in effect since first extended in 1979
- the term MFN was changed in normal trade relations
- in 2000, the Congress approved permanent normal trade relations status for
Chiba, conditional to its accession to the WTO.

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