SECTION I :Introduction 

This Paper studies Article XIX of GATT, a safeguard measure imposed as a response to a surge in imports and the serious injuries of domestic firms.  Many economists have interpreted causality from different lenses, and expressed their perspectives on article XIX.  Most seem to criticize the implementation of Article XIX because the causality between unanticipated increase in imports and damage to the domestic industry is tenuous.   Because article XIX is a  commonly applied policy in modern international trade disputes,there is a lot of material to review.  This paper would specifically look at prerequisites of escape clause cases, along with defining a surge in terms of imports and the specific implementation of Article XIX.  Arguments concerning the possible causality of domestic injury are also included to challenge various theories that are introduced currently.  Summaries of article reviews by famous economists like Alan Sykes are written down, however, this paper aims to rebut or build onto current popular theories and interpretations of article XIX, by specifically looking at the wheat dispute between the U.S and E.U in 1997.  Evidence, data and interpretations will be given to facilitate a better justification, that ultimately disproves the causality between a rise in imports and injured domestic firms in the wheat dispute case, and to show that there are little valid contentions concerning the current GATT justification.  

In Sectio II I present the following section being literature review which aims to establish a  clear definition and a framework of article XIX, along with a summary summarizing various economic papers that reviews the article, then presenting a distinct view that “better fits and interprets” the situation.  The next section goes over the specifics of the example case that this paper would be adopting in order to prove the thesis.  The famous American-European Union Wheat dispute is presented with details 

SECTION II: Literature review 

The surge in imports is the prerequisite for article XIX to be put into use. The dramatic increase in the number of imports exceeding the normal values, understood as a surge, is commonly seen in the modern world of trades.

A surge in imports brings more competition to the domestic market of the importing country.  Surge in imports tend to suggest that the domestic market may not be competitive, thus the consumers demand more of foreign products, resulting in an increase in supply of the product to the importing country.  The exporting countries usually have advantages of specialisation in production and efficiency to dominate markets with a lower sale price, which attracts large amounts of consumers, due to a little marginal cost of production compared to its competitors.  However, it could also be an incentive for domestic firms that once lacked enough motivation when it had more monopolistic power over the domestic market in the past to produce higher quality products with more efficiency in order to survive in the market. 

On the exporting side, the country enjoys a larger market share of the product as it increases its exports to achieve increased revenues in foreign markets, following results being consumer surplus. The economic welfare brought from the surge of imports into another country, along with expanding market shares and firm size helps companies from the exporting side build onto its economies of scale. Ultimately, increased exports to another country potentially helps efficient firms achieve monopolistic power on foreign markets whose domestic firms stand little chance of winning the competition. 

Literature Review (Article XIX)

Known as the “escape clause,”,Article XIX authorizes a country to respond to the surge of imports by imposing to it in the way of implementing quotas, quantitative restrictions, or tariffs.  There is a provision in Article XIX to compensate the exporter in an alternative product. Article XIX is a major component of the GATT/WTO designed to Such policy of the GATT was initially released in 1994, to address the injuries caused to a country’s economy when imports rise dramatically in quantity, which leads to damaging proliferating competition to bring in the domestic company.  Article XIX being a well known and commonly imposed safeguard policy,  holds lots of interpretations and justifications.  

Article XIX is a commonly applied policy in modern trade, which means there is a lot of literature to reference.  It is assumed that the cause of injured domestic firms is the result of surged imports, thus countries respond by imposing a reversal of tariff reductions as safeguard measures to address this issue.  However, there is no strong evidence that shows the direct link and causality between the rise in imports and injured industries.  This is the major flaw of article XIX.  There are many interpretations of what happened in the market that results in domestic injuries.  This shows the irrelevance and absurdity of claiming the surge to be the actual issue.  
 Agricultural products like wheat, fruits, and vegetables are dependent on the weather.  Sudden changes in weather are unpredictable, and sometimes lead to damaging aftermaths.  Extreme cases are catastrophes like natural disasters in the sector of raw materials.  Hurricanes, floods, earthquakes, fires are challenges that the agricultural industry face, as these externalities can dramatically alter the yield.  Less extreme cases are like the Mexican-American grape dispute of March of 2001.   Undesired weather can challenge the efficiency and the cost of production, which is one of explanations for domestic firms that are failing.  An example being the chile agriculture industry (shown in figure below), the production possibility curve shifts inwards as factors of production (capital, land) are destroyed.  Therefore neither can the firm work more efficiently than before, nor can it achieve a point that is outside of the curve.  Simultaneously, there could potentially be a rise in imports, however this doesn't justify a direct link between it and the injured domestic firms.  

We often see an increase in production of firms that attempt to achieve economies of scale when cost of production is lowered when subsidised by the government.  (see figure below)   To maximize sales revenue and achieve profit, firms aim for more sales, internationally and domestically.  Governments’ encouragement of production and consumption in the form of subsidies enables the firm to achieve a higher level of competitiveness in foreign markets.  In safeguard cases, one of the interpretations of causality is the large amounts of subsidised goods entering the importing country’s market. This results in injured industries, which fail to compete without subsidies.  “Loans or subsidies to cover periods of losses can be as effective as protection in enabling an industry to become "competitive."Subsidies from the government grants a lower cost of production of products to a firm, with a lower marginal cost firms may achieve more competitiveness with setting a lower and unfair price in the market. 

Monopoles hold the power to control the price of a product in a market, however it is relatively allocatively inefficient.  Mergers and acquisitions are ways to create a monopoly.  A merged firm acquires the ability to achieve economies of scale which lowers their cost of production, obtaining dominance in the market to challenge the survival of any other existing competitor.   Disney being an example, the monopolistic company acquired Pixar in 2006 for 7.4 billion dollars.  However monopolies tend to fail in allocating resources efficiently with the lack of competition and incentive.  Not only does the abuse of such power create allocative inefficiency but also market failure.  With a surge in import, domestic merged monopolies may find a hard time dealing with relatively more competitive products entering the market.  The inefficient production and allocation of resources results in failure, thus the companies get “serious injuries” due to a rise in imports.  

 In Alan O. In Sykes's Article review on the “escape clause” in international trade titled “Protectionism as a "Safeguard": A Positive Analysis of the GATT "Escape Clause" with Normative Speculations”,  Sykes argues against the normative justification of the implementation of GATT safeguard policies, revealing their flaws and absurdity in conventional arguments and notions on the topic.   “This section disputes these popular notions, arguing that protection for "injured" industries cannot be justified by principled efficiency or equity arguments regarding its effects upon the pro- tected industry and workers”, Sykes had said in the article.   The protection of injured firms in a country is commonly understood as the cause of a rise in imports, thus bringing more competition to the market.  Foreign firms that tend to be more efficient in producing hold monopolistic power over the importing nations’ domestic firms. This means that the marginal cost of producing an extra unit of the product is higher in domestic firms, which drives the prices higher for the domestic products. Given the choice of consuming a cheap high quality product, that is produced by the foreign firms as the cost of production tends to be lower, the domestic product suffers from a consumer shortage, as there are cheaper substitutions offered to consumers in the market.  
3A

Sykes then introduced the argument that economists make arguing for safeguard measures, which is “restoring competitiveness”. The argument assumes that firms would benefit from the protection as the safeguard provides them profit, which gives opportunity to them to develop and enhance capital.  Examples of investing in new and better technology, provision of better training and education to workers, may increase the efficiency and production possibility of the firm, which ultimately restores their competitiveness in the global market once the protection period has ended.  

Sykes addressed this argument by pointing out the flaws in assumptions.  Problematic issues like accuracy of choosing firms that hold potential rebuts the likelihood of such restore of competitiveness to happen.  Furthermore, Sykes argues that the protection offered to failing industries in the way of setting quotas or tariffs are simply unnecessary.  Sykes showed that other equally powerful alternatives like subsidies and investments that the government offers tends to be persuasive even in this case of excluding social externalities and nonpecuniary impacts when trades are restricted simply to grant protection.   “The suggestion that temporary protection may restore the competitiveness of failing industries is ultimately unpersuasive.” 

3B

Sykes argues against the argument that protecting injured industries by implementing protectionist policies leads to a guaranteed gain in social welfare, equity, and wealth distribution.

In Ezra Ginzburg’s article titled “An Analysis of Article XIX: The Safeguard Problem after the Uruguay Round '', Erze argued that Article XIX is simply an imperfect policy that requires reformation.  Ginzburg states that there is actually no need to show causality, or in other words, a strong relation between protection of industries and trade, when invoking Article XIX.  Countries may take advantage of the ambiguous definitions made by the GATT, by simply showing the existence of an injury in the domestic sector that is somewhat related to foreign trade.   Ginzburg goes on and presents an example, which states “Uruguay Round created a draft Agreement on Safeguards which "omits any requirement of linkage between increased quantities and GATT obligations.”  Ginzburg reinforces his argument on the need to strengthen article XIX by showing the definition of “serious injuries' ' in the domestic market to be ambiguous.  Countries have an easy time defending the reasons for them invoking this article, and such abuse in the escape clause urges a change in the fundamental requirements of Article XIX.  Ginzburg suggests that Article XIX would be greatly improved by changing their definition of serious injury.
Economist Brian Hindley in the article titled “GATT Safeguards and Voluntary Export Restraints: What Are the Interests of Developing Countries”, argues that countries tend to prefer voluntary export restraints rather than apply Article XIX, also known as the escape clause to respond to the damage done to the domestic market.  Hindley states that “two broad approaches to a resolution of this problem have been suggested. One is reform of Article XIX and the other is direct action against VER”. All of this points to collusive agreements between exporters and importers.  This approach to the appliance of Article XIX was also seen in Ezra Ginzburg’s article on strengthening the GATT system and article XIX.  Hindley mentions that small countries and less economically developed countries tend to find coercion when it comes to limiting exports.  Brian argues that these voluntary export restraints only seem voluntary in appearance when it comes to trading with a powerful trading partner.  Given an example of exporters facing the coercion of choosing VERs in situations when importers legally meet the circumstances stated in article XIX, and threatens to impose such policy when a VER is denied on the exporting party.    “Developed country protectionism is a threat to the interests of developing countries; but no action on safeguards in the GATT will remove that threat,” said Hindley.

Kenneth Kelly in the article titled “THE ANALYSIS OF CAUSALITY IN ESCAPE CLAUSE CASES” attempts to determine the causal explanation of the change in import supply and the state of the domestic market.  Kelly suggests that there is no consistent theory or explanation of the economic impacts caused to domestic industry in response to a surge in imports.  Kelly first argues that the trade law of 1974 fails to define the term “serious injury”, leaving behind an ambiguous understanding and measurement of injured domestic firms.  Kelly took the good “shakes and shingles” as an example to test the causality.  First, Kelly set up a hypothesis in which goods are homogeneous, and after calculation, Kelly explains that there is no direct link or causality between imports and the operation of domestic firms.  Rather, the injury of domestic firms has more to do with the “decrease in demand of their product and the decreased supply of their inputs”. However in this case, goods are viewed by customers as identical products, meaning that there would be a case in which goods are differentiated. Kelly used data to analyse a case of which non rubber footwear surged in imports.  Calculating with ITC, Kelly concludes that with heterogeneous goods, the “domestic output was 16% higher than it otherwise would have been in the absence of a shift in domestic supply”, and that “The estimated elasticities and the observed changes in prices and quantities imply that increased import supply of non rubber footwear is responsible for a decrease of 31% in domestic production.”  However, a single case cannot justify the determination and causality of injured domestic firms, rather it only studies the demand and supply elasticity of differentiated products in response to the sudden change.  It also determines the factors eg. substitution, and their impact on the elasticity of products in a market.  
In Chad P Bown’s article titled “Trade adjustment in the WTO system: are more safeguards the answer?”  Bown argues that in principle, safeguard measures aim to shield domestic industries from imports, “while it facilitates the exit of firms and workers from the import-impacted industry and their transition to expanding sectors.”  However, in practice government protection to domestic industries only “offer breathing space”  to firms affected by competition.  Bown states “These safeguards often do nothing to assist the adjustment via exit of firms or workers from a declining industry, and the result is an anti-adjustment bias.”  Rather, countries should be encouraged to put greater reliance on existing agreements on safeguards, rather than adopting other trade restrictions eg. Antidumping.  “As with the safeguard statute, the resulting import restrictions reduce incentives for domestic firms and factor owners to adjust to increased international competition, either by becoming more competitive or by shifting into a domestic sector that is expanding” says Bown in the article.  As for concerns regarding special safeguards, it lacks “explicit incentives to adjust out of a declining industry that may be using the provisions to hang on despite a loss of international competitiveness.”

Summing up all previously mentioned article reviews by famous economists, it is apparent that there are different interpretations of article XIX and its issue with causality between imports and domestic injury.  Many think that the ambiguous definitions that are included by article XIX rules should be strengthened to prevent an abusive use to maximize profits.  It certainly lacks justifications when it comes to filing article XIX towards imports, which is assumed to be an act of reasonable anti-dumping.  Rather countries ought to find more evidence and explanation of the details of their injured domestic firms, along with showing validity of the causality.  
I propose that rather, it is the domestic firm itself that fails to achieve optimum efficiency, which resulted in a decline in the competitiveness of their products, having little to do with the rise in imports.  One factor may be the lack of competition in the domestic market.  Market failures are often seen in any domestic economic sector, and could be caused by various factors.  Monopolistic powers that domestic firms may hold when they meet a certain level of efficiency and dominance in the market, rather than achieving economies of scale, firms tend to suffer from diseconomies of scale.  

Simultaneously and coincidentally, there may be foreign products entering the market, and firms may accuse them of being the reason that they suffer from competitive injury.  However the government and firms fail to recognize the state of the industry.  Lack of incentives, communication, management, education are all signs of inefficiency, and the failed allocative efficiency in monopolistic firms are way more common.  

Simple inefficiency in the domestic market is much more persuasive than the surge of imports entering the market.  The U.S was the biggest agriculture producer, capital resources being the most efficient, producing extremely competitive products in the market.  However, weather issues that may lead to destruction and inefficiency may be the case of the sensitive wheat industry.  The European Union’s common agricultural policy and potential subsidies grants unfair competitiveness to the wheat, which relatively outweighs the US wheat production that lacks government subsidy.  The domestic market is weak to external factors that may alter efficiency, rather than imports from an overall less efficient region.  

There are many questions that are not addressed in the paper.  For example, whether or not it is justified to file article XIX against imports that are subsidised when entering domestic markets, or the feasibility of monopolistic firms to achieve optimum results.  There are many cases to look at when it comes to studying the escape clause. This paper specifically analyzes the 1997 wheat dispute between the United States and the European Union.  

SECTION  III

Specifics of the case:

1997 Wheat Gluten dispute between United States and European Union.  

In 1997, the US announced the implementation of quota restrictions on the imports of wheat from the European Union, under article XIX.  Domestic injury was said to be harmed due to the surge of imports of wheat from the European Union, resulting in unfair competition in the domestic wheat market.  The US claims that the domestic firms failed due to the surge, therefore requesting safeguard measures.  This section looks at the case from a neutral perspective, presenting all the missed and ambiguous information.   After a decade of increased wheat import from the European Union, the United States imposed quota restrictions on their trade partners, justifying their protectionist action with Article XIX.  With a percentage from 34 to 75 in just 3 years, the US faced a rapid increase in wheat import from the EU solely.    (see figure below) 

On the domestic side, the production of wheat is shown in the figure below.  As we can see, there are steep slopes of decline and rise in the production of wheat, roughly, the production of wheat from 1997 onwards is shown to be in a decreasing trend.  

“On September 19, 1997, the Wheat Gluten Industry Council filed a petition with the Commission under Section 202 of the Trade Act requesting relief from imports of wheat gluten.”

It is important to investigate the state that the domestic producers were in during this period of time. , and  I have collected data from famous and large domestic wheat firms in 1997 and put the information into perspective.  The debate originates from the arguments that show whether or not there is a straightforward and clear causal justification between injured firms and a surge in imports of wheat.  

The 1997 agricultural industry of wheat domestically offers data to look at from different aspects.  The Midwest, Manildra, Heartland, and ADM constituted the large domestic sector of wheat production, producing the majority of wheat at that period of time.  “The latter began production in June 1996. Heartland, Manildra and Midwest accounted for the substantial majority of domestic production of wheat gluten during the period of investigation. Each of the companies produces wheat gluten and wheat starch in a joint production process. The Heartland, Manildra and Midwest all produce other byproducts or derived products. The Midwest, in particular, further processes wheat starch into alcohol.”

Pre Panel specifications of both countries:

Before the panel, both parties requested to find out about a certain area that may involve the legality of actions, therefore challenging the legitimacy. On the European side, they insisted on findings that breached  “Articles I and XIX of the GATT 1994 and Articles 2.1, 4, 5, 8 and 12 of the Agreement on Safeguards.” The United States thus shows that the safeguard measures satisfy Article rules.

The petition that the US filed on the surge of imports from the EU on the 19th of september 1997 appears valid to the GATT, thus the commission justifies the act of imposing safeguard measures on the imports of wheat from the EU.  “On June 1, 1998, the President imposed quantitative restrictions on imports of wheat gluten,” the wheat investigation made by the US international trade commission said.  

The US commission selected four large firms that contribute to the majority production of wheat, being midwest, Manildra, Heartland, and ADM for investigation.  The GATT looks into the financial aspect of the Midwest, “To derive the wheat gluten financial data from the overall corporate financial data, the Commission audit conducted a reconciliation which entailed a detailed evaluation of the firm’s operations and accounting system.”  With the conclusion of fully satisfied verification objectives.

“On December 23, 1997, the parties submitted post hearing briefs to the Commission. In its post hearing brief, petitioner answered the questions of Commissioner Crawford and the Commission attorney, and provided further explanation of the allocation methodologies in a detailed 12-page response (much of which is confidential business information)”, even though one of the reports on the firm ADM seemed to be incorrect as it generalized wheat gluten and wheat starch operations, and “did not provide separate breakouts between its United States and Canadian operations.”  

Counter arguments that rebuts the theory of increased imports leading to injured industries states that increased capacity of the domestic firms are the answer to causality. 

 “The increase in domestic production capacity had several effects on the domestic industry. It affected the capacity utilization rate, given the mathematical relationship between the two. While domestic production increased by approximately 12 percent between 1993 to 1995, before the import surge, average capacity increased by over 50 percent.” 

“With respect to the period 1995-1997, the increase in reported capacity had an effect on the capacity utilization rate, but had a considerably lesser downward effect than did the sharp decline in domestic production.”  It is found that even though the increase in capacity did have some minor effects on the firm's condition, it fails to be proven to be significantly influential to the firm’s production and efficiency, and how they are performing in the market in general.  

The commission adopts the argument on increased imports leading to injured domestic firms, as it finds direct links between declining domestic production, shipments, unit prices, and industry financial performance in those years, even as domestic demand and consumption  were increasing and the surge in imports.  The commission stated:”In particular, the significant decline in domestic production and shipments as demand was increasing in 1996 and 1997 cannot be attributed in any degree to the increase in capacity.” 

Ultimately, domestic capacity was not the cause of the injury to domestic firms, rather it has more to do with large amounts of imports entering the market.  

SECTION IV

Panel report 

On 26 July, 1999, a second panel report was established on the case, by the WTO’s Dispute Settlement Body.  On the11 of October 1999, the panel was composed.  

The panel found that the United States was inconsistent in obeying article rules of article 2.1, 4 and Article XIX of GATT.  The presence of a rise in imports, as well as “domestic injury” was not proven.  “The causation analysis applied by the USITC did not ensure that injury caused by other factors was not attributed to imports.”  The US violated Article 12.3 of the Safeguards Agreement due to the lack of provision on immediate information and “timely notifications” on the finding of “serious injuries.”. Simultaneously, the US violated “Article 8.1 of the Safeguards Agreement.”.  Concessions were obligated to be provided to exporting members that were affected by the implementation of the safeguard measure, which the US failed to meet up to. 

“On 26 September 2000, the US notified its decision to appeal to the Appellate Body certain issues of law and legal interpretation covered in the Panel Report and certain legal interpretations developed by the Panel.”

It was confirmed that the U.S has not acted consistently in terms of meeting up to its obligations.  However, a reverse in article 4.2(a)’s interpretation was obtained.

“The Panel acted inconsistently with Article 11 of the DSU in finding that “the USITC Report provides an adequate, reasoned and reasonable explanation with respect to ‘profits and losses.” Therefore, the panel reversed its finding, and found no error in exercising judicial economy in not examining the claims of the EC under Article XIX:1(a) of the GATT 1994, and also under Article 5 of the Safeguards Agreement and Article I of the GATT 1994.”

“At its meeting of 19 January 2001, the DSB adopted the Appellate Body report and the Panel report, as modified by the Appellate Body report.”

Appellate report

There are various arguments on the legality in the appellate report.  The two parties both appeal “certain issues of law and legal interpretations in the panel report.”

“On 26 September 2000, the United States notified the DSB of its intention to appeal certain issues of law covered in the Panel Report and certain legal interpretations developed by the Panel”

“On 3 June 1999, the EC requested the establishment of a panel. At its meeting on 16 June 1999, the DSB deferred the establishment of a panel.”

The United States argues that the argument about a lack of “consistency” in terms of the definition of the word “cause” in the panel report, is invalid. Rather,  the United States claimed that “the plain meaning of 'causal link' in Article 4.2(b), first sentence, is consistent with this understanding of 'to cause.”,and that “legal standard applied by the USITC satisfies this requirement.”

“The United States requests the Appellate Body to reverse the Panel's findings regarding notification and consultation.”  The United States believes its responses to the provision of information and data, are “immediately” done. The test also mentioned that the compliance of Article 12.1 was valid, as well as the provision of information on the condition in which the domestic firms are in, which was said to be caused by a surge in imports.  

Furthermore, the United States claims that their suppliance of information is enough to satisfy the information specified in Article 12.2.

The European Community filed an appellate report, stating that the quantitative restrictive safeguard measured on imports of wheat gluten from Europe has violated trade laws and policies.  “The EC considered these measures to be in violation of Articles 2, 4, 5 and 12 of the Agreement on Safeguards; Article 4.2 of the Agreement on Agriculture; and Articles I and XIX of GATT 1994.”  

The European Community’s contention states that the “inconsistency” argument that was brought up on the panel report, stands.  Furthermore, the European Community reinforces the argument on lack of causality.  “The practical effect of the United States' interpretation of Article 4.2(b), however, would allow a safeguard measure to be imposed whenever there is serious injury and imports caused any injury. The European Communities submits that this cannot be the case, and adds that its own interpretation of Article 4.2(b) is consistent with the object and purpose of the Agreement on Safeguards, with the exceptional nature of safeguard measures, and with the negotiating history of the Agreement on Safeguards” The European party elaborated by assuming that even if the standards of “cause” are adopted by the definitions provided by the United States, inconsistency still existed and the United States still lacked evidence to prove the link of such domestic injuries and imports.  

Official approach: (WTO, GATT)

At the end of the first panel report, conclusion was made that the United States was inconsistent in terms of definitions. The panel also favored the European party due to various expectations not being met by the United States’.  The discussion of the immediate response time of providing essential information and data, in which the European Community accused the United States of failing, concluded in favor of the European party as well.  

On the second appellate report, “The Appellate Body recommends that the DSB request that the United States bring its safeguard measure found in this Report, and in the Panel Report as modified by this Report, to be inconsistent with the Agreement on Safeguards, into conformity with its obligations under that Agreement.”

SECTION V

Hypothesis and Conclusion 

Flaws tend to exist in the panel, and there are certainly counterarguments against the justifications against it.  It is essential to look into the domestic sector of the wheat market in the US, however it is equally important to obtain information from the exporting party, the European Union, and put evidence into perspective.  The reason why the domestic market of wheat was failing to operate at the optimum level, and thus failing to achieve enough competitiveness to compete against cheap priced European Wheat Gluten that entered the market rapidly in large quantities, has more to do with the exporter.  The causality between “serious injury” of domestic firms and the rise in imports is linked, however not directly.  The cause of this domino effect that ultimately killed the US domestic firms was because of subsidies and advantageous policies implemented on the agricultural sector in Europe.  Such government intervention assisted, and will continue to assist the European agricultural products to win the game of competition in foreign markets, allowing wheat industries from Europe to lower their marginal cost of production, subsequently lowering the price unfairly to a level that other non-subsidised products can no longer compete on.  

To conclude, the argument that the lack of competitiveness of American wheat is due to subsidised wheat from the EU that resulted in the injured firms, is more accurate than simply saying a surge in imports is the cause of the whole “injury.”