Baby GATT Back: The End Of The World Trade Organization?

Submitted by Hugo Erken, head of International Economics at Rabobank

The WTO Appellate Body crisis

• On 10 December, two members of the highest dispute settlement body of the World Trade Organisation, the Appellate Body, are retiring. As the US has been blocking the appointment of new members since 2017, the Appellate Body, as of today, won’t be able to fulfil its tasks

• The shutdown of the Appellate Body carries the risk that the entire dispute mechanism of the WTO collapses

• The discontent of the US with the WTO’s dispute settlement system (DSS) is not new. The US is especially dissatisfied with judicial overreach, the WTO’s rulings in anti-dumping cases and the slow process of the entire DSS. However, the data shows that the US is not in a disadvantageous position vis-à-vis other countries in the rulings of the WTO

• Hence, a more strategic reason to strip the Appellate Body of its powers is that the US wants to settle international disputes again according to the GATT regime, the predecessor of the WTO. Under GATT, large trading blocs will have the upper hand over smaller ones and dictate the rules of the trading game

What has happened?

On 10 December, two member of the highest body of the dispute settlement system (DSS) of the World Trade Organization (WTO), the Appellate Body, are retiring. What is problematic is that since 2017 the United States has blocked the appointment of new members to this body, because it is dissatisfied with the way the Appellate Body operates. All WTO members must agree with the appointment of new members and the US has used its veto. Under normal circumstances, the Appellate Body has seven members who review cases. But, due to the US blockage, the number of members has gradually declined over the last two years to only three members in the last couple of months, which is the minimum requirement for the Appellate Body to review cases. As of today, the Appellate Body has insufficient members to fulfil its task.

Choking off funding

The US also has cranked up the pressure on the Appellate Body by choking off its funding. In order to secure the WTO’s preliminary Budget for 2020, members states complied to the US demand to lower the annual spending of Appellate Body members by 87% and the operating fund by 95%.

How does the dispute settlement system work?

With the founding of the World Trade Organisation in 1995, countries have also agreed to forge a judicial framework to formalise the way disputes between member states are resolved. The Dispute Settlement Understanding (DSU) sets out the procedures under the flag of the WTO. If consultation among quarrelling WTO members has failed to produce a solution, the case is taken to an ad hoc dispute panel, whose decisions are binding unless appealed. Cases that are appealed, are brought before the Appellate Body. The Appellate Body is only able to rule over the dispute panel’s legal findings and conclusions. The Appellate Body report is final and legally binding and the defending country must bring itself in conformity with WTO obligations within a ‘reasonable period of time’. If a defending party fails to implement a panel or Appellate Body decision, the complainant party may be given the right to respond with protectionist measures. This was for instance the case in the Airbus dispute early October of this year, where the WTO ruled that European airplane manufacturer Airbus received illegal subsidies. As a result, the WTO authorized the United States to impose retaliatory tariffs of 100% on USD 7.5bn worth of export products from the EU.

An Appellate Body in limbo

With a total case load exceeding 600 cases since the start of the WTO in 1995, the DSS is probably the busiest international dispute settlement system in the world. The Appellate Body has an extremely important task within this system, as two thirds of the disputes are appealed. All in all, the Appellate Body could be seen as the Supreme Court of trade rulings or the international arbiter of trade. However, now that this body has been shut down and at the same time is choked off important funding sources, the entire dispute mechanisms of the WTO is at risk. In his farewell speech, departing Appellate Body member Peter Van den Bossche said: “One can predict with confidence that, once the Appellate Body is paralyzed, the losing party will in most cases appeal the panel report and thus prevent it from becoming legally binding. Why would WTO members still engage in panel proceedings if panel reports are likely to remain unadopted and thus not legally binding? As from 11 December 2019, it is therefore not only appellate review but also the entire WTO dispute settlement system that will no longer be fully operational and may progressively shut down.”

Why is the US asphyxiating the WTO’s dispute settlement system?

The discontent of the US with the WTO’s dispute settlement system, and the Appellate Body in particular, is not something that has been solely brought to the fore by the Trump Administration. In fact, there has been a litany of US-led complaints over the last decade (see here for a reconstruction). There are three reasons which are important to address and which illustrate the frustration of the US:

1. Judicial overreach: the US has criticized the judicial overreach of the Appellate Body in interpreting WTO law. This covers a numbers of problems, for instance the practice by the Appellate Body to follow previous rulings. Moreover, the US has argued that the Appellate Body takes an overly broad view of matters that it can deal with. For instance, the US would like to adopt protectionist measures as a means to curb the negative impact of tradedistorting subsidies provided to state-owned enterprises (see here). This complaint of course relates to China’s growth model. But a number of Appellate Body interpretations have prohibited the US from installing such trade barriers.
2. Anti-dumping: another topic which has led to frustrations in Washington is that the US has lost 93% of all anti-dumping cases (2 out of 29) which have been reviewed by the WTO (see here).
3. Slow process: all stages of the dispute settlement process should take no longer than 18 to 19 months, if we take into account an extended panel period and appeal period. In practice, however, the duration of proceedings has reached an average of almost 34 months (see Reich, 2017).

Is the action by the US proportionate?

The question of course is whether asphyxiating the WTO’s dispute settlement system is the appropriate way to safeguard US interests. Although the dispute settlement system is far from flawless, endangering the existence of the Appellate Body is perhaps not proportionate.

Moreover, to avoid the situation we are currently facing, WTO members have continuously been working on reform proposals, but thus far neither seem to have pleased the US, leading to the deadlock that we are facing today. Peter Van den Bossche says: “It is, however, not clear to me, whether any reform of the current system, short of its virtual elimination, will satisfy the United States.”

What do the data tell us?

If we look at the data, both the US and the EU are by far the biggest users of the DSS. Over the course of time, the US has filed 132 cases as complainant and was defendant in 164 cases (Figure 1). Of the complaints it has filed, the US has won 90% of the cases (see Jacques Delors Institute, 2018), but at the same time it is also the country that loses the most cases in which it is respondent. All in all, the win/lose ratio does not differ much from that of other countries.

Strategic reasons

So the data does not show that the US is in a disadvantageous position vis-à-vis other countries in the ruling of the WTO. At the same time, the shutdown of the Appellate Body is quite drastic, which fuels the suspicion that there must be a more strategic reason for the US to take these draconian measures.

And on this we can obviously only speculate, but one motivation could be that the US wants to settle international disputes again according to the GATT (General Agreement on Tariffs and Trade) regime, which is the predecessor of the WTO. With the Appellate Body in limbo and DSS likely to collapse, trade disputes would have to be settled again under that regime. Under GATT, disputes were not resolved within a judicial formalised framework (with legally binding rulings), but had to be resolved the diplomatic way. This means we are shifting to a more power-oriented regime, rather than a law-oriented one. Especially large countries could block rulings under the GATT regime, without being penalised. Indeed, McGivern (2002) argues that the complaining country could only retaliate by consent of all GATT Contracting Parties, includes the defendant, which ensure that retaliation under GATT was completely absent. This perspective might sound interesting to the US Administration and is in line with its ‘America First’ doctrine, as large trading blocs will have the upper hand over smaller ones and dictate the rules of the trading game.

Trade powerplay

If countries are not able to persuade the US to lift the blockage on the appointment of Appellate Body members, the world will lose its international legal trade arbiter (i.e. the Appellate Body) and the dispute settlement system will likely collapse in a short period of time. Meanwhile the EU is trying to patch the broken system, by copying the Appellate Body framework and rallying partners to join this temporary appeal system voluntarily. Norway and Canada have agreed to join, but the US, China and India have refused.

If the current issues are not resolved in a reasonable time frame, this implies that, in the future, countries will have to settles trade disputes again according to the GATT regime, which generally means trade rules will be dictated by the most powerful countries. Especially smaller countries will lose out, as larger countries can simply ignore a ruling against them without repercussions. This is a fate that may befall smaller emerging market economies and could expose their vulnerabilities. Many smaller European countries, such as the Netherlands, are protected by overarching EU framework under which they operate. The United Kingdom, on the other hand, is already vulnerable due to Brexit and the current course of events will likely impinge on its trade perspectives even more.