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CHAPTER 15 REGIONAL INTEGRATION

1. OVERVIEW OF RULES

(1) Regional Integration

In addition to the global economic regime based on the GATT and IMF systems, whichhas sustained the world economy since World War II, regionalism, through whichneighbouring countries seek to strengthen their economies by entering into some form of“regional integration” has become a major trend. This trend was triggered by the EU marketintegration. In both developed and developing countries, customs unions and free trade areas(FTAs) continue to increase and expand. Today, they account for a considerable amount ofworld trade (Figure15-1, 15-2). In the WTO, regional trade agreement (RTAs) is referred to as customs unions, FTAs, and interim agreements. In this chapter, we use the term “regionalintegration” to signify both RTAs and other forms of regional cooperation. Almost 90 percentof the WTO Members are parties to such RTAs. Japan, Korea and Hong Kong are among thefew exceptions.

Article XXIV of the GATT allows RTAs to be exempted from the most-favoured-nationprinciple under certain conditions; RTAs must not raise barriers to trade with countries outsideof the region. This is because while RTAs promote trade liberalization within the respectiveregions, if they raise barriers to trade with countries outside the regions, they would impedetrade liberalization as a whole. From this standpoint, the adequate application of ArticleXXIV should be needed lest the WTO is turned into an empty shell.

Moves towards “Regional Integration”

In recent years, moves towards regional integration have been more and more active,with countries seeking to strengthen their ties with other countries. In Europe, when theTreaty on the European Union (the Maastricht Treaty) took effect in November, 1993, theEuropean Union (EU) was created, which enlarged and built upon the European Community(EC). The enlargement of the EU took place on January 1, 1995 by accession of three newcountries, Austria, Sweden and Finland, which were former members of the European FreeTrade Association (EFTA). Meanwhile, the September, 1993 signing of the side agreements tothe North American Free Trade Agreement (NAFTA) launched the free trade arrangement inNorth America in January, 1994. Elsewhere, AFTA (the ASEAN Tree Trade Area) beganreducing tariffs among its members in January, 1993. It has continued to expand its range ofitems covered, and has agreed to make efforts toward the acceleration of the integrationprocess with a view to implementing the AFTA free trade agreement by 2003, and to beginnegotiations on access to services area. On the other hand, in the Americas, certain countriesin Latin America initiated the Southern Common Market Treaty (MERCOSUR) in January,1995.

One of the trends that have recently been observed is to create mechanisms for broaderregional co-operation. This includes: 1) enlargement of existing regional integration,including the FTAs between the EU and the Central and Eastern European countries (CEECs),the FTA to be set up between the EU and the Mediterranean countries, and the creation of aFree Trade Area of the Americas (FTAA); 2) linkage between regional integrationorganizations, such as economic co-operation, including the creation of a future FTA betweenthe EU and MERCOSUR; and 3) continent-based regional co-operation that may not

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necessarily be seeking to create a FTA or customs union, such as Asia-Pacific Economic Co-operation (APEC) and the Asia-Europe Meeting (ASEM).

The APEC is some form of regional co-operation that does not immediately seek toestablish customs unions or FTAs. The APEC is founded on an open regionalism that seeksnot only to reduce the barriers to trade among its member economies but to make the result ofthese efforts available to other non-region economies as well. In November, 1994, anunofficial summit of the leaders of the APEC economies was held, and a joint declaration wasissued “setting a goal of free and more open trade and investment by the year 2010 in thedeveloped countries, and 2020 in the developing countries” (the Bogor Declaration). At theManila meetings in November, 1996, all members submitted specific Individual Action Plans(IAP). All members (including new participating members in 1998, i.e. the RussianFederation, Vietnam and Peru) submitted revisions of the Plans at the Vancouver meetingsheld in November, 1997 and at the Kuala Lumpur Meeting in November, 1998. Thus, stepstoward liberalization and facilitation have been taken.

Japan, like Korea, Hong Kong, and Taiwan, is a WTO member that does not belong toany regional trade agreement. Japanese basic trade policy is to create an environment for freeand transparent international economic activities by strengthening common international rulesthrough active participation in the next round of WTO negotiations. At the same time, we alsoconsider that we need to strengthen regional and bilateral ties while they complementinternational rules. Such efforts will promote multilateral liberalization in the future and willexpand the range of economic activities in which Japan enjoys a close economic partnershipwith Asian countries. From this standpoint, private-sector groups between Japan and Koreaare jointly studying the potential for a free trade agreement, and the governments of the twocountries are negotiating earnestly with a view to consulting an investment agreement. LastDecember, Japan reached an agreement with Singapore for a study group composed ofindustries, governments, and academics to study a free trade agreement as well. <Figure 15-1> Growth in the Value of World Trade by Region, 1990-98 (Trade in Goods)

(Unit: Billion Dollars)　　　EXPORT IMPORT

1998 ( % ) 1990-8 1998( % ) 1990-8WorldNorth America(America)South AmericaWestern EuropeAsia(Japan)(China)

5270 ( 100) 897 (15.4) 682(12.9) 276( 5.2) 2348(44.5) 1293(24.5) 388( 7.4) 184( 3.5)

6 7 7 8 5 7 4 15

5465 (100) 1152 (21.1) 944(17.3) 340( 6.2) 2367(43.3) 1086(19.9) 280( 5.1) 140( 2.6)

6 8 8 14 4 5 2 13

EU(15)NAFTA(3)MERCOSUR(4)ASEAN(10)

2181(41.4) 1014(19.2) 80( 1.5) 329( 6.2)

5 8 7 11

2172(39.8) 1280(23.4) 99( 1.8) 279( 5.1)

4 8 16 7

(Source) WTO Annual Report 1999(the WTO Secretariat)(NOTE) 1990-8:rate of increase (%)

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<Figure 15-2> Ratio of Internal to External Trade for Major Regions (Trade in Goods)

EXPORT 1998 IMPORT 1998

Total(billiondollars)

InternalExports(%)

ExternalExports(%)

Total(billiondollars)

InternalImports(%)

ExternalImports(%)

EU(15)NAFTA(3)MERCOSUR(4)ASEAN(107)

21811014 80 329

62.7 ( -)51.3 (10)24.9 (22)22.0 (12)

37.3 ( -)48.7 ( 5)75.1 ( 5)78.0 (11)

2172 1280 99 279

63.1 ( -)39.9 (11)21.2 (22)22.6 (12)

36.9 ( -)60.1 ( 7)78.8 (15)77.4 ( 6)

(Source) WTO Annual Report 1999 (the WTO Secretariat)(NOTE)1) Figures in parentheses ( ) for internal/external exports and internal/external imports show the 1990-1998

growth rate (%).2) Numbers given here may not match those in Figure 15-1 because of the margin for error in the

calculations.

(2) Legal Framework

(i) Existing GATT/WTO Provisions on Regional Trade Agreements (RTAs)

Tariff reductions applying exclusively to specific countries are prohibited in principleunder Article I of the GATT, which requires most-favoured-nation treatment as a basic rule.

The WTO, however, under Article XXIV of the GATT, authorizes the establishment ofcustoms unions, FTAs and interim agreements, if their purpose is to facilitate trade within theregion, and not to raise barriers to trade with countries outside of the region. The WTO allowsthese RTAs to be exempted from the most-favoured-nation principle as long as they conformto the following conditions outlined in Figure 15-3.

So far, the question of whether most customs unions or FTAs conform to Article XXIVof the GATT has been examined by working parties established separately for each RTA forwhich notification has been given. However, there is almost always disagreement over how tointerpret Article XXIV since the wording is vague: “substantially all the trade between theconstituent territories”, “other restrictive regulations of commerce (ORRCs)”, “on thewhole....shall not be higher or more restrictive.” Because of this, in almost every case, theclaims of the parties to the FTAs and customs unions and those of third countries withcompeting interests have been given equal weight.

Interpretation of Article XXIV became an issue in the review of the Treaty of Rome thatestablished the European Economic Community (EEC) in 1957. Indeed, only six of the 69working parties that had completed reviews by the end of 1994 had been able to reach aconsensus on conformity questions. But while there have been conflicts of opinion on ArticleXXIV interpretation in almost every review of a RTA, the legitimacy of most-favoured-nationtreatment for a RTA has only been contested in three panel cases. None of these panel reportshas been adopted by the GATT Council.

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<Figure 15-3> Conditions of Customs Unions, FTAs and Interim Agreements under Article XXIV of the GATT.

(Conditions under Article XXIV: 5, 8 of the GATT) - ORCs :other regulations of commerce - ORRCs :other restrictive regulations of commerce

Article XXIV:5 Article XXIV:8Customs Unions (a) The duties and ORCs shall not on

the whole be higher or morerestrictive than the general incidenceof those previously applicable in theconstituent territories prior to theformation.

(a)(i) The duties and ORRCs (except,where necessary, those permittedunder Articles XI, XII, XIII ,XIV,XV and XX) are eliminated withrespect to "substantially all the trade"between the constituent territories ofthe union.(ii) Substantially the same duties andORCs are applied by each of themembers of the union to the trade ofterritories not included in the union.

Free Trade Areas(FTAs)

(b) The duties and ORCs shall not behigher or more restrictive than thosepreviously existing in the sameconstituent territories prior to theformation.

(b) The duties and ORRCs (except,where necessary, those permittedunder Articles XI, XII, XIII, XIV,XV, and XX) are eliminated withrespect to "substantially all the trade"between the constituent territories .

InterimAgreements

(a) (b) same condition as in thecustoms unions or FTAs(c) any interim agreement shallinclude a plan and schedule for theformation of such a custom union orof such a FTA within a reasonablelength of time.

(Compensatory adjustment under Article XXIV:6)– With respect to a Customs Union, in fulfilling the requirements of Article XXIV:5(a), when a

contracting party proposes to increase any rate of duty inconsistent with the Article II, theprocedures set forth in Article XXVIII shall apply for compensatory adjustment.

(Notification to the Contracting Parties, Considerations)– Any contracting party deciding to enter into a customs union or FTAs or an interim agreement,

shall promptly notify the WTO. (Article XXIV:7(a))– After notification, the contracting parties will discuss and review the plans and schedules in the

interim agreement with the parties to the agreement, the Contracting Parties shall makerecommendations where appropriate. (Article XXIV:7(b))

(ii) Treatment of RTAs Among Developing Countries

To address RTAs among developing countries, the GATT has issued the decision of thecontracting parties on November 28, 1979 (“Differential and More Favourable TreatmentReciprocity and Fuller Participation of Developing Countries,” hereinafter “EnablingClause”), reached during the Tokyo Round negotiations, to serve as the basis for specialtreatment accorded to developing countries in matters of trade. The Enabling Clause allowsRTAs entered into among less-developed contracting parties for the mutual reduction orelimination of tariffs and non-tariff measures to be exempted from the most-favoured-nationprinciple under Article I of GATT as long as the following conditions are met (paragraph 2(c),see Figure 15-4).

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<Figure 15-4> Condition of the Enabling Clause

(Conditions)- Such regional arrangements shall be designed to facilitate and promote the trade of developing

countries and not to raise barriers to or create undue difficulties for the trade of any othercontracting parties (paragraph 3(a)).

- And not constitute an impediment to the reduction or elimination of tariffs and other restrictionsto trade on a most-favoured-nation basis (paragraph 3(b)).

(Notification to the contracting parties, Consultations)- Parties to such regional arrangements shall notify the contracting parties and furnish them with

all the information they may deem appropriate to such action (paragraph 4(a)).- And afford adequate opportunity for prompt consultations at the request of any interested

contracting party (paragraph 4(b)).

There are three ways to view the relationship between the RTAs among developingcountries and the Enabling Clause and Article XXIV of the GATT.

(a) The Enabling Clause was enacted so that developing countries could increasetheir exports and further develop their economies. RTAs between developingcountries should therefore be looked at only under the terms of the EnablingClause.

(b) The Enabling Clause only imposes certain requirements on contracting parties tonotify and consult countries that are entering into agreements or taking measuresthat are by nature partial and non-inclusive. It is therefore not sufficient as a basisfor dealing with RTAs. This must be done under Article XXIV.

(c) Judgements concerning RTAs among developing countries should take intoaccount both Article XXIV and the Enabling Clause.

How to examine such RTAs first became a focus of discussion in 1992 with theformation of the MERCOSUR, an arrangement entered into by Brazil, Argentina, Uruguayand Paraguay. Since the GATT was formally notified of MERCOSUR in March, 1992, somecontracting parties called on the GATT to form a working party under the Council to examinethe agreement under the terms of Article XXIV of the GATT. However, a consensus wasreached to have the Committee on Trade and Development (CTD) review MERCOSUR underthe terms of reference in light of both the Enabling Clause and Article XXIV and report backto the contracting parties with a copy of its report going to the Council. With theestablishment of the new WTO Committee on Regional Trade Agreements (CRTA) inFebruary, 1996, examinations are now performed by this Committee. A similar debateregarding the AFTA has been raised, but there has been no consensus. So far only the CTDhas been notified of the agreement to form the area.

As noted above, the disciplines regarding free trade agreements in the Enabling Clauseare unclear. Review procedures need to be clarified in order to avoid the abuse of free tradeagreements based on the Enabling Clause.

(iii) New Rules in the WTO Agreement

During the Uruguay Round negotiations, countries studied ways to remove theambiguity that had made interpretation of Article XXIV difficult. This led to a new“Understanding on the Interpretation of Article XXIV of the General Agreement on Tariffs

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and Trade,” in which there is an explicit requirement to calculate “the general incidence of theduties” with an average weighted for trade volume rather than the arithmetical average usedby the EU. There was also a proposal to prohibit RTAs from excluding major goods, forexample agricultural products, from “the substantially all the trade between the constituentterritories” clause, but no consensus could be reached on this issue. Instead, limitedimprovements were made as shown in Figure 15-5. For the services area, countries agreed toadd wording similar to Article XXIV of the GATT to Article V of the GATS (see Figure 15-6).

<Figure 15-5> New Rule for Clarification of Article XXIV of the GATT

(a)Understanding on the Interpretation of Article XXIV of the GATT 1994.- The “general incidence of duties and other regulations of commerce” shall in respect of duties and

charges be based upon an overall assessment of weighted average tariff rates and of customs dutiescollected (paragraph 2).

- The “reasonable length of time” referred to in Article XXIV 5(c) should generally not exceed 10 years(paragraph 3).

- When a Member forming a customs union proposes to increase a bound rate of duty, the procedure setforth in GATT XXVIII must be commenced before tariff concessions are modified or withdrawn(paragraph 4).

- Members benefiting from a reduction of duties as a consequence of the formation of a customs union oran interim agreement are not obligated to provide compensatory adjustment (so-called "reversecompensation") to the constituents of such an agreement (paragraph 6).

- The Council of Trade in Goods may issue appropriate recommendations based on working party factrecognition reports regarding the creation of a regional union or the addition of new members (paragraph7).

(b)The New Anti-Dumping Agreement (Article 4.3)- Where two or more countries have reached under the provisions of Article XXIV:8(a) of the GATT 1994

(customs unions) such a level of integration that they have the characteristics of a single, unified market,the industry in the entire area of integration shall be taken to be the domestic industry for purposes ofantidumping measures.

(c)The New Subsidies Agreement (Article 16.4)- Same provisions as in the New Anti-Dumping Agreement.

(d)Agreement on Safeguards (Article 2.1, footnote)- Nothing in this Agreement prejudges interpretation of the relationship between Article XIX and Article

XXIV:8 of GATT 1994.(e)Agreement on Rules of Origin (Annex II)

When a Member applies preferential rules of origin to the other Members of the union Area, a member mustensure that- Administrative determinations of general application set out clearly the requirements to be fulfilled in

order to meet the preferential rule of origin (Paragraph 3(a)).- Preferential rules of origin are based on a positive standard (Paragraph 3(b)).- All laws, regulations and determinations relating to preferential rules of origin are to be published in

accordance with the provisions of Article X:1 of GATT 1994 (Paragraph 3(c)).- In introducing changes to the preferential rules of origin or new preferential rules of origin, they shall not

apply retroactively (Paragraph 3(e)).

<Figure 15-6> General Agreement on Trade in Services Article V (Economic Integration)

Article V of the Agreement on Trade in Services provides the following conditions forconclusion of an agreement liberalizing trade in services within the region:- Has substantial sectoral coverage in terms of number of sectors, the volume of trade affected

and the modes of supply (the GATT requires “substantially all trade”) (Paragraph 1(a));- Provides for the absence or elimination of substantially all discrimination, through: 1)

elimination of existing discriminatory measures, and/or 2) prohibition of new or morediscriminatory measures (Paragraph 1(b));

- Shall not in respect of any member outside the agreement raise the overall level of barriers to

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trade in services compared to the level applicable prior to the agreement (Paragraph 4);- May not seek compensation for trade benefits that may accrue to any other member from such

agreement (Paragraph 8); and- The Council for Trade in Services may establish a working party to examine an agreement

(Paragraph 7(a)) (This is not an obligation, which is different from the case of trade in goodswhere the establishment of a working party is obligatory.)

(iv) Issues Studied by the Committee on Regional Trade Agreements (CRTA)- Strengthening Disciplines and Procedures -

In accordance with the growing number of RTAs, further increase in review burdenswas anticipated because of regular notifications from existing RTAs. In view of thesedevelopments, it was agreed to make the transition to a single committee, which would be incharge of all reviews. This transition is expected to greatly improve the efficiency of thereview process, and it was with this in mind that the General Council established the“Committee on Regional Trade Agreements (CRTA)” in February, 1996 as a specialcommittee to review regional integration.

The CRTA is solely responsible for all of the reviews that used to be conducted byindividual working parties for each RTA under the direction of the Council on Goods, Councilon Services, and CTD. It also provides analysis of the impact of RTAs on the multilateral freetrading system. More specifically, the CRTA has been assigned the following terms ofreference: (a) to carry out the examination of RTAs (Figure15-7) adopted by the Council forTrade in Goods, the Council for Trade in Services or the CTD; (b) to consider how therequired reporting on the operation of such agreements should be carried out and makeappropriate recommendations to the relevant body; (c) to develop procedures to facilitate andimprove the examination process; and (d) to consider the systemic implications of suchagreements and regional initiatives for the multilateral trading system and the relationshipbetween them (so-called “systemic issues”).

(a) Examination of RTAs

As of May, 1999, the CRTA was referred to examine 68 RTAs, 31 of which reports wereunder investigations or unacceptable. The examinations of RTAs are still proceeding. As aresult, none of examination reports have been adapted since the CRTA had been established(All of the examination reports are mere draft and contain nothing more than description ofthe Pros/Cons. ).

(b) Reporting on the Operation of Agreements

The “Understanding on the Interpretation of Article XXIV of the GATT” obligatesexisting RTAs to report periodically to the Council for Trade in Goods on the operation of theagreement (paragraph 11). This obligation does not extend to trade in services. In addition,RTAs under the Enabling Clause are required to notify and submit appropriate information toCTD, but adequate information has not been submitted to CTD. This has led to considerationto improve the required reporting on the operation of RTAs. While such efforts are certainlynecessary from the standpoint of improving the transparency of implementation, detailedreporting is also a burden, and would represent an additional obligation beyond existing legalobligations and overlap with the TPRM process. The Committee is therefore discussingspecific ways to implement a biannual reporting system.

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(c) Procedures to Facilitate and Improve the Examination Process

In order to facilitate and improve the examination procedures by solving such problemsas those related to the increasing number of “after the fact” examination, and insufficientprovision of information for the examination, the CRTA is working to facilitate andstandardize the provisions of information for examination of RTAs. For the standard formatfor the provision of information on RTAs, Members have agreed on non-binding guidelinesfor both goods and services and the Committee took note of the Standard Formats. For theprocedures to facilitate and improve the examination process, the Committee took note of thenon-binding, voluntary guidelines setting out notification timings, standard examinationprocessing periods, and the composition of reports, containing the Committee’s furtherconsideration and improvement of the guidelines.

(d) “Systemic Issues” - Systemic Implications of Agreements and Initiatives for theMultilateral Trading System and the Relationship Between Them

To deal with “Systemic Issues,” the WTO has created the “Checklist of SystemicIssues” focused on identifying systemic issues as they emerged from RTA examinations andinterpretation of Article XXIV of the GATT. The Committee began considering approachesfor the analysis of “Systemic Issues” using the checklist. The Committee is considering theconcepts of “other restrictive regulations of commerce” and “substantially all the tradebetween the constituent territories” in Article XXIV:5 and 8, which are used to judge whether“other regulations of commerce” in the RTA have raised the barriers to the trade of othercontracting parties with such territories (see Figure15-8).

<Figure 15-8> Major Points of the Systemic Issues Emerged from WTO Rules for RTAs

1) “The general incidence of ORCs” clause in Article XXIV:5 Article XXIV:5 states that the RTAs shall not raise duties and ORCs to the trade of third parties, but there

is contention over how to judge if barriers have risen. Members have agreed that the evaluation under ArticleXXIV:5 of “the general incidence of the duties and ORCs” shall in respect of duties and charges be based uponan overall assessment of weighted average tariff rates, and of customs duties collected, but there is still noagreement on the method to be used in overall assessment of “the general incidence of ORCs.”

2) Relationship between Article XXIV:4 and Article XXIV:5-9

Article XXIV:4 states that the purpose of RTA should be to facilitate among the parties and not to raisethe barriers to the trade of third parties. Article XXIV:5-9 define the requirements and criteria for “duties andORCs” maintained in an RTA, the obligated procedure under the GATT. In addition,, definitions of customsunions and FTAs are provided.

The two divergence of opinions was addressed by Members. One view, addressed by the EU and othermembers, has been that Paragraph 4 is clarified and pointed out by the provisions of Paragraphs 5-9, whichfollow it. Paragraph 4 itself is not a standard of judgement, in other words, if the requirements of the provisionsof Paragraphs 5-9 are met, then Paragraph 4 is automatically met. They therefore argue that even if the formationof a customs union results in the raising of new barriers to the trade of other contracting parties with respect toindividual measures, a customs union will not be recognized to “raise barriers to trade of other contractingparties” in Paragraph 4, as long as the general incidence of ORCs “on the whole” is not higher or morerestrictive than that in Paragraph 5(a).The other view has been that Paragraph 4 is itself a standard of judgement.

3) The “substantially all the trade between the constituent territories” clause in Article XXIV:8Article XXIV:8 states that the range of liberalization under a customs union and a FTA must be

"substantially all the trade between the constituent territories". No criteria have been agreed to for determiningwhat constitutes “substantially" all the trade in Articles XXIV:8. Two distinct conceptual views exist, oneemphasizing its quantitative dimension, the other calling for a qualitative analysis. Under the qualitative view ofthe term "substantially" all the trade basically focuses on the possibility of an RTA to cover a large option of the

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parties' trade and exclusion of major sectors, particularly agriculture, from intra-RTA trade liberalization. Therehas been a proposal to integrate the quantitative and qualitative approaches.

4) Relationship between Article XXIV:8 and other provisions of the WTO AgreementsArticle XXIV:8 stipulates that the possible exceptions to “the duties and ORRCs” to be eliminated

include those measures found in Articles XI, XII, XIII, XIV, XV, and XX. The fact that, however, Article XIX(Emergency Measures) and Article VI (Anti-dumping Measures) are not mentioned among the possibleexceptions is a source of contention. A number of questions have been raised in CRTA discussions, within thecontext of either the extended scope of WTO obligations after the Uruguay Round, or the characteristics ofenlarging existing customs unions, or both. Specifically, the issue is whether a customs union’s existingmeasures such as safeguards measures, anti-dumping measures, import restrictions (against third countries) canor should automatically be extended to new members of the union, and whether an RTA members can impose asafeguard or anti-dumping type action only for countries outside of the region. Different views have beenexpressed on whether there are justified by Article XXIV:8 in the CRTA.

(3) Economic Implications

"Trade Creation Effect" and "Trade Diversion Effect"Regional integration expands markets and promotes competition by eliminating barriers

to trade among constituent countries. This contributes to more efficient allocation of resourcesand greater productivity among the constituent countries, as well as having a “trade creationeffect” that improves the economic welfare of the members. These aspects are quite obviouslypositive for the economies that are integrated. With regard to countries outside the region, thecreation of a expanded regional market as a whole can be expected to have a positive sideeffect of an increase of trade opportunity.

On the other hand, the positive trade creation effect can also in fact be overshadowed bya negative “trade diversion effect” if the elimination of barriers to trade between members ofthe region causes trade that had been conducted with efficient non-regional countries to bediverted to less efficient regional countries.

“Investment Diversion Effect”Interest has recently been growing in the “investment diversion effect” of regional

integration as well. For example, in 1984 the EU received only one-third of the directinvestment that the United States received, but by 1989 was at the same level of the UnitedStates. For foreign companies, the single, unified market that regional integration creates isalso an attractive investment market, and the larger the integrated market, the greater the scalemerits and therefore the attraction of locating there. However, in as much as investmentresources are limited, this has the effect of diverting investment away from other countries.

Naturally, investment decisions are part of a company's business judgement and theinvestment diversion effect should be seen as the result of this. But if regional integrationbrings with it trade policies that discriminate against products from outside the region, then itmay distort the investment pattern between regions. (For example, if regional integrationresults in stricter rules of origin for non-regional products, then it will encourage directinvestment in the region rather than exports to it.)

Economic Evaluation of Regional IntegrationThe impact on constituent countries and outside countries from these two effects differ

according to the contents and the policies of the agreement and the time that has elapsed. Ingeneral, the positive “trade creation effect” exceed the negative “trade diversion effect” in thecase of constituent countries, although one cannot deny the possibility that the reverse may

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also hold. Imports from outside countries, on the other hand, tend to be placed at acompetitive disadvantage to imports from constituent countries because RTAs usually raisebarriers to trade relatively, if not absolutely.

Thus, regional integration may affect outside countries negatively. However, byincreasing the productivity and making constituent countries highly competitive, it may leadto elimination of barriers and to worldwide trade liberalization in the future. Generally, thereduction of tariffs through the multilateral efforts in the round has tended to decrease thelevel of discrimination against outside countries through preferential margins. Nevertheless,new rules and policies that discriminate against and disadvantage outsiders can still be seen.Below are concrete examples of measures found in some RTAs that may violate GATT/WTOprinciples and disciplines.

(a) Movement towards stricter preferential rules of origin;(b) Conditional rules to not apply tariffs on certain products, that are applicable only

to certain corporations, but that are not applied to new entrants or outsiders; and(c) Increase of tariff rates imposed on outside countries just before a regional

integration agreement has been signed (forestalling).

These problems must not be repeated in the process of regional integration. Integrationshould be pursued in such a way that outsiders can enjoy the positive trade creation effectswhile the negative effects of trade diversion are minimized. In this respect, APEC, "an openregional integration" does not affect outside countries negatively because it has few tradediversion effects.

2. PROBLEMS AND TRADE POLICIES IN RTAS

As mentioned above, Article XXIV of the GATT is not necessarily administered strictly.However, now that moves towards trade liberalization are extensive such as the enlargementof the EU, the formation of the Free Trade Area of America (FTAA) and the planning of theTrans-Atlantic Free Trade Area (TAFTA), and that regional integration such as customs unionand FTAs has been given more and more weight, it is essential that RTAs do not constituteexcessive barriers against non-parties, and are administered in such a way to complement themultilateral trading system.

Since there are many RTAs in the world nowadays, they have a large influence on worldtrade. From this standpoint, it is essential that RTAs should keep the consistency with ArticleXXIV of the GATT and attempt to administer with a view to complementing multilateraltrading system. We must be cognizant that were Article XXIV of the GATT interpreted in anarbitrary fashion that grants exceptions to the most-favoured-nation treatment rule, it wouldrisk turning the WTO into an empty shell.

Regional integration can have both positive and negative effects for the multilateral freetrading system. That is why we advocate the use of the WTO framework to minimize theadverse effects of regional integration while maximizing the positive effects of its anticipationof multilateral liberalization. Weshould make every effort to see that the liberalizationachieved within a regional integration is extended to the entire WTO at some point in thefuture. Japan is a core member of APEC and believes that APEC’s principle of openregionalism (the idea that benefits should be extended on a most-favoured-nation basis)should be actively applied in this context.

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During the course of the WTO Committee on Regional Trade Agreements (CRTA)deliberations, Japan articulated the need for clearly stated rules to minimize the adverseeffects on outside countries during the debate on the interpretation of the provisions of ArticleXXIV. Japan also argued that the preamble and body of Article XXIV should not beinterpreted and judged formalistically, but in relation to their conformity to the entire WTOAgreement, and particularly within the context of most-favoured-nation treatment and thepurposes of the WTO.

There are three specific points to be made in this regard. First, when the establishmentof a RTAs results in rules of origin being used to substantially increase the barriers to trade onoutsiders, then it is in contravention to the requirement in Article XXIV:5 that restrictions oncommerce may not be any higher than prior to formation of the customs union or the FTA.Second, clarification is needed in the implementation of “substantially all the trade betweenthe constituent territories." Third, when a regional integration is enlarged, the safeguards andanti-dumping measures should not be automatically extended without fresh investigations toestablish injury to the domestic industry, and when they are applied, application only tooutsiders and not to members is not justified under Article XXIV. For all three of these points,clear rules need to be articulated.

(i) European Union

The European Economic Community (EEC), based on the Treaty of Rome that wassigned in March, 1957, was established in January, 1958. It was aimed at the creation of theSingle Common Market, and by 1968, had completed the establishment of a customs unionand a common agriculture policy. They then went on to remove barriers within the region, andliberalize the movement of four basic actors, “goods, people, services, and capital.” This setthe stage for the signing on November 1, 1993 of the Treaty of Maastricht, which charts thecourse to political union as well as economic and monetary union for the twelve countries ofthe "European Union (EU)". Later, in January, 1995, the accession of Austria, Finland, andSweden brought its membership to fifteen.

From January, 1994, the EU and three European Free Trade Association (EFTA)countries (Norway, Iceland, and Liechtenstein) established a “European Economic Area(EEA)” that goes beyond “the scope of a FTA by including liberalization of the movement ofpeople, goods, capital and services, and enhanced and expanded co-operation in research anddevelopment, environment, and other areas”

In order to strengthen its relationship with the Central and Eastern European countries(CEECs), the EU has signed ten “Europe Agreements” that seek to establish FTAs (andultimately accession to the EU) by liberalizing trade and removing duties and quantitativerestrictions on industrial imports, by reducing duties on agricultural imports, by liberalizinginvestment and services, and by providing economic co-operation. These agreements define abroad range of co-operation, including co-operation in the political, economic, and socialspheres, but must be ratified by EU members before they take effect. Because of the timerequired to achieve ratification, the trade portions of the Europe Agreements will take effect inthe form of provisional agreements, and cooperation is now moving forward in trade areas(the core of which is the establishment of FTAs).

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EU is also strengthening its economic relationships with the countries of theMediterranean. It has begun to negotiate free-trade agreements between Europe and theMediterranean countries to replace the first agreements dating from the period 1975-77. Thenew Europe-Mediterranean Association Agreements are being negotiated, to introducereciprocal trade liberalization for most industrial products, and trade liberalization in servicesand free movement of capital. The objective of the EU and Mediterranean countries is toestablish a wide FTA between all countries by 2010.

Twelve countries - which are largely central and eastern countries - have applied formembership in the EU. In December, 1997, the European Council announced that the EU andthe applicants, other than Turkey, will begin the process to accession from April, 1998. Todate, the following negotiating countries for formal accession have got through the firstscreening: Cyprus, Hungary, Poland, Estonia, Czech Republic and Slovenia. Since themeeting of the Board of Ministers for Foreign Affairs held in November, 1998, the Councilhas conducted formal negotiations on the accession. In addition, negotiations regarding theremaining five countries (Slovak Republic, Bulgaria, Romania, Latvia and Lithuania) willalso proceed in light of annual progress in preparation,

As examples of the construction of broader regional cooperation between the EU andother countries, for the purpose of establishing the FTA is the framework cooperationagreement between the EU and MERCOSUR and their Member States which was signed inDecember, 1995. This agreement provides the framework to promote economic cooperationand establishes the basis for a future interregional partnership. Furthermore, the EU and theUnited States have considered the creation of “the Trans-Atlantic Free Area (TAFTA)”through the reduction of barriers to trade. In December, 1995, the EU and the United Statesadopted “the New Transatlantic Agenda,” which provides a framework for dialogue andcooperation in several economic and political areas.

(a) Tariff Increases in Contravention to GATT Article II

The Tariff Schedules of the three New EU Member States (Austria, Finland, andSweden) were replaced by the Common Tariff Schedule of the EU, which resulted in highertariffs on some items, most notably semi-conductors, computers, and transportationequipment, effective January 1, 1995. Japan therefore initiated negotiations with the EU forcompensation under the provisions of Article XXIV:6 of the GATT. These negotiationsresulted in an agreement by the EU to bring forward to 1996 the concession rates scheduled totake effect in 1997 under the Uruguay Round Agreement, and to accelerate or further reducefinal concession rates for products, such as semi-conductors and photographic film.

In this case, the EU increased the bound rates of the new member states withoutconducting prior negotiations with WTO Members with the exception of the United States. Itwould be problematic for such a practice to be repeated upon further enlargement of the EU(the accession of the CEECs and the Baltic States). Prior negotiations under Article XXVIII:1of the GATT with interested countries must, in principle, precede the increases in bound rates.

(b) Meeting the Condition of “Substantially All the Trade” under Article XXIV:8

The Agreements that the EU have signed to exempt agricultural products or the likefrom trade liberalization. We should need to consider fully whether the Agreements of the EU

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would meet Article XXIV:8 of the GATT requiring that ORRCs be eliminated on"substantially all trade" within the region.

The EEA Agreement requires that member countries make efforts to liberalize trade inagricultural and marine products, but does not provide for the complete elimination of bothduties and ORRCs. In Protocol 3, the EEA Agreement stipulates that variable surcharges,reflecting differences in production costs within the area, be retained for imports of vegetablesand certain other agricultural products.

The European Agreement between the CEECs and the EU has special provisions withrespect to liberalizing trade in textiles, clothing, and agricultural products (The CEECs musteliminate quantitative restrictions, quotas and approvals on specific imports from the EU andreduce duties on a limited number of products. The EU must eliminate restrictions on importsfrom the CEECs, while extending tariff quotas and reducing primary tariff rates on certainproducts). On the other hand, the elimination of duties and quantitative restrictions aren’tprovided in this special provisions.

Regarding customs unions, EU-Turkey Customs Union excepts certain agriculturalproducts from trade liberalization, and EU-Andorra Customs Union applies only to industrialgoods.

(c) “Automatic” Extension of Anti-dumping Measures to new members of the EU,“Selective” Non-application of Anti-Dumping Measures imports from the EUmembers

The enlargement of the EU resulted in “automatic” extension in the three new countriesof the anti-dumping measures (against third countries) implemented by the twelve existingmembers. Japan protested this matter to the EU commission and final agreement was reachedwhich provided a special arrangement for expedited review, upon request, of anti-dumpingmeasures for the EU as a whole.

Automatic extension of anti-dumping measures without fresh investigations to establishinjury to the domestic industry is, in our opinion, in contravention to the principle of ArticleXXIV:5 of the GATT that obligates not be “more restrictive” after the formation of a customunion than before. Nor do we think it justified in light of the stronger disciplines oninvocation of anti-dumping measures in the new Anti-dumping Agreement.

Under Article XXVI of the EEA Agreement, a party to the agreement may not invoke ananti-dumping action against imports from another member country. Unlike a customs union,which is regarded as a single customs territory with a single “domestic” industry stipulated byArticle VI of the new Anti-dumping Agreement, the FTA members maintain separate anddistinct domestic industries. Thus, the GATT provides no justification for the EU to exemptthe EFTA countries from application of an anti-dumping measure and to impose anti-dumpingduties on third parties in a discriminatory manner simply based on the fact that it is a memberof a FTA. We think such action is not justified under Article XXIV of the GATT, and to do sowould be in violation of Article I of the GATT (MFN Treatment).

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(d) Increase in Polish Customs Duties on Automobiles

Poland raised its tariffs on imports of automobiles in January, 1992, two months beforethe date the European Agreement entered into force in March, 1992 from 15 percent to 5percent. This tariff rate will be reduced to zero percent for automobiles from the EU and to24.5 percent for automobiles from outside the EU in the future. It also established a zero tariffimport quota (30,000) for EU automobiles.

Because Poland raised tariffs just before the entry into force of a RTA, we believe itviolates GATT Article XXIV:5(b) of the GATT which stipulates that duties should not beraised upon the entry into force of a FTA. One could argue that there was no violation ofArticle XXIV:5(b), because the tariffs were already raised at the time the RTA went into force,but in light of the fact that the agreement had already been signed in December, 1991 whenthe increases were made, it is more logical to view the hikes as having come about inconjunction with the agreement. Furthermore, if we were to allow this line of argument, itwould be easy to evade legal obligations.

In addition, there are non-transparent and uncertain elements regarding the EuropeAgreements between the EU and the CEECs. At the current stage, at any rate, the zero tariffimport quota of the Europe Agreement is unlikely to meet Article XXIV requirement ofcovering “substantially all the trade.” We, therefore, find serious problems with the attemptsto expand MFN exceptions, for example, by establishing a non-tariff quota for the EU. Suchnon-tariff quotas are not justified by Article XXIV and therefore violate Article I and XIII.This is not isolated to the case regarding Poland but may soon happen in other CEECs, wheredue to the anticipated enlargement of the EU, barriers to the outside may be raised andunjustifiable MFN exceptions created.

India requested the establishment of a panel on this matter in the GATT Council inNovember, 1994, and the Council established the panel. In September, 1995, India againrequested Article XXIII consultations with Poland under the WTO rules. In August 1996, thetwo countries notified the WTO that they had a mutually agreed solution to DSB (Polandcreated a special quota of preferential tariff rates for countries affected which qualify for theGSP). Japan, the United States and other countries also pointed out these problems when theEU-Poland Interim Agreement was examined at the WTO.

(e) EU-Turkey Customs Union

In entering into the Customs Union Agreement between the EU and Turkey on January1,1996, Turkey unilaterally imposed quantitative restrictions on textiles effective January1,1996. These restrictions seek to preserve the EU’s remaining restrictions on textile andclothing products under the MFA and cover exactly the same items for which the EU hasquantitative restrictions. This is a clear violation of Article II of the Agreement on Textiles andClothing, which bans the imposition of any new import restrictions other than transitionalsafeguards for all measures except those in place prior to the WTO. It also clearly violatesGATT Article XI which provides for a general ban on quantitative restrictions, as well asArticle XXIV:5(a) stipulation that ORCs under a customs union shall not be higher or morerestrictive than prior to the formation of such union. With regard to this case, Japanparticipated as a third party in a WTO panel and an Appellate Body proceedings. As a resultof examination by the WTO, these restrictions were found to be in violation of Article XI andXIII of the GATT, and in violation of Article II of the Agreement on Textiles and Clothing .

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<Box-1> The Fourth Lomé Convention and EU Restrictions on Banana Imports

In December 1989, the European Communities signed the Fourth ACP-EEC Conventionof Lomé with countries of Africa, the Caribbean, and the Pacific (ACP). The Conventionprovided for preferential treatment between members and their former colonies and under itACP countries received preferential treatment in banana imports. Present ACP States partiesto the Lomé Convention is 71 which includes 54 WTO Members.

Prior to market integration, the EU banana import regime waived the 20 percent advalorem tariff on imports from ACP States under the Convention of Lomé, allowing theirbananas to be imported tariff-free. Individual EU States could, however, impose quantitativerestrictions. In February, 1993, a panel was established at the request of Panama, Costa Rica,Guatemala, Nicaragua, and Venezuela (EEC-Member States’ Import Regime for Bananas(1993)). The panel report was issued and circulated to Members in June, 1993 and found thequantitative restrictions of EU members to be in violation of Article XI:1 of the GATT(general ban on quantitative restrictions), and the special measures favouring ACP bananas tobe in violation of Article I of the GATT(Most-favoured-nation Treatment) and unjustifiedunder Article XXIV of the GATT. The EU did not, however, allow this panel report to beadopted.

In February, 1993, the EU decided, in connection with market integration in January,1993, to replace quantitative restrictions on banana imports with a tariff quota regime, and tomove to a specific duty rather than an ad valorem duty. The change took effect in July, 1993.Five countries, Columbia, Costa Rica, Guatemala, Nicaragua and Venezuela maintained thatthis import regime violated Articles I, II, III and XI. Consultations failed to reach a mutuallysatisfactory solution, so a panel was established at the request of the countries in June, 1993(EEC-Import Regime for Bananas (1993)). The panel issued and circulated its report inFebruary, 1994, finding: 1) the change from an ad valorem to specific duties to be in violationof Article II:1 of the GATT(requirement to apply tariffs that are not any more disadvantageousthan the bound tariff), 2) discrimination in the assignment and tariff rates for tariff quotas tobe in violation of Article I because ACP bananas were given preferential treatment over thoseof other countries, and 3) the violation of Article I to be unjustified by claiming that it fellunder the FTA provisions of Article XXIV.

In considering whether the preferential treatment of ACP bananas was justified in termsof Article XXIV, the panel focused on the Convention of Lomé and the fact that only the EUundertook the obligation to eliminate trade barriers; the ACP countries came under noobligation whatsoever. It therefore found that a non-mutual agreement, in which only part ofthe constituent countries in the region eliminate ORRCs, did not constitute a FTA as definedin Article XXIV. The interpretation that the EU had advocated under the provisions of Part 4(Trade and Development), that the unilateral elimination of barriers to trade by developedcountries for the benefit of developing countries in treaties in which developing countriesundertook no obligation to liberalize should be considered to meet the requirements of ArticleXXIV, was not adopted in light of the fact that a waiver had been granted in the general most-favoured-nation treatment regime and an agreement had been reached on authorizationconditions.

The panel report had been brought to the Council in March, 1994, but the EU blockedits adoption. As GATT terminated at the end of 1995, this panel report was not adopted.

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During this period, the EU and the ACP States applied for a waiver under Article I:1 for theFourth ACP-EEC Convention of Lomé, which was granted by the session of the ContractingParties to the GATT 1947 in December, 1994. During the Uruguay Round negotiation, the EUoffered an increase in the amount of tariff quota for bananas in exchange for withdrawal of thepanel proceedings , and reached on agreement, with four countries except Guatemala. FromJanuary, 1995, the quota allocations were implemented with respect to Columbia and CostaRica according to the agreement.

Later, the new EU banana import system, established after the waiver had beenobtained, resulted in a complaint being filed in May, 1996 by the United States, Guatemala,Honduras, Mexico, and Ecuador claiming violations of Article I and XIII (Non-discriminatoryApplication of Quantitative Restrictions).The panel was then established and in September,1997. At a DSB meeting, panel report submitted in April, 1997 and a report by the AppellateBody submitted in September of the same year were adopted. (See Chapter 1 Most-Favoured-Nation Treatment Principle for a discussion of the content of this report. See Chapter 14,“Unilateral Measures” for the dispute between the United States and the EU over theimplementation of the recommendations.)

(ii) The North American Free Trade Agreement (NAFTA)

The North American Free Trade Agreement (NAFTA), which is a RTA for the UnitedStates, Canada, and Mexico, was signed on December 17,1992 and took effect on January1,1994. It seeks to eliminate barriers to trade within the region, and establish a framework forinternational cooperation. To do this, it will establish rules for investment, intellectualproperty rights, and competition policy in addition to ordinary rules on the trade in goods andservices (elimination of tariffs and quantitative restrictions within the region, harmonizedrules of origin etc.).

In December, 1994, the three NAFTA members reached an agreement with Chile tobegin negotiations on its membership in the RTA (a FTA between Canada and Chile tookeffect in June, 1997). During the Summit of the Americas held at roughly the same time, withparticipation from all thirty-four countries in the Americas except Cuba, agreement wasreached to conclude negotiations on the Free Trade Area of the Americas (FTAA) by 2005.

(a) Strengthening of Rules of Origin

Rules of origin in NAFTA adopt the change in tariff heading (“CTH”) approach used inthe United States-Canada FTA. However, the number of goods subject to origin requirementsin addition to the CTH has increased relative to the United States-Canada FTA. As a result,more and more parts and materials of finished goods are required to be of NAFTA origin,often resulting in rules more restrictive than the United States-Canada FTA rules.

The substantial strengthening of Rules of Origin may well violate Article XXIV:5 of theGATT which stipulates “Duties and ORRCs” shall not be higher or more restrictive than thecorresponding duties and other regulations of existing in the same constituent territories priorto the formation of the FTA. Several examples illustrate the more-stringent NAFTA rules oforigin. Under the United States-Canada FTA, textile products satisfy the origin rule if thefabrics originate in the region. Under NAFTA, however, products must be produced fromyarns originating in the region in order to qualify as North American origin. (see Figure 15-9)

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<Figure 15-9> Comparison of the Rules of Origin for Textiles Products Between the United States-Canada FTA and NAFTA

Yarns Origin Fabrics origin US-Canada FTA NAFTAInside Inside ○ ○

Inside ○ ×OutsideOutside × ×

　　　　Note: A circle means to be treated as U.S.-Canada or NAFTA origin, and a cross means reverse.

Colour television sets (CTVs) are considered to be of either United States or Canadianorigin if they satisfy the United States-Canada FTA 50 percent value-content requirement. ForCTVs over 14 inch to qualify as North American under NAFTA, however, the colour picturetube (CPT) or at least either the funnel or front panel of the CPTs must originate in NorthAmerica. After January, 1999, in addition to the foregoing, components such as tuners andtuner control systems and audio detection and amplification systems must be of NAFTAorigin for a CTV to qualify for North American origin status.(see Figure 15-10)

With respect to automobiles, both the United States-Canada FTA and NAFTA require achange in tariff heading and a certain level of local content. The United States-Canada FTA’slocal-content requirement is 50 percent. However, NAFTA’s initial requirement of 50 percentwill be raised eventually to 62.5 percent. In addition, NAFTA did not follow the UnitedStates-Canada FTA in its “roll up” of certain automobile components when calculating theregional value content of finished automobiles. Under the United States-Canada FTA, as longas the completed part has originated in the region, the entire cost of the part is included in theregional value content of the finished vehicles (the entire cost will be excluded if thecompleted part does not originate in the region). Instead, NAFTA adopts the “tracing” rule,which only allows the North American materials or components constituting certain NorthAmerican auto parts to be counted toward the regional value content requirement of theautomobiles. Since the calculation method of local content is different between the two FTAs,figures used in each FTA cannot be simply deemed as equivalent. Nevertheless, consideringthe adoption of the tracing rule, origin rules for automobiles have been strengthened underNAFTA.

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<Figure 15-10> How NAFTA Calculates the Local Content of Automobiles

(The Method of the NAFTA)

(Net costs) - (Value of parts from outside the region) Local content rate = --------------------------------------------------------------- Net costs *

To calculate the value of non-regional parts, NAFTA uses a “tracing method” rather than the “roll-up method”used by the United States- Canada FTA. The use of the tracing method enables the actual value of non-regional parts to be calculated regardless of whether they have more than 50 percent local content.

(note *) Net costs are defined as the ex-factory price. However, if this price includes marketing costs, royalties, or shipping, those expenses are deducted.

(Reference : The Method of the United States – Canada FTA )

(Price of parts and materials originating in the United States or Canada) + (Direct assembly costs in the United States or Canada) Local content = ---------------------------------------------------------------------------- Price of the exported product

Because roll-up system is used for calculations of local content, a part with 50 percent local Content will be counted as a 100 percent domestic part, while one with less than 50 percent Local content will not be counted at all.

(b) Coverage of the Agreement

With respect to trade in agricultural goods, NAFTA consists of three separateagreements: one between Mexico and the United States, one between Mexico and Canada,and the United States-Canada FTA, which will continue to apply to trade between those twoparties.

Import restrictions between the United States and Mexico will be replaced by tariffmeasures when NAFTA takes effect. Between Canada and Mexico, however, quantitativerestrictions and tariffs will remain on dairy products, sugar and sugar confectionery, chicken,and egg products. Between the United States and Canada, the United States-Canada FTAprovides a schedule for eliminating tariffs on agricultural products, but not for abolishing non-tariff measures on such products. There will also remain certain tariffs on fresh fruits andvegetables.

Quantitative restrictions on agricultural products – between the United States andCanada and between Canada and Mexico – are allowed under the provisions of Article XI ofthe GATT, but it is limited to the extent that such restriction is necessary under the provisionArticle XXIV:8(b) of the GATT. Japan should monitor WTO consistency of these measures.

(c) “Selective” Non-application of Safeguard Measures on imports from the NAFTAmembers

Article 802 of the NAFTA allows members not to apply safeguards to other NAFTAparties in taking a safeguard action. Safeguards are emergency measures to protect domesticindustry and therefore involve a temporary suspension of other obligations under the GATT. Itis not rational to apply them selectively only to imports from third parties while givingpreferential treatment to imports from its RTA partners. We therefore see the “selective” non-

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application of safeguard measures under NAFTA as a violation of Article XXIV:8(b) of theGATT.

(d) Transition Period

Schedules for eliminating tariff and non-tariff barriers within the FTA vary according tothe countries and goods concerned:1) United State - Canada (under the terms of the United States-Canada FTA):

All import restrictions, except those on agricultural products, will be completelyeliminated by January 1, 1998.

2) Canada - Mexico:Restrictions on imports from Mexico into Canada of products for which schedules

have been formulated will be eliminated by January1, 2003. Restrictions on importsfrom Canada into Mexico of corn, kidney beans, and certain other products for whichschedules have been formulated, will be eliminated by January1, 2008. Restrictions onimports of other products will be eliminated by January 1, 2003 at the latest.

3) United States - Mexico:Restrictions on imports from Mexico into the United States of saccharine, sugar-

based confections, footwear, glass products, watches, and other goods will beeliminated by January 1, 2008. Restrictions on other imports will be eliminated byJanuary 1, 2003 at the latest. Restrictions on imports from the United States intoMexico will be eliminated according to the same schedule as imports from Canada intoMexico.

Among the requirements that the WTO places on interim agreements is that they resultin the formation of a such a customs union or a FTA within a reasonable length of time(Article XXIV:5 of the GATT). “The Understanding on the Interpretation of Article XXIV ”takes this farther by defining a reasonable length of time as ten years, absent exceptionalcircumstances. The NAFTA members have not explained clearly why a period in excess of tenyears is required, so there are reasonable doubts about whether the treaty meets therequirements for an interim agreement.

(iii) MERCOSUR (El Mercado Comun del Sur), the southern Cone Common market

The southern Cone common market (MERCOSUR) agreement was signed on March 26,1991 and took effect on January1, 1995. MERCOSUR is composed of four countries Brazil,Argentina, Uruguay, and Paraguay, and is an interim agreement that seeks the establishmentof a customs union by 2006.

MERCOSUR has reached an agreement with the Andes common market (fourcountries: Columbia, Venezuela, Ecuador, and Bolivia) to form a FTA by 2005, andnegotiations towards that goal are in progress. In June, 1996, it approved the creation of aFTA with Bolivia, and in December, 1997 the participation of Chile in this FTA. There arealso plans to expand MERCOSUR into a South American Free Trade Agreement (SAFTA) oreven a Free Trade Agreement of the Americas (FTAA). MERCOSUR also signed an inter-regional cooperation agreement with the EU in December, 1995. (See Section (1) above.)

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(a) Degree of Progress towards "Substantially the Same Duties"

MERCOSUR common tariffs on goods from outside countries are between 0-20 percentfor about 85 percent of all items (total of 9,000 items). Member countries are permitted to listexceptions, and they are broad. There are both common exceptions for all four members andindividual exceptions for specific members. MERCOSUR gives its members a maximum ofeleven years to make the transition to common tariffs (Argentina and Brazil must have thetransition complete by 2001, Uruguay and Paraguay have until 2006 to phase them in). Wewill need to watch closely to ensure that the agreement meets the condition in ArticleXXIV:8(a)(ii) of the GATT for “substantially the same duties.”

(b) New or Higher Common Tariffs

The MERCOSUR common tariffs have resulted in the tariff rates on some itemsexceeding the bound rates. By rights, MERCOSUR ought to have followed Article XXIV:6 ofthe GATT, initiated the concession amendment procedures found in Article XXVIII, andnegotiated adjustments with interested countries before the common tariffs were imposed. Itdid not do so. The common tariffs took effect on January 1,1995, harming the interests of itstrading partners in contravention of Article II of the GATT. Japan, the EU, Canada, and othercountries have therefore reserved the right to negotiate with MERCOSUR under ArticleXXIV:6.

On November 13, 1997, Brazil imposed a 3 percent across-the-board hike in the tariffson most of the common tariff goods and exceptions (the tariff rate on most common tariffgoods went from 14 percent to 17 percent, the maximum tariff rate from 20 percent to 23percent, the rate on excepted capital goods from 17 percent to 20 percent, and the rate onautomobiles was held at the current level of 63 percent). MERCOSUR members have alsoagreed to raise common tariffs by a flat 3 percent by December 31,2000. Such hikes incommon tariffs would seem to go directly against Article XXIV:4, which states that “thepurpose of a free-trade area [is] not to raise barriers to the trade of other contracting partieswith such territories.” It is also likely to be a violation of Article II.

(c) “Selective” Non-application of Safeguard Measures on imports from the MERCOSUR members

MERCOSUR’s common safeguard rules are not clear on whether other members of theregion will be exempted. However, when Brazil enacted safeguards for toys in January, 1997and Argentina for footwear in September, 1997, other MERCOSUR members were exempted.Exempting members and applying safeguards selectively to third parties is in violation of thenon-discrimination rule in the Safeguards Agreement, and is also in violation of ArticleXXIV:8(a)(i) of the GATT. With regard to the footwear safeguards case, EU requested theestablishment of Panel, and it came to conclusion that applying safeguards selectively was notjustifiable.

(iv) AFTA, the ASEAN Free Trade Area

The January, 1992 ASEAN summit reached an agreement to begin work towards a FTAand on January 1, 1993, member countries began to reduce their tariffs. AFTA membersemploy a system known as “Common Effective Preferential Tariffs” (CEPT), in which they

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phase in tariff reductions within the region, ultimately seeking intra-regional tariffs of 0-5percent by 2003. Quantitative restrictions on CEPT items will also be eliminated by 2003.

AFTA was expanded to include Vietnam in January 1996, and during 1997, AFTAagreed to work towards the eventual membership of Cambodia, Laos, and Myanmar.

Moreover, The December 1998 ASEAN summit decided to accelerate theimplementation of the reducing CEPT products from 2003 to 2002, and to expand them. Asresult, this summit also decided to bring forward one year for an end of implementation AFTA,so that AFTA will be completed by 2000.

(a) Handling of RTA for Which Notification is Received under the Enabling Clause

As we have already noted, AFTA provided notification to the Committee on Trade andDevelopment (CTD) as mandated by the Enabling clause, but there is still no consensus onwhether it should be reviewed for conformity to Article XXIV of the GATT.

In February 1993, the United States, the EU and others members argued before theGATT General Council that the CEPT at the core of AFTA required detailed review because itsought to create an integrated market. CEPT, they said, was an agreement on comprehensivetariff reductions and therefore not only was it extremely important from the GATT perspective,it also went well beyond the size and scope of the regional agreements intended by theEnabling clause. Developing countries argued that CEPT was a RTA between developingcountries as defined in Paragraph 2(c) of the Enabling clause, and notice of it having beenprovided to the CTD, and subsequent handling was up to the developing countries themselves.A solution to the impasse has yet to be found.

(b) Intra-regional Preferences

The ASEAN Industrial Cooperation (AICO) scheme, which took effect in November,1996 under the ASEAN framework, allows two or more countries approving items for AICOto give preferential 0-5 percent tariffs on AICO-designated items to applying companies,conditional on the companies having been founded in the ASEAN countries, having at least30 percent local capitalization, and at least 40 percent local content in their products. We willneed to monitor AICO administration closely. It has the potential, depending on how it isadministered, to raise barriers to imports.

As a result of the 1998 ASEAN summit, for only two years, that is, 1999 and 2000, themember countries decided to remove the conditions that at least 30 percent localcapitalization was needed for the purpose of getting the preferential 0-5 percent tariffs onAICO-designated items for applying companies.