the most-favoured-nationclause and regional economic...

The Most-favoured-Nation Clause and Regional Economic Integration

IntroductionThe most-favoured-nation ("m.f.n.") clause has been one of the central

provisions in commercial treaties over the past three hundred years. 1 It has oftenbeen referred to as the foundation stone on which the whole. edifice of moderninternational trade has been erected. In hundreds of bilateral treaties betweencountries. at all stages of development and with varied economic systems theclause appears in diverse forms,· but always with one constant objective - toensure that the· citizens of one State receive at the hands of another treatmentnot less favourable than that accorded to the citizens of third States. In essenceit is a promise of non-discrimination against the commerce of the othercontracting party.

All States are vitally concerned to ensure that· there will be no adversediscrimination so far as their citizens are concerned in respect to the conditionsunder which they engage in commercial relations with other countries. Inparticular, as the Economic Committee of the League of Nations recognised in1934,2 no country is willing or able to admit the application to its exports inthe country of destination of higher or more burdensome customs duties orother import charges than those applicable on importation to the goods of othercountries. To avoid this, countries have followed the practice of securingundertakings .in· commercial treaties mutually to apply to e.achother's goods andinstruments of commerce the most favourable terms which .are applied whetherat the time of concluding the treaty or in the future to similar goods comingfram other countries.

The use of the clause, and its form, scope and effectiveness, have beendictated by and have changed with the conditions prevailing from time to time inInternational political an d· economic relations. In the course of the nineteenthcentury the legal commitments of the major trading countries in relation .. tocommercialpoIicy werespelt out in a multitude of permanent or long term"treaties of commerce and navigation" which usually specified "Nationaltreatment" or "inland parity,,3 in certain respects, and which incorporated alsothe· m.f.n. clause in one or other of its many forms. During the inter-war years,and particularly during the Depression, m.f.n. treatment was seriouslyundermined by the growth of trading methods which, even though they mightnot differentiate. between countries so far as the imposition of tariff duties wereconcerned, did discriminate between them in the allocation of import. quotas, inthe control of foreign exchange, and through the use of compensating andclearing agreements.4 It was one of the basic purposes of the Havana .Charter ofthe In ternational Trade Organisation to restore the operation of the m.f.n.principle to its former position as the main in strument for the regulation ofworld trade; and in the General Agreement on Tariffs and Trade (G.A.T.T.), thatprinciple is incorporated as the fundamental rule to which aU the ContractingParties must subscribe. But, paradoxically, the Charter and the G.A.T.T. alsoextended the operation of one exception to that principle, which has had· the

1. A short history of the mfn. clause will be found in The Most-Favoured-Nation C1JZuseFirst Report by Mr. E. Ustor Special Rapporteur for the International Law Commission.Document A/CN. 4/213 (1969).

2. Document C.379 M.250 (1936) II.B.3. That is, that the same treatment would be accorded to the citizens of the foreign State

as to its owncitizens~ for example in regard to personal and property rights, the rightto engage in trade, or to have access to the courts.

4. 'For, details, see J. B. Condliffe: The Reconstruction of World Trade, (1940). Chapter 8.

4 THE UNIVERSITY OF QUEENSLAND LAW JOURNAL

effect of limiting seriously the application of the principle in the conditions ofthe post-war world. The exception in question is that in favour of customsunions and free-trade areas.

The reasons which led to a liberal treatment of that exception are notdifficult to ascertain. Evidence is abundant that the United States Government,whose proposals for Consideration by an International Conference on Trade andEmployment formed the basis for the discussions on the Havana Charter, wasconcerned to· circumscribe so far· as possible one. particular exception to the ruleofm.f.n. treatment, namely that in favour of existing preferential systems.s

Other exceptions were regarded as much less significant. The Proposals containeda provision permitting the formation of a customs union which was modelled onthe clauses which appeared in nineteenth century bilateral agreements sanctioningthis derogation ·.from m.f.n. treatment. The American negotiators apparently didnot contemplate of complete or perfect customs unions, though they werealarmed at the prospect that approval for interim measures destined to lead tocustoms· unions might serve as a pretext for the introduction of new. preferentialarrangements. Their position was simple: preferences were economically .a .• badthing; full customs unions were economically a good thing. Preferences shouldtherefore be curtailed as far as· possible, while full customs unions should bewholeheartedly welcomed. 6

The American attitude to preferences has not perceptibly changed,' but in thecase· of customs unions, disenchantment is evident in recent American statementsand writings. Professor Dam of the University of Chicago writes of Article XXIVof the G.A.T.T.:

"If a single adjective were to be chosen to describe Article XXIV, thatadjective would be 'deceptive'. First, the standards established are deceptivelyconcrete and precise; any attempt to apply the standards to a specificsituation reveal ambiguities which, to use an irresistible metaphor,go· to theheart of the matter. Second, while the rule appears to be carefully conceived,the principles enumerated make little economic sense. Third, the dismayingexperience of the Contracting Parties has been that no customs union· orfree-trade area agreement presented for review has complied with ArticleXXIv, and yet every ~uch agreement has been approved by· a tacit or explicitwaiver."s

5. See Brown: The United States and the Restoration of ftJorld Trade, (1950). pp. 70-75.6. uPreferenceshave been opposed and customs unions favoured in principle by the

United States. This position may obviously be criticised as lacking in logicalconsistency. In preferential arrangements, discrimination against the outer world ispartial; in customs unions it is complete. But thedistinetion is none the less defensible.A customs union creates a wider trading area, removes obstacles to competition, makespossible a more economic allocation of resources, and thus operates to increaseproduetionand raise planes of living. A preferential system, on the other hand, retainsinternal barriers, obstruct:; economy in prod uetion, and restrains the growth of incomeand demand. It is set up for the purpose of conferring a privilege on producers withinthe system and imposing a handicap on external competitors. A customs union isconducive to the expansion of trade on a basis of multiJateraJism andnon-discrimination; a preferential system is not." Clair Wilcox: A Chapter for WorldTrade, .. (1949). p. 70. The author was a member of the U.S. delegation to the HavanaConference.

7. Except in relation to preferences for. developing countries. The· Second" UNCfADConference adopted in 1968 a Resolution which recognised "the unanimous agreementin favour of the. early. establishment of a mutually acceptable· system of generalizednon-reciprocal and non-discriminatory preferences which would be beneficial to thedeveloping countries."

8. "Regional Economic Arrangements and the G.A.T.T.: The Legacy of a Misconception."30 University of Chicago Law Review (1963). at p. 619.

THE MOST-FAVOURED-NATION CLAUSE 5

The G.A.T.T. like every other legal instrument, cannot help reflecting thepreoccupations (and misconceptions). current at its birth. For the United States,the attack on discrimination seemed in the circumstances of the immediatepost..war world to require three things in particular: - the restoration of them.f.n. principle; the rejection of the right· to use import quota controls; an d theelimination of preferential arrangements. The G.A.T.T. Articles clearly reflect theresults of this thinking. The overriding obligation under the GA.T.T. assumed byall contracting parties is to accord m.f.n. treatment to products from othercontracting parties. It is also a fundamental principle of the·G .A.T.T. thatprotection is to be granted to domestic industries exclusively through the tariff;the use of quantitative restrictions as a means of protection is expresslyprohibited, except in certain carefully defined circumstances. In relation topreferences, theG.A.T.T. operated so as to freeze the maximum margins ofpreference at their levels in 1947, and it prohibited the creation of any newpreferences unless the contracting parties accorded the right to do so.

The application of these rules did indeed lead over the next decade to amarked decline in discrimin~tion against U.S. products. The restrictions byWestern European countries on imports of industrial products from NorthAmerica had been almost completely removed by 1959; and the impact of theexisting preferential systems had diminished both through the reductions in themargins of preference resulting from tariff negotiations under GA.T.T. auspices,and much more significantly, through the fact that the most dynamic sector oftrade had become that between the developed countries themselves rather thanbetween them. and the developing countries. But with the decline .in the oldforms of discrimination there emerged a new possibility of discrimination in theform ofregional economic blocs.

In 1957, the Treaty of Rome established the European Economic Community.In 1959 the. Stockholm Convention established the European Free TradeAssociation. These two institutions have served as models for a host of otherprojects for economic integration. At the present time, negotiations· areproceeding to widen the membership of the E.E.C. by the inclusion of otherEuropean countries. At the same time, special preferential arrangements withcertain developing countries are under active consideration. The result has beenthe erection of a great trade bloc. Fears have been expressed that current moves,if they are discriminatory and preferential in character, could represent adeath-knell for the multilateral trade system9 and lead to the fractionalisation ofthe trading world into discriminatory regional groupings.

It seems appropriate therefore to examine once again the legal rules. whichregulate the creation of economic unions of various kinds between countries.This study will cover, necessarily very briefly, the operation of the m.f.n.principle, the exceptions to that principle in favour of trade groupings, and thescope and application of Article XXIV of the G .A.T.T.

The Most-Favoured-Nation ClauseWe have been warned by Lord McNair that there is no such thing as the

most-favoured-nation clause. IO This remark was certainly. just when it waswritten, and it is still to be borne in mind when any question arises as to theinterpretation of the clause in bilateral treaties. But no less than eighty per centof world trade is conducted among the contracting parties to the G.A.T.T., andin their mutual relations the clause has a unique formulation. Article I of theG.A.T.T. provides:9. See statement by the Director-General of G.A.T.T., reported in (1970) 4 Jounzal Of

World Trade Law at p.SO!.10. The Law of Treaties, p. 285. (1938).


With respect to customs duties and charges of any kind imposed on orinconnection with importation or exportation or imposed on the internationaltransfer of payments for imports or exports, an d with respect to the method oflevying such duties and charges, and with respect to all rules and formalities inconnection with importation and exportation and with respect to all mattersreferred to in paragraphs 2 and 4 of Article 111,11 any advantage, favour,privilege, or immunity granted by any contracting party to any productoriginating in or destined for any other country shall be accorded immediatelyand· unconditionally to the like product originating in or destined. for theterritories of all other contractin g parties.

The clause is limited to m.f.n. treatment in respect to trade matters. It isexpressly cast in the unconditional form. An unconditional clause extendsautoffiaticaUyandwithout .compensation every favour granted to another nation,while the effect of a conditional clause is to except from· its operation all favoursobtained by granting an eqUivalent - that is, by bargain or reciprocity agreement-except on payment of a like consideration.12 Until 1923 the United States'had insisted on the conditional form of the m.f.n. clause in its commercialtreaties,13 but in that year it announced a change of policy in favour of theunconditional. form of the clause, thus coming into line with the practice of themajor trading countries of Europe. 14 Thus there was general agreement prior tothe Second World War in favour of unconditional. treatment, and the formulationof the.m.f.n. rule in the G.A.T.T. simply reflects that agreement.

Accordingly, .the. effect of Article I is that contracting parties are under anobligation to generalise in favour of all other contracting parties any advantagesthey concede to products originating in or destined for any other country.Moreover, Article II requires each contracting party to accord to the othercontracting party treatment no less .favourable than that provided in theappropriate schedules to the Agreement. The Schedules of Concessions specifythe maximum duties which may be imposed on· products of territories ofcontracting parties. when .they .·are imported into the territory of a particularcon tracting party. It would be an obvious breach of a con tracting party'sobligations under Article II if it were to impose duties in excess of these setforth in the Schedules. IS It would equally be a breach of obligation un derArticle •.. I.· •to extend treatment more favourable than that accorded in theschedules to some contracting parties, or to non-members,and to deny this toother con tracting parties.

11. This article provides for national treatment on internal taxation and internal charges.12. Report of Sub-Committee of Committee of Experts lor the Progressive Codzfication of

InternationaL Law on the Most Favoured-Nation Clause. See (1928) 23A.J.l.L.(SpecialSupplement) at. p. 136.

13. Asa result, under the treaties by which the United States has pledgedmost-favoured-nation treatment, it has felt itself free to bargain in favours with othercountries without extending to its most-favoured countries the concessions it hasgranted to third countries in return for reciprocal concessions; in other words, it hasfelt that it has fulfilled its obligations, under its pledges to accord most-favoured-nationtreatment when it has accorded to a country to which it has promised such treatmentthe lowest rates of customs duty which it has freely and without special compensationaccorded. to a .third country. In this respect the American interpretation. is antitheticalto. the unconditional and commonly accepted form and interpretation of the clause,according to which there must be equality oftreatment and consequently the extension()ffavours or concessions for whatever reason granted - to aU countries with whichmost-favoured-nation treaty pledges are in operation. W. McClure: A New AmericanCommercial Policy, (1954) p. 169.

14. For details, see Hackworth: 5 (1941) Digest of International Law pp. 271-277.15. Article XXVIII of the G.A.T.T. provides a detailed procedure for the modification or

withdrawal of concessions.

THE MOST·FAVOUR.ED·NATIONCLAUSE 7

The· writer has pointed· out in another Article 16 that what was novel aboutthe G.A.T.T. was not so much the agreement by the contracting parties toaccord m.f.n. treatment to each other, as the development in conjunction with itof the technique of multilateral tariff bargaining in accordance with ArticleXXVIllbis of the G.A.T.T. The essential feature of the great GA.T.T.negotiating conferences, the last of which was the Kennedy Round whichterminated in June 1967, was the holding of simultaneous bilateral ormultilateral negotiations between countries and the generalisation of the resultingconcessions by virtue of the m.f.n. principle among all the contracting parties.These negotiations were conducted on the basis of reciprocity and mutualadvantage, except that the developed countries agreed in 1963 that they wouldnot expect to receive full reciprocity from the developing countries. Thenegotiating procedures are such that each contracting party can judge the valueof the concessions it grants in favour of all its trading parties and the advantagesit will receive from concessions granted by importers of its products.

Exceptions in Favour of Economic IntegrationIn the formula for m.f.n. treatment drawn up by the Economic Committee of

the League of Nations, the exception to the obligation to grant unconditionaland unrestricted m.f.n. treatment in tariff matters was expressed as follows:

"Nevertheless, the advantages now accorded or which may hereafter beaccorded to other adjacent countries in order to facilitate frontier trafflc, an dadvantages resulting from a customs union already concluded or hereafter tobe concluded by either contracting party, shall be excepted from theoperation of the Article."17

The practical reasons justifying the exception for frontier traffic are obvious,and G.A.T.T.Article XXIV (3) (1) makes it clear that the provisions of theAgreement are not to be construed to prevent advantages accorded by anycontracting party to adjacent countries in order to facilitate frontier traffic. Inrelation to customs unions, the Economic Committee stated:

"The most·favoured-nation· clause frequently includes a provision allowing forthe possibility of each of the parties concluding a complete customs unionwith a. third power. In such a case, the economic· unit becomes in practicesomething different from the political unit, and the customs union may beregarded rather as the abolition of a customs frontier than as a form ofdiscrimination between competing foreign· purveyors.

In such cases, the exception to the most-favoured-nation clause takes theform of a reservation covering the privileges accorded to a third power. invirtue of a customs union which has been or may hereafter be concluded. Theclause may be drawn up in different ways, but the variations do not involvesubstantial differences. It appears in a large number of treaties.

It is sufficient to declare that customs unions constitute exceptions;recognised by tradition, to the principle of most-favoured-nation treatment."Whether customs unions were impliedly excluded from the operation of an

m.f.n. agreement is a matter about which there is considerable uncertainty. TheEconomic Committee of the League thought that they were,but recommendedthe insertion of an express exception in commercial treaties according m.f.n.treatment, in the terms set out in the above formula. I8 Most European publicists

16. "International Business and the Law" (1970) 7 U.Q.L.5 3, at p. 18.17. Document 1933, 11 BI, p. 21.18. This formula was based on well settled precedents. According to Snyder: The


take the view that customs unions constitute de plein droit an exception tom.f.n .. treatment. In accordance with this opinion, the member States of theEuropean Communities did not seek a waiver of their m.f.n. obligations in favourof the common market, since they regarded it as impliedly excepted in theirm.f.n. treaties.19

Professor Jacob Viner has shown from a study of diplomatic controversiesarising out of m.f.n. obligations of members of customs unions that the issue ofcompatibility of customs unions with m.f.n. obligations was not nearly soclear-cut as European doctrine would have us suppose.20 The precedents showedthat several European Countries had taken divergent positions on the question.The British21 and United States22 Governments had· consistently maintained thatin the absence of an express reservation, preferential treatment accorded tomembers of a customs union was inconsistent withm.f.n. obligations.Nevertheless, he concluded that if customs unions were complete, it was unlikelythatm.f.n.obligations would now be anobsta.cle to their formation. Asjustification for this view he instanced the century-long record afcustoms unions'which were permitted to .operate without protest, or without successful protest:the practice of including express<exceptions ·af customs unions from m.f.n.obligations; the position taken by the Economic Committee of League; and theprovisions of the Havana Charter.

Under the classical exception from m.f.n. treatment of "a customs unionalready established or to be established", the questionnaturaUy arose as to thekind of customs union which would fall within the exception. The traditionalanswer was summarised in a memorandum submitted to the Permanent Court ofInternational Justice by Austria in the Austio-Gernuzn Customs Regim.eCase andaccepted by it as correct.23 This stated the requirementsofa customs union as:uniformity of customs law and customs tariff; unity of the customs frontiers andof the customs territory vis-a-vis third states; freedom from import and exportduties in the exchange of goods between the partner states; and apportionmentof the duties collected according to a fixe d quota.24

While there was considerable support for the view that participation in acomplete customs union did not constitute a derogation from m.f.n. obligations,there was much less agreement so far as other forms of tariff agreement were

Most-Favoured-Nation Clause (1948), customs union clauses were to be found in 280agreements in the modern period. He refers to the Treaty of Rapallo as indicative ofthe general type of provision covering this rna tter; it excludes from the normaloperation of the m.f.n. clause "favours granted by one of the contracting parties to athird state on account of a customs union already established or to be established."

19. See Pescatore: Relations Exterieures des Communautes (1961) III R. des Cours, at p.175 and authorities cited therein.

20. The Customs Union Issue, pp. 5-12 (1950).21. Schwarzenberger: ~~The Most-Favoured-Nation Standard in British State Practice"

(1945) B. Y.B.I.L. at p. 109 summarises the position as follows. "In the absence of anexpress · reservation, a State can. demand under the mJ.n. standard the benefits ofexclusive preferential treaties, bilateral ormultiJateral, between the promisor and thirdStates, such as customs unions which leave the international personalities of thecontracting States intact." See also .McNair, op. cit., at p. 294.

22. "This Government ... never contemplated that a custorns union would be an impliedexception to the m.f.n. clause ... nor can this Government be held to any recognitionof such an exception as a principle of international law. This Government has nevertaken cognizance of the alleged continental tradition of customs· unions as impliedexceptions; indeed, it is doubtful if such a tradition was ever recognized by other thana few nations. International law does not find its present growth in the traditionalhabits of continental nations alone." Statement by the Solicitor for the Department ofState, quoted in Hackworth, op. cit. p. 295.

23. P.C.I.J. Series AlB, No. 41.24. References to other defmitions will be found in Viner, Ope cit. p. 5.

THE MOST.FAVOURED·NATION CLAUSE 9

concerned. In particular, the •question frequently arose of the compatibility withm.f.n. obligations of concessions granted by some countries2S to others byreason of. historical,· geographical or other special ties. The British ImperialPreference System is·one clear example of an arrangement' to accord preferentialtreatment. to certain countries. However, the United Kingdom did not leave thequestion of the consistency of this system with its m.f.n.obligationsin .doubt; itfollowed the practice of inserting in controversies its m.f.n.treaties an expressreservation allowing such treatment.26 It was also common to find in commercialtreaties express exceptions in. favour of countries belonging to a particular region,such as the so-called Baltic Clause, Nordic Clause, Iberian Clause,Central-American clause, etc.2 7 Probably in the absence of an express exception,preferential tre.atment on the basis of regional propinquity would be contrary tom.f.n. obligations.28

In view of the formulation of the m.f.n.principle and the exceptions theretoin theG.A.T.T. and the ad.herence. of most of the major trading nations to theG.A.T.T., the controversies about the consistency ofspecia.l tariff arrangementswithm.f.n. obligations have lost much of their practical significance in" tradematters.29 However, a consideration of the legal regimes which had beencommon prior to· 1947 is useful as.a prologue to the examination· of the prese.ntG.A.T.T. rules, and also because of their continuing relevance to m.f.n. treatiesbetween non-members of theG.A.T.T. or between members andnon-mernbers.3o

25.

26.

27.

28.

29.

30.

Special relations between. colonies and mother countries were generally not regarded ascoming within the scope of anm.f.n. clause; but there was no such consensus as regardsspecial relations between independent Dominions.As Schwarzenberger points out (lac. cit. , at .p. 109) the same object was also· achieved'by limiting mof.n. treatment to that of any other foreign country and by defining aforeign. country in relation to the United Kingdom as any country or territory notunder the sovereignty protection, suzerainty or mandate of His Majesty.For details about these clauses, see Snyder, Ope cit., pp. 174-180. The trade agreementsbetween the Eastern European. Countries and Australia contain a clause exceptingcertain countries linked by a special re.lationship with each of the contracting parties.This is the conclusion of the Economic Committee of the League, which stated that"the exceptions falling within these categories could not be accepted as. implicit byamere. reference; ·..• they must .be expressly . stated and their· meaning and scope •• mustbeagreed to by the parties· concerned." The Ottawa Conference (1932) declared thatregional agreements. could not be allowed to override· mJ.n. obligations and in thatsame year the United Kingdom refused to waive its rights to m.f.n. treatment undercommercial treaties with Belgium and the Netherlands· so as to allow the OuchyConvention to come intoeffe·et. As a result, the Convention lapsed.This paper is concerned. only. with the trade aspects of the mJ.n. clause, and with theexceptions to that clause in favour of trade groupings. The wider questions of theapplication of such clauses to such matters as the right of establishment of companies,taxation, and industrial property rights, and whether there is an. implied "economicunion" exception to m.f.n. obligations are considered in P. Hay: 44The EuropeanCommon Market and the Most-favoured-Nation Clause" (1962) 23 Univ.PittsburghL.R.661.The U.S.S.R. is an important trading country which is not a member of G.A.T.T. ASoviet writer has expressed the following opinion in relating to exceptions to the m.f.n.clause in favour of customs unions: U Another exception from the most-favoured-nationsystem is the .exclusion from the operation of the system of relations between stateswhich have formed a customs union. States which enter into a customs union form asingle customs territory, establish a single customs tariff, and carry out a single customspolicy. In other words,in the field of international economic relationships, a customsunion functions as a complete unit which is the subject of these relationships. If a statepreserves its own custonlS sovereignty, there is for the time being no customs union,and any customs privileges agreed upon are subject to the operation of themost..favoured..nation system. Wherethere.is a customs union in which the customssovereignty of participating states is ~elinquished the situation is different. Those rights


G.A.T.T. Article XXIVThe American Proposals for the Expansion of World Trade and Employment

contained an exception to permit the formation of customs unions in accordancewith the classical formulation in bilateral treaties. This draft underwent threesignificant changes in the course of negotiations. In the first place, the conditionsunder which recourse to the exception was permitted were spelt out in somedetail. Secondly, provision was made to cover the case of an interim arrangementleading to the· formation of a customs union. Thirdly, the idea of a free tradearea was developed.

It is pertinent to recall that when the American Proposals· were put forward in1945, the possibility of wide-ranging economic union in Europe seemed veryremote.3I But the position had changed considerably by the time that therelevant rules were being hammered out in Geneva and Havana. The MarshallPlan had come into operation; and in the Hearings and Congressional Debatesleading to the Economic Co-operation Act of 1948, there was unanimity infavour of movement towards a customs union in Western Europe.

It is not proposed to examine in detail all the provisions in Article XXIV ofthe G.A.T.T. The study will be limited to those provisions which have been mostmaterial in the consideration of the two most significant economic groupings, theEuropean Economic Community and the European Free-Trade Area.

In Article XXIV (4), the contracting parties recognise the desirability ofincreasing freedom of trade by the development, through voluntary agreementsof closer integration between the economics of the countries parties to suchagreements. The philosophy that customs unions were a good thing is given. clearexpression in this sentence. But there were some members who had their doubtswhether customs unions inevitably would lead to an in crease in trade. Theirconcern is expressed in the following sentence in which iris recognised that thepurpose of· a customs union or free-trade area should be to facilitate tradebetween the constituent territories and not to raise barriers to the trade of othercontracting parties with such territories.

It is outside the scope of this paper to consider the economic argumentsabout the effects of customs unions or free-trade areas. It is en ough to say thatthe optimistic view which prevailed in the drafting of the charter that "from aneconomic standpoint based upon Free Trade reasoning, complete customs unionsare to be wholeheartedlywelcomed"32 has been generally superseded by a more

which the participants in the customs union gran t one another are not extended tothird states with which the member-states of the customs union have ooncludeda treatyon the basis of the most-favoured..nation system.

It .must be. observed, however, t1Yel t the inclusion in customs unions of importantgroups of states would lead to an essential limiting of the operation of themost-favoured"nation principle, and even in essence to its renunciation. The attemptmade under the influence of the U.S.A. to create an economic unification of theimportant capitalist countries of Western Europe and at the same time to form acustoms union of those countries basimlly undermines the most-favoured-nationprinciple. However, the attempt is meeting with growing opposition even on the part ofsome capitalist states of Western Europe which rightly see in these attempts a directthreat to their sovereignty. Customs unions, as a rule, can take place when aneighbouring small state adheres to the. customs territoryofa po\verful state withwhich it has very close economic links." Genkin: "The Principle of theMost-Favoured-Nationin Trade Agreements among States" (1958) 9 SovetskoyeGosudarstvo i Pravo 22, atp. 28.

31. European customs unions which survived the war were those of France-Monaco,Italy-San Marino, Switzerland-Liechtenstern, and Belgium-Luxembourg.

31a.For detailed studies, see Jackson: World Trade and the Laws of G.A.T.T., pp. 575-623;and DAM: The G.A.T.T. Law and International Economic Organization, Ch. 16.

32. G. Haberler: Theory of International Trade, p. 390. (First published 1933).

THE MOST·FAVOURED~NATION CLAUSE 11

cautious and critical attitude. Since the publication in 1950 of Viner's smallbook The Customs Union Issue, it has been recognised that a customs union willhave both trade creating and trade diverting effects, and that the question as towhich of these effects will be predominant depends on a large number offactors. 33

Paragraph 5 of Article XXN constitutes a recognition by the ContractingParties that the constitution of customs unions and free-trade areas can bepermitted only on certain specified con ditions. The paragraph begins ·with theunequivocal provision that "the provisions of this Agreement shall not prevent, asbetween the territories of contracting parties34 , the formation of a customsunion or of a free-trade area or the adoption of an interim agreement necessaryfor the formationofa customs union or of a free-trade area."But this isqualified by the proviso that "with respect to a customs union, or an interimagreement leading to the formation of a customs union, the duties and otherregulations 'Of commerce imposed at the institution of any such union or interimagreement in respect of trade with contracting parties not parties to such unionor agreement shall not on the whole be higher or more restrictive than thegeneral incidence of the duties an d regulations of commerce applicable in theconstituent territories prior .. to the formation of such union or the adoption ofsuch interim. agreement as the case may be".

It will be observed that the critical date (so far as the. duties and otherregulations of commerce are concerned) is the institution of the union. or interimagreement. Indeed, the provisions of Article XXIV are directed predominantly atthe question .of the legitimacy of the formation of a customs union or free-tradearea, rather than. at their continuing operation. There is nothing in the terms ofArticle XXIV (5) to suggest that the duties in force at the formation of theunion are. thereby boundagaillstsubsequent increase. A union which satisfied therequirements of the Article .8t its institution would be free in the future to raiseits unbound duties, just· as any contracting party may do.• The only qualificationto .this is contained in Article XXIV (4), whe.re it is recognised that the purposeof a customs union should. be not to raise barriers to the trade of othercontracting parties. It would be pushing this provision too far to suggest that itoperated so as to bind the whole tariff of the customs union upon its formation.On ·the contrary, it .. is an important but unresolved question whether this.provision has an independent operation, or whether any obligations it may

33. Much of the economic literature on customs unions is referred to and discussed in theArticle by Dam, loc. cit. at pp. 622-635. See in particUlar I. Frank: The EuropeanCommon Market, p. 140 (1961). Professor Frank singled out three generalisations uponwhich to judge particular customs unions as far as· trade effects are concerned. First, thelarger and more diversified the area encompassed by a customs union, the greater thescope for trade diversion. Second, a customs union is the more likely to increaseeconomic welfare, the higher are the tariffs on imports with the partner countriesbefore the formation of the union. And finally, a customs union is likely to result inless trade diversion and therefore more economic. welfare, to the extent that its tariffagainst the outside is low.

34. The G.A.T.T. Article permits a departure from m.f.n. obligations in favour of customsunions and free-trade areas which comprise the territories of contracting parties. Butboth the Havana Charter, in Article 44 (6), and the G.A.T.T. in Article XXIV (10)provide that the Contracting Parties may by a two-thirds majority approve proposalswhich do not fully comply .with the requirements of Article. XXIV, and the HavanaOtarter further provided in Article 98 (3) that members may enter into agreementswith· non-members in accordance with Article 44 (6). The Contracting Parties appliedArticle XXIV (10) in the case of the Stockholm Convention (Switzerland and Portugalwere not members of G.A.T.T.). Previously they had utilised the waiver procedureunder Article XXV.


impose are not completely specified in paragraph 5.3 S This was indeed one ofthe central issues before the Contracting Parties when the Treaty of Rome wassubmitted to the G.A.T.T. for examination. The argument for the EEC memberswas that paragraph 5 spelled out in full the criteria by which it should. bedetermined whether the purpose required by paragraph 4 had been attained.Other members took the view that paragraph 4 was the controlling provision, orat least that paragraph 5 must be interpreted and applied in accordance with thegeneral principle expressed in .paragraph 4.

Article XXIV (5) requires that the duties and other regulations of commerceimposed '.'shallnot on the whole be higher or more restrictive· than the generalincidence of the duties and regulations of commerce applicable in the constituentterritories prior to the formation of such union". In its original (1947)formulation, it. was provided that the duties etc. "shall not on the whole behigher or more stringent than the average level of the duties etc. prior to theformation of such union". At the Havana Conference, the words "average levelof the duties" were replaced by "general incidence of the duties". The'explanation .given for the change was that "this phrase should not require amathematical average of customs duties but should permit general flexibility sothat the volume of trade. may be taken into account".36

The experts who drafted the Treaty of Rome took the view that what theformula reqUired was that. "the overall total of duties payable under the commontariff .shall not represent a higher percentage of the· value of imports into theunion than. the total of the duties formerly imposed by the Member Statescompared. with their total imports".3? In other words, they ·thought that thechange in wording at Havana required the substitution of an unweighted indexby an index weighted by the value of imports,38 though they felt that apreferable index would be one where the weights were the total consumption ofthe participating countries rather than their imports. However, they alsoconcluded that a weighting on the basis of imports would be impractical. In theresult, therefore, the experts came· down in favour of unweighted averages,though theybeUeved· that a tariff based on a simple mathematical average wouldbe higher than the level allowed by the G.A.T.T. rules.

Article 19 of the Treaty of Rome provided accordingly that the duties appliedunder the common external tariff were to be fixed at the level of thearithmetical average of the duties levied in the four customs areas covered by theCommunity. But it also provided that the duties to be taken into account incalculating the average were to be those actually levied on 1 January 1957 (asopposed to those legally applicable) an d it fixed a maximum rate for manycate.goriesofproducts where the arithmetic average would otherwise have led tohigher rates.

The Six contended at the Twelfth Session of the G.A.T.T. that this provisioninsured full compliance with the G.A.T.T. stipulation. The objection made to thisby many other members was that the general incidence of a duty only beascertained by examining the effect of a particular rate· on the volume of trade in

35. a. Pescatore, loco cit., at p. 181: "Paragraph 4 of Article xxrv is an economicdirective rather than a legal rule ... It appears to be only the expression of a generalidea which introduces the more precise provisions which follow."

36. G.A.T.T.: Ano,lytic Index of the General Agreement, p. 103.37. Cited in A. Loveday: HArticle XXIV of the G.A.T.T. Rules," Economia Internazionale,

(1958) Vol. XI, p. 1.38. Loveday comments, loc.. cit. at p. 6, that this is a bad index because duties so high as

to prevent imports. would not enter into the equation at .all,· and all duties effective inchecking imports would have their weights written down. See also Frank, Ope cit.p.176.


an individual commodity; it was not enough simply to look at the height of atariff. To support this objection they naturally relied heavily upoo theexplanation given in the Analytic Index for the fmal formulation of the rule. Itwas further contended that regard must be had not only to the effect of a tariffon trade in a particular commodity, but also to its effect on the trade ofparticular countries. If Article XXIV (5) did not require the establishment of astrict arithmetical average of the national customs for each tariff item, butpermitted flexibility provided that the common external tariff was not "00 thewhole"higher than the national tariffs, then it was obvious that tariffs or otherrestrictions on products of predominant importance in the .trade of certaincountries could be increased without infringement of G.A.T.T. obligationsimposed by paragraph 5. To meet this point, reliance was placed on theconcluding words of paragraph 4, viz. "the purpose of a customs union shouldbe ... not to raise barriers etc." As was mentioned above, the relationshipbetween paragraphs 4 and 5 of Article XXIV is one of the many obscurities inthat Article, and no agreement on the subject proved possible. TheE.E.C.refused to acknowledge any obligation under Article XXIV to take. account ofthe effects of a common tariff on either the trade of in dividual third countries orimports of particular commodities.39

It is convenient at this point to refer to paragraph 6 of Article XXIV, beforeproceeding further with the analysis of paragraph 5. This states:

"If, ·in fulfilling the requirements of sub-paragraph 5 (a), a. contracting. partyproposes to increase. any· rate of duty inconsistently with the provisions ofArticle 11, the procedure .set ... forth in Article. XXVIII shall apply. In providingfor compensatory adjustment, due account shall be taken of the compensationalready afforded .. by the reductions brought about in the corresponding dutyof.the other constituents of the union."

In order to bring its tariff into line with the common external tariff of acustoms union, it may be necessary for a member to· increase certain rates' ofduty, though that member has accepted a binding in relation to these rates underArticle II of the G.A.T.T. Paragraph 6 makes it clear that a member cannot beprevented by Article II from increasing those duties. The remedy of thoseaffected thereby is to use the procedures laid down in Article XXVllI.40

Thus far the interpretation of paragraph 5 (a) has been discussed as thoughthe only restriction to be taken into account was a customs duty. But theparagraph refers to "duties and other regulations of commerce",. and it requiresthat the general .incidence of the duties and other regulations of commerceshould not on the whole be higher etc. Presumably the terms "duties" and"other. regulations of commerce" must be read disjunctively in this passage, asthere is. no method •(or at least none known to the writer) by which the jointincidence of duties and all other regulations of conunerce can be judged.

There is no definition in the G.A.T.T. of the expression "other regulations ofcommerce", but it is a phrase wide enough to enbrace all non-tariff barriers totrade. However, it was argued by many non-members of the Community at theTwelfth Session that the prima facia width of the expression should be read

39. Another reason why it proved impossible to reach agreement on the compatibility ofthe Treaty of Rome with Article XXIV was that tariff levels were not .fixed by theTreaty for .many important categories of products.

40. Note in this connection Article III (4) of the Treaty of Rome: "Member States, inconsultation with the Commission, shall take all necessary measures with the object,more especially of adjusting aU tariff agreements in force with outside countries so thatthe entry into force of the common customs tariff may not be delayed."


down because of the reference in paragraph 8 (a) of Article XXIV to "duties andother restrictive regulations of commerce". This question will be looked at laterin this paper in the context of paragraph 8.

Paragraph 5 (b) of Article XXIV relates to the formation of a free-trade area.It states:

"With respect to a free-trad.earea, or an interim agreement leading to theformation of a free-trade area, the duties and other regulations of commercemaintained in each. of the constituent territories and applicable at theformation of such free-trade. area or the adoption· of such interim agreementto the trade of contracting parties not included in such areas or not parties tosuch agreement shall not be higher or more restrictive than the correspondingduties and other regulations of commerce existing in the same constituentterritories pnor to the formation of the free-trade area, or interimagre.ement,as the case may be."

There was no historical exception of free-trade areas from the operation of'the m.f.n.· clause, and there was no reference to them in the United StatesProposals.. The exception to permit arrangements whereby internal restrictionsamong the participating .members. would be removed, though a common externaltariff was not established, was proposed by Lebanon and Syria,41 and adopted inthe •.·form set out·.in ·the preceding paragraph.

The difference in wording between paragraphs 5 (a) and5 (b) of ArticleXXIV is· obviously a reflection of the fundamental differe·nce between .customsunions and free-trade areas, namely that the former does, and the latter does not,require the· adoption of a common external ·tariff. The difficult problem ofassessing the compatibility of a common tariff with the G.A.T.T.. requirementsdoes not therefore arise in the case of a free-trade area. The point of theprovision is simply to ensure that the discriminatory effects which#inevitablyfollow from the elimination of tariff and other restrictions between theconstituent territories will not be heightened by the increase of the externaltariff ofamember against third countries.

Paragraph 5 (c) requires that any interim agreement leading to the formationof aCllstoms union or free trade area shall include a plan and schedule for theformation of such a customs union or free trade area within a reasonable lengthof time. Customs unions and free trade areas cannot be established uno ictu, andit is recognized in the G.A.T.T. that interim arrangements must be permittedprovided they are sufficiently detailed and limited in point of time. Even acursory .examination of the Treaty of Rome and the Stockholm Convention willshow how conscious were the members of their obligations under G.A.T.T. inthis regard.

We must now tum to consider paragraph 8 of Article XXIV. This providesthat for the purposes of the agreement: (a) a customs union shall be understoodto mean the substitution of a single customs territory for two or more customsterritories, so that

(i) duties and other restrictive regulations of commerce (except, wherenecessary, those permitted under Articles XI, XII, XIll, XIV, XV andXX) are eliminated with respect to substantially all the trade betweenthe constituent territories of the union or at least with respect tosubstantially all the trade in products originating in such territories, and,

(ii) subject to the provisions of paragraph 9, substantially the same dutiesand other regulations of commerce are applied by each of the membersof the union to the trade of territories not included in the union;


(b) A free-trade area shall· be understood to mean a group of two or morecustoms territories in which the duties and other restrictive regulations. ofcommerce (except, where necessary,. those permitted under Articles XI, XII, XIII,XIV~ XV and XX) are eliminated on substantially all the trade between theconstituent. territories in products originating in such territories.

The term. "customs territory" is defined in paragraph 2 of Article XXIV asany territory with respect to which separate tariffs or other regulations ofcommerce are maintained for a substantial part of the trade of such territorywith other territories.41

The effect of this paragraph is that to qualify as a customs union or freetrade area, the members of an economic grouping must eliminate duties andother restrictive regulations of commerce on substantially aU th_e trade inproducts originating in their territories.

The expression "substantially all the trade" is patently imprecise, though thegeneral objective is clear enough. It· seems that the criterion adopted in relationto customs unions was that only complete unions could be tolerateg~partial

unions were regarded as simply-a form of preferential system. It was thereforenot· enough that duties should be reduced; they must be eliminated. And·itwasnot ienough that the range of goods covered should be ·extensive;· it should becomplete, or at least substantially.so. Whatever .meaning is to·OO attributed to theexpression, it seems clear that the intention was that it should be a restrictiveone. But in what way should it be restricted? Was it intended. that the limitsshou~ld be determined merely be some quantitative figure or were qualitativeconsiderations also. relevant?

The question arose most sharply in the G.A.T.T. examination of theStockholm Convention in 1960. The critical point was that the Articles of theConvention, which relate to the elimination of trade restrictions within the area,prOVide for the exclusion of agriculture and fishing. If qualitative considerationswere relevant, then it was arguable that the exclusion of such an importantseeforof trade as agriculture was incompatible with the requirements ofparagraphS· (b). On a mere. quantitative test, .on the other hand,. there wasprobably no failure to comply, since over 90 per cent of trade between theme!mbers of EFTA was covered by the Convention.· Many non-members. of theSeven contended however •that qualitative considerations were relevant and . thatthe figure of 90 per cent was unduly inflated because it included tradecon:ducted under bilateral agreements concluded under Article 23 of theConvention.42 It proved impossible within the working party to reach agreementon whether the requirement to eliminate restrictions on "substantially aU thetrade" had been satisfied.

It will be observed that whereas paragraph 8 (b) refers in relation tofree-trade areas to substantially all the trade between the constituent territoriesin products originating in such territories, paragraph 8 (a) refers in relation tocustoms unions to substantially all the trade between the constituent territoriesof the union or at least with respect to substan tiallyall the trade in productsoriginating in· such territories. In the case of free ..trade .areas, one of the majordifficulties is to establish satisfactory. rules of origin ,soas10 .• limit the ... tradewhich is freed from restriction to· products which originate·in their constituent

41. One contracting party could have several customs territories, and reciprocaly severalcontracting parties might constitute one customs territory.

42. The exclusion of agriculture from the Convention was obviously of serious concernparticularly to Denmark. To induce it to accede, bilateral agreements on agriculturaltrade were made by some EFTA countries with Denmark.


territories.43 It would be impossible for them to accept an obligation toeliminate restrictions. on all trade between them, irrespective of its origin, sincethis would make the maintenance .of their independent external tariffsmeaningless. Such an obligation could however be assumed by a customs unionwhich must have a common external tariff; the qualification expressed in theconcluding part of paragraph 8 (a) (i) is merely a recognition that members oracustoms union should not be required to assume .·more onerous obligations thanthose ofa free-trade area.

The major. problem which has arisen un der paragraph 8 is whether it permitsor re quires the me mbers of a customs union or free-trade area to eliminatequantitative restrictions in respect to trade between the members withouteliminating them at the same time in respect to trade with other contractingparties.

The view expressed by members of the E.E.C. can be summarised as follows.First,Article XXIV (5) provided a generaLexception from other provisions of theG.A.T.T.so as to permit the formation of a customs union, on condition that-certain requirements were satisfied. This exception coveredtherefore not only aderogation from their· m.f.n. obligations in relation to tariffs,but also· from theobligations in ..• Articles .. XI to. XN .relating to the elimination of quantitativerestrictions an d the non-discriminatory. administration of such restrictions.Second, paragraph 8 (a) of Article XXIV required them to eliminate duties andotherrestrictive regulations of commerce (including quantitative restrictions) withrespect to their trade inter see The result was. therefore that they were obliged toeliminate quantitative restrictions in their mutual trade, but they were notobliged .• to .remove. them against .non-members .. at the same time.. Their onlyobligation with respect to non-members was that expressed in paragraph 5 (a),namely not to make .them. more· restrictive than priorto the formation of theUnion·.

Substantially the same argument was advanced on behalfof the Seven in theexamination of the. Stockholm Convention. The opposing argument asserted:

(a) that the obligations of contracting parties under Articles XI to XIV toadminister quantitative restrictions in a non-discriminatory way, and not tohave re.course to quantitative restrictions except subject to the conditionsimposed by those Articles, were not affected by their agreement to fonn acustoms union ·or free-trade area, since adherence to those provisions wouldnot prevent the formation ofa customs union or free-trade. area. This wasshown by the reference in paragraphs 8 (a) (i) and 8 .(b) to· the right· ofmembers of· a customs union or free-trade area to. maintain restrictiveregulations of commerce where they were permitted under Articles XI to XVand XX, since this envisaged that a customs union or free-trade area couldbe formed though internal. quotas persisted.

(b) that ... paragraphs 5 (a) and 5 (b) had no application to quantitativerestrictions..This appeared, it was argued, from the contrast between thelanguage in paragraphs 8 (a) and (b) which refers to "restrictive" regulationsof commerce.

In essence the argument for the· outsiders was that while a customs .unionnecessarily demanded a common external tariff, (and hence a derogation fromm.f.n. tariff) it was contemplated that individual members might impose quotas

43. For an account of the way in which the EFtA negotiators handled the twin problemsof rules of origin and deflection of trade, see Lambrinidis: The Stnlcture, Function andLaw ofa Free Trade Area (1965) Ch. 7.

THE MOST-fAVOURED-NATION CLAUSE 17

if these Were justified .by Articles XI to XIV, and hence no general derogationfrom those Articles followed from the formation •of a customs union. Theopposing argument was to the effect that members of a customs union orfree-trade area were no more under an obligation to extend to outsiders anymeasures of Jiberalisation than· they were to extend to .them the benefits of theirmutual· tariff reductions.

The Treaty orRome contains rather elaborate provisions in Articles 30. to 31relating to the abolition of quantitative restrictions between member states; andthese served as· a model for the Stockhobn Convention. The view taken. by theSix .at the Twelfth Session was deeply influenced. by the conviction that whilethe. full· benefits of a customs union required the abolition of quantitativerestrictions on their mutual trade, they (or at least some of them) were nofinasufficiently strong balance of payments position to extend .. any measures. ofIiberalisation simultaneously to non-members. Once. again the legal positionremained unresolved,·. but the .Six stated an intention to reduce quotarestrictiopsagainst outsiders as their payments' ·position permitted.

ConclusionThe application of Article· XXIV of the G.A.T.T. has raised many difficult

and important legal problems; and to these problems there are as yet no agreed,settle.dsolutions. One might be inclined to conclude that the 'disagreementssimplYiIeflectthedivergent trade interests of members and non-members ofcustoms unions or free-trade areas, and that the G.A.T.T. rules have had littleweight with countries which have decided in. favour of some form of tradeintegration. This would be a mistake. There is abundant evidence in the languageof the instruments setting up customs unions or free-trade areas, in thedeclarations of member Govemments,and in the submissions made before theG.A.T.T.. Sessions or Working Parties, to show that the most carefulconsideration is given by states to their G.A.T.T. ohligationsinthe drafting ofsuch schemes..

Unfortunately, the language. of Article XXIV is flexible and impreciseenough to lend a good deal of justification to the .diverse interpretations whichhave been placed upon it. It may be that a reformulation of this. article would· bedesirable in the interests of certainty; but it would be foolish to suppose thatany reformulation would be easily achieved, particularly as' so many majortrading countries. have accepted commitments. based upon their .understanding ofthe a,rticle's requirements. It may also be that the article. expresses a defectiveview of the economically desirable critea for regional trade groupings.44 Bu·t onemust assume that. at least in the foreseeable future, no change in the terms ofthearticle. is likely. Moreover, a tightening. of the prescriptions of Article XXIVwould possibly only lead to further applications under Article XXV for a waiverfrom obligations imposed by theG .A.T.T.

The trend. towards regionalism in the economic aspects ofinternationaLUfe,as expressed in customs. unions and free-trade areas,. is tendingtoaconsiderabl~

degree to confine the operation of the m.f.n. clause to relations between. blocsrather than between individual states. Unfortunately, the difficulties in achievinginternal harmony within a· trade bloc are sometimes such that they are unable tocontemplate the lowering of barriers against outsiders; and those outsiders intheir turn become on Iy too. conscious of the discriminations practised againsttheir trade, and come consequently under internal pressure to retaliate. The

44. See the criticism of the standards applied in Article XXIV· by . Dam, .1oc. cit. .pp..622--635.


standard antidote for this illness is the initiation of a new round of tradeIiberalisation measures. It must remain for the future to judge whether the roundinitiated in 1973 will provide for greater liberalisation of world trade,. or whetherthere will be a further retreat from multilateral trading into discriminatoryregional blocs.

K.W.RYAN*

* B.A.,LL.B.(Qld.)Ph.D.(Cantab.). Barrister-at-law,GarricleProfessOt of Law and Head,Department of Law, University of Queensland.

the most-favoured-nationclause and regional economic...

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