At first glance, this article deals with a simple classification issue only: the coverage of certain manufacturing operations and the resulting products under the General Agreement on Trade in Services (GATS) rather than under its long-standing counterpart in merchandise trade, the General Agreement on Tariffs and Trade (GATT). Yet there are important structural/conceptual differences between the two Agreements, which may have far-reaching consequences, inter alia, for the use of GATT-based tariffs and trade remedies. It is submitted that the generally applied classification system in services could prompt companies to (re-) define the ownership conditions of otherwise identical production activities, with a view to achieving cover under the GATS and thus avoiding GATT disciplines. However, the relevant criteria separating goods- from services-related operations are not only hard to specify and monitor in practice, but it is also difficult to see an underlying economic rationale. In the interest of clarity and consistency, WTO Members might thus want to close this definitional trapdoor. Due to the rapid proliferation of international production-sharing arrangements, the stakes will likely be rising.
As long as the King behaves, his subjects will follow his example and the world will govern itself.
Lao-tzu, Tao Te Ching, 6th century BC.
Man must be disciplined, for he is by nature raw and wild.
Immanuel Kant, Pädagogik, 1803
The entry into force of the General Agreement on Trade in Services (GATS), as a result of the Uruguay Round (1986–93/4), added a new dimension to the multilateral trading system: its extension to a category of products—services—that were traditionally considered to be ‘intangible’, ‘non-storable’, or even ‘non-tradable’. Inevitably, given the novelty of the concepts involved, the interaction between the GATS and the General Agreement on Tariffs and Trade (GATT), its long-standing counterpart in merchandise trade, has led to problems of interpretation.
As could have been expected, the early dispute rulings in the history of the GATS, though few in number, revolved around some basic questions of scope and coverage. In this respect, EC—Bananas clarified, inter alia, that the application of the two Agreements—GATT and GATS—is not mutually exclusive. Apart from measures that fall exclusively within the scope of GATT, when they affect trade in goods as goods, and measures exclusively within the scope of GATS, when they affect the supply of services as services, there is a third category: measures that fall within the scope of both agreements. According to the Appellate Body, ‘[t]hese are measures that involve a service relating to a particular good or a service supplied in conjunction with a particular good’.1
This article deals with another facet of the interaction between GATT and GATS that has been widely ignored to date: the potential applicability of GATS disciplines to certain operations that are traditionally considered as goods-producing activities, such as farming, mining, or manufacturing. Indeed, manufacturing processes, if conducted on a fee or contract basis, are listed as services in the Sectoral Classification List that has been generally used by WTO Members to schedule their specific commitments in services. Whenever an economic entity performs such functions, GATS rules become applicable at certain stages. As a result, divergent sets of trade disciplines apply to otherwise identical operations and the resulting products, depending on who—the producer/supplier or somebody else—owns the inputs and outputs.
To outline the ensuing uncertainties and, possibly, the need for clarification, the following discussion focuses on the production of metal products, machinery, and equipment that is conducted on a fee or contract basis (‘contract manufacturing’). Nevertheless, there are many more cases, possibly extending across the full range of agricultural, mining, and manufacturing processes, where similar issues may arise. While there are no concrete examples at present, to our knowledge, it is well conceivable that structural differences between GATT and GATS could be used by economic operators with a view to benefiting from the investment-liberalizing and -protecting effects of the GATS and/or avoiding trading partners’ use of GATT-based tariffs and trade defence instruments, in particular anti-dumping and countervailing duties.
Available information suggests that contract manufacturing is far more than a definitional artefact. Given its increasing commercial importance, a number of statistical offices recently started providing relevant data despite the conceptual complexities involved. In Hong Kong, China, for example, imports of ‘manufacturing services’ reportedly amounted to HK$139.5 billion in 2011 or 3.4% of the economy’s total imports of goods and services (24.1% of total imports of services).2
The following observations are organized into four main sections. Starting point is a discussion of the definitional scope of ‘services’ and its relevance for the interpretation and application of GATS disciplines. The focus is on the Services Sectoral Classification List and, more specifically, on the definition provided for ‘services incidental to …’ and relevant sub-sectors, including ‘manufacturing on a fee or contract basis’. In the light of the Classification List, section III then traces possible changes in the applicability of GATT and GATS disciplines, depending on certain ownership criteria, although the underlying production processes and resulting products might be identical. As a next step, section IV seeks to explain potential consequences for the use of tariffs and trade remedies and the ensuing incentive for companies to set up international production arrangements in a particular way. This is complemented by a brief recapitulation of how this issue has (not) been dealt with in the WTO to date. Finally, section V indicates how WTO Members could avoid the classification-related uncertainties in the treatment of genuinely identical manufacturing processes, provided they manage to overcome their long-standing inertia.
II. WHAT ARE SERVICES?
A. The GATS is silent, but …
The GATS does not contain a definition of ‘services’, insofar comparable to the GATT, which does not define the meaning of ‘goods’ either. If anything, there is an almost tautological paraphrase in Article I:3(b) of the Agreement: ‘ “services” includes any service in any sector except services supplied in the exercise of governmental authority’. Apparently, this particular provision is not primarily intended to define the definitional scope of Agreement, but to exclude one particular type of services, those provided in the exercise of governmental authority, from cover.
Nevertheless, GATS Article I:2 specifies what constitutes the ‘supply of a service’ in terms of four modes of supply. These consist of conventional cross-border trade, i.e. supplies from the territory of one Member into that of another Member (mode 1), supplies in a Member’s territory to a service consumer of another Member (mode 2, consumption abroad, with tourism as a typical example) as well as supplies through commercial presence (mode 3, generally involving inward foreign investment) or through the presence of natural persons (mode 4) in a Member’s territory.
In turn, the distinction between individual modes depends on the territorial presence and/or the nationality of the suppliers or users involved.3 Under mode 1 only the former criterion matters; the service must be provided from the territory of one Member (B) into that of another Member (A) regardless of the nationality of, or relationship between, sender and recipient (e.g. the transportation of furniture by a B-based remover from its stores in B to those in A). In the case of mode 2, the consumers’/users’ nationality and actual location matter: a natural or juridical person of A obtains a service from a supplier of whatever nationality within the territory of Member B (e.g. a patient from A travels abroad for medical treatment in a hospital established in B). Mode 3 is concerned whenever a person of another Member supplies services within A’s territory through business or professional establishment to users/consumers of whatever nationality (e.g. an international consultancy firm incorporated in B establishes a branch in A to provide specialized services to clients in A or elsewhere). In a similar vein, mode 4 covers situations in which natural persons of another Member (B) supply services in A, either as independent professionals or as employees of a foreign-owned service firm (e.g. the international consultancy firm sends staff from its headquarters to support its fledgling office in A).
A definitional backbone of what constitutes a service is provided, however, by the Services Sectoral Classification List MTN.GNS/W/120, the so-called W/120. The list was developed by the then GATT Secretariat in the early 1990s at the request of Uruguay Round participants and has generally been used since for scheduling services commitments.4 W/120 consists of 11 large sectors, from business services to transport services, which are composed of some 160 sub-sectors, as well as a residual category of ‘other services not included elsewhere’. This implies that at least those sub-sectors that are explicitly listed in W/120, mostly in combination with a classification number drawing on the United Nations’ provisional Central Product Classification (CPC prov.)5, can be considered to fall under the GATS. In turn, the CPC, which was initially developed for statistical purposes, further defines what is covered by individual categories.
B. Implications of the Services Sectoral Classification List
GATS Article XX:1 requires each WTO Member to submit a schedule of specific commitments setting out the access obligations assumed under the Agreement. While widely different in product scope and substantive content, all schedules are organized according to a common format. It consists of four columns which specify, respectively, the sector concerned; any limitations on market access, as defined in GATS Article XVI, per mode of supply; any limitations on national treatment, according to Article XVII, per mode of supply; as well as any additional commitments, pursuant to Article XVIII, the Member may undertake on measures not falling under market access or national treatment.
To identify the sectors covered, the use of W/120 is strongly recommended in the Scheduling Guidelines, which were adopted by Members in March 2001, and to which it is attached.6 According to the Appellate Body’s decision in US-Gambling, both the Scheduling Guidelines and W/120 constitute supplementary means of interpretation within the meaning of Article 32 of the Vienna Convention.7 Accordingly, they can be referred to in order to confirm the meaning of specific commitments resulting from the application of Article 31 of the Convention (General Rule of Interpretation), or when an interpretation according to this Article remains ambiguous or obscure, or when it leads to a result that is manifestly absurd or unreasonable.8 Indeed, current services schedules could not be understood without recourse to the Scheduling Guidelines since their format and structure as well as some of the key terms used to specify the level of commitments (‘unbound’ and ‘none’) are not contained in the GATS itself.9 This is also the case when it comes to defining the precise scope of individual modes of supply.
The Services Sectoral Classification List provides not only a reference point that helps Members to define the object of a commitment but also circumscribes a (minimum) outer perimeter of the Agreement in terms of sectoral coverage. While any Member is free to depart from W/120 in spelling out commitments in its respective GATS schedule, the sectoral extension of the Agreement is given. It cannot be changed by individual Members, for example, with a view to exempting services that are listed in W/120 from horizontal GATS obligations, which apply across all services deemed to fall under the Agreement. Such obligations are independent of the existence of specific commitments and include in particular the requirement of most-favoured-nation (MFN) treatment. In other words, whenever GATS disciplines differ from (potentially) corresponding GATT provisions, the listing of a product/service in W/120 may determine the respective scope of application, including that of the MFN clause under GATS Article II. The only ‘special case’ is air transport, which is fully included in W/120 although the GATS almost completely exempts this sector from coverage.10 Given its legal status (see above), any modifications of W/120 would need to be endorsed collectively by Members.
C. Scope of ‘manufacturing services’ (‘contract manufacturing’) and possible consequences
Among business services, one of the eleven large service sectors, W/120 lists five distinct categories that are incidental to non-services activities. They relate, respectively, to agriculture, hunting and forestry (CPC 881), fishing (CPC 882), mining (CPC 883 and 5115), manufacturing (CPC 884 and 885, except for 88442), and energy distribution (CPC 887). To facilitate the following discussion, the spotlight is on ‘services incidental to the manufacture of metal products, machinery and equipment’ as covered by CPC 885; in turn, this category comprises nine sub-categories, from ‘manufacture of basic metals on a fee or contract basis’ to ‘manufacture of other transport equipment on a fee or contract basis’. Our basic line of argument would not change, however, if any of the other ‘services incidental to …’ had been chosen. For instance, it appears that sub-categories of CPC 884, such as ‘manufacture of textiles, wearing apparel and leather products on a fee or contract basis’ (CPC 8842), would prove at least as economically relevant as the current example.
|Sectors without specific commitments||Sectors subject to specific commitments|
|A. All services (except B and C)||Unconditional obligations:||Unconditional obligations (see 2nd column) Conditional obligations:|
|B. Special cases||See above, except for most-favoured-nation treatment|
|C. Excluded sectors/measures (i) Services provided in the exercise of governmental authority (Art. I:3)|
|(ii) Air transport (measures affecting traffic rights and directly related services, barring three exceptions)|
|Sectors without specific commitments||Sectors subject to specific commitments|
|A. All services (except B and C)||Unconditional obligations:||Unconditional obligations (see 2nd column) Conditional obligations:|
|B. Special cases||See above, except for most-favoured-nation treatment|
|C. Excluded sectors/measures (i) Services provided in the exercise of governmental authority (Art. I:3)|
|(ii) Air transport (measures affecting traffic rights and directly related services, barring three exceptions)|
Source: Rudolf Adlung, ‘Public Services and the GATS’, 9 JIEL 2 (2006) 455–85, at 459.
a Permissible departures: (a) MFN exemptions listed pursuant to Article II:2; (b) participation in Economic Integration or in Labour Market Integration Agreements (Art. V and Vbis); (c) recognition of foreign licences, certificates, etc. (Art. VII); (d) General Exceptions (Article XIV); and (e) prudential measures in financial services (Annex on Financial Services).
b Purpose: Ensure compliance with MFN principle.
c More comprehensive transparency obligations, including notification requirements, than in sectors not subject to specific commitments.
d Purpose: Prevent excessive regulatory activities and/or particularly burdensome requirements from undermining the commercial value of specific commitments.
e Purpose: Prevent market distortions (e.g. through anti-competitive cross-subsidization) in areas where specific commitments have been undertaken.
f Market access and national treatment may be made subject to limitations.
g Negotiations in this sector were suspended in 1996. Commitments that have been undertaken, nevertheless, may be withdrawn without compensation at the conclusion of the current round.
The Explanatory Notes contained in part III of the United Nations’ Provisional Central Product Classification further specify the content of ‘manufacturing on a fee or contract basis’ (‘contract manufacturing’) in the context of ‘services incidental to manufacturing’. Accordingly, relevant activities consist of ‘manufacturing services rendered to others where the raw materials processed, treated or finished are not owned by the manufacturer’ and also include ‘assembly, installation other than construction work, fitting of articles, maintenance and repair services’. Though this initial version of CPC was developed in the late 1980s, and might now appear to be outdated in parts, later versions do not contain significant changes in this particular area.11
Overall, 27 Members currently maintain commitments under CPC 885 (situation as of end-December 2012). As far as modes 1–3 are concerned, these are mostly without sector-related limitations on either market access or national treatment (‘none’).12 Two more Members have offered to undertake new or significantly extended commitments in the context of the Doha Round.13 In a number of cases, the sector-specific entries are qualified by horizontal limitations that apply across all services contained in the schedule concerned. Relatively frequent are exclusions of subsidies from national treatment, implying that the authorities retain the right to exempt foreign-supplied services or foreign service suppliers from financial assistance they may use in support of like domestic services or service suppliers.14
Yet, the question in the current context is not only whether relevant commitments have been undertaken but also whether the existence of a particular category in W/120 automatically implies, or exempts from, certain disciplines. A closer look into the GATS may help. Article XX:3 stipulates that the schedules of commitments ‘shall be annexed to … and form an integral part’ of the Agreement. Accordingly, as treaty text, schedules reflect the common intentions of all WTO Members.
Once a schedule contains commitments on CPC 885, this might be deemed to reflect Members’ collective recognition that this particular sector falls under the GATS and, consequently, is subject to horizontal obligations such as MFN treatment. In US—Gambling (para 182), the Appellate Body confirmed that ‘Members’ Schedules constitute relevant context for the interpretation of subsector 10.D of the USA’s Schedule’ which, in turn, was ‘the logical consequence of Article XX:3 of the GATS’ (emphasis added). Yet, in quoting the Panel, the Appellate Body cautioned that ‘use of other Members' Schedules as context must be tempered by the recognition that “[e]ach Schedule has its own intrinsic logic …”’15
III. POLICY CONSTRAINTS: A HYPOTHETICAL CASE
Imagine that SMW (Swabian Motor Works), a producer of cars based in A considers relocating the manufacturing of certain models to a lower-cost country B. The country’s attractiveness may be due in part to a generous subsidy programme intended to promote new investment and/or additional production in the car industry. SMW’s management ponders two scenarios of how to organize relations with the producer/supplier in B, which it intends to establish as a joint-stock company. To ensure close control over the company’s operations, SMW will keep a majority equity stake.
Scenario I: The B-based company procures the materials and components on its own account, from whatever sources, and performs the manufacturing process according to the instructions received. The cars are sold to SMW, which, in turn, markets them under its brand name in A and abroad. Scenario II: SMW provides all materials and components, which it continues to own. Again, these inputs may stem from a variety of sources, including from suppliers located in B. On completion of the manufacturing process, identical to that carried out under scenario I, the manufacturer is paid for the services rendered and SMW receives its cars for sale.
Of course, the two scenarios are highly hypothetical and, possibly, may never exist in such pure form. They simply serve to explore the applicability of potentially relevant GATT and GATS provisions and their interaction/overlap during individual stages of the procurement, production, and sales process.
A. Production- and investment-related disciplines
The existence of such disciplines at multilateral level essentially depends on the applicability of the GATS provisions governing mode 3 (commercial presence). This apparently is the case under scenario II, given that the new company, to be established in B, is a service supplier within the definitional scope of CPC 885 and is majority-owned by a juridical person of another Member, i.e. A.16 In contrast, transactions under scenario I would not fall under the GATS, even if the production processes and resulting products were identical to those described under II, simply because the manufacturer itself owns the inputs which, in turn, precludes coverage under W/120.
Conducting a manufacturing process on a fee or contract basis, in accordance with CPC 885, offers the following advantages from the perspective of a foreign investor (in this case, SMW):
participation in the benefits associated with any relevant GATS commitments on market access and national treatment that B might have undertaken under CPC 885, in particular with regard to mode 3 and, possibly less so, mode 417 and
automatic extension, under the GATS' MFN clause, of the best treatment (in terms of taxation, subsidization, levels of foreign equity participation, employment of foreign nationals, etc.) that B might extend to like suppliers from other countries and/or is committed to respect under the most favourable of its bilateral investment treaties (current and future).18
Thus, everything else being equal, there is an incentive for the investor (SMW) to opt for contract manufacturing. In some 20 WTO Member economies the project would then benefit from full commitments on market access and national treatment under mode 3 (with the possible exclusion of subsidies)19, implying, inter alia, the absence of quantitative restrictions on the number of suppliers, their operations and assets and, in most cases, levels of equity participation. In virtually all other instances, the investor could rely at least on MFN treatment, subject to a range of permissible departures. The possibly most important cases are Regional Trade Agreements falling under GATS Article V (Economic Integration) and the MFN exemptions Members could list pursuant to the Annex on Article II Exemptions. The latter possibility existed only on the Agreement's entry into force (date of acceptance for acceding Members).20
There is some evidence that treaty obligations add an element of predictability to a country’s trade and investment regime which could influence locational decisions.21 Apparently in expectation of such effects, the vast majority of WTO Members have signed bilateral investment treaties that, inter alia, guarantee foreign investors MFN treatment and national treatment on a post-establishment basis (there are currently over 2700 such treaties around the world). Similar motivations may have induced a number of Members to undertake GATS commitments on mode 3 (commercial presence) for CPC 885 and other services involving contract manufacturing. In turn, as alluded to before, such effects might prompt investors to prefer a particular legal/institutional form of engagement, e.g. manufacturing on a fee or contract basis, over alternative arrangements where the manufacturer owns the materials and components used as inputs.
Apart from the investment-related effects, there are further considerations that could impinge on SMW’s locational and organizational decisions: the vulnerability of the cars produced in B, supposedly benefitting from lavish subsidization, to trade remedies that other Members may take under relevant multilateral Agreements on Trade in Goods, in particular the Agreement on Subsidies and Countervailing Measures (ASCM). The latter Agreement allows, inter alia, for the introduction of countervailing duties to offset the subsidies extended in B (export subsidies and subsidies promoting local content are prohibited per se).22 Another possibility, though probably less relevant in our hypothetical case, but in many other instances, is the use of anti-dumping duties pursuant to the Agreement on Implementation of Article VI of the General Agreement on Tariffs and Trade 1994 (AD Agreement).23 SMW’s domestic rivals that refrained from outsourcing and continue to produce in A are potential petitioners for defensive action under either Agreement.24
Comparable instruments do not exist under the GATS. Concerning subsidies, the only discipline generally applicable across all services, whether scheduled or not, is the MFN requirement. In scheduled sectors, it is complemented by the national-treatment obligation, which, however, may be subjected to limitations. There are no further constraints although, according to GATS Article XV, Members recognize that ‘in certain circumstances, subsidies may have distortive effects on trade in services’. The Article thus provides for negotiations ‘with a view to developing the necessary multilateral disciplines to avoid such trade-distortive effects’ and to address ‘the appropriateness of countervailing procedures’. However, these negotiations have made very little progress, if any, since their inception some 15 years ago, and the issue of countervailing duties has played virtually no role.25 In turn, the possibility of anti-dumping action is not even mentioned in the GATS as a negotiating issue. The drafters might have seen the difficulties, given the specificities of services (intangibility, etc.) and associated data problems, of defining any appropriate basis for such action.
B. Product-related disciplines
1. The broad picture
A production process under scenario I—conducted on the manufacturer's own account (‘own-account manufacturing’)—would qualify as a ‘normal’ manufacturing operation beyond the definitional scope of the GATS. Consequently, the investment- or employment-related effects mentioned above with regard to modes 3 or 4 of the GATS would not materialize. Of course, what would continue to matter for the resulting products, if traded beyond the border, is the GATT and its product-focused disciplines. In turn, this means for importing countries that tariffs are the only legitimate instruments of ‘normal’ trade protection and, if the relevant criteria are met, remedies against dumped imports. National treatment is otherwise guaranteed (GATT Article III), implying that domestically established manufacturers must not in principle benefit from other protective measures. Subsidies, while exempt from the scope of GATT Article III, are disciplined under the Agreement on Subsidies and Countervailing Measures (see above).26
The Scheduling Guidelines seek to clarify the respective scope of GATS and GATT. They expressly confirm that:
There is no requirement in the GATS to schedule a limitation to the effect that the cross-border movement of goods associated with the provision of a service may be subject to customs duties or other administrative charges. Such measures are subject to the disciplines of the GATT.27
This means, by way of example, that the existence of import tariffs on, say, cars would not be inconsistent per se with full commitments on cross-border trade of road freight transport, including car carrier services, despite the ensuing discrimination of foreign supplies/suppliers of such services as compared to like domestic supplies/suppliers, which tend to focus on internal rather than on cross-border transport.
There is an apparent element of tension, however, between these stipulations and Article I:1 of the GATS (‘This Agreement applies to measures by Members affecting trade in services’) and its interpretation by the Appellate Body in EC-Bananas:
In our view, the use of the term ‘affecting' reflects the intents of the drafter to give a broad reach to the GATS. The ordinary meaning of the word ‘affecting' implies a measure that has ‘an effect on', which indicates a broad scope of application. This interpretation is further reinforced by the conclusions of previous panels that the term ‘affecting' in the context of Article III of the GATT is wider in scope than such terms as ‘regulating' or ‘governing'.28
Who would doubt that the imposition of duties on whatever goods that are ‘associated with the provision of a services’ could affect supplies of transport services, postal and courier services, wholesale and retail trade, and possibly many more services? What the drafters of the Guidelines might have wanted to avoid, however, is the invocation of GATS commitments with a view to challenging completely legitimate restrictions, under the GATT, across possibly the full range of merchandise trade. Unfortunately, however, they did not endeavour to further clarify the concept of measures restricting movements of goods that are ‘associated’ with the provision of services as compared to measures that ‘affect’ trade in services.29
Under scenario II—manufacturing on a fee or contract basis (contract manufacturing)—the GATT certainly matters as well. However, its interaction with GATS disciplines may warrant further attention. The two Agreements come into play, interact or overlap, at different stages of the production/marketing process.
It seems reasonable to assess the manufacturing operation, including the underlying investments, in the light of the GATS as far as the supply of W/120-listed services (CPC 885) is concerned. Accordingly, it would be completely legitimate for B to grant production subsidies as long as all foreign-owned firms producing like services within its territory benefit from MFN treatment and, in the event of relevant commitments, national treatment. Yet, what would this mean for the resulting goods (cars) once these are imported into A or any other country?
If the extension of production subsidies cannot be challenged under the GATS, this does not automatically imply that competing car producers or, rather, the respective authorities, are deprived of their rights under the ASCM. Thus, in the current case, the fact that measures promoting contract manufacturing, whether investment, production and even export subsidies, are consistent with one set of disciplines, under the GATS, would not exempt the resulting products from equally legitimate countermeasures or prohibitions under the GATT.
2. Relevance of individual modes
It is important to bear in mind that the product-related disciplines discussed in the following, from the perspective of an ‘importing’ country under modes 1 and 2, apply regardless of the ownership status of the producer in B. Thus, departing from our hypothetical case, the company might well be domestically owned.
Cross-border trade (mode 1).
If a car, which has been manufactured on a fee or contract basis, is to be treated as a good on importation into another WTO Member’s territory, the question arises what this Members’ GATS obligations and commitments under mode 1 actually entail. The full commitments (entry: ‘none’) undertaken by 20-odd WTO Members on cross-border trade under CPC 885 must have meaning. However, what could it be?
A closer look into the GATS may help. Pursuant to Article XXVIII(b), the supply of a service is defined to include its ‘production, distribution, marketing, sale and delivery’. It could thus be argued that a contract manufacturing service, while produced and delivered abroad, forms part of a good, and is to be treated as such, when it enters the territory of the Member concerned. Nevertheless, other facets of what constitutes the supply of a service, such as sale and marketing, can be provided cross-border independently of the good. These would not only be covered by the MFN and other horizontal obligations under the GATS but could also be made subject to specific commitments. Of course, such commitments would not be very commercially meaningful, but this is the case for many other mode-1 commitments as well, including in sectors such as hospital, hotel, or restaurant services.
Consumption abroad (mode 2).
Both versions of the Scheduling Guidelines explain the scope of mode 2 as follows:
Consumption abroad: This mode of supply is often referred to as ‘movement of the consumer'. The essential feature of this mode is that the service is delivered outside the territory of the Member making the commitment. Often the actual movement of the consumer is necessary as in tourism services. However, activities such as ship repair abroad, where only the property of the consumer ‘moves', or is situated abroad, are also covered.30
There can be little doubt, given its inclusion in W/120, that manufacturing on a fee or contract basis is as much a service as ship repair which, in turn, is listed as ‘maintenance of repair of vessels’ with a reference to CPC 8868. However, if it is sufficient for a transaction to be covered by the GATS that only the property of the consumer (in this case, SMW) moves or is situated abroad, it may well be presumed that, from A’s perspective, the resulting supplies fall under mode 2 of the Agreement. If there is an element of uncertainty, it is the question whether the SMW-owned raw materials and components need to be delivered into B, whether from A or any other Member, or whether they must simply be owned by SMW, regardless of their origin. The fact that the Scheduling Guidelines expressly refer to the possibility that the property ‘is situated abroad’ weighs in favour the latter option.
In turn, the above considerations suggest that tariffs or other trade restrictions A might impose on the cars that have been manufactured abroad on SMWs account, need to be assessed in the light of the GATS. Their importation could no longer be considered simply to constitute cross-border movements of goods (cars) that are ‘associated with the provision of a service’, e.g. road freight transport (car carriers) and that, according to the Scheduling Guidelines, would therefore be subjected to the GATT. In the present context, services are not used as a means of transport, communication or otherwise, but—comparable to ship repair—form a constitutive component of a transaction falling under mode 2 of the GATS.31 From this perspective, the imposition of tariffs or the introduction of trade remedies constitute government measures that affect trade in services within the meaning of GATS Article I:1.
The policy implications could be significant:
First, pursuant to GATS Article XVII:3, the existence of mode-2 commitments on national treatment in the sectors concerned (here: CPC 885), if not qualified by relevant limitations, would require the importing Member to refrain from taking measures that modify the conditions of competition in favour of own like services or service suppliers. Yet the imposition of import tariffs on contract-manufactured supplies almost inevitably results in such a modification of competitive conditions provided the services/suppliers concerned can be considered to be alike.32 If so, however, the Member would not be allowed under the GATS to impose on such supplies the car duties it might have inscribed in its tariff schedule under the GATT. By the same token, if the imports traded under both scenarios constitute like products in the sense of GATT Article I:1 (General Most-Favoured-Nation Treatment), regardless of the commercial arrangements governing the production process, this Member would need to suspend its tariffs in order not to violate its MFN obligation under the GATT.33 As a last resort, of course, there would still be the option of renegotiating a commitment under GATS Article XXI, with a view to withdrawing any bindings on national treatment under mode 2, against compensation of affected Members.
Second, the imposition of countervailing or anti-dumping duties on contract-manufactured supplies falling under mode 2 of the GATS, while permissible under the GATT, might be inconsistent with that Member's MFN obligation under the GATS. Article II:1 requires Members ‘with regard to any measure covered by the Agreement’, thus including supplies falling under mode 2, to extend ‘immediately and unconditionally’ to services/suppliers of all other Members the best treatment they may grant to like services/suppliers of any country. A distinction based on subsidy- or pricing-practices that might be employed or tolerated by the originating country would certainly be inconsistent with this standard. Thus all Members, regardless of their mode-2 commitments, would no longer be able to use GATT-consistent trade remedies vis-à-vis contract-manufactured supplies commissioned abroad. There is neither a possibility under the GATS to introduce countervailing or anti-dumping measures, nor to obtain new MFN exemptions after WTO accession beyond those already contained in a Member’s respective list, if any (section III.A). Of course, the relevance of the MFN obligation depends on the existence in at least one-third country of like services/service suppliers.
In the context of this particular case, it is important to bear in mind that the hypothesized consequences arise only in the relationship between A and B, given that the ‘consumer’ of the services supplied in the territory of B is a juridical person incorporated under the laws of Member A.34 Sales of the B-produced SMWs into the territory of other Members would not constitute mode-2 trade from the perspective of these Members as long as the importers/commissioners concerned do not own the raw materials and other inputs used. Third countries are not bound, of course, by the mode 2 commitments undertaken by Member A. However, uncertainties remain. For example, what would be the situation if other subsidiaries of SMW, established in C, D etc., owned the inputs and commissioned the cars for marketing in their respective countries?
3. Scope for protective action (?)
The above considerations do not necessarily imply that an importing Member is deprived of any scope for trade-defensive measures against foreign supplies of contract-manufactured products under mode 2 of the GATS. One conceivable option is the extension of subsidies that would strengthen the competitive position of domestic industries and, thus, tilt the playfield against foreign supplies (‘import-displacing subsidies’).
The Scheduling Guidelines explicitly clarify that ‘[t]here is no obligation in the GATS which requires a Member to take measures outside its territorial jurisdiction’. This implies that the subsidy-related disciplines—MFN treatment and, depending on commitments, national treatment—which must be respected vis-à-vis domestically established foreign-owned suppliers, need not be extended to like suppliers competing from abroad.35
Producer-related subsidies, investment grants and the like are thus deemed permissible under the GATS, regardless of their trade effects, even under full commitments.36 Moreover, a large share of the Members that undertook commitments under CPC 885 retained the right to use discriminatory, i.e. national-treatment inconsistent, subsidies. It might be argued that these Members are not only entitled to subsidize competing domestic suppliers of contract manufacturing services but also the resulting products (cars) in order to persuade potential aspirants (SMW) not to move abroad.
However, there are important constraints. Other Members whose producers are adversely affected by the (compensatory) subsidies that might be granted by A could resort to counter-measures under the ASCM if the relevant criteria are met. As indicated before, such measures could consist of countervailing duties as far as the products (cars) enter their own markets or, in the event of trade-displacing or -impeding effects elsewhere, the Members could request consultations and, if inconclusive, refer the case to dispute settlement. Moreover, the government already subsidizing its contract-manufactured exports (B) might increase the initial levels of support and engage in sort of a ‘subsidy race’.37
IV. … AND WHERE IS THE PROBLEM?
A. Implications for GATT-based tariff protection and trade remedies
The preceding discussion suggests that, if the overlap/interaction between GATS and GATT causes problems, these arise mostly in the context of what is defined as trade under mode 2 (consumption abroad) of the GATS.
Firstly, it appears that in the absence of relevant limitations on national treatment under mode 2, the Members with commitments on CPC 885—and/or other services provided on a fee or contract basis—might have foregone the right to impose their GATT-scheduled import duties on the goods concerned, including those produced on the manufacturers’ own account, once their companies conduct contract manufacturing operations abroad.38 Indeed, none of the more than 20 Members with commitments under CPC 885, some of which host car producers, currently maintain potentially relevant limitations or deny bindings (entry: ‘unbound’). In the context of our hypothetical case, this could imply that, ultimately, they may need to fully liberalize all car imports under the relevant tariff category. Of course, whether this is considered to be a ‘problem’ depends on the perspective taken. In any event, as long as the commitments apply, and are complied with, the outcome would be trade liberalizing.
Secondly, in view of the GATS’ MFN obligation, the authorities concerned would need to accept the contract-manufactured imports even if the conditions for GATT-based trade remedies were met. The GATS does not allow for such measures, with the exception of MFN-based safeguard actions. (Such actions would be permissible in the absence of market-access commitments or, otherwise, if a scheduled limitation provides for adequate scope.) As indicated before, a Member’s inability to take anti-dumping or countervailing measures does not depend on the existence of specific commitments; it simply results from the quasi-automatic extension of the MFN obligation to services and their suppliers under the GATS. Also, the Scheduling Guidelines seem to imply that it is irrelevant whether SMW holds an equity stake in, or directly provides the inputs used by, the B-based manufacturer. What ultimately matters is SMWs prior ownership of the materials, parts and components used and, thus, its status as a mode-2 consumer of contract manufacturing services under CPC 885 (section III.B.2(b)).
Of course, as noted above, the government concerned might extend producer- or product-related subsidies in order to neutralize its domestic consumers’ preference for cheaper contract-manufactured foreign cars. (The vast majority of Members, i.e. those without commitments under CPC 885 plus those whose commitments are subject to relevant limitations, would be free to extend such subsidies.) However, this option does not appear to be particularly attractive. First, contrary to the use of anti-dumping or countervailing duties, there would be a fiscal cost and, second, the extension of compensatory support, MFN-based, regardless of the origin of the contract-manufactured supplies, would impinge on a possibly far wider range of Members than those that initially indulged in subsidization. And the subsidies might then be challenged or countervailed under the ASCM.
These considerations are not meant to imply that there is a conflict between potentially relevant treaty provisions. (According to Jenks, ‘conflict of law-making treaties arises only where simultaneous compliance with the obligations of different instruments is impossible’.)39 Indeed, Members could simultaneously meet their obligations under GATS and GATT/ASCM—in not intervening at all. The authorities might simply dispense with their right to employ regular tariffs and/or to resort to potentially relevant trade remedy provisions under the GATT. However, the consequences could prove politically difficult to accept.
Otherwise, the Members concerned might reconsider the implications of mode 2 commitments under the GATS on their ability to operate import tariffs on contract manufactured supplies. If deemed necessary, existing commitments on CPC 885 and similar categories could be renegotiated, subject to compensation of affected Members, under GATS Article XXI. Moreover, acceding countries, which still have the possibility to list MFN exemptions, could do so in order to retain scope for countervailing or anti-dumping actions on contract-manufactured supplies.40
There are possibly very few processed goods that could not be produced alternatively through contract manufacturing or conventional own-account operations. If the former type of arrangements proliferated, this might seriously constrain, according to our reading, Members’ use of trade remedy provisions. The implications of the MFN clause for anti-dumping and countervailing measures are unavoidable. As a result, there would be a disparity in treatment between products manufactured on a fee or contract basis in a highly subsidizing country (B), constituting mode 2 supplies from the commissioner’s home-market perspective (A), and the same products, with similar levels of subsidization, produced on a conventional basis (own-account manufacturing). The former supplies would be less prone to countermeasures on importation into A than the latter. In the absence of other (dis-) incentives, SMW would thus be well advised to go for the contract manufacturing option. It would prove attractive not only in view of its investment-protecting effects, owing to Bs mode 3-related obligations (section III.A) but could also help prevent trade-defensive interventions on the part of A and, possibly, additional countries where SMW has set up subsidiaries that commission and import as well the cars contract manufactured in B.
Nevertheless, it is difficult to see any economic or other rationale for discriminating between identical products resulting from identical processes and offered under identical conditions. Had Members anticipated the potential consequences, as submitted above, would they have endorsed W/120 and the Scheduling Guidelines? The extension of the Agreement’s scope to ‘manufacturing services’ is also surprising insofar as the resulting products were already covered, undoubtedly, by GATT disciplines prior to the GATS’ entry into force. They reflect the concessions exchanged in previous trade rounds and, thus, represent a deliberately conceived balance of rights and obligations.
Within the framework of GATT, all cars imported into A, regardless of how the production process was organized, would draw the country’s regular tariffs and could be subjected to trade remedies. Our reasoning thus implies that the creation of the GATS—or, rather, the adoption of the Scheduling Guidelines and W/120—reduced the relevance of certain GATT disciplines for a specified range of products, which, depending on the respective contractual conditions, are now subject to the GATS. At the same time, the coexistence of the two Agreements provides a playfield for innovative production arrangements that, in reality, might be surrounded by a far higher degree of uncertainty than our example (SMW) suggests.
B. (Non-) treatment in the WTO to date
The scenarios outlined above are still hypothetical insofar as there is no evidence to date of any related trade frictions. Nevertheless, the situation could change. With the proliferation of international supply chains, there may be increasing government interest in attracting productions or production stages that are deemed to be of strategic economic or developmental importance. And it is somewhat intriguing to see that the legal status of the policies that might be used has drawn so little attention to date. It may be worth recalling that the range of sectors potentially concerned reaches far beyond contract manufacturing within the scope of CPC 885 (‘services incidental to the manufacture of metal products, machinery and equipment’), which we used as a proto-typical case.41
In late 2000, a Chairman's Note circulated in the competent WTO body, Committee on Specific Commitments, invited delegations to comment on the following issues: ‘(a) various services, that are supplied to manufacturers, are subject to the GATS and are classified or classifiable under W/120; (b) pure manufacturing should, however, not be classified as services, even if it is carried out on a fee or contract basis; (c) services incidental to manufacturing, such as drilling, should be treated on a case-by-case basis'.42 In the following discussion, most participants agreed that, in principle, manufacturing activities should not be classified as services, although some said that the classification in the CPC of ‘manufacturing on a fee or contract basis' as a service should be given more attention. Doubts were also raised whether it was within the mandate of the Committee to reach formal conclusions on such issues. In May 2001, the chairperson then summarized that ‘it seemed that generally Members did not consider the issue to be a matter of priority' and that the discussion be ‘concluded at that stage without drawing any conclusion'.43
A related issue was taken up by WTO Members in 2012, again in the Committee on Specific Commitments, based on a Secretariat Background Note on energy services.44 The Note refers to past discussions in the Committee of whether production ‘on a fee or contract basis' should be regarded as a service under the GATS and considers this question to be important for the energy sector as well. For instance, section 884 of the CPC covers ‘manufacture of coke, refined petroleum products and nuclear fuel, on a fee or contract basis'. According to the Secretariat Note, if production on a fee or contract basis were considered to be a service, this would mean, inter alia, that oil refining is subject to the GATS when performed accordingly. Yet, the Committee's informal exchange on this issue apparently remained very limited, again, in scope and depth.
One aspect has been completely ignored in past discussions among Members: the profound definitional uncertainties blurring the distinction between contract manufacturing and conventional own-account operations. The hypothetical scenario described above, relatively clean and neat, will possibly never be replicated in practice. Rather, the competent authorities would be confronted with a plethora of thorny questions. For example, what is the level of (non-) ownership above which manufacturers will be deemed to provide their services on a fee or contract basis; does it suffice if two-thirds, four-fifths or (…) of the inputs are owned by others?45 Is it possible for any subsidiary within a multi-national production network to commission subsidiaries in other countries with contract manufacturing operations and thereby qualify as a service consumer under mode 2 (section III.B.2(b))? And what about situations in which a manufacturer, keen to avoid GATT disciplines, simply lends the necessary funds to the commissioner (SMW) which would then buy and own the inputs?
WTO Members’ hesitation to deal with issues surrounding contract manufacturing may have wider ramifications beyond their obligations and commitments under the GATS. Equally concerned are many Regional Trade Agreements (RTAs) covering services, which are also based essentially on W/120 and employ the same modal definition as the GATS. (Some 100 RTAs have been notified to the WTO to date under relevant provisions.) Pursuant to Article V:1 of the GATS, the parties to such agreements are required, inter alia, to provide for ‘substantial sectoral coverage’ and, in the sectors covered, for ‘the absence or elimination of substantially all discrimination, in the sense of Article XVII’ (national treatment). This implies that the questions discussed before may be even more pressing in an RTA context whenever the signatories assumed new or deeper commitments, beyond their GATS schedules, on contract manufacturing operations. Indeed, there are 28 WTO Members without GATS commitments on either CPC 884 or 885 that scheduled such services in one or more of their RTAs (situation as of November 2011).46
V. BACK TO THE DRAWING BOARD?
It is quite unlikely that Members were aware of the subtleties discussed above when they endorsed the Scheduling Guidelines and W/120 in the early 1990s. The challenge of creating a new agreement—with its particular modal structure, extension to the treatment of producers/suppliers, possibilities of non-tariff trade protection, etc.—left little time and resources to explore conceptual and definitional ramifications in detail. In turn, after the start of the Doha Round, some 10 years later, there was little appetite for such work either. New or improved commitments are difficult to negotiate against the backdrop of parallel negotiations on scheduling and classification issues, which might not only change the ‘balance’ of existing commitments but also the framework within which the results would be implemented. This could explain, to a degree, why Members preferred to consider issues surrounding contract manufacturing not to be ‘a matter of priority’ in the early days of the Doha Round.
There are quite a number of critical observers of the WTO system who might concur with this assessment, though possibly for different reasons. From their vantage point, there should be other priorities for WTO Members than agonizing over classification issues on the borderline between goods and services trade. Rather, the current segmentation of trade disciplines ought to be removed. The objective would be to facilitate the operation of global value chains through common rules that embrace all cross-border supplies of products, whatever their nature, as well as movements of users (whether physically or electronically) and of producers/production factors (capital and workers).47 Indeed, some strides in this direction have been made in a number of recent RTAs, in the form, for example, of cross-cutting chapters covering investment and labour movements in both goods and service sectors.
Nevertheless, no trade agreement, however open, is reasonably conceivable without proper sector classification. There will always be sectors considered to warrant special treatment for whatever (cultural, social, etc.) policy reasons, which, thus, have to be defined accordingly. And the ‘borderline problem’ is unlikely to vanish either. The vast majority of current RTAs allow the parties, as far as goods are concerned, to take countervailing, anti-dumping or safeguard actions.48 The agreements normally refer to existing GATT provisions, possibly combined with additional consultation or information-exchange clauses, and a bilateral safeguard mechanism during a phase-in period. Contract-manufactured supplies, however, are on the other side of the definitional border.
Therefore, the question remains what could (or should) be done to address the inconsistencies or, at least, uncertainties discussed in this article. Two options are realistically conceivable, either of which would need to be approved by the Council for Trade in Services.49
The Sectoral Classification List W/120 could be modified. In the current context, this would mean removing ‘services incidental to manufacturing’, as defined in CPC 884 and 885, from the List. ‘Maintenance and repair services of equipment’, including machinery, electrical products, optical instruments and the like, would not be affected as they are covered elsewhere under W/120 and CPC50; and the same applies to repair services of transport equipment, i.e., of vessels, aircraft, rail transport and road transport equipment, and an additional range of products.51
Members might reconsider the Scheduling Guidelines. The scope of mode 2 could be reduced to situations where only the service consumer, rather than his property, moves abroad to receive a service in person, e.g. as a tourist or student. Similar discussions were conducted, inconclusively, however, some 15 years ago with a view to clarifying the status of electronic transactions in financial services (e.g. a consumer in A uses the Internet to open a bank account, buy an insurance policy, or commission an architect in B).52
What would a cost/benefit assessment look like?
Given the generally liberal current GATS commitments contained in a number of schedules (over 20 on CPC 885 only), both options could have commercially significant ramifications—although few Members might have realized this to date. As explained above, a full commitment on mode 2 (consumption abroad) in relevant sectors could ultimately mean under current rules that the competent authorities have foregone the right to impose customs tariffs on the supplies concerned, whether originating from contract manufacturing operations or not. In turn, this reading implies that the existence of such commitments constitutes a significant concession.
While a redefinition or clarification of the status of mode 2 in the Scheduling Guidelines would not impinge on commitments under other modes, a classification change—i.e. the removal of CPC 884 and 885 from W/120—would also affect potentially meaningful access commitments under mode 3 (commercial presence).53 To a certain extent, these effects might be contained by the current framework of 2700-odd investment treaties and, increasingly, the investment chapters of RTAs that tend to apply on a cross-sectoral basis. However, while protecting established suppliers, investment treaties do not normally create new access opportunities.54
Moreover, given the impossibility of reconciling anti-dumping or countervailing measures with the MFN requirement of the GATS, as presumed above, all Members would regain the right to impose such measures on contract-manufactured supplies imported on a commercial scale into their territory. This applies under both options. What appears to be a step backwards, in terms of liberal access conditions, might look differently from a trade negotiator’s perspective. Everybody would have restored their ability to take defensive action, in conformity with relevant GATT Agreements, across the full range of merchandise trade. And this may matter increasingly over time, whether one likes it or not, given the rapid proliferation of new forms of international production arrangements and the ensuing temptation for governments to facilitate their companies’ participation through financial incentives.
Finally, there should be an overriding ‘public-good’ rationale for collective action to close the definitional trapdoor. Otherwise, what purpose would be served by trade disciplines that discriminate, contingent solely on ownership rights, between identical products that result from identical operations? Whether one subscribes to our interpretation of relevant WTO provisions or not, the above discussion indicates the existence of profound uncertainties with potentially significant economic implications. It is possibly only a matter of time for a WTO dispute panel to be involved. Rather than relying on case-related adjudication, however, it would certainly be preferable for Members to develop a broadly applicable solution, in a non-confrontational setting, that helps clarify the borderline between GATT and GATS in the case of ‘manufacturing services’. As indicated before, such clarification would also benefit many RTAs, close to 30 at present, where similar questions arise.
Of course, the possibility remains for Members to continue sitting tight and, in the tradition of Lao-tzu, allow things to sort themselves out. Yet this is not without risks. Experience suggests that in the absence of common disciplines, everybody feels free to impose their own rule. And Kant may be right: man is by nature raw and wild.