NOTES ON BASIC MATERIALS
is that it is incongruous to the aims and objectives of
Why compensation cannot replace trade retaliation
in the WTO Dispute Settlement Understanding
 The WTO Dispute Settlement Understanding (DSU) has
served an integral role in increasing the legitimacy of
the multilateral trading system by providing a rules-
based, binding, and impartial forum for WTO
Members to resolve their disputes.1
 One of the more frequently heard criticisms of the
current system of trade retaliation is that the
imposition of retaliatory trade measures is
economically inefficient. The reason for the
inefficiency is that trade retaliation causes consumers
in the nation imposing the trade retaliation – that is,
the importing country – to pay more for the imported
goods. Moreover, any considerable rise in tariff levels
to a segment of imports has the potential to increase
political considerations, such as increased lobbying
efforts and rent-seeking from a multitude of domestic
interests.2 This is problematic for smaller developing
countries who rely on larger developed countries for a
large percentage of their total trade and for consumer
goods where there may be no alternative supplier or
the additional costs associated with a new supplier
may make certain goods inaccessible to the local
market.
 As both trading partners understand that retaliation
will likely harm the smaller partner more than it harms
the larger partner, the threat of retaliatory measures
often lacks credibility. Without credibility, a threat of
retaliation loses any potential coercive effect.
 [T]he tremendous imbalance in the trade relations
between developed and developing countries places
severe constraints on the ability of developing
countries to exercise their rights under Article 22. 3
 the economic strength argument could even
extend to trading relationships between larger,
developed countries.4
1
Bryan Mercurio, Why compensation cannot replace trade
retaliation in the WTO Dispute Settlement Understanding,
World Trade Review (2009), pg. 1.
2
Bryan Mercurio, Why compensation cannot replace trade
retaliation in the WTO Dispute Settlement Understanding,
World Trade Review (2009), pg. 4.
3 8
TN/DS/W/19 (2002), at 1. (INDIA’s proposal to the DSU
Review)
4
US–Foreign Sales Corporation (DS 108), where the EU has
not exercised its DSB sanctioned right to impose retaliatory
measures to the amount of US$4 billion against US imports,
at least in part because of the economic and competitive
effect the increased tariff barriers will have on European
 Another criticism often made against trade retaliation
the WTO. the sanctioning of the imposition of higher
trade barriers in an attempt to remedy another
Members transgression (or perhaps to punish the
offending Member) seems contradictory as the higher
trade barriers resulting from the retaliatory measures
will inevitably lead to a reduction of trade between
the parties concerned.5
 An additional criticism is that retaliatory measures do
not benefit the aggrieved party but instead damage
the innocent. To illustrate, the banana ndustry in the
US would not have been positively affected as a result
of US retaliatory measures against European sweet
biscuits and cheese resulting from European non-
compliance in EC–Bananas. Instead, Europe continued
to discriminate in favour of certain banana growing
countries to the detriment of the US industry ), while
US biscuit manufacturers and cheese makers
benefited from the protection and those specific
industries in Europe suffered. 6
 Finally, many commentators assert that prospective
remedies discourage immediate or timely compliance.
Under the current system, Members are not punished
for past discretions, but are only subject to the
suspension of concessions. Thus, remedies in the WTO
are (almost) without exception only prospective in
nature.7 Such a system emphasizes that the intent,
aim, and objective of the dispute settlement
mechanism is to resolve the dispute, rather than
‘punish’ a Member for failing to abide by its WTO
obligations.
 In Australia–Leather8, which held that Article 19.1 of
the DSU does not limit remedies under Article 4.7 of
the SCM Agreement to prospective action only. See
footnote no. 22 on repayments.
 The concept of ‘punishment’ does not generally
appear in public international law.9
 Most commentators therefore believe that
Members are under an obligation to comply
industries.
5
Anderson (2002: 129) (stating, ‘the idea of legitimizing
retaliation is contrary to the objective of reducing
impediments to trade’)
6
Supra, pg. 6.
7
EC–Bananas, WT/DS27/RW/ECU, at para. 6.105
WT/DS126/RW
9
‘State Responsibility: Titles and Texts of the Draft Articles on
Responsibility of States for Internationally Wrongful Acts
Adopted by the Drafting Committee on Second Reading’, U.N.
GAOR Int’l L. Comm’n, 53d Sess., U.N. Doc.
A/CN.4/L.602/Rev.1 (2001). see generally, Duff and Garland
(1995)
 with the rulings and recommendations of
adopted panel and Appellate Body reports.
o However, Judith Hippler Bello: ‘[T]he
WTO has no jailhouse, no bail
bondsmen, no blue helmets, no
truncheons or tear gas’.10
o ‘Even assuming [WTO law is
mandatory], a legal realist, and a legal
economist, would ask not what the
formal law specifies, but what it does in
response to breach. Ubi ius ibi
remedium. Here, the law in action
clearly does not operate as a property
rule. States that violate WTO law are
neither subject to enforceable specific
performance-type remedies, nor do
they experience any penalty for their
violation beyond the potential
authorization of withdrawal of
equivalent concessions.
o as a matter of fact and practice, if not as
a matter of legal doctrine, the WTO
legal system is best characterized as
employing a liability rule, rather than a
property rule.11
 (rebalancing view12):
some commentators argue that the objective of
the ability to suspend concessions is to
rebalance the tariff concessions and other
obligations which Members have agreed to.
Thus, if one Member is violating the rules and
thereby nullifying or impairing benefits, the
other Member can violate the rules as well in
order to restore the original balance.
 ‘induce compliance’ viewpoint13:
On the other hand, some commentators believe
the purpose of the ability to suspend
concessions is to induce the Member
complained against to comply with its
obligations under the covered agreements. 14
Thus, the ultimate goal is to have the offending
measure brought into compliance, and
suspension is designed to achieve this outcome.
o However, the arbitrators in US–Offset
Act recently cast doubt upon the theory
10
(Bello, 1996: 417).
11
(Trachtman, 2007: 146).
12
Palmeter (2001: 291), Palmeter and Alexandrov (2002:
647).
13
EC-Bananas, WT/DS27/ARB, at para. 6.3; EC-Hormones,
WT/DS26/ARB, at para. 40.
14
Charnovitz (undated: 21), Bronckers and van den Broek
(2005: 112).
stating that the concept of inducing
compliance is not expressly referred to
in any part of the DSU. By relying on
‘inducing compliance’ as the benchmark
for the selection of the most
appropriate approach we also run the
risk of losing sight of the requirement of
Article 22.4 that the level of suspension
be equivalent to the level of
nullification or impairment.
 Other commentators, however, have slightly differing
views, such as that principles of contract law and the
efficient allocation of resources are the driving force
behind retaliation implementation.15
On compensation:
 Trade compensation has only been utilized once since
the formation of the WTO.16 While it is an efficient
form of rebalancing concessions, it is not the preferred
retaliatory method. the preferred retaliatory method
– trade retaliation – almost always involves the
complainant Member raising its import barriers on
certain products exported by the respondent Member
and thereby harming the economic welfare in both
countries. This is because:
o First, a complaining Member does not
prefer trade compensation as its
exporters are not necessarily the
exporters that benefit.
o The other reason is that while in the
former the complaining Member retains
control over both the level of the
suspension of concessions as well as the
targeted products, the latter hands over
control to the responding Member, who
can unilaterally end the trade
compensation when it believes it has
complied with the rulings of the DSB (or
otherwise decides it no longer wants to
offer trade compensation).
On mandatory trade compensation:
 one advantage: it creates, rather than contracts
trade.
 ‘contingent liberalization commitments’: this
proposal suggests that Members nominate, or
pre-establish, the sectors and forms of trade
compensation to be triggered if and when the
Member fails to comply with a ruling of the
DSB.
15
Schwartz and Sykes (2002).
16
Japan–Taxes on Alcoholic Beverages (WT/DS8/AB/R,
WT/DS10/AB/R, WT/DS11/AB/R) where the Japan agreed to
apply reduced tariff rates on specific items pending full
implementation of the Appellate Body report.
 one of the several hurdles to the introduction of
mandatory compensation is its enforceability.
generally, trade compensation, by its very nature,
harms an innocent industry in the non-compliant
Member. The decision to expose innocent industries
to more foreign competition (by a reduction in tariff
rates) is an important one that should be taken only
after careful analysis of the trade policy aims,
objectives, and an analysis of the economic positions
of all affected innocent industries at issue. Placing
such a decision in the hands of the complaining party
or a panel/Appellate body may be seen as a too
intrusive step which infringes upon the sovereignty
and potentially the economic welfare of a nation.
 Moreover, as any form of compensation is, by its
nature, an act that must be performed by a non-
complying Member, it will always essentially be a
voluntary act. 17 Neither a harmed Member, nor the
WTO, can force another Member to provide
compensation. ‘mandatory’ compensation depends
upon the good faith compliance of the Member
concerned.
 There is nothing to suggest that mandatory trade
compensation will assist the aggrieved industry.
There is also nothing to suggest that mandatory
trade compensation will encourage a greater level of
compliance than trade retaliation. Remembering
that compensation is by its very nature necessarily a
voluntary act, the issuance of mandatory
compensation orders would perhaps actually result
in a decrease in the DSU’s overall compliance rate.
On financial compensation
 the traditional form of compensation is ‘trade
compensation’. Some commentators, however,
now view financial compensation as an
alternative form of compensation. This entails
the responding Member to provide a financial
benefit (i.e. a direct payment) to either the
complaining Member’s government or to an
industry, group or association within that
Member’s territory.18
 despite having long been a part of public
international law, the concept of financial
compensation has often been raised and
rejected throughout the history of the
GATT/WTO. In fact, financial compensation was
first raised and rejected as part of the original
GATT 1947 negotiations.47 The concept was
again raised in 1964 when Brazil and Uruguay
17
Bryan Mercurio, Why compensation cannot replace trade
retaliation in the WTO Dispute Settlement Understanding,
World Trade Review (2009), pg. 12.
18
Supra, pg. 14.
formally suggested its consideration. 19 The idea
resurfaced and again failed to gain the support
of Members during the course of the Uruguay
Round.20
 Thus, the legality of financial compensation under the
current DSU remains questionable as there is nothing
in the text of the DSU or any other WTO agreement
which provides a clear basis for its usage, and multiple
attempts to include such a legal basis have failed.
 Despite this, financial compensation was used to
resolve the US–Copyright dispute when the US
agreed to financially compensate the EC in exchange
for allowing the continuation of the infringing practice.
 Financial compensation as an alternative to traditional
retaliatory measures has significant support among
developing country Members and LDCs as well as from
a handful of prominent scholars. 21
 financial compensation is also likely to have a
compliance inducing effect. Faced with a large
financial compensation claim (such as the $4 billion
authorization in US–FSC), a Member may decide to
expedite compliance in order to avoid financial
compensation it may either not be able to afford or
could not pay for political reasons.
 Moreover, financial compensation would likely be
more attractive to developing countries and smaller
developed country Members who may not be able to
practically or effectively retaliate against the Member
concerned.
 Bronckers and van den state that:
[F]inancial compensation (sh)ould be an additional
choice for injured Members, not a replacement for
trade compensation or retaliation. If worse comes to
worst, and the violating Member does not live up to
its obligation to pay monetary compensation, the
aggrieved Member could still be given the option to go
back to retaliation.22
 In fact, recent US FTAs have increased the usage of
financial compensation, such as by adopting a
format whereby the non-compliant country can
prevent the imposition of retaliatory trade measures
by agreeing to pay the complaining government an
annual ‘monetary assessment’ set at one-half of the
level of trade suspension (or otherwise as set by
19
GATT Document L/2195/Rev.1, Annex 4 (1964);
COM.TD/F/W.1 (27 April 1965); COM.TD/ F/W.4 (11 October
1965).
20
‘Negotiating Group on Dispute Settlement: Communication
from Nicaragua’, MTN.GNG/NG13/W/15 (6 November 1987).
21
WT/GC/W/162; TN/DS/W/17; TN/DS/W/33; Bronckers and
van den Broek (2005: 109–126); Bronckers, (2001: 41);
Pauwelyn (2000: 345–346).
22
Bronckers and van den Broek (2005: 116).
 agreement).59 But again, the monetary assessment
(financial compensation) is voluntary and cannot be
demanded by the complaining party.
 Problems arising from financial compensation: (1) it
allows the continuation of the WTO inconsistent
measure, (2) its consistency with the MFN principle is
questionable (as held by both the panel and appellate
body in EC-Poultry case)
 Other commentators have summarily dismissed the
MFN argument by merely stating that ‘providing
monetary compensation is not ‘‘an advantage, favour
or immunity’’ [sic] which must be immediately and
unconditionally granted to every Member _ Therefore,
[financial compensation] does not thereby imply that
it is to be provided on an MFN basis.23
o But the relevant text, negotiating
history and Appellate Body
interpretation of the issue in EC–Poultry
all suggest that compensation must be
administered on a non-discriminatory
basis.24
 Financial compensation is attractive as it is not trade
restrictive, it is in line with the liberalization aims and
objectives of the WTO, and it has the ability to
encourage compliance. However, the value of
financial compensation is subject to several
limitations. For instance, financial compensation will
always rely upon the willingness of the non-
compliant Member to provide the monetary
compensation. Moreover, while financial compliance
may resolve the dispute between the two parties, it
does not necessarily address the problem of
redressing the injury on the aggrieved industry.
More worrying, financial compensation allows for
the continuation of the inconsistent measure and, in
doing so, contradicts Articles 3 and 22 of the DSU.
Moreover, the consistency of financial compensation
with the MFN principle so enshrined in the WTO is at
the very least still subject to debate, while its
consistency with the SCM Agreement has not to date
been fully explored. Thus, while financial
compensation is congruent with the liberalization
aims and objectives of the WTO, its consistency with
several other systemic parts of the WTO is
questionable and uncertain. Perhaps most worrying
is the fact that financial compensation could lead to
a two-tiered system whereby richer Members could
‘buy’ themselves out of their obligations and
commitments while poorer Members could not
afford to pay compensation in order to continue
flouting their obligations and commitments.
23
Eleso (2006: 29).
24
See O’Connor and Djordjevic (2005: 132).
 WTO panels lack the inherent power of
discretion due to the atypical nature of such
bodies: a power to suspend proceedings would
thus have to be based on different grounds. 25 in
Mexico–Soft Drinks the Panel rejected Mexico’s
request not to exercise its jurisdiction
maintaining that it did not have “discretion to
decide whether or not to exercise [it] in a case
properly before it.”26 The Appellate Body upheld
the approach followed by the Panel in Mexico–
Soft Drinks, arguing that the Panel would not
have fulfilled its mandate of making “an
objective assessment of the matter before it,
including an objective assessment of the facts of
the case and the applicability of and conformity
with the relevant covered agreements” if it had
declined to exercise a validly established
jurisdiction.27 The Panel’s decision to exercise
jurisdiction was based on several provisions of
the Dispute Settlement Understanding (DSU),
43 which the Panel considered did not permit it
to choose whether to exercise otherwise valid
jurisdiction. the Panel reasoned that declining
to exercise jurisdiction would amount to failure
to perform the Panel’s duties and have the
effect of ‘ diminishing ’ the rights of the US,
contrary to Articles 3.2 and 19.2 of the DSU 28

Overcoming Jurisdictional Isolationism at the
WTO– FTA Nexus: A Potential Approach for the
WTO
 The subject matter of WTO agreements
overlaps with FTAs. As a result, disputes at the
WTO may overlap with disputes under FTAs and
within customs unions.
 WTO disputes may be linked to broader
disputes before these tribunals, although the
WTO may be seen as a more effective forum for
resolving disputes given the relative speed of
delivering
25
FRIEDL WEISS, THE WTO DISPUTE SETTLEMENT SYSTEM,
1995–2003, at 885; Lorand Bartels, The Separation of Powers
in the WTO: How to Avoid Judicial Activism, 53 INT’L COMP.
L.Q. 861, 862 (2004).
26
WTO, Panel Report, Mexico—Tax Measures on Soft Drinks
and Other Beverages, paras. 7.4–7.18, WT/DS308/R, Oct. 7,
2005.
27
Panel Report, Tax Measures on Soft Drinks and Other
Beverages, paras. 51–53, WTO Doc. WT/DS308/AB/R
(adopted Mar. 6, 2006).
28
Panel Report, Mexico – Soft Drinks , at paras 7.4– 7.9.
  Stating that it considered that the language of
the DSU was expressed in the imperative ( ‘m
embers shall have recourse to … the rules and
procedures of the DSU ’ ; ‘ panels shall address
the relevant provisions in any covered
agreement or agreements cited by the parties
to the dispute ’; and ‘ a panel should make an
objective assessment of the matter before it ’ ),
29
the Appellate Body opined that ‘ it is diffi cult
to see how a panel would fulfi l that obligation if
it declined to exercise validly established
jurisdiction and abstained from making any fi
nding on the matter before it ’ . 30 While
acknowledging that panels have inherent
powers (such as exercising judicial economy), 31
the Appellate Body opined that despite the
existence of these powers, the relevant
provisions of the DSU require panels to make a
ruling on the merits of the dispute once
jurisdiction has been established. 32 Reiterating
the Panel’s rights discourse, the Appellate Body
also stated that a member who initiates a
dispute ‘i s entitled to a ruling by a WTO
judgments and perceived greater enforcement
powers created by the threat of cross-sectoral
retaliation. Because the WTO dispute
settlement mechanism is competent to examine
only breaches of WTO law, it does not prevent
other fora such as the ICJ from successively or
simultaneously examining other aspects of a
particular dispute.33
 overlap of jurisdiction in international trade law
coupled with the rise in adjudicative fora which
have compulsory jurisdiction (such as the WTO)
increases the risk of forum shopping and confl
icting decisions being delivered and hence of
fragmentation of international law. This can
occur where divergent judgments emanate
from two different international dispute
settlement fora with the same or a similar
normative lens, such as the WTO and NAFTA. 34
29
DSU, Arts 7.2, 11
30
Appellate Body Report, Mexico – Soft Drinks , at para. 47.
31
Appellate Body Report, Mexico – Soft Drinks , at para. 45.
32
Appellate Body Report, Mexico – Soft Drinks , at para. 48-
53.
33
Nicaragua – Measures Affecting Imports from Honduras
and Colombia (WT/DS188, WT/DS201)
34
Report of the Study Group of the International Law
Commission, fi nalized by Martti Koskeniemmi,
Fragmentation of International Law: Diffi culties Arising from
the Diversifi cation and Expansion of International Law , UN
Doc A/CN.4/L.682, 13 Apr. 2006, at para 34.
 While the DSU provides that Panels must ‘c
larify the existing provisions of those
agreements ’ and that ‘r ecommendations and
rulings of the DSB cannot add to or diminish the
rights and obligations provided in the covered
agreements ’, 35 it does not limit the sources
that the WTO can utilize when ‘ clarifying ’ the
provisions of the WTO agreements, nor directly
address situations where WTO members have
entered into treaties with other members which
infl uence their rights and obligations within the
WTO framework, including jurisdictional
issues.36
 It is well settled that the WTO dispute
settlement mechanism only has jurisdiction to
decide on claims of violations of rules under the
WTO covered agreements, and cannot, for
example, decide whether a rule contained in an
FTA has been violated. However, Article 31(3)(c)
of the VCLT provides that a treaty interpreter
should, when interpreting treaty text, take into
account ‘a ny relevant rules of international law
applicable in the relations between the parties ’.
 The WTO tribunal’s limited jurisdiction does not
limit the sources of law that it is competent to
utilize when interpreting WTO agreements, 61
meaning that panels and the Appellate Body
must consider customary international law,
WTO law, and applicable external sources of
international treaty law (such as a relevant FTA)
together, in accordance with rules on the
interplay and confl ict of norms.
 However, utilizing Article 31(3)(c) of the VCLT by
taking into account FTAs when interpreting
WTO rules such as the DSU may not assist. In
the recent European Communities – Measures
Affecting the Approval and Marketing of Biotech
Products case 37 a Panel held that the obligation
to take account of exogenous rules of
international law when interpreting WTO law
applied only to those rules that were binding on
all WTO members, and not, for example, those
treaty-based rules of international law that
were binding between the disputants but not all
other members, such as FTAs.
 Pauwelyn proposes that where parallel
proceedings arise before the WTO and an FTA
35
DSU, Art. 3.2.
36
Pauwelyn, ‘ H ow to Win a World Trade Organization
Dispute Based on Non-World Trade Organization Law?
Questions of Jurisdiction and Merits’ , 37 J World Trade
(2003) 997, at 1003.
37
WT/DS291, WT/DS292, WT/DS293, 29 Sept. 2006.
 which does not contain an explicit confl ict
clause, in exceptional cases – where the
subject matter, scope, and substance of the
dispute are the same – issues of jurisdiction
should be resolved by reference to rules such as
lex posterior 67 and lex specialis . 38 Where
application of these rules signals that the
jurisdiction of one forum must prevail, he
argues that the other forum should fi nd it does
not have the jurisdiction to hear the dispute. 39

Pauwelyn:
Terms to note:
1. Natural forum
2. Fork-in-the-road provisions
a. Explicit forum selection clauses 40 and
so-called fork-in-the-road
clauses41similarly regulate
"related"though not exactly the
same-"actions."42
3. Related actions
4.

38
Pauwelyn, ‘ Bridging Fragmentation and Unity:
International Law as a Universe of Interconnected Islands ’ ,
25 Michigan J Int’l L (2004) 903, at 912– 1015.
39
Pauwelyn, supra note 58, at 1015.
40
ECHR, art. 35(2)(b)
41
NAFTA art. 2005. ID]isputes regarding any matter arising
under both this Agreement and the [GATT), any agreement
negotiated thereunder, or any successor agreement (GATT),
may be settled in either forum at the discretion of the
complaining Party .... Once dispute settlement procedures
have been initiated under Article 2007 or dispute settlement
proceedings have been initiated under the GATT, the forum
selected shall be used to the exclusion of the other ....
42
Pauwelyn, forum-shoppping (basic materials)