The World Trade Organization and the future of multilateralism By Richard Baldwin, Journal of Economic perspectives, Winter 2016 The GATT (General Agreement on Tariffs and Trade) was established in unusual times. The demand for trade liberalization was great, because tariffs were still high from the Smoot Hawkley enactment and retaliations in the 1930s. Leaders of the largest trading nations wanted to avoid the protectionist mistakes of the 1920s and 1930s. After the outbreak of the cold war, world trade integration became a geostrategic as well as commercial issue. The US, the clear global leader after World War II wanted post-war globalization to be based on international institutions. But the US Congress did not want a new international organization. That is how a general agreement without any formal organization came into existence. Note: The Tariff Act of 1930 better known as the Smoot Hawley Tariff or Hawley Smoot Tariff was sponsored by Senator Reed Smoot and Representative Willis C Hawkley and raised US tariffs on over 20,000 imported goods. The Act and the retaliatory tariffs by America's trading partners reduced American exports and imports by more than half during the Depression. Many economists feel that the Smoot-Hawley Tariff worsened the impact of the Great Depression. Key principles behind GATT There are one general and five specific principles under GATT. The general principle is that the world trade system should be rules based, not results based. Thus, the focus is on designing the rules for conducting trade and not on the volume of exports or market share. The five specific principles are: non-discrimination, transparency, reciprocity, flexibility and decision making by consensus. Non-discrimination has two aspects: at the border and behind the border. Non-discrimination at the border is called Most Favoured Nation treatment. Any tariff which is applied, should be applied equally to all the WTO members. But exceptions are allowed like free trade agreements. Within the country, taxes and regulations must be applied equally to both domestic and imported goods. Transparency means that liberalizing trade and reducing conflicts over trade is easier when the actual policies are transparent to all.
Reciprocity means when a nation lowers its barriers to imports, it can expect other nations to do so. During the GATT days, an exception was made for developing countries who did not have to reduce their tariffs. When a nation does something that undoes the gains from a previous agreement, the aggrieved nation can retaliate. Flexibility: There are some exceptional situations in which nations can impose trade barriers. But GATT seeks to discipline such nations with various strictures and requirements for compensation. Decision making by consensus: With some exceptions, most WTO decisions are by consensus. Brief history of GATT The first phase of GATT up till 1960, began with a major wave of tariff cutting in the 1947 inaugural Geneva round. The other early rounds were not focused on tariff cutting. They considered details of rules and accessions such as those of Germany and Japan. Moreover, tariffs were not the main hindrance to trade in the 1950s. Instead, restrictions remaining from war time along with state trading and inconvertible currencies were the binding constraints. The second phase from 1960 to 1972 was triggered by European regional trade liberalization. For example, the Dillon round dealt with tariff concessions European members had to make to other GATT members in compensation for the formation of their customs union. The Kennedy round (1963-67) was an effort by the US, Japan and other large exporters to redress the trade diversion arising from the customs union. The decline in tariff rates in developed countries after about 1967, was partially due to GATT but also due to non-gatt initiatives. These included the elimination of tariffs across much of Europe and the US Canada auto pact of 1965. In this phase, regionalism and multilateralism advanced hand in hand. Tariffs in low income nations did not fall as they enjoyed special and differential treatment. The third phase of trade liberalization started in 1973. Again, regionalism and multilateralism advanced together. The Tokyo round was launched in the same year as the EU was enlarged with the admission of Britain, Ireland and Denmark. The EU signed bilateral trade agreements with most other West European nations. The fourth phase of trade talks started in the mid-1980s. In 1986, GATT members launched the Uruguay round. The US and Canada started talks about a bilateral free trade agreement. The EU was enlarged to include Spain and
Portugal, while launching the Single Market program which eliminated a vast range of non-tariff barriers. The original element in the fourth phase was tariff cutting by developing nations but they did this outside GATT. These countries signed many regional trade agreements like Mercosur in South America and the South African customs union. The Juggernaut effect Before GATT, exporters had only an indirect interest in their nation s import tariffs. But under the GATT reciprocity principle, foreign tariff levels became linked to domestic levels. The principles of GATT altered domestic political realities in developed nation members. The author has developed a model called the Juggernaut effect. The first round of tariff cuts generates momentum for trade liberalization. As tariffs drop, import competing firms face additional international competition. Many of them shrink or become less profitable or go out of business. Meanwhile foreign tariff cutting boosts the prospects of exporters. They expand and become profitable. In short, a onetime tariff strengthens the forces of liberalization. A few years down the road, another multilateral round may be launched. Exporters have an incentive to fight for domestic tariff cuts due to the reciprocity principle while import competing firms have an incentive to fight against them. But the anti-liberalization camp is weaker now and the pro liberalization camp stronger. So the government finds it politically easier to cut tariffs once again. With each succeeding round of tariff cuts, exporters become stronger, importers weaker and the trade liberalization juggernaut rolls on. This model also explains why multilateral and regional tariff cutting progress in random. Once regional tariff cuts weaken protectionists and strengthen the liberalizers, governments find it optimal to lower their tariffs both multilaterally and regionally. Indeed, regional trade agreements can kick start multilateral trade liberalization. When countries of Western Europe began to cut intra- European tariffs, the US, Japan and Canada found it necessary to respond. They lobbied for a GATT round as a way of dealing with the discrimination. The GATT negotiations process The GATT process included a set of rules designed to make political reversals difficult for individual members. A nation s past tariffs were bound in the sense that previously agreed tariff levels were not open to further negotiation. A nation s partners could retaliate against any violation of such tariff bindings by raising their own tariffs against the violating nation s exports. This ensured that each nation s exporters would be punished for any backsliding by its own government.
GATT worked on consensus. And to enable consensus, some escape hatches were provided. The Special and differential treatment clause meant that developing nations did not have to reciprocally cut their tariffs. But the developing nations were not indifferent to the success of GATT. They were free riders who liked the ride. The developed countries allowed this free riding because developing nations at that time were rather insignificant. Another escape hatch during the Tokyo round, was called the Codes approach. Each set of rules agreed upon was adopted in the form of a code that would be binding only for those members that voluntarily signed them. This usually meant the developed nations. Countries that signed the code extended the terms to those which did not, under the principle of non-discrimination. A dispute had to be settled by consensus. Blocking the dispute settlement process was another hatch. The combination of a dispute settlement procedure with an escape hatch facilitated agreements with ambiguous wording. New realities By the 1970s, tariffs in developed nations were already fairy low on the products they had been willing to negotiate. Agricultural and labour-intensive items like textiles were not on the negotiating table. Developing nations were disappointed at the lack of liberalization in agriculture and labour-intensive manufactures. The agenda was broadened during the Tokyo round with the codes approach to including non-tariff issues in the negotiations. In the Uruguay round in 1986, new areas of interest to exporters in the developed nations were added: intellectual property, foreign investment and services. These areas came to be known as TRIPS, TRIMS and Services. Agriculture and clothing were also put on the table to fuel the interest of agricultural and low wage exporters. The dynamics of the negotiations and the increasing importance of developing countries created new challenges. Developed countries already had high standards of IP protection for foreigners. So they could gain only if the developing countries adopted the IP protection standards of developed countries. At the same time, developed countries began to worry that while opening of agricultural and textile markets would benefit developing countries, they would not receive much by way of TRIPS or TRIMS. The Uruguay round ended with a feature called Single Undertaking. All members were obliged to accept all the Uruguay round agreements as one package. The new areas involved far more ambiguity and newness. There was a fear that gains achieved might be offset by clever forms of protection and
convenient national interpretation of the rules. So the Uruguay round eliminated the possibility of blocking a dispute resolution on adoption of a panel ruling. Effectively, the escape hatch was removed. Why WTO negotiations have stalled Under GATT, exports of manufactured goods grew twice as fast as the production of manufactured goods from the late 1990s till the collapse of trade in 2009. Booming trade and rising incomes encouraged member countries to follow the code of conduct. Under WTO, the progress has been disappointing. Little progress has been made on trade liberalization for almost two decades, since a handful of agreements in 1997. The Doha round that started in 2001 is stalled. Only the dispute settlement mechanism has worked properly. Why is the WTO finding it difficult to move forward? One reason is that the developed countries have lost their earlier clout. Developed countries earlier accounted for two thirds of the world s imports. That share has come down over time with the emerging economies growing much faster. The sheer number of developing countries in WTO has also tilted the agenda. Developing countries have become more active in defensive coalitions that prevent access to their own markets than in offensive coalitions focused on getting better access to foreign markets. The reciprocity principle and small size of the developing markets meant that they had limited availability to ask foreigners to open up their markets. So, there was little to gain from offensive coalitions. In contrast, the consensus principle gave developing nation coalitions a good deal of blocking power, which they have used especially for their most politically sensitive markets. Regionalism has also created challenges. Regional trade agreements have always been a part of the intentional trade negotiations agenda. But from around 1990, their role has changed. As the number of regional trade agreements has increased, the political and economic capital consumed in the negotiations has also increased. The Doha round might have been more successful if WTO had been the only game in town. Many of the regional trade agreements have gone beyond tariff cutting and included legally binding assurances aimed at making the signatories more business friendly towards trade and investment flows from other signatories. In the late 1990s, many bilateral investment treaties were signed. This was a clear indication that many WTO members were interested in areas that went beyond what the WTO was set up to negotiate.
The rise of offshoring redefined industrialization. Earlier, it meant building a supply chain at home to become competitive abroad. High tariffs were an integral part of the process. In the new scheme of things, countries joined an international supply chain to become competitive and then industrialized by expanding the quantity and range of tasks performed. In this new model, tariffs hindered rather than helped industrialization. So, developing nation tariffs started falling independent of WTO negotiations. Two-way tariff cutting had earlier been the main fuel for trade liberalization. But now exporters saw their sales to developed nations boom even as the Doha round struggled and went through round after round of failure. There was no longer the need to fight domestic protectionists at home when foreigners were lowering their tariffs unilaterally. GATT negotiations typically involved the US, EU, Japan and Canada bargaining among themselves over tariff cuts and then giving the developing countries a free ride. In contrast, in WTO negotiations, all but the poorest countries are expected to agree to binding tariff cuts and other policy commitments. The Doha round talks are binding on every member unless explicit exceptions are made. It is no longer the don t obey don t object option that developing nations had under earlier GATT talks. So, it is not a big surprise that developing countries have been far more vocal in the Doha round, in a bid to protect their domestic interests. Multilateral negotiations under WTO are far more challenging than under GATT. The Doha round has more than 100 potential veto players unlike the GATT when the central negotiations involved the US, Canada, Japan and the EU. Business interest in the negotiations is low. This is because industrial trade accounts for 80% of all trade. But tariffs had already been lowered in developing and developed countries. The exporters of developed nations were now the free riders on unilateral tariff cutting by emerging markets. They were no longer interested in lobbying their own governments for a Doha deal. WTO tariff cutting talks focus on bound tariff rates and not applied rates. For many WTO members, actual applied rates are much lower than the bound rates. If the developing nations had not lowered their applied rates so much below their bound rates, developed nation exporters would have had something to fight for. In agriculture, the biggest protectionists, EU and Japan have lowered distortions unilaterally for purely domestic reason. Farm populations have dropped so that the power of rich nation farm lobbies has dropped. The EU has broadly switched its agriculture support policies to non-trade distorting forms
and basically eliminated export subsidies in major reforms that took place in 2003, 2008 and 2013. Agricultural trade is far from free and fair. But the mercantilist gains from a conclusion of the Doha round is lower in 2016 than it would have been in 2001. Meanwhile, many emerging economies have deployed some of their new-found wealth in new trade distorting agricultural policies of their own. The rise of offshoring has shifted the focus to areas that were not included in the Doha round s 2001 agenda. WTO members have vetoed the expansion of the agenda. And they are using regional free trade agreements and bilateral investment treaties to get around the situation. The new world involves a nexus of trade in goods, services, knowhow, physical investment, key personnel and financial capital. Developed countries are in general happy to offshore work to the developing countries provided they respect their tangible and intangible property rights and ensure that the necessary flows of goods, services, investments will be unimpeded. The institutional mechanism for getting these assurances has not been the WTO but regional trade agreements and bilateral investment treaties. The political economy has switched from my market for yours to my factories for your reform. The WTO seems frozen in time with the Doha round having made little progress. Talks are focused on trade in industrial and agricultural goods when the world has really moved forward. Meanwhile, a lot of progress has been made in internationalizing production outside the ambit of the WTO through regional trade agreements and bilateral investment treaties. Scholars like Bhagwati have argued that regional trade agreements would lead to inefficient diversion of trade. But overall econometric evidence suggests that trade diversion due to bilateral and regional trade agreements may not be that much of a concern. The preferential tariffs that these agreements introduce have not blocked global tariff cutting. Trade diversion becomes relevant only when a bilateral treaty is truly discriminatory against trade from countries not included in the agreement. But many of the regional agreements concern matters where such discrimination is impractical. For example, in today s globalized environment, it is difficult to identify the nationality in a way that clever lawyers cannot find ways to circumvent. With the rise of China, offshoring and unilateralism, the negotiating items on the Doha agenda no longer provide a win-win bargain for all. Any attempts to expand the WTO agenda are blocked by countries who have been largely left aside by the rise of offshoring. Those countries are still looking for reduced barriers to exports of agricultural and labour-intensive goods.
The emergence of the so-called regionals like the Trans Pacific partnership and Trans-Atlantic Trade and Investment partnership can be thought of as a partial multilateralization of existing deep disciplines by sub groups of WTO members who are deeply involved in offshoring and global value chains. These mega regionals are not a good substitute for multilateral agreements. They will lead to fragmentation of the international trading system. Concluding notes The WTO does not look like going beyond the Doha round and address deep disciplines. The WTO seems to be moving towards a two-pillar system. The first pillar, the WTO continues to govern international trade as it has done since it was set up in 1995. The second is the mega regionals which focus on trade in intermediate goods and services, investment and intellectual property protection, capital flows and the moment of key personnel. China and India may stay not join these groupings and may negotiate terms from outside the group.