The World Trade Organization, International Trade Relations and Issues
On June 17, 1930, the U.S. Congress passed the United States Tariff Act of 1930, also called the Hawley-Smoot Tariff Act, which raised import tariffs by 20 percent to protect American firms and farmers, adding substantial pressure to the international economic environment of the Great Depression. It was the last U.S. congressional policy which set actual tariff rates. The Act raised the United States’ already-high tariff rates, which were enacted in 1922 to protect American farmers from declining prices due to European overproduction.
In response to the stock market crash of 1929, protectionist feelings grew in Congress and the president of the United States, Herbert Hoover, consequently signed the bill. Within 2 years, over 20 foreign countries adopted similar tariffs, making worse an already-depressed world economy and reducing global trade. American trade with Europe fell by some two-thirds between 1929 and 1932, while overall global trade declined by similar levels in the 4 years that the legislation was in effect.
In 1934, President Roosevelt signed the Reciprocal Trade Agreement Act, reducing tariff levels and promoting trade liberalization and cooperation with foreign governments. From 1934 to 1947, the United States entered into more than 30 bilateral tariff agreements, and over this period, the average level of tariffs fell to about half of the 1934 levels.
In 1947, the United States and some of its allies began trade negotiations under a new set of rules that became known as the General Agreement on Tariffs and Trade (GATT). Under the terms of the agreement, countries began to meet periodically, called Rounds, to reduce tariffs and settle trade policy issues. The first five rounds were organized around reducing tariffs on specific products. With the Kennedy Round (1964–1967), countries negotiated an across-the-board percentage reductions in tariffs for a range of goods. The Tokyo Round (1973–1979) established rules on subsidies and prohibited export subsidies on manufactured goods but not agricultural goods or textiles and apparel. The Uruguay Round of GATT, which started in 1986, addressed these issues, and after over 7 years of negotiations completed the round and led to the creation of the World Trade Organization, which began operations in 1995, and today has grown to 164 countries.
The ninth major round of trade negotiations began in 2001 in the city of Doha, Qatar. Known as the Doha Development Round, its aims were to decrease farms subsidies by developed countries; reduce tariffs on manufactured goods by the developing countries; reduce tariffs on textiles and apparel that poor countries cared about; free up trade in services; and negotiate rules in four new areas—competition, investment, government procurement, and trade facilitation. After years of negotiations, the developing countries refused to accept the large reduction in their industrial tariffs in exchange for greater access to the agricultural markets of the rich countries, ending the negotiations in 2008.
Some of the key provisions of GATT (WTO) are as follows:
- Member countries cannot discriminate against each other. Every member must extend most favored nation status (MFN) to all other members. This means that if a country lowers tariffs on one trading partner, then those lower tariffs must be given to every other WTO member.
- A country is permitted to temporarily raise tariffs when the imports cause or threaten serious injury to domestic producers. These are called safeguard and escape clause provisions.
- Countries are permitted to form free trade areas and customs unions if the tariffs with the outside parties are not higher or more restrictive than the tariffs before the formation of the agreements.
- Foreign goods should receive national treatment; that is, they should be treated similarly to the same ways that domestic goods are treated once they enter a nation’s markets.1
The WTO has several essential functions. It ensures that the member countries implement the reductions in tariffs and other trade barriers. It periodically conducts a trade policy review of its members to make sure that members comply with its rules and agreements. WTO also has a “dispute settlement” process, which formalizes the process by which member countries can settle their trade disputes. Under this process, if a country accuses another country of violating the WTO rules, it can bring the case to the WTO. WTO will then select a panel of experts to hear the case and reach a conclusion. The guilty party can appeal the decision, and the case can be brought before an appellate body to review the case. If the appellate body agrees with the lower body, then the guilty country must correct its policy to abide by the WTO rules. If the country refuses to comply, then the WTO grants the country that filed the complaint the authority to retaliate.
The General Agreement on Trade in Services
The Uruguay Round also created the General Agreement on Trade in Services (GATS), which covers most rules for trade in services. Member obligations under GATS are similar to the ones under trade in goods: that is, MFN treatment, market access, and national treatment. The GATS covers all services except the services provided by the government and air transportation services.
According to GATS, there are four modes of supplying services: cross-border trade, consumption abroad, commercial presence, and presence of natural persons. Cross-border supply is defined to cover services flows from one country to another country, such as banking services transmitted via telecommunications or mail. Consumption abroad refers to situations where a person travels to another country as a tourist or a patient. Commercial presence implies that a country provided a service in another country by establishing a physical presence, such as a hotel chain. Presence of natural persons consists of persons of one country entering another member country to supply a service such as accounting, teaching, or medical services subject to residency rules set by the host country.2
The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS)
A large volume of the value of international trade is in the form of trade in intellectual property, knowledge, and branding. The Uruguay Round introduced intellectual property rules into the multilateral trading system for the first time, and members of GATT signed the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).3 Prior to TRIPS, other agreements had been established to protect intellectual property, such as the Paris Convention for the Protection of Industrial Property, the Berne Convention for the Protection of Literary and Artistic Works, and the World Intellectual Property Organization (WIPO).
The main instruments used to protect intellectual property are copyrights, trademarks, patents, industrial design, trade secrets, and test data. An interesting instrument is geographical indication, which is a name or an indication associated with a place that is sometimes used to identify a product. This geographical design does not only say where the product comes from but, more importantly, it identifies the product’s unique characteristics, which are the result of the product’s origins. Well-known examples include Champagne, Scotch Whiskey, Tequila, Darjeeling, and Roquefort cheese. Sparkling wine can only be named Champagne only if the grapes are grown in the Champagne region of France, and Tequila can only be produced in Mexico.
Intellectual property protection of pharmaceutical products has become a significant issue between the developed and developing countries. Developing countries complain that these patent protections make these drugs extremely expensive, which creates a public health problem in their countries. Drug companies argue that without patents, new drugs would not be developed due to their high costs of development and production. Another problem is with counterfeit products. Many brand name goods are sold in other countries with counterfeit trademarks, leading to loss of sales of the original brands and loss of reputation due to the poor quality of the counterfeit products.
Developing countries see technology transfer as part of the bargain in which they have agreed to protect intellectual property rights. The TRIPS Agreement aims for the transfer of technology and requires developed country members to provide incentives for their companies to promote the transfer of technology to least-developed countries to help them create a solid technological base.
International Trade and Labor and Environmental Issues
In recent years, the United States and other advanced countries have demanded that labor and environmental standards be included in trade negotiations. Labor standards refer to all issues that directly affect workers, such as health and safety standards, the use of child labor, minimum wages, and the right to form unions. Consumer groups are concerned about the poor working conditions and “sweatshops” in poor developing countries. Labor unions are concerned that the absence of minimum wages and lack of collective bargaining in those countries gave an unfair cost advantage to those countries, thus threatening jobs in the advanced economies. In response to these demands, corporations have started to monitor and improve the working conditions of their overseas plants and contractors. However, in practice, this monitoring is inadequate and has led to major industrial tragedies, such as the collapse of a garment factory in Bangladesh in 2013, which killed more than a thousand workers. Shortly after the disaster, Walmart and other American and European retailers stopped buying garments from certain factories based on the suppliers’ poor record of safety standards. Some governments have relied on the use of trade barriers to enforce labor standards. The U.S. administration under President Obama dropped Bangladesh from the list of countries eligible for a program called the Generalized System of Preferences, which gives low tariff to low-income countries.
Some proponents of trade barriers sometimes use the issue of labor standards as a means of protecting the domestic industries and their workers. This explains why many developing countries are opposed to labor standard negotiations by the developed countries. There is a suspicion that efforts by developed countries for labor standards are a way to weaken the comparative advantage of low-income countries in such industries as textiles and apparel, which require an abundance of low-skilled, low-productivity, and low-wage workers.
Another concern of proponents of trade barriers is that developing countries intentionally lower their labor standards to attract foreign direct investment. In practice, there is little or no evidence that countries use low labor standards to invite foreign investment. While there is evidence that a country can reduce production by prohibiting the formation of labor unions, there is no evidence that this type of policy has given any country a comparative advantage that it did not already have. Many of these low-income countries have not only low labor standards but also poor roads, ports, power supply, schools, and telecommunications, which discourages foreign investment.
Many opponents of free trade claim that trade is harmful to the environment and thus propose putting trade barriers to enforce environmental standards. It is true that industrial production can lead to environmental damage, but we must distinguish between environmental impacts that remain within the country and those that cross national boundaries.
Opponents of trade barriers to enforcing environmental standards claim that compliance with domestic environmental standards increases the cost of production and will reduce the competitiveness of firms. This encourages countries to lower their environmental standards to stay competitive. Furthermore, it causes countries with high environmental standards to move their production facilities to countries with low standards. This was an argument against North American Trade Agreement (NAFTA), where opponents of the agreement claimed that American companies would move their operations to Mexico, which had lower environmental standards, in addition to lower labor standards.
The other concern with environmental problems is when one country’s pollution spills over to another country and when the combined industrial production of many countries leads to global problems like the depletion of the ozone layer and climate change. The WTO does not deal directly with the environment but allows countries to adopt their laws concerning environmental issues, provided these laws do not discriminate against foreign companies operating in the country. Instead, global environmental issues are addressed through international agreements such as the Kyoto Protocol, which successfully eliminated the use of chlorofluorocarbon, which contributed to the depletion of the ozone layer. In 2015 more than 190 nations met in Paris and agreed on a plan to limit climate change by submitting national plans to reduce carbon emissions, with the United States withdrawing from the accord in 2017.
Preferential Trading Arrangements
An alternative to multilateral negotiations to trade liberalization is the formation of preferential trading arrangements (PTA) among two or more countries. There are several types of PTAs.
A free trade area (FTA) is when two or more countries agree to remove all tariff and nontariff barriers among themselves. Each member nation is permitted to set its own set of trade restrictions against nonmembers. An example is NAFTA between the United States, Canada, and Mexico which has been renegotiated and re-named, the United States Mexico Canada Agreement (USMCA) The United States also has FTAs with Australia, Chile, Israel, Columbia, and a host of other countries.
A customs union is an agreement between two or countries to remove all tariffs and nontariff barriers between themselves. Also, a customs union establishes a common external tariff and other trade restrictions against nonmembers.
The fact that an FTA does not have a common external tariff as does a customs union leads to a problem with FTAs. For example, suppose the United States has a higher tariff on Chinese bicycles than Mexico or Canada. China can export the bicycles to either Canada or Mexico and then ship them to the United States. To prevent this action, FTAs have rules of origin that specify what type of goods can be shipped duty-free within an FTA. For example, under NAFTA rules at least 60 percent of the product must be produced within the three countries to qualify for duty-free status.
A common market is a customs union that also allows for the free movement of factors of production across national borders within the economic bloc. The European Union is an example of a common market.
Effects of Preferential Trading Arrangement
Suppose in the United States the price of a shirt is $20.00, while in Canada, it is $8.00 and in Mexico, it is $6.00. Under these circumstances, the United States will import shirts from Mexico, since Mexico is the lowest-cost producer. Now suppose the United States sets a 100 percent ad valorem tariff on all shirts made in Mexico and Canada. The price of shirts in Canada increases to $16.00, and the price of the Mexican shirt rises to $12.00. In this case, the United States continues to import all its shirts from Mexico.
Suppose the United States establishes a free trade agreement with Canada and removes the tariff on Canadian shirts while keeping the tariff on Mexican shirts. In this case, the price of Canadian shirts falls from $16.00 to $8.00, with the Mexican shirts price remaining at $12.00. The United States will now import all shirts from Canada since it is cheaper than Mexican shirts.
The formation of this FTA has two effects on the volume of trade. First, there is a shift away from the lowest-cost Mexican producer to the lowest-cost FTA producer. This shift is called trade diversion, which reduces world welfare because the United States no longer imports from the country that has a comparative advantage. Resources are directed away from shirt production in the low-cost world producer, Mexico, and directed toward shirt production in the higher-cost partner, Canada. The second effect is the expansion of trade between the United States and Canada is called trade creation which increases the welfare of the two countries.
Whether the formation of the FTA is beneficial to the United States and Canada depends on the relative strengths of the forces of trade diversion and trade creation. Let’s examine the welfare effects of the formation of the FTA in the United States. Consumers will benefit because the price of the shirts falls from $12.00 (the Mexican price plus the tariff) to $8.00. Producer surplus falls due to the fall in the price of the shirt. The government loses the tariff revenues because it no longer imports from Mexico and Canadian imports are tariff-free. The gain offsets part of this loss in government revenues to the consumers in the form of lower prices. The remainder is a net loss to the United States because the American consumers now pay a higher price for the Canadian imports than the Mexican imports. The difference in the price between the Canadian shirt and Mexican shirt times the quantity of shirt imported diverted from Mexico to Canada represents the cost to the United States of trade diversion.
Because trade expands between the United States and Canada, however, there are gains. The drop in the price of shirts results in real production and consumption effects. Overall, the United States is better off if the benefits of trade creation with Canada are greater than the losses of trade diversion from Mexico.
WTO members are obliged to notify the WTO when they form a PTA. PTAs are discriminatory since countries in a PTA deny MFN status to non-PTA members. WTO has allowed PTAs under the assumption that the trade creation exceeds the trade diversion. The latest PTA is the Trans-Pacific Trade Partnership (TPP), which establishes an FTA among 12 countries that border the Pacific Ocean: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States. In 2017, President Trump decided to leave the partnership agreement.
1https://www.wto.org/english/thewto_e/thewto_e.htm ( accessed October 25, 2017)
2https://www.wto.org/english/tratop_e/serv_e/gatsqa_e.htm. ( November 24, 2017)
3https://www.wto.org/english/thewto_e/whatis_e/tif_e/agrm7_e.htm.