Political Economy of Trade Policy and the Multilateral Trading System (MTS)

1. Political Economy of Trade Policy and the Multilateral Trading System (MTS)

2. Objective • Understand economic and political rationales of trade policy choices • Understand arguments for and against free trade • Introduce the multilateral trading system and its key principles

3. Outline • Arguments for free trade • Arguments against free trade • National welfare argument • Terms-of-trade argument • Income distribution argument • Median voter theorem • Key principles of the multilateral trading system

4. Free trade vs. protectionism • Trade Theories attest the generalsuperiority of free trade over protectionism (and autarky, i.e. no trade, in the extreme case)! (See the emphasis carefully). • Does not mean that there is a consensus on this issue. • Does not mean no one losses from trade – in trade there are winners and losers • Does mean that on aggregate the gains from trade exceed the loses.

5. Free trade vs. protectionism • Trade is seen as engine to growth and higher living standards. • It is argued that free trade: • Increases efficiency (everyone specializing in production of what he/she can do better) • Economies of scale (enlarges markets) • Dynamic gains (competition, learning, innovation) • Lowers the chance of being subverted by interest group politics

6. Why then wide spread protectionism exists?

7. Arguments against free trade • National welfare arguments • Terms of trade argument • Market failure argument • Income distribution arguments

8. National welfare argument • Terms of trade argument, i.e. • levying tariffs so as to lower price of imports (a case for big countries that can influence international price through their demand) • Tax exports (negative subsidy) so as to increase price of exports (e.g. Saudi Arabia’s export tax on oil). • Difficulty with this argument • All large countries have this incentive • Retaliation/trade wars

9. National welfare argument … Cont’d • Market failure argument • Externalities • Producer and consumer surpluses do not properly measure costs and benefits • Argues that when marginal social benefit is different from producer surplus (i.e. positive production externalities) an import tariff is justified. • Dysfunctional labour markets • unemployment etc

10. National welfare argument … Cont’d The Domestic Market failure argument .. Cont’d • is part of the theory of the second best: • Theory of the second best • concerns what happens when one or more optimality conditions (conditions that would make markets to function perfectly) cannot be satisfied in an economic model. • If demand and supply in labour market are not equal (e.g. unemployment), should prices in goods market set at market-clearing levels? • First-best policies • It is always preferred to deal with market failure as directly as possible.

11. Income distribution argument • Rather than maximizing national welfare, politicians maximize likelihood of election/reelection • See the Median voter theorem below here • According to this theorem, a policy should be chosen with a view to pleasing many voters. But, is that the case in trade policy?

12. Median voter theorem … • In trade policies, the median voter theorem does not seem to be a strong case, i.e. often a small group will manage to influence the policy (E.g. U.S. sugar quota and subsidy)! Why? • Answer: public good nature of political activity on behalf of a group (The economist Mancur Olson first pointed out this fact). • Politically effective and well-organized groups win in trade policy!

13. The Multilateral Trading System (MTS)

14. The MTS • What is the MTS? • What are its major principles?

15. What is the MTS? • The MTS refers to: • A set of multilateral (international) rules that govern international trade. • These rules are multilaterally negotiated and agreed under the auspices of formerly the GATT and now the WTO. • The rules are implemented nationally by each government. • The multilateral trading system was created out of the ashes WWII.

16. Major principles of the MTS • Non-discrimination • Most favoured nation treatment • National treatment • Tariffs only regime (with some exceptions for agricultural goods) • Continuous negotiation towards further liberalization. • Binding and enforcement – commitments are binding and enforceable through dispute settlement systems

17. The MFN Clause Article I of GATT 1994 reads: ‘… any advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties.’ (Article I.1 of GATT).

18. ? ? The MFN Obligation: When Privilege is to a WTO Member A extends advantage to G: who should it extend to?

19. ? The MFN Obligation When Advantage is to a non-WTO Member A extends advantage to H: who should it extend to?

20. The National Treatment Principle • Article 3 (4). of GATT “The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use. …”

21. “Like Products”? Central to both MFN and NT is the concept of “like products’ What does ‘like products’ mean in the WTO legal system?

22. Why MFN?

23. The Origin of MFN • As a concept of international trade policy, MFN has a long history dating back to the twelfth century. • But, it seems to first appear in written agreements in the 17th century in US-France trade deal (see, Prof. John Jackson). • Its objective and purpose is the prohibition of discrimination among like products

24. Rationale for MFN • Loosely categorized as: • Economic • prohibition of discrimination on “like products” • Reducing trade distortions; • Expansion of multilateral trade; • Less costly than web of bilateral agreements • Political (or “less economic considerations) • Reducing political tension that discriminatory trade policy would have created

25. Criticism on MFN • Erosion of special and differential treatments for developing countries • Encourages “free-riding” • Free-riding could lead to a subtle protectionism (see an example in the next slide)

26. The achievements of MTS: • The MTS is in general credited to have: • Contributed to the massive reduction of trade barriers during the last half century • Contributed to the unprecedented expansion of global trade; hence helped growth and development; • Contributed to easing trade tensions (trade wars);

27. MTS: the criticisms • Lopsided/Unbalanced/unjust rules • Barrier to market entry for certain products of poor countries textiles and garments and agricultural products • Narrowly focused on trade liberalization • Deficiency in social dimension of trade

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