WTO and International trade cooperation

1. WTO and International trade cooperation Oatley, Chapters 2 and 3

2. The World Trade Organization and the World Trade System – Chapter 2 • Growth in world trade • 1953: $84 billion • 2005: $10 trillion • More importantly, trade grows more rapidly than output • Internationalization of production and consumption • This is based on political structures: the WTO (and its predecessor, GATT)

3. WTO • WTO – commonly negotiated and enforced rules to govern world trade • In 1995 GATT became what is now WTO • WTO • is a forum for trade negotiations • administers trade agreements • Provides mechanisms to resolve trade disputes

4. As a political system, WTO can be broken down into 3 parts: • A set of principles and rules • An intergovernmental bargaining process • A dispute settlement mechanism

5. I. WTO principles • WTO is based on 2 core principles: • Market liberalism • Non-discrimination

6. Market liberalism • Assertion: Open/liberal trade system raises world living standards • This provides the economic logic for WTO

7. Non-discrimination • Identical opportunities to trade • 2 forms: • Most-favored nation (MFN): Article 1 of GATT…. • but there are exceptions to MFN, including regional trade arrangements and customs union… • there is another exception: the Generalized System of Preferences (GSP) • National treatment: Article 3 of GATT

8. Beyond this there are hundreds of rules and more than 60 agreements since 1947, comprising 30,000 pages of text

9. II. International bargaining • Decision making process • Negotiate agreements to liberalize trade • Tarrifs • Non-Tariff Barriers (NTBs) • WTO Ministerial Conference • Agenda and target dates for conclusion of the round • Resulting agreement is ratified by WTO members • To date, 8 rounds have been concluded • The 9th, Doha Round, began in 2001 (yet to be concluded)

10. See Table 2.1 on page 26 for summary of trade negotiations and Rounds (notice the expanding range of subjects covered). • Rules provide a framework of law for international trade relations • Rule-based system • Multilateral trade system

11. III. Dispute Settlement Mechanism • Ensuring compliance by helping governments resolve disputes • Independent quasi-judicial tribunal • Investigates facts and the relevant WTO rules • Governments may be required to alter policy or compensate other countries

12. Power and interests in the World Trade System • Distribution of power in the international system • World trade system has shifted between open and liberal periods to periods in which it is closed and discriminatory • Hegemonic Stability Theory • WTO reflects the interests of those who created it • Hegemon: country that produces a disproportionately large share of the world’s total output and leads in the development of new technologies • Hegemon has economic interest in open and liberal international trade system • But, as hegemon declines, it becomes less supportive of liberal trade and the system shifts toward greater protectionism

13. Hegemonic power and the creation of the postwar trade system • Great Britain as the hegemonic power in 19th century • Industrial Revolution • Trade flourished • Late 19th century: British hegemony in decline • End of World War 1, US economy was twice as large as that of Britain • During transition, however, international trade system shifted toward discriminatory and protectionist practices

14. WWI as low point for liberal trade • US was not willing (though possibly able) to promote liberalism • 1929 Great Depression • US raised tariffs in 1930 • Trading blocs • Imperial Preference System • Other countries followed suit

15. US trade policy changed • In 19th century US was not interested in exporting since it could not compete with British firms in foreign markets • Protectionism as preferred policy • But, US industrialization made trade less threatening to US • Exports became more attractive • US industry became increasingly willing to accept lower tariffs at home in return for lower tariffs abroad

16. 1934: Reciprocal Trade Agreements Act (RTAA) • US negotiated bilateral agreements with countries to lower tariffs • 1947: GATT • 1950s: US moved to strengthen GATT • Marshall Plan: import of (critical) American goods into Europe • Asymmetric trade liberalization: US opened market to Europeans while Europeans continued to discriminate against American goods • By 1960s Europe was ready for trade liberalization

17. Hegemonic decline and the world trade system • Rise of Japan as an industrial power • Rise of Western Europe (European Union and common market, collectively represented at WTO) • US shifting toward protectionism? • US adopts more aggressive trade policy (bilateralism) • This led to concern that the multilateral trade system was at risk • However, there is also plenty of evidence that multilateral trade flourishes despite apparent US hegemonic decline • Trade rounds continue to be concluded (despite the delay in the Doha round) • WTO was established in 1995, enjoying support of developing countries

18. How to explain this? • Inertia: the US decline is leading to change, but it is not immediately apparent • OR: • Institutions: maybe a hegemon is not required to sustain it!

19. The Evolving WTO: New Directions, New Challenges • Trends: • Extension of the scope of WTO rules • Growing difficulty of reaching agreement within the WTO

20. Extension of scope of WTO rules • Not just tariffs anymore • Nontariff barriers • Intellectual property • Trade in services • Investment • Etc.

21. Agreement on Trade-Related Aspects of Intellectual Property (TRIPs) • New rules to govern services • Trade Related Investment Measures (TRIMs) • Technical Barriers to Trade and the Agreement on Sanitary and Phytosanitary Measures (SPS)

22. Problems • The problem with some of these agreements is that they can be used for protectionism under the guide of SPS (health risks from imports) • E.g. Is there anything harmful from hormone-treated beef? • So, new WTO rules intrude deeply into national policies • Doha Round: Agriculture, subsidies and service sector liberalization

23. Another problem • Reaching consensus with so many members is difficult • There were 150 members as of 2007….30 more had applied • Diverse interests (wealthy, advanced industrialized countries versus middle-income countries versus developing countries) • Additionally WTO is not popular outside (see the various protest movements mobilizing against the WTO) – problem of legitimacy • Should the decision making mechanism be changed? • And shouldn’t civil society be allowed to participate in the decision-making process? • But these are contradictory questions (effectiveness versus legitmacy) regarding the direction of reform necessary

24. The Greatest Challenge?: Regional Trade Arrangements and the WTO • Regional trade arrangement (RTA) • Free trade area (eliminate tariffs on goods, but each member retains independent tariffs on goods entering their market from nonmembers) • Customs union (member governments eliminate all tariffs on goods entering the union from nonmembers)

25. RTAs are discriminatory • Article XXIV of the GATT allows for RTAs (with proviso) • But, rapid proliferation of RTAs may threaten multilateral international trade and WTO • Impact of the European Union following demise of Soviet Union • There numerous reasons why RTAs have been gaining popularity • But, do RTAs complement or challenge WTO?

26. RTAs complement WTO in liberalizing trade, but challenge the WTO through institutionalization of discrimination • Trade creation: more trade as a result of RTA • Trade diversion: more trade between RTA members at the expense of non-members • RTA’s net impact on trade is the difference between the trade it creates and the trade it diverts • Could this all lead to protectionist trade blocs? Too early to tell where RTAs will take us

27. The Political Economy of International Trade Cooperation – Chapter 3 • Why does the WTO exist: interests • But, we also require cooperation • Cooperation, in turn, requires assurances (trust and guarantees) • Institutions are the usual method to solve this problem • WTO • Abstract logic of cooperation: • Trade theory (welfare gains) • But Prisoner’s Dilemma is constraining cooperation • Examine how WTO helps governments cooperate in order to liberalize trade and capture welfare gains

28. The economic case for trade • What are “gains from trade”? • Why does trade generate these gains? (comparative advantage)

29. Theoretical frameworks: • Partial equilibrium (focus on market for a single commodity – highlights how production and consumption of this commodity change in response to trade) • General equilibrium (focuses on entire economy – change of all goods in response to trade) – concept of comparative advantage (the underlying reason why these gains exist)

30. The gains from trade in partial equilibrium • Examine what happens when a country shifts from autarky to trade • See figure 3.1 on page 49 • ‘Consumer surplus’ increases • Horizontal line: quantity • Vertical line: price • Consumer surplus: difference between what people are willing to pay and the market price that they do provides consumers with a surplus • Producer surplus: analogous concept on the supply side • Together, consumer surplus and producer surplus depict the amount and the distribution of social welfare generated in the market • We assume here that domestic producers and consumers of shirts are ‘world price takers’ – figure 3.1 • At the world price, domestic consumers buy more shirts than domestic producers supply • As a result, trade changes the equilibrium shirt production and consumption: domestic shirt production falls, domestic shirt consumption rises, and imports fill the difference between

31. Aggregate social welfare is higher under this new equilibrium • The improvement in aggregate welfare is the gain from trade • Trade has made consumers better off • But trade has made producers worse off • Gains from trade arise because the amount by which consumers gain is greater than the amount that producers lose • Consumers have more money in their pockets with trade than without • And producers can be compensated for their losses through the gains. • This is what is meant by the claim that trade raises social welfare • We can also calculate the losses from protectionism, known as efficiency losses caused by tariffs • Consumption distortion (consumers buy too few shirts compared with world price of shirts) • Production distortion loss (producers produce too many shirts)

32. Voluntary Export Restraints • Quota rents

33. The Gains from trade in General Equilibrium • Examines how trade alters equilibrium production and consumption in the economy as a whole • 2x2x2 model, based on 2 countries, each of which produces 2 goods using 2 factors of production • Production possibility frontier (PPF) – factors are finite, so resource allocation decisions must be made…opportunity costs • Marginal rate of transformation tells us how many shirts that country forgoes for each computer it produces • Depending on our assumptions we may implicitly assume that factors yield diminishing marginal returns (although it is simpler to assume constant marginal returns, as is the case in the example from the textbook)

34. Consumption indifference curves: combinations of goods consumed to maximize collective utility • Indifference curve – consumer enjoys identical utility from every combination of shirts and computers • Slope: marginal rate of substitution

35. Production and consumption will occur where the PPF and the indifference curve are tangent. • Point e on Figure 3.2 • Under autarky, equilibrium production and consumption in the US equals 60 million computers and 120 million shirts

36. To appreciate how trade affects the equlibrium we need another country • China (figure 3.3) • Possibility frontier • Marginal rate of transformation is 20 • Point of tangency • Equilibirum: 13 million computers and 140 million shirts under autarky

37. How trade affects equilibrium production and consumption in both countries (see Figure 3.4) • Specialization • US: computers • China: shirts • US acquires more shirts per computer when it buys them from China than when it produces them at home • A computer buys 20 shirts in China whereas at home a computer buys only 3 shirts

38. How does trade affect consumption in both countries? • Equilibrium consumption in both countries has expanded beyond what was possible under autarky • US consumption expands from 60 million computers and 120 million shirts under autarky to 75 million computers and 150 million shirts • Chine consumption expands from 13 million computers and 140 million shirts under autarky to 25 million computers and 250 million shirts. • Consumers achieve greater utility: higher indifference curves = gain from trade • Principle of comparative advantage • Important: even countries that produce every good at a higher cost than all other countries gain from trade by specializing in the goods that they produce best

39. What determines which goods a country will produce relatively well and less well? • Hecksher-Ohlin (H-O) model: factor endowments • Labor and capital • Countries possess these factors in different amounts • Cost of production • Comparative advantage in goods produced using a lot of their abundant factor

40. The politics of trade cooperation • Whereas the trade theory introduced suggests the logic of unilateral trade liberalization, governments adopt the opposite logic • Invert the logic of trade theory • Analyze the domestic politics of trade policy • Interests of domestic firms are heavily represented in domestic trade politics, but the interests of consumers are often overlooked • As a result, governments care little about consumer gains and care a lot about trade’s impact on domestic industries

41. Not all domestic industries gain from trade liberalization • Trade liberalization becomes possible only through international agreements that provide reciprocal tariff reductions • But, additionally there is an ‘enforcement problem’ • Consider Prisoner’s dilemma • Considering this we note that China’s most preferred outcome is unreciprocated access to the US market; it’s second best outcome is reciprocal tariff reductions • PD is a symmetric game: payoff order for US is the same • So, ‘protect’ is a dominant strategy • That is, protect yields more utility for Chine than liberalize regardless of the US strategy • And protect is the US’ dominant strategy, too. • Pareto suboptimal • Nash equilibrium

42. Problem: international system does not provide effective enforcement mechanisms (anarchic)

43. The WTO and Trade Cooperation • Iterated prisoner’s dilemma • Conditions for shift in strategy (see page 66) • Governments must care about future payoffs • WTO helps iterate the game by creating expectations of repeated interaction • WTO provides information that governments need to in order to use reciprocity strategies • Transparency means that it is easier for governments to determine whether a specific trade measure adopted by a particular government is or is not consistent with WTO rules • WTO’s dispute settlement mechanism helps governments use the WTO to enforce trade agreements • See Figure 3.6 on page 67 (outline of standard procedure)

44. Dispute Settlement Body (DSB) creates a formal panel to investigate complaint • Three experts • Final report • Appeal of panel’s decision • DSB creates appellate body • Report • Government policy may need to be amended or compensation may be required • Process should take less than 15 months to complete • E.g. EU’s banana import regime and the WTO • This case demonstrates that WTO helps governments gain the assurances they need in order to conclude trade agreements required to capture the gains from trade