Unit – II Foundations and Concepts of International Trade Law

International trade involves the cross-border movement of goods, capital, services and
even labour – not as such with the relations of States. In market economies, trade is an
activity carried out primarily by individuals, firms and other non-State entities. But,
international trade is also very much concerned with States; like all economic activity,
international trade is “State dependent.”

A complicating factor in the case of economic exchanges that cross borders is that in
addition to being autonomous political and legal units, in principle States are also, or at least
they try to operate as, autonomous economic units. The international or world economy is
often seen as being constituted by the separate national economies of national States. The
economy of a State as the accumulation of economic activities of individuals who live within
it – but it is also more than that. The State generally has a currency of its own and regimes to
regulate the use of that currency. The State disposes of substantial funds n its capacity as
employer. Through direct grants to individuals and through monetary and fiscal policies
States take action to affect economic activity within their borders. They adopt laws to
regulate economic activity. Even in market economies, the role of the State in relation to the
economy is a significant one. At one level the actions of States in relation to economic
activity are facilitative. States provide legal infrastructures. However, although these actions
may be facilitative, they can also be a source of restriction.

The principle of sovereignty of States would suggest that all of these actions are
perfectly within the authority of a State. Taking measures in respect of the health of its
population, encouraging employment and hence economic welfare within the State, ensuring
national security or deciding on the conflict of its foreign policy – these are surely things that
a sovereign State can do. These are all matters in the domestic jurisdiction of States. Yet such
interventions fall under the disciplines of international trade law.

States agreed to accept such disciplines because they accept that a liberal trading
order is in their interests and in the interests of all States. And it is in their interest because of
the principle of comparative advantage, that is, States that specialize in what they are efficient
at producing in the result produce more and hence enhance economic welfare. As a result,
States are better off if they do not place barriers on the import of goods into their territories
and enjoy the benefit of laws not imposing such restrictions. This rationale lies at the heart of
the GATT and of the WTO.

Nevertheless, a caveat is necessary. The adoption of a multilateral trading regime

cannot be equated simply with general acceptance of economic rationale of comparative
advantage and the idea of free trade. Rather, the widespread acceptance of liberal trading
order may result less from any philosophical or ideological commitment and more from the
actual evidence that economic growth has occurred in those States that have actively
participated in international trade since the Second World War, and a comparison of that
growth with the disastrous period of protectionism between the World Wars. That is, a liberal
trade regime is being adopted because pragmatically it seems to be better than the other
options. However, whatever the political motivation, the reality of the move to a liberal trade
order that is based on the economic rationale of comparative advantage is understandable.

Basic Concepts of International Trade Law

Most Favoured Nation (MFN)

The fundamental legal proposition of international trade law is the “most favoured
nation” principle. It was the centre-piece of the GATT and it remains pivotal to the new
regime of the WTO. On its face, it is a principle of non-discrimination, a principle of
equality. It seems an appropriate principle to have in a legal regime of States – a principle
consistent with Article 2(1) of the United Nations Charter which enshrines the idea of
equality, i.e., with the idea of equality of States.

The MFN principle developed in the context of bilateral treaties of “friendship,

commerce and navigation” which were some of the earliest ways in which states provided a
framework for the cross-border trade of their citizens. Such treaties were not limited to trade
in goods; they dealt with such matters as access to markets, the right of establishment,
freedom of movement and freedom of navigation. An MFN clause ensured that the right of
market access given to the citizens of one State would not be undercut by better rights being
granted to the citizens of another State. It provided that the rights granted were to be as good
as those granted to the “most favoured nation” with which each dealt.

This is, of course, a limited “equality” principle. It grants equality of access to

individuals from different States into the market of the state granting MFN. In that sense it
does provide equality between States, but equality only between those State that seeking
access to the market of the MFN granting State, and only in respect of those States that have
a bilateral treaty granting MFN. Under the old treaties of friendship, commerce and
navigation there was no equality with those States who had not negotiated such treaties. The
nationals of States with which treaties had been concluded were to be treated at the border in
the same way. No one was to obtain any advantage.

But there was only equality of access to market, there was no guarantee of equality
within the market of State granting MFN made no commitment to treat foreign nationals as
well as its own citizens within its domestic market – MFN did not include “national
treatment.”

Granting the nationals of another State treatment just as good as that given to the
nationals of a third State sounds like giving something for nothing and that is how MFN was
sometimes perceived. That is, benefits would only be extended if they were paid for. Using
tariffs to illustrate, it would operate in this way. Let us assume that State A signed a treaty
with State B granting conditional MFN treatment, and let us assume that there is a 20 percent
tariff on the importation of shoes from B into A. And assume further that A then signed a
treaty with State C under which it agreed that the tariff on shoes imported from C would be
only 10 percent. If the treaty between B and A had provided for unconditional MFN, then B
would be entitled automatically to have the tariff on its shoes imported into A lowered to 10
percent. It would be entitled to the same treatment as the “most favoured nation”, that is,
State C.

But where A and B have a treaty that grants only conditional MFN, then A’s tariff on
shoes would be lowered for B only if B gave A some something to pay for the benefit of the
lowered tariff – a tariff reduction on reduction on shirts imported from A into B, for example,
under conditional MFN, benefits are extended only on the basis of a reciprocal benefit being
provided. And this introduces an idea that has also been central to thinking about
international trade law, that is, the idea of reciprocity. A benefit is granted only if a benefit is
granted in exchange. Access to your market is given only in exchange for your access to the
claimant State’s market. The economic rationale for free trade shows that the belief that there
is some disadvantage in granting MFN without getting something in exchange is mistaken.
Reducing barriers to trade benefits the State that reduces just as it benefits the State whose
access to the market has been facilitated. Both obtain the benefits of increased efficiency.
 But the idea of reciprocity has not gone away. As we shall see, it has influenced the
way GATT has functioned, and it remains behind discussions about “fair” trade. It is a legacy
of what one would call “nation State thinking” in the field of international trade.

MFN and GATT

The achievement of GATT was to turn the MFN principle of non-discrimination.

What GATT did was to apply MFN multilaterally – to all GATT contracting parties. It was
no longer a principle that would apply only bilaterally, nor was it dependent on the
negotiation of a special treaty. Parties to a GATT had to grant most-favoured nation treatment
to all Contracting Parties.

Article 1 of the GATT

“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 contracting parties.”

A reduction in tariffs in favour of one State has to be granted to all contracting States.
Every GATT contracting party was to be entitled to the same treatment under GATT’s MFN
provision. This, of course, solved the first limitation of the old treaties of friendship,
commerce and navigation. MFN did not have to be negotiated on a country-by-country basis.
By becoming a party to the GATT, a State automatically got most-favoured-nation treatment
from all other GATT parties.

In addition, GATT opted for unconditional MFN. There was no need for reciprocity –
advantages, favours, privileges or immunities were to be granted “unconditionally”. The
economic rationale for free trade governed and conditional MFN was rejected. GATT Article
I said nothing about treatment received within the domestic market. Article I provided for
equality of access; it did not provide for equality within the market. That was the function of
the “national treatment” provision of GATT.

National Treatment

The principle of “national treatment” also has a long history in bilateral treaties. The
“right of establishment” is a form of “national treatment” that was frequently found in treaties
of friendship, commerce and navigation. The purpose of the “national treatment” principle in
the context of trade in goods is that once goods have crossed a border and entered a market,
there should be no distinctions made between such goods and domestic goods. Article III(4)
of the GATT articulates this principle in the following –

“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.”

The intent of this rule is to ensure that the conditions of competition are the same for
domestic as for imported goods. Thus, a State could not levy a sales tax on imported
products. Nor could it permit domestic producers alcoholic beverages to set up their own
distribution schemes but require imported beverages to be distributed through a State-
managed scheme. “National treatment” is not a principle that requires States to treat foreign
goods, foreign producers or foreign investors any better than their domestic counterparts. It
should not to be equated with the “international minimum standard” principle according to
which foreign nationals may claim better than national treatment.

National treatment is not concerned with how good or how bad treatment is – only
that it is the same for imported products as it is for domestic products. “National treatment”
along with MFN constitutes the principle of non-discrimination in international trade.

Non-Discrimination – Equality of States

The underlying rationale for the “non-discrimination” principle is international trade,

on its face, appears to conform with the idea of the equality of States. It requires that States
not discriminate against the products of other States at the border and that within their
markets they do not treat imports any differently from domestic products. That seems to be
precisely an articulation in the context of international trade of the right of each State to equal
treatment under international law as contemplated in Article 2 of the United Nations Charter.

In fact, it has been argued that the GATT principle of non-discrimination is itself
discriminatory. Equality of access to markets, it was said, discriminates in fact against
developing States. The idea that non-discrimination in GATT was in fact discriminatory vis-
à-vis developing States led to claims in GATT for preferential treatment for these countries –
claims to deviate from the unconditional application of MFN.
 The economic basis for such preferential treatment is controversial. The theoretical
argument goes that preference creates inefficiency, and thus in the long run developing
economies do not become more efficient and more productive through preferential market
access. Their artificially induced comparative advantage, it is argued, only requires continued
and strengthened preference to survive. The end result is that claims are made for even more
preference rather than for its removal.

The empirical argument against any entrenched preferential trade treatment as a

means of development is based on the economic success of certain Asian States. Their
development has occurred while participating in the world trading system, although they have
been able to take advantage of preferences available for developing States. However, “non-
discrimination” in international trade has not been perceived as an unalloyed principle of
equality.

In fact, the principle of non-discrimination embodied in the MFN and “national

treatment” rules has nothing to do with States as such. To start with, the direct beneficiaries
of non-discrimination are individuals – purchasers who are able to purchase more cheaply
and efficient producers who are able to benefit from expanded markets and greater
production. Their States benefit as a consequence of the benefits accruing to these
individuals. States were important in the context of GATT because they are the mechanisms
for achieving the objective of trade liberalisation. States formed GATT, because they were
the only mechanisms at the international level that had the mandate and capacity to negotiate
about trade liberalisation and give effect to the disciplines necessary to effect that
liberalisation. After all, it was their regulations and restrictions on trade that had to be
liberalised.

What was necessary for GATT to be effective, however, was not statehood as such; it
was that the contracting parties have responsibility for economic regulation. This is made in
the accession article of GATT which provides– “A government not party to the Agreement,
or a government acting on behalf of a separate customs territory possessing full autonomy in
the conduct of its external commercial relations and of other matters provided for in this
Agreement… on terms to be agreed between such government and the Contracting Parties.”

Now, it is true, of course, that this description fits States because they are the principal
kinds of customs territories with autonomy over their commercial relations. But statehood
was not a necessary condition for participation in such a trading regime, nor did the drafters
of GATT see it necessary to define accession in terms of States as most international
agreements would do. MFN and “national treatment” apply to Hong Kong and European
Union although they are not legally States or nations.

Non-discrimination in international trade is not about the equality of States. It is

simply a mechanism for enabling the effective operation of the principle of comparative
advantage. According to this principle, production and global welfare are enhanced if States
do not impose barriers to trade. The absence of these barriers ensures that realisation can
occur and that production is efficient.

If barriers are impose through differential tariffs – one tariff for one State or set of
States and another for other States – then efficiency cannot be enhanced. Producers of goods
will not be able to reap the benefit of their “comparative advantage” in production of those
goods if they are forced with tariff walls in their export markets. Consumers o these goods
will not reap the benefits of lower prices. Less efficient producers benefit from high tariffs
which protect their access to their domestic market. Efficiency is thus not promoted and
hence comparative advantage is not allowed to work. And if efficiency is not being pursued
as an objective and comparative advantage is not working, then the rationale for the world
trading system disappears. Trade simply becomes competition between States – economic
rather than military warfare.

Thus, non-discrimination in international trade is all about making the market

mechanism work – about ensuring that the benefits of specialisation and exchange are
realised.

Therefore, to see the principle of non-discrimination in international trade in terms of

the international law principle of the equality of States is to misconceive the function of the
principle and to misunderstand its role in the international trading system. In this sense,
international trade law and international law sound as if they are speaking the same language,
but they are talking about quite different things.

The Role of Sovereignty in the Development of International Trade Law

It would be a mistake, however, to move from recognition that the underlying

rationale of the international trading regime is economic and that the basic principle of that
regime of non-discrimination pursues an economic rather than political or social objective, to
the conclusion that States are irrelevant to international trade law. GATT and the WTO are
not concerned with statehood, but that is not the same thing as saying that States are no
longer important.

States are, of course, the principal mechanisms by which international trade law is
created – GATT and the WTO are treaties. And international trade law is implemented by
States through their domestic laws. Markets operate within legal frameworks and States
provide those frameworks. But in a further and more important sense, much of international
trade law can be understood in the light of the fact that international trade law is developed
through the activities of States. This can be illustrated by looking at the area of tariffs.

MFN in the context of GATT requires States to treat the products of other contracting
parties in the same way at the border. It did not prevent States from imposing tariffs – it is
just that tariffs have to be applied in a manner that is not discriminatory. Tariffs are not of
themselves illegal under GATT, nor are they illegal under the WTO.

In an economist view tariffs are bad because they interfere with specialisation and
exchange; because they encourage the allocation of resources to inefficient domestic industry
and discourage more efficient imports. The result is that consumers are worse off, that is, they
have to pay more than they should for the goods the buy and thus have less money available
for other purchases or for investment. As the theory of comparative advantage shows, where
States do not specialise in producing that at which they are efficient, then production suffers
and global economic welfare suffers. So, by such a standard tariffs are bad.

Why then does GATT not prohibit tariffs? Surely that would be more welfare-
enhancing than simply saying that tariffs are to be applied on an MFN basis. One reason is
that governments gain revenue from tariffs.

Furthermore, tariffs are generally regarded as better than other types of protective
measures. A tariff is transparent. Its impact is clear and it can be taken into account by
producers and importers in a way that non-tariff barriers cannot. This transparency also
makes it easier to focus on tariff reduction.

By contrast, quotas or quantitative restrictions, a common form of non-tariff barrier,

are not transparent and are much more difficult to discharge. Quotas are quite clearly
regarded as bad in liberal trade theory, and in principle at least GATT Article XI prohibits the
imposition of quotas. The philosophy under which GATT proceeded is that if protection is to
continue, then better that it be in the open, transparent form of tariffs. One of the major
achievements of the Uruguay Round was to reduce barriers to trade in respect of agriculture.
This was done in part by changing non-tariff barriers into equivalent protection in the form of
tariffs. Perhaps most significant reason for not prohibiting tariffs in GATT is that the
consequence of the immediate abolition of tariffs at the time GATT came into effect would
have been at least uncertain and at worst catastrophic.

The commitment to reducing tariffs on the basis of reciprocity, in spite of the

economic arguments that favour unilateral reductions, is an indication of the ambivalent
attitude that States have had towards liberal trading regime.

Finally, it can be said that the international trading regime that exists under the WTO
has emerged from the interplay of sovereignty or “nation State” consensus and economic
imperatives. The rules of the WTO contain both obligations on States and permissive rules of
conduct that balance shorter term nation State objectives. With a longer-term commitment to
the international trading regime, or reflect the commitment of States to particular mechanisms
and objectives that may run counter to the underlying rationale for international trade. The
WTO embodies that balance between economics and politics.

Within this framework there is considerable scope for the interplay of international
law and international trade law. Obligations under the WTO agreements are to be interpreted
in accordance with principles of international law, and on the basis of the GATT dispute
settlement process the WTO has built a binding system of international adjudication
including a binding appellate process. Thus, there are procedural, institutional and substantive
developments under the WTO that have important implications for the process and substance
of international law.