Gatt ,WTO and Globalization

Summary
What are the basic benefits of free trade? What is the role of institutions like the GATT and WTO? Brief history of GATT and WTO What are some of the big controversies over trade policy and the WTO?

Free Trade
Over the last 230 years economists have built a powerful case for lowering trade barriers and liberalizing international trade Some of the important benefits of free trade include: Increased competition which benefits consumers with lower prices and greater choice Greater economic efficiency through an international division of labour and economies of scale Faster transfer of technology and capital which creates faster growth

Exceptions
Economists have also uncovered certain exceptions to the general case for free trade. The case for free trade generally assumes a competitive economy. Under monopolistic industries or with increasing returns it may be possible for trade barriers to improve social welfare For a large economy like the US, a measure like a tariff may improve its terms of trade and therefore benefit the economy Despite these theoretical exceptions most trade economists accept the general case in favour of free trade Firstly the theoretical exceptions are not empirically important in the context of the global trade system Secondly even if in practice there may be a case for trade barriers in an increasing returns industry, identifying such an industry and calculating the optimal tariff is very difficult In practice protectionist measures will be chosen because of the political pressures rather than sound economics

Infant Industry Argument

One of the most popular arguments against free trade This says that emerging industries should be given protection so as to enable them to withstand global competition. The protection can be withdrawn when the industry matures Some of the problems with this argument is that it assumes that governments are in a position to pick long-term winners Also consumers are in effect forced to make a long-term loan to the protected industry. If the industry deserves support it should be able to raise money through the capital markets which would also allow it to grow to maturity Arguably it is not the nationality of the ownership that matters. What matters is how efficiently an economy utilizes its scarce resources There is no guarantee that the government will withdraw protection as infant industry grows. Indeed as the industry matures it may become more powerful politically.

Protection as redistributive measure

Trade barriers are often cited as a means of helping disadvantaged groups: e.g. the small scale sector or small farmers. However trade barriers are not an effective means of helping disadvantaged groups. The benefits often accrue to affluent groups. For examples trade barriers to agriculture in the EU, Japan and the US often benefit large farmers and agrobusinesses The costs are often borne by relatively poor consumers. Therefore anti-poverty programs financed by general taxation are probably a more effective method of helping the poor than trade barriers

Trade and Jobs

To understand the impact of trade on variables like employment it is important to understand the relationship between the current and capital account. Current Account + Capital Account = Net change in forex reserves In general the current account deficit will balance each other out: e.g. current account deficit will be associated with capital account surplus and vice versa Therefore while it may seem that a current account deficit may lead to lost jobs this ignores the fact that the associated capital account surplus will increase employment. Thus the US which runs large current account deficits covers those deficits by extensive capital inflows from various Asian central banks. These inflows mean that interest rates are lower than they would otherwise be which helps create employment in interestsensitive sectors like construction. This balances out the jobs lost because of the current account deficit.

Financial Globalization
While most economists support free trade in the goods markets there is more skepticism about free capital flows. There are number of reasons: Financial sector is especially prone to destabilizing market failures like contagion effects, moral hazard, adverse selection The Asian crisis showed some of the hazards of financial market liberalization. Countries like Thailand borrowed extensively short-term dollar denominated debt when it was easy to raise money during the fixed exchange rate period. However when the fixed exchange rate came under pressure and was abandoned many companies and banks were saddled with inflated debts

Hypothetical
Suppose you are in charge of the trade policy of a country and have three choices 1) 2) 3) Both countries have low trade barriers You have low trade barriers and the other country has high trade barriers Both countries have high trade barriers

Clearly 1 is the best but which is better between 2 and 3. If other countries impose trade barriers should you also raise trade barriers? Broadly speaking the answer is no though there are a few exceptions. Even if other countries impose trade barriers it doesnt make sense to raise them for your own economy. However if this is the case why dont all countries pursue free trade policies. Why are trade negotiations and the WTO needed?

Power of Interest Groups

Suppose you have a proposal to reduce trade barriers in say the toy industry A million consumers will benefit $15 per year 10 major domestic producers lose a $1 million per year. From the social point of view lowering trade barriers makes sense since the total benefit is greater than the total cost However the benefit is dispersed among a very large number of consumers who dont have the incentive to lobby for the proposal since their individual benefit is very small The 10 producers have a great deal of incentive to stop the proposal since their individual loss is great

How Trade Negotiations Help

Trade negotiations help because they link lower trade barriers in one country with lower trade barriers in many other countries This helps mobilize powerful export lobbies which can counteract the influence of domestic companies which compete with imports In terms of our previous example the 10 produces who lose 1 million dollars each may be balanced by 10 or more exporters who gain a million dollars each through trade liberalization

Trade Negotiations
Binding: Trade agreements work by imposing limits on tariff rates for different products. Once imposed countries commit to never raising tariffs above that limit Export subsidies are not allowed with the major exception of agrigulture New import quotas are forbidden though existing quotas are sometimes allowed to continue. Such quotas have gradually been reduced

Actual Tariffs versus Ceiling

Origins of GATT
After WW2 the US and UK attempted to rebuild the global economic system which had broken down because of depression and war Bretton Woods Agreement created the IMF and World Bank GATT (General Agreement on Trade and Tariffs) was signed by 23 countries in 1947 Unlike the other two the GATT was an agreement and not a formal organization though over the decades its Geneva secretariat became a de facto organization

GATT
GATT negotiations over 47 years were divided into 8 rounds The number of countries increased sharply from 23 in the first Geneva round to 118 in the last Uruguay round The scope of trade negotiations also increased over the years Dumping and non-trade barriers were discussed in the Kennedy and Tokyo rounds The final Uruguay Round extended into new areas like intellectual property, services and agriculture. This round also paved the way for the birth of the WTO

GATT rounds

Source: FAO

Growth of World Trade

Source: BBC News

World Trade Organization

The World Trade Organization was formed in 1995 as a successor to the GATT. Currently has 151 members and is headed by Pascal Lamy: a former civil servant from France.

The highest authority is the ministerial conference which meets at least once every two years and consists of all the WTO members One level below are the General Council, the Dispute Settlement Body and the Trade Policy Review Body

Functions of the WTO

Provides a forum for negotiating new trade treaties Implements and administers existing trade treaties Evaluates national trade policies to ensure they are WTO-compliant Provides poor countries with training and assistance to ensure WTO compliance Produces research on global trade issues

Principles of the Trading System

Most Favoured Nation (MFN): If a country makes a trade concession to one country it must make it to every WTO member. A few exceptions including regional free trade areas and agreements with poor countries National Treatment: Once a foreign good has entered the market it must be treated the same as a local good Stability and Predictability: Trade agreements make international transactions more predictable by committing governments to particular policies like setting ceilings on tariff rates. Fair competition: Trade agreements have provisions against dumping which is considered a form of unfair competition Promoting Economic Development: Developing countries are given more flexibility in implements agreements. Their influence during negotiations has increased in recent rounds like Uruguay and Doha

Dispute Settlement Mechanism

Compare to GATT the WTO has a better dispute settlement mechanism with much clearer procedures and deadlines Dispute mechanism reduces the need for unilateral action The process takes about 12-15 months from beginning to end Preferred solution is for countries to solve the dispute on their own Under the dispute mechanism governments have the right to appeal decisions but beyond that they cannot block the findings of the dispute panel. They must: a) Change their policies b) Offer compensation c) Face sanctions

Example: US gasoline regulations

In 1995 Venezuela raised a complaint against US environmental regulations of gasoline These regulations were less stringent for US refineries compared with imported gasoline clearly violating the national treatment principle The WTO panel ruled against the US after which the US and Venezuela negotiated new rules A good example of small country successfully using the dispute settlement mechanism However some critics complained that the WTO was undermining US sovereignty

Example: Banana Quotas

Because of their historical ties, European countries like Britain and France imposed import quotas favouring West Indian bananas against cheaper Central American imports. These were later extended to Europe In 1995, the US took the case to the WTO because the quotas affected the Chiquita Banana Company. It won the case but the EU was inititally unwilling to significantly change their import regime The US retaliated by imposing tariffs on certain European products like handbags Finally the dispute was resolved through negotiation

Doha Round
Launched in 2001 the focus was on helping poor countries The agenda included reducing trade barriers and cutting farm subsidies in rich countries which hurt farmers in poor countries So far the round has made little progress because of reluctance of the EU to open its agricultural markets and the US to meaningfully cut agricultural subsidies The greater power of big developing countries like China, India, Brazil and South Africa (G4) has also made negotiations more complicated

Agricultural Subsidies

Source: Earthtrends

Controversies
Some have argued that the WTO gives too little power to poor countries and that increased globalization damages the environment. Some critics claim that the WTO is too bureaucratic and is unaccountable to voters Another criticism is that WTO negotiations have become too complex and that bilateral, regional negotiations or unilateral reductions of trade barriers are more effective Some argue that intellectual property rights (IPR) should be kept distinct from trade negotiations

Regionalism vs global trade

There is a major conflict global trade liberalization through the WTO and regional and bilateral deals like NAFTA, Mercosur, ASEAN etc. With the failure of WTO talks the latter have become more prominent However regional deals come with various problems. They make trade rules extremely complicated They may reduce economic efficiency by diverting trade more than creating it. Smaller countries will usually have less bargaining power in bilateral negotiations with big countries

Free Trade Area and Customs Union

Customs Union: External goods face a duty when they enter the union but can move freely thereafter. Countries must choose common external tariff E.g. EU Free trade Area: e.g. NAFTA. Goods move freely between countries but face different external tariffs. E.g. Mexican shirt doesnt face duties to enter US but a Chinese shirt entering via Mexico would face duties

Conclusion
The GATT and WTO have been enormously successful in reducing trade barriers in most of the world However the WTO has many challenges in the future including: a) reducing agricultural subsidies b) handling controversies about environmental and IPR issues c) countering the trend towards regionalism and bilateralism in the trading system