Multilateral and regional associations of nation-states with objectives related to international trade.
The expression “trade organization” can be used to refer to industry associations that aim to advance the interests of the firms in a given industry both domestically and internationally. The focus of the following discussion, however, is on public organizations that aim broadly at the development of international institutions to regulate international trade. Other public offices, such as the U.S. Export-Import Bank or local and national trade promotion offices conducting overseas advertising campaigns for domestic exports, are not included. Multilateral trade organizations are open to all countries, while regional (including bilateral) trade organizations usually include only countries in a given region and, in any case, restrict membership to a particular set of countries.
There are many multilateral economic organizations (e.g., the International Monetary Fund [IMF]), but the two primary organizations focusing on international trade are the World Trade Organization (WTO) and the UN Conference on Trade and Development (UNCTAD). Of these two, the WTO has the greater influence on the rules and regulations governing international trade.
The overall goal of the WTO is to promote the movement toward free international trade through the establishment of clear, generally accepted rules and the provision of assistance in resolving trade disputes between members. The WTO was launched in 1995 following the successful completion of the Uruguay Round of trade negotiations. The new organization includes the General Agreement on Tariffs and Trade (GATT), the General Agreement on Trade in Services, the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), and several other multilateral trade agreements such as the Agreement on Agriculture and the Agreement on the Application of Sanitary and Phytosanitary Measures. An International Trade Organization (ITO) had been envisaged at the time of the 1944 Bretton Woods Conference, at which the International Bank for Reconstruction and Development (also known as the World Bank) and the IMF were established. It was not until 1947, however, that the first steps toward such an organization were taken with the creation of GATT, which was supposed to be incorporated into an ITO when such an organization was formed.
An agreement to establish the ITO was reached at the 1948 Havana Conference, but the agreement was never implemented because the U.S. Congress refused to ratify it. As a result, until 1995, efforts to liberalize international trade were carried out through GATT, even though it did not have the full status of an international agreement. Officially, GATT was a treaty among a set of “contracting parties” rather than a legal entity in its own right. One reason the United States was reluctant to see the formation of a strong international organization aimed at promoting trade liberalization was the existence of U.S. agricultural support policies that might have been challenged within such an organization. Until the Uruguay Round (1986–1994), agriculture was not covered by GATT disciplines and trade in agricultural products continued to be fettered by a wide range of trade barriers and trade-distorting domestic support programs.
Two main activities were carried out under the auspices of GATT, and these two functions continue to be the primary mechanisms for promoting trade liberalization by the WTO. The first is the organization of periodic rounds of trade talks known as multilateral trade negotiations (MTNs). The purpose of these talks is to develop new agreements concerning the rules governing international trade. The Doha Round, launched in 2002, was the ninth MTN. The early rounds focused primarily on reductions in tariffs on manufactured goods. The Geneva Round in 1947, the first MTN, led to reductions in about 45,000 tariff lines in twenty-three countries. In subsequent rounds, further tariff reductions were negotiated at the same time that the number of contracting parties increased. Thus, the Annecy Round (1949) involved twenty-nine countries, thirty-two countries participated in the Torquay Round (1950– 1951), thirty-three in a second Geneva Round (1955–1956), and thirty-nine in the Dillon Round (1960–1961).
While work on tariffs has continued in all subsequent rounds, new issues have been added to the trade liberalization agenda. For example, the Kennedy Round (seventy-four participants in 1963– 1967) included an antidumping agreement, while the Tokyo Round (ninety-nine participants in 1973– 1979) added such topics as government procurement and product standards. The Uruguay Round was the most ambitious, tackling such contentious issues as agricultural trade barriers, trade-related investment measures (TRIMs), trade in services, and intellectual property rights. At the beginning of the Uruguay Round, 103 countries participated in the talks, and this number rose to 128 when it was completed. As of February 2005, 148 countries had joined the WTO. The duration of the MTN has increased along with the number of participants.
The second major function of the WTO is the resolution of disputes between member countries. The various rounds of MTNs have resulted in a set of commitments by the member governments concerning tariffs, nontariff barriers, and many other trade-related issues. Most of these commitments amount to an agreement by the government of a country to “bind” its tariffs or nontariff barriers on a given item at a certain level. An important principal of the WTO is the concept of normal trade relations (NTR), formerly known as most-favored-nation status. NTR requires that countries extend any tariff concessions made to one WTO member to all others. Thus, if a country binds its tariff on imported automobiles at, say, 5 percent, it must apply this tariff to all sources of imports. It would violate its commitments under the WTO if it offered a lower tariff to one country while charging 5 percent to all the rest. Likewise, if a country raises a tariff or a nontariff barrier above its bound level, that country would be in violation of its WTO commitments. In cases such as these, countries that are harmed by the higher tariffs or by the discriminatory application of trade barriers can file a complaint with the WTO, triggering the dispute resolution process.
Dispute resolution, unlike the periodic rounds of trade talks, is a permanent activity of the WTO at its headquarters in Geneva, Switzerland. In the original GATT, a country against which a complaint had been filed could often veto the formation of a dispute resolution panel. One of the changes introduced with the launch of the WTO at the conclusion of the Uruguay Round was the strengthening of the dispute resolution process so that countries can no longer block action on complaints filed by other countries. When a complaint is filed, the permanent secretariat of the WTO first determines whether the complaint has any merit and, if it does, calls for the establishment of a dispute resolution panel. This panel hears the arguments of both sides in the dispute and eventually renders a judgment on the complaint. If it is determined that a country has indeed violated the commitments it has made under the WTO, there are three possible remedies. First, the country can change its policies to the satisfaction of the parties that filed the complaint. If it changes its policies but the aggrieved parties are not satisfied, a new complaint may be filed. The second possible remedy is for the country in violation of its commitments to negotiate compensation for the countries filing the complaint. Finally, if no agreement can be reached on suitable policy changes or compensation, the country can maintain its trade barrier but the parties that filed the complaint are given the right to retaliate through the imposition of trade barriers of their own. Under these circumstances, the retaliatory trade barriers do not violate the WTO commitments of the countries applying them.
The main goal of the WTO is to encourage the development of a liberal trade regime. The basis for this objective is the theoretical demonstration that a regime of universal free trade is the optimal arrangement for the world as a whole. Under some circumstances (e.g., an optimal tariff), a country’s welfare can be increased through the use of trade barriers. But the gains realized by the country applying the barriers always come at the expense of other countries, and for the world as a whole there is always a net welfare loss. The economic theory of comparative advantage is based on an assumption of perfect competition internationally. This theory shows that there are welfare gains when countries specialize according to comparative advantage and trade for the goods in which they have a comparative disadvantage. Even when markets are not perfectly competitive, it can be shown that there are gains from free trade. The implication of these theoretical results is that everyone would be better off if a liberal trade regime could be established.
The problem is that this ideal state is difficult to achieve, as the use of trade barriers and other protectionist devices is widespread. The institutional framework that is needed to support liberal trade would have to include laws, rules, and regulations without which widespread protectionism is the most likely outcome. Institutions that will guarantee a liberal trade regime are international public goods. Public goods have special characteristics (nonrivalry in consumption and high exclusion costs) that give rise to a form of market failure. Because an individual cannot be prevented from consuming the public good (and therefore made to pay for it), he or she will tend to behave as a “free rider,” enjoying the benefits of the public good without contributing to its provision. Within countries, governments that take charge of providing the good and taxing citizens to pay for it overcome the public good’s problem. The classic examples of public goods are national defense and a country’s legal system. The problem with international public goods, of course, is that there is no international government to take charge of their provision. Instead, the world must rely on international organizations such as the United Nations (UN), the IMF, and the WTO.
This account suggests that one might consider protectionism to be a kind of free riding. Politicians can often realize political gains by implementing trade barriers that protect powerful industries from foreign competition. The costs of protectionism are often hidden while the political benefits are plain to see. Politicians often purport that the best situation is one in which they are able to protect politically powerful special interests while foreign governments allow open access to their markets. This is a modern form of the doctrine of mercantilism, according to which countries benefit from exports but are harmed by imports. As all politicians tend to share this perspective, there is a natural tendency for protectionism to proliferate, reducing everyone’s welfare.
One of the reasons that the delegates to the Bretton Woods Conference were eager to set up an international trade organization was their memory of the disastrous trade war set off by European nations during the 1920s and then the United States with the passage of the Hawley-Smoot Tariff of 1930. International trade contracted significantly and the economic crisis became even worse. In the absence of a world government, GATT and later the WTO were created to provide the international public good of liberal trade institutions. Assurance that a set of rules and enforcement mechanisms agreed on by all members will be applied fairly and equally is what is needed to overcome the incentives favoring protectionism, and this is what the WTO supplies.
Each successive round of trade negotiations has addressed increasingly complex issues and has lasted longer than its predecessors. If these precedents hold, the Doha Round, launched in Doha, Qatar, in 2002, may last a long time. During the Uruguay Round, the United States and the European Union (EU) worked out many of the more contentious issues, with many other countries simply following the lead of these economic heavyweights. As the Doha Round has proceeded, individual countries and coalitions drawn from all members of the WTO appear to be actively making proposals. The Doha agenda includes further work on agriculture, TRIMs, TRIPS, and such new issues as the relationship between trade and global environmental protection. Agreements in the WTO must be reached by consensus, which means that countries that do not like a particular provision can veto it or obtain exemption from that discipline. The requirement of unanimity means that any agreements reached will be the product of compromise and extensive negotiation.
The other multilateral trade organization is UNCTAD, which is a UN agency with a permanent headquarters in Geneva. Although UNCTAD has been concerned with trade issues since its inception in 1964, its main focus is on development. GATT and the WTO are linked to the UN system but have budgetary autonomy and separate identities. UNCTAD, on the other hand, responds directly to the UN General Assembly. During the 1960s and 1970s, UNCTAD was heavily influenced by the work of the UN Economic Commission for Latin America, headed by the celebrated Argentine economist Raul Prebisch, a founder of the dependency approach to development. UNCTAD became an important forum for advocates of special and preferential treatment for developing countries and those calling for a New International Economic Order (NIEO). The basis for these policy recommendations was the belief that trade and other economic relations between wealthy and low-income countries were biased against the developing countries so that a NIEO was needed to make these relations fairer and more equal. The trade-liberalizing efforts conducted under the aegis of GATT were seen as particularly dangerous to developing countries. In recent years, UNCTAD appears to have moved away from this orienta tion, although many of these ideas live on in the antiglobalization movement that developed toward the end of the twentieth century.
UNCTAD’s main goal is to assist developing countries to take advantage of trade and investment opportunities on an equal footing with high-income countries. Its primary functions are to provide a forum for discussion of policy issues, to collect and distribute data on trade and development, and to offer technical assistance to developing countries in areas related to trade such as the use of information technology to build trade relations. The organization has been successful in obtaining preferential treatment for developing countries through the Generalized System of Preferences (GSP) and the Global System of Trade Preferences, both of which have been incorporated into the WTO. It has also promoted international commodity agreements and technical assistance for the development of new industries in low-income countries. In recent years, UNCTAD has worked more closely with the WTO, and the notion that developing countries should receive special treatment in the course of trade liberalization has become central to the WTO’s work.
The aim of the multilateral WTO is a regime of universal free trade. Regional trade organizations, in contrast, strive to establish liberal trade only among a particular group of countries. Such organizations are set up by regional trade agreements negotiated by the interested parties. Regional trade agreements are discriminatory because they involve preferential treatment of the parties to the agreement. In a regional trade agreement, a country can apply lower tariffs to particular goods imported from its partners than it applies to countries that are not parties to the agreement. This preferential treatment violates the WTO principle of normal trade relations, and the WTO has had to allow exceptions to NTR for countries belonging to both the WTO and a regional trade organization. In general, regional trade agreements are accepted under the WTO as long as the average level of protection when the regional agreement is in place is no higher than the average level before the agreement was implemented.
There are many types of regional economic agreements. The most simple is a preferential agreement such as the GSP described in the previous section. The GSP is administered as part of the WTO, and no separate regional organization has been set up to implement it. Another example of a preferential agreement is the Lomé Convention, which is an arrangement between the EU and a number of African, Caribbean, and Pacific states, most of which were previously colonies of various EU members. In these cases, one set of countries agrees to lower or eliminate its general trade barriers for some other set of countries, usually on the grounds that the beneficiaries of the preferential treatment are low-income countries that need assistance in entering world markets.
A more elaborate preferential arrangement is a free-trade agreement (FTA), in which the member countries lower or eliminate trade barriers applied among them. The members of an FTA are free to maintain their preexisting trade policies with countries outside the FTA. This can lead to a problem known as “trade deflection.” Suppose that one country has a tariff of 10 percent on textile imports while another has a tariff of 5 percent. If the two countries form an FTA, there will be no tariff between them but different tariffs facing the rest of the world. Textile exporters will try to sell products destined for the country with the higher tariff in the low-tariff country and then reexport them to the other country under the FTA, thereby avoiding the higher tariff. To prevent this, most FTAs include complex rules of origin designed to distinguish imports from the FTA partners from those that actually have their origin in a nonmember country.
Another way to prevent trade deflection is for the members of the FTA to harmonize their trade policies by adopting a common external tariff regime. Free-trade areas with a common external tariff are known as customs unions. As trade expands within a customs union, countries often find it advantageous to free up the movement of factors of production (labor and capital) within the union. A customs union with free factor movements is known as a common market. Further regional integration can lead to the formation of an economic union, with free movement of goods and factors, common trade policies, and harmonized macroeconomic policies. Another form of regional integration is a monetary union in which the countries have a common currency issued by a central bank that oversees a common monetary policy. In moving from an FTA to the more elaborate regional organizations, the member countries give up increasing degrees of national sovereignty. In a customs union, they can no longer pursue autonomous trade policies. In a common market, they cannot regulate capital flows or use special qualifications or requirements as barriers to the free movement of labor. In economic and monetary unions, important macroeconomic policies are no longer under the control of the individual countries.
It has occasionally been suggested that regional trade liberalization is a more effective way to reduce protectionism than the more complex multilateral approach embodied in the WTO. This raises the question of whether economic welfare is generally increased by the establishment of liberal trade regimes in particular regions when protectionism is widespread outside the regional agreements. It turns out that the answer to this question is ambiguous, a result that follows from the theory of the second best. This theory shows that welfare may be greater when there are many violations of the conditions required for the first-best optimum than when some, but not all, of these violations are corrected.
The first fundamental theorem of welfare economics shows that a global optimum will automatically be reached if there is perfect competition, perfect information, and no market failures or barriers to entry. Suppose that an economy is perfectly competitive except for a monopoly that also generates a negative externality (e.g., air pollution). Welfare would be increased if the monopoly could be turned into a set of competitive firms and the externality corrected. But welfare may not be enhanced if the monopoly is broken up and nothing is done about the pollution externality. This is because a monopoly reduces its output relative to what would be produced by a set of competitive firms. Because the competitive firms produce more, there will be an increase in pollution and the net welfare impact may be negative.
Regional economic integration is an example of a second-best arrangement. The first-best situation is global free trade. The theory of customs unions draws on the results of the theory of the second best to show that removing trade barriers among a set of countries while leaving global trade barriers intact could actually lower welfare. When two countries form a customs union, trade may be diverted from a lower-cost producer outside the union. The EU is a customs union, and its formation led to the replacement of a wide range of agricultural imports from Australia and North America with internally produced goods. The EU has a comparative disadvantage in the types of temperate agricultural products that had been imported from Australia and North America. The diversion of trade from the lower-cost producers to the high-cost European producers led to a lowering of welfare in the EU. There are other goods, however, in which the EU has a comparative advantage. The formation of the customs union led to the elimination of trade barriers applied to these goods, and the resulting expansion of internal trade, known as trade creation, gives rise to welfare-enhancing gains from trade. In general, the formation of a customs union will lead to both trade creation and trade diversion, and it is theoretically possible that trade diversion will be greater than trade creation with the result that overall welfare will be lowered.
Empirically, it does not seem to be the case that regional economic agreements have generated such large amounts of trade diversion that they have resulted in a lowering of welfare. More important, there are dynamic effects of customs unions that are usually much greater than the static welfare effects of trade creation and trade diversion. These dynamic effects include economies of scale as firms expand to exploit the larger market created by the union, the better use of resources, and the increased competition. It appears that the overall impact of most regional agreements has been positive, at least within the customs unions formed by such agreements. This does not resolve the issue of whether a regional approach to trade liberalization is more effective than the multilateral approach of the WTO. Even if the members of regional trade organizations experience welfare gains, it will still be the case that everyone would be better off with global free trade. Because re gional trade organizations are based on discriminatory trade policies, some have expressed fears that protectionism between regional organizations could lead to lowered global welfare, particularly for countries that have the misfortune not to be part of one of the regional agreements. On the other hand, if the regional agreements are generally open to new members, it may be the case that their proliferation will actually serve to move the world closer to global free trade.
It could be said that the most successful example of a regional trade organization is the United States, which is a customs union with harmonized trade policy, a common market with the free movement of labor and capital, an economic union with common monetary and fiscal policies, a monetary union with a common currency, and a political union that renders the fifty states a single actor in world affairs. Another example of a successful regional trade organization is the EU. Six countries (Germany, Netherlands, Belgium, Luxembourg, France, and Italy) created the European Economic Community (EEC) with the signing of the 1957 Treaty of Rome. The EEC was eventually combined with other regional economic organizations such as the European Coal and Steel Community and referred to as the European Community (EC). In 1972, the United Kingdom, Ireland, and Denmark joined the EC, followed by Greece in 1981 and Spain and Portugal in 1986. In 1992, the Treaty of Maastricht was adopted to replace the Treaty of Rome, transforming the EC into the EU. The addition of Austria, Finland, and Sweden brought the membership of the EU to fifteen and the process of enlargement of the EU has continued with the accession of Poland, the Czech Republic, Hungary, the Baltic states, and several other east European countries. In 2004 the EU agreed to consider membership for Turkey if it fulfills certain political criteria within the next decade.
In the beginning, the EU was a customs union with a common external tariff. Before the adoption of the Maastricht Treaty, the EU had begun implementing a program aimed at the creation of a common market through the elimination of all remaining trade barriers and the freeing up of the movement of labor and capital. The Maastricht Treaty set out the goals of establishing economic and monetary union as well. The monetary union was created in 1998, although England, Sweden, and Denmark have opted out of the common currency, the euro, which was placed in circulation in the other member states in 2002. Besides expanding the economic agreements, the EU has set out an agenda for achieving harmonization of internal security and defense arrangements. If the EU is ever able to realize full political union, it will, like the United States, become a fully integrated nation-state.
The creation of the EU and the monetary union has required great sacrifices in national sovereignty by the member states. Individual countries are no longer in full control of their trade policies, their national standards and job certification requirements, their financial systems, and their fiscal and monetary policies. Agricultural policy is also conducted at the union level rather than by individual countries, and the EU negotiates as a single party at the WTO. In return, it appears that the members of the EU have experienced greater economic growth and prosperity than would have been achieved had they not formed the union. The EU is a formidable economic power, and its citizens enjoy high standards of living.
A less ambitious experiment in regional integration was launched in 1994 with the ratification by Canada, the United States, and Mexico of the North American Free Trade Agreement (NAFTA). NAFTA added Mexico to the preexisting Canada-U.S. Free Trade Agreement. Because NAFTA created a free-trade area rather than a customs union, it included extensive rules of origin to prevent trade deflection. NAFTA does encompass additional provisions not normally found in an FTA. These include arrangements related to investment flows as well as the North American Agreement on Labor Cooperation and the North American Agreement on Environmental Cooperation, both of which were added toward the end of the negotiations in an effort to placate labor and environmental groups in the United States that strongly opposed NAFTA. These two side agreements establish institutions to ensure that domestic labor and environmental laws in the three member countries are carried out appropriately and to work toward some har monization or coordination of these laws. The main provisions of the agreement itself set out schedules for the gradual reduction and eventual elimination of trade barriers between the three countries. As NAFTA is relatively recent, it is too early to detail the economic impact of the agreement. Most evidence so far seems to support the predictions of the ante analyses that NAFTA would have relatively small, positive impacts on income, employment, and economic growth. The borders between the three countries were relatively open and there was extensive cross-border trade before NAFTA was created, so the agreement has not in general led to radical changes in prices or trade flows. The effects of the agreement have been more significant in Mexico and Canada than in the United States, which has a much larger economy than its partners.
Other regional trade organizations include the Mercado Comun del Cono Sur (MERCOSUR; Southern Cone Common Market), the South American common market created in the 1990s by Brazil, Argentina, Uruguay, and Paraguay, the older Economic Community of West African States (ECOWAS), and many more. MERCOSUR has aspirations of becoming a full-fledged common market, while ECOWAS has never been much more than a forum for discussion. Many of the regional trade organizations established by developing countries have foundered because the member countries were more likely to be trading with former colonial powers than with each other, so the gains from economic integration were limited.
The United States participates in bilateral trade agreements with Israel and Jordan, and Chile has entered into many bilateral arrangements with countries and regional trade organizations such as MERCOSUR. At the other extreme, there has been much talk of a free-trade area encompassing all of North and South America as well as of a Pacific Rim FTA referred to as the Asia-Pacific Economic Cooperation forum. The proliferation of regional trade agreements that seems to be occurring may contribute to broader trade liberalization as the regional blocs expand and accept new members. At the same time, their existence may lower the incentives for some countries to participate in the nondiscriminatory, multilateral trade talks organized by the WTO.
The success of the WTO, the EU, and other trade organizations seems to have led to a desire to use them for purposes other than trade liberalization. This is particularly true in the case of global environmental protection. For example, many have argued that the WTO should establish a set of environmental preconditions that would have to be met by countries before they would be allowed to participate in the liberal trade regime that is the primary purpose of the WTO. The WTO and other trade organizations have also been criticized for not eradicating poverty and hunger. Because multilateral and regional trade organizations have been created to promote liberal trade, it is not surprising that they have not made much of a contribution to such nontrade international problems as global warming, HIV/AIDS, or debt relief in low-income countries. As a general rule, it seems more sensible to attack these types of problems through the creation of international institutions that target them directly than to attempt to solve them through the use of trade barriers coordinated by the WTO. In any case, the tension between liberal trade and other legitimate international concerns will continue to be an issue within the WTO, the EU, NAFTA, and other trade organizations.
E. Wesley F. Peterson
See also: Mercantilism; Nontariff Barriers; Protectionism; Tariffs.
Hoekman, Bernard, and Michel Kostecki. The Political Economy of the World Trading System: From GATT to WTO. Oxford: Oxford University Press, 1996.
UN Conference on Trade and Development. “UNCTAD in Brief” (http://unctad.org/en/aboutorg.htm, accessed August 2002).