OECD Observer: Making the global market work

The OECD Observer

Making the global market work
Regional trading blocs may have their advantages, including helping to open up markets, but they can cause complications in the long run which multilateral talks then have to resolve. Though perhaps slow to start with, multilateral agreements can deliver a more effective, coherent, global marketplace.

By Ken Heydon
Trade Directorate
Published on: October 26, 2001
Page 27

As Doha approaches, it is worth reminding ourselves that liberalisation of trade multilaterally, through the WTO, is not the only game in town. Multilateral efforts co-exist with unilateral, bilateral and regional initiatives. Unilateral market opening by developing countries in services has, for example, been widespread as a way to draw in skills and investment and to strengthen the synergies between the service sector and the rest of the economy. But unilateralism can also have a darker side –where it involves the extra-territorial application of domestic laws or the imposition of the will of the stronger over the weaker members of the international trading community. Unilateral pressure can also influence regional and, particularly, bilateral preferential trade agreements. But as this year’s OECD ministerial communiqué points out, while WTO-consistent preferential trade agreements can complement coherent multilateral rules and progressive multilateral liberalisation, they cannot replace them.

Much recent interest surrounds regionalism, which broadly speaking includes bilateral as well as wider trade agreements. Regionalism commands attention first because of its scale. The percentage of world trade accounted for by preferential regional trade agreements (RTAs) is expected to grow from 43% at present to 55% by 2005 if all expected RTAs are realised. The thickening web of RTAs is bringing greater diversity and complexity to international trade relations. This includes APEC, which is a non-preferential arrangement; free trade areas where individual members retain their own, differing, tariff regimes, requiring complex rules of origin; or customs unions with a common external tariff. Some agreements, such as the European Union, go further and entail a process of deep integration, including – as we are about to witness – the adoption of a common currency.

But the key reason for the sharpened focus on regionalism has to do with motivation. Traditionally RTAs have predominantly been between adjacent countries seeking to maximise the benefits of proximity, often with a strong underlying political or strategic rationale. More recently, the growth of RTAs has reflected an additional element: a belief on the part of government that regional or bilateral arrangements are both speedier to negotiate and more far-reaching than multilateral agreements through the WTO. This creates pressure for more RTAs, as countries seek to avoid being left out. This pressure may help explain why Japan and Korea are now actively discussing RTAs, not only with one another but with Singapore in the case of Japan and as far away as Chile in the case of Korea. This is a sea change for these major traders who until now had eschewed preferential regional agreements. A similar shift away from geographic considerations – if not from traditional political ones – is also seen in free trade agreements signed recently between South Africa and the EU, between Mexico and the European Free Trade Association (Iceland, Liechtenstein, Norway and Switzerland), between the United States and Jordan and between the EU and Egypt.

Business too may have played a role in sparking these shifts. As product cycles get shorter and multilateral negotiating cycles get longer – the Uruguay Round took seven years – regional and bilateral arrangements may appear to bring speedier results in terms of opening markets. Indeed, as policymakers prepare for the WTO ministerial meeting in Doha in November, there is a perception that the business community is less engaged in supporting multilateral negotiations than it was in the lead-up to the Uruguay Round.

Building blocks or stumbling blocks?

But do RTAs actually help or hinder multilateral trade liberalisation? In fact they can do both and it is perhaps this dual characteristic which helps explain why it is so difficult for the WTO’s Committee on Regional Trade Agreements to establish whether particular RTAs conform to WTO rules and obligations. In many ways RTAs complement the multilateral trading system, by helping to foster a culture of market opening and structural reform. They promote “trade creation”, to the extent that high-cost domestic production is replaced by lower cost imports from partners. They foster growth, as market enlargement allows firms to exploit economies of scale more fully. And, as widely remarked, they can act as laboratories for deeper integration. In services, for example, the Canada-US free trade agreement provided an opportunity to test the principles of national treatment and non-discrimination in a way that helped structure negotiation of the General Agreement on Trade in Services (GATS) in the Uruguay Round, which in turn fed back into the treatment of services in the North American Free Trade Agreement (NAFTA), initially grouping the US, Canada and Mexico. But there are also potential downsides to preferential regional and bilateral agreements. They can detract from multilateral efforts by stretching scarce negotiating resources and political capital. They can distort trade through “trade diversion” to the extent that imports from low cost producers outside the agreement are replaced by higher cost production from partners within it. And, as a counterpart to breaking new ground, RTAs can cause friction between systems by generating potentially incompatible rules and standards between different RTAs and the rules and disciplines of the WTO. The most stark example of this is the proliferation of different rules of origin, which are needed to prevent third countries accessing an entire trade agreement area via the member with the lowest tariff.

RTAs are hardly a coherent way of setting the rules and standards for an expanding global marketplace. Nor does their complexity help to reduce transaction costs for business. Some countries belonging to many agreements now have 20 or more different tariff rates for the same product. Multiple dispute settlement fora can encourage forum shopping, with plaintiff countries going from one body to another in a bid to obtain satisfaction, thereby prolonging disputes and adding further uncertainty to the conduct of business. And different arrangements for contingency protection, such as anti-dumping, in different RTAs can lead to grey areas and an increased risk of trade harassment and rent seeking.

All of this can leave the global marketplace in quite a muddle. So while RTAs may break new ground, they may also leave some of the more intractable market access problems to be sorted out multilaterally.

Questions to answer

Several questions have to be asked. To what extent do RTAs really complement the WTO, even symbiotically as regionalism and the multilateral trading system give and take ideas from each other? Are RTAs more, a WTO-plus? Do particular agreements – including in sensitive areas like agriculture and textiles – go beyond or fall short of WTO commitments? How far do rules or provisions – in areas like the environment, competition policy, labour, and special and differential treatment – go beyond what might be possible, or desired, in the WTO? The OECD’s answers on these are likely to be nuanced. But they will not challenge the proposition clearly stated at this year’s OECD ministerial meeting: regionalism, though often stemming from deeply-rooted political or strategic objectives, cannot substitute for the multilateral trading system. Importantly, the predictability afforded by multilateral rules helps smaller players, whether countries or businesses. And the bigger the numbers of players, the bigger are likely to be the gains. As Jean-Jacques Rousseau, the French philosopher, put it in Du Contrat Social:

“Enfin chacun se donnant à tous ne se donne à personne, et comme il n’y a pas un associé sur lequel on n’acquière le même droit qu’on lui cède sur soi, on gagne l’équivalent de tout ce qu’on perd, et plus de force pour conserver ce qu’on a.”

(“Finally, each man, in giving himself to all, gives himself to nobody; and as there is no associate over whom he does not acquire the same right as he yields others over himself, he gains an equivalent for everything he loses, and an increase of force for the preservation of what he has.”)

Note: the English version is from a published translation of the whole work by GDH Cole,an English historian and social theoretician who died in 1959. It is available at http://www.constitution.org/jjr/socon.txt.

Making the global market work

Ken Heydon, Deputy Head, OECD Trade Directorate

References

· Moore, M., “Why the world needs a new round of trade talks”; Metzger, J.-M., “Can Qatar pick up where Seattle left off?”; and Camdessus, M., “A trade round for development”, in OECD Observer, No. 226/227, Summer 2001. Read them at www.oecdobserver.org

· Environmental Goods and Services: The Benefits of Further Global Trade Liberalisation, OECD, 2001.

· Trade and Regulatory Reform: Insights from Country Experience, OECD, 2001.

· For more information on UCTAD X, see http://www.unctad-10.org/index_en.htm

· Visit the OECD Trade website at www.oecd.org/ech/

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Technology and Trade: Competing in the World Economy

SESSION II

Michael Borrus, Co-Director, BRIE and Ronald H. Brown, Secretary, Department of Commerce

http://brie.berkeley.edu/~briewww/pubs/conf/tech_summit/session2.html

Three major themes emerged from the discussion during this session. First, participants from both government and the private sector stressed the continued problem of ensuring broad access to foreign economies for U.S. firms, emphasizing that access should be pursued through a variety of unilateral, bilateral, regional and multilateral means. Second, participants agreed that even while pursuing the goal of access aggressively, the United States must avoid a reversion to beggar-thy-neighbor policies and must continue its traditional defense of an open international trading system under multilateral GATT norms. General support was thus expressed by industry participants for the NAFTA and consummation of the GATT Uruguay Round, with some reservations about specific features of the draft Uruguay Round agreement. Third, session speakers and questioners emphasized the need for an integrated trade policy that focuses not only on foreign markets but on the domestic determinants of trade competitiveness at high wages--particularly investment in people, machinery and the supplier infrastructure of small- and medium-sized equipment, materials, component and contract manufacturers.

Significantly, administration officials also expressed the intention to reconceive trade policy broadly over the next few years to fit the specific needs of a post-Cold War, high-tech domestic economy. In particular, Bo Cutter (NEC) emphasized a "new American economic model" of trade policy with four characteristics: (1) integrating trade policy with domestic policies that promote American technology leadership; (2) pursuing reciprocal access to foreign economic systems, rather than simply to markets, thus supplanting the Cold-War trade agenda's exclusive focus on reciprocal reduction of manufactured good tariffs at the border; (3) preventing the rules and actions of other nations from determining the composition of production (i.e., the industrial sectors and production activities) of the American economy, in part by developing common international rules to contain the effects of interventionist industrial policies and to protect intellectual property; and (4) creating symmetrical international openness that would encourage ideas, technologies and investment to flow into as well as out of the United States.

Returning to the three principal themes of the session, on the first issue of ensuring foreign economic access, government and business representatives agreed that flexibility--that is, a willingness to adapt tactics and goals to changing circumstances and different markets--is crucial to success. Participants from both the public and private sectors agreed that Japan's unique characteristics do make it a "special case." George Scalise of National Semiconductor cited in particular the strong coalition between government, business, and finance in Japan that makes entering the Japanese market much more difficult, as well as predatory practices (such as dumping) that Japanese firms have used to undermine the competitiveness of even healthy U.S. firms. Past experience shows that a successful counter-strategy must include strong anti-dumping laws, specific quantitative targets for market access, and strong incentives for compliance. James Morgan of Applied Materials emphasized, however, that current Japanese economic troubles and American competitive improvements make this an ideal time for accessing Japan, a strategy he felt was available even to small business. Government officials generally agreed with these diagnoses, with Brown citing the success of the Semiconductor Agreement as a model and arguing that the administration's comprehensive focus on Japan is neither protectionist nor bashing but tactically crucial to accomplish freer-trade. However, David Lam of Expert Edge cautioned against becoming "too Japan-focused" and missing out on the tremendous business opportunities in the rapidly-expanding markets in the rest of East Asia, and particularly in China which is rapidly becoming one of the world's largest industrial producers.

Industry participants suggested that it is not always the foreign-country government that restricts U.S. exports, but actions here at home. In the case of Eastern Europe, noted Esther Dyson of EDventure Holdings, it is the U.S. government's own unilateral high-technology export restrictions under COCOM that limit exports and allow foreign competitors to claim potentially lucrative markets for themselves. While the recent decision to decontrol computer workstations significantly was widely applauded, the pace of techno-logical advance will overtake that decontrol decision within 18 months. Consequently, industry participants called for and government officials intend a thorough re-thinking of the export control regime.

Robert Saldich of Raychem offered other examples of unilateral U.S. actions that impede exports to Asia: Vietnam, a market denied to U.S. firms by the continuing embargo; and China, which will cut back on imports of goods and capital from the United States if Congress revokes China's most favored nation (MFN) status for human rights reasons. Private-sector participants warned that government inaction on the issue of tied aid has also hurt exporters. U.S. government representatives stated that while they prefer that foreign governments cease the practice of giving tied aid, a $150 million tied-aid fund has been set up in the United States to serve as a "club" in the meantime. The Commerce Secretary noted also that this administration is committed to a more aggressive policy of unilaterally encouraging foreign procurement of U.S. goods, citing the recent example of a $10 billion procurement decision by the Saudi government in which President Clinton personally intervened to help secure the sale for U.S. industry.

Increased access to foreign economies requires the pursuit of widely different policies and business strategies in different regions and nations, but participants agreed that those tactics could not be permitted to undermine multilateral open trade under GATT auspices. In pursuing this second theme of discussion, administration speakers emphasized their determination to continue pushing toward freer trade through international agreements--specifically, the GATT Uruguay Round and NAFTA. This commitment to negotiated access does not preclude the use of unilateral action, however. Frost identified the government's strategy as being a "market-oriented, rules-based" approach, saying that the administration would "pursue breakthroughs wherever possible"--using rules where possible, but also responding through quantitative benchmarks and bilateral pressure when existing rules do not keep up with changes in technology and markets. She also noted the administration's commitment to use bilateral and regional agreements as a means of strengthening (rather than undermining) multilateralism by using the more stringent conditions embodied in bilateral agreements to "ratchet up" standards of free trade in multilateral fora.

Industry participants faulted the administration not for this strategy but for the results it has achieved. They proclaimed their strong support for NAFTA as a "pro-free trade agreement that creates jobs," expressing concern only that the administration had not sold the agreement well enough: one participant complained that the message that "NAFTA means jobs expansion, not jobs contraction" had not gotten out to the public. Government speakers in turn called for industry to help sell the agreement, arguing that NAFTA's opponents are making the treaty a scapegoat for a long list of societal ills, such as unemployment and pollution, and that government needs the private sector to help overcome public fears.

On the Uruguay Round, industry support was more reserved. Although Cutter noted that the administration is pursuing market-opening in areas implied by the "new American economic model," such as intellectual-property protection, industry participants felt that the draft GATT agreement falls short in several respects. Specifically cited were the draft text's failure to ban compulsory licensing, and weaknesses in the current tariff reduction, anti-dumping, and intellectual property texts, which do not go as far as some industry representatives would like. More generally, there were several warnings that multilateralism should not be allowed to become foreign unilateralism by default, with foreign governments setting the rules in crucial areas. The administration was urged to take a tougher negotiating position or risk a diminution of support for the Uruguay Round agreement unless substantial concessions are won before the end of the year. In response, Cutter urged industry participants to support the agreement even if they disagree with specific provisions, saying that holding out for a perfect agreement would preclude any agreement. A recommendation emerged that problematic parts of the Uruguay Round text might be reserved for further negotiation, thus permitting support for the general agreement with a proviso for future improvements.

The third theme of the session emerged as several participants drew attention to the domestic determinants of trade competitiveness. Brian Turner of the Work and Technology Institute urged that government take an "integrated, systemic, strategic approach" to trade policy, concentrating not only on issues of market access but also on domestic determinants. Specifically, he called for public-private partnership in such areas as technology development and worker training, noting that because "the majority of the workforce of 2010 is already at work," government and industry must focus on upgrading the skills of those workers. As examples of what government could do, Morgan cited support for the supplier infrastructure and of cooperative activities like Joint Venture Silicon Valley (JVSV) which comprise broad coalitions of business, government, academia and labor. He also suggested that both public and private actions should be tested against a single standard: is the action or policy likely to help or hurt the long-term U.S. competitive position in the global economy? Lam cited as one such affirmative effort, JVSV's Global Trading Center which, in cooperation with the Commerce Department, is developing the capability to promote exports particularly from small business. Saldich and others called for government action to reduce the cost of investment by U.S. corporations through several measures: (1) implementation of a "permanent, significant" R& D tax credit; (2) faster depreciation for capital investments; and (3) a return to the status quo ante in the accounting treatment of stock options (referring to the newly proposed FASB rules). Finally, Morgan and others cautioned that, given the availability of competitive technologies outside the United States, federal technology development contracts should not preclude U.S. companies from utilizing global strategic alliances. All of these changes would help to encourage reinvestment in the domestic economy's export sectors, thus ensuring that new high-wage jobs would be created and that the domestic economy would benefit through exporting to take advantage of the foreign trade opportunities created by the new approaches in U.S. trade policy.

The Concise Encyclopedia of Economics

Free Trade Agreements and Customs Unions

by Douglas A. Irwin

Ever since Adam Smith published The Wealth of Nations in 1776, the vast majority of economists have accepted the proposition that free trade among nations improves overall economic welfare. Free trade, usually defined as the absence of tariffs, quotas, or other governmental impediments to international trade, allows each country to specialize in the goods that it can produce cheaply and efficiently relative to other countries. Such specialization enables all countries to achieve higher real incomes.

Although free trade provides overall benefits, it hurts some people, most particularly the shareholders and employees of industries who lose money and jobs because they lose sales to imported goods. Some of the groups that are hurt by foreign competition wield enough political power to obtain protection against imports. Consequently, barriers to trade continue to exist despite their sizable economic costs. Although it has been estimated that the U.S. gain from removing trade restrictions on textile and apparel would have been over $12 billion for 1986 alone, for example, domestic textile producers have been able to persuade Congress to keep tariffs and quotas on imports.

While virtually all economists think free trade is desirable, they differ on how best to make the transition from tariffs and quotas to free trade. The three basic approaches to trade reform are unilateral, multilateral, and bilateral.

Some countries, such as Britain in the nineteenth century and Chile and South Korea in recent decades, have undertaken unilateral tariff reductions—reductions made independently and without reciprocal action by other countries. The advantage of unilateral free trade is that a country can reap the benefits of free trade immediately. Countries that lower trade barriers by themselves do not have to postpone reform while they try to persuade other nations to lower their trade barriers. The gains from such trade liberalization are substantial: a major study by the World Bank shows that income grows more rapidly in countries open to international trade than in those more closed to trade.

However, multilateral and bilateral approaches—dismantling trade barriers in concert with other countries—have two advantages over unilateral approaches. First, the economic gains from international trade are reinforced and enhanced when many countries or regions agree to a mutual reduction in trade barriers. By broadening markets, concerted liberalization of trade increases competition and specialization among countries, thus giving a bigger boost to efficiency and consumer incomes. Britain reaped additional benefits from unilaterally lowering its tariffs in the nineteenth century because its success with free trade prompted other countries to lower their barriers as well.

Second, multilateral reductions in trade barriers may reduce political opposition to free trade in each of the countries involved. That is because groups that otherwise would be opposed or indifferent to trade reform might join the campaign for free trade if they see opportunities for exporting to the other countries in the trade agreement. Consequently, free trade agreements between countries or regions are a useful strategy for liberalizing world trade.

The best possible outcome of trade negotiations is a multilateral agreement that includes all major trading countries. Then free trade is widened to allow many participants to achieve the greatest possible gains from trade. The General Agreement on Tariffs and Trade (GATT), which the United States helped found after World War II, is an excellent example of a multilateral trade arrangement. [Editor's note: since this was written the GATT has been transformed into the World Trade Organization (WTO) in 1995.] The major countries of the world set up GATT in reaction to the waves of protectionism that crippled world trade during the Great Depression. With over 100 member countries, GATT is both an international agreement that sets the rules for world trade and an international institution that provides a forum for members to negotiate reductions in trade barriers.

As a multilateral trade agreement GATT requires its members to extend most-favored-nation (MFN) status to other trading partners participating in GATT. MFN status means that each member of GATT receives the same tariff treatment for its goods in foreign markets as that extended to the "most-favored" country competing in the same market, thereby ruling out preferences for, or discrimination against, any member country. Since GATT began, average tariffs set by member countries have fallen from about 40 percent shortly after World War II to about 5 percent today. These tariff reductions helped stimulate the large expansion of world trade after World War II and the concomitant rise in real per capita incomes among developed and developing nations alike. The gain from removal of tariff and nontariff barriers to trade as a result of the Tokyo Round (1973 to 1979) of GATT negotiations has been put at over 3 percent of world GNP.

Although GATT embodies the principle of nondiscrimination in international trade, Article 24 of GATT permits the formation of "customs unions" among GATT members. A customs union is a group of countries that eliminate all tariffs on trade among themselves but maintain a common external tariff on trade with countries outside the union (thus technically violating MFN). This exception was designed in part to accommodate the formation of the European Economic Community (EC) in 1958. The EC, which has grown from six to a dozen participating countries, has gone beyond reducing barriers to trade among member states. It also coordinates and harmonizes each country's tax, industrial, and agricultural policies. The EC aims at even greater economic integration than in a customs union by moving toward a common market—an arrangement that eliminates impediments to the mobility of factors of production, such as capital and labor, between participating countries.

GATT also permits free trade areas (FTAs), such as the European Free Trade Area, which is composed primarily of Scandinavian countries. Members of FTAs eliminate tariffs on trade with each other but retain autonomy in determining their tariffs with nonmembers.

Unfortunately, GATT has encountered difficulties in maintaining and extending the liberal world trading system in recent years. Discussions on trade liberalization often move slowly, and the requirement for consensus among GATT's many participants limits how far agreements on trade reform can go. While GATT successfully reduced tariffs on industrial goods, it has had much less success in liberalizing trade in agriculture, services, and other areas of international commerce. Moreover, slower growth of the world's economies in the seventies and eighties increased protectionist pressures worldwide. These pressures caused a proliferation of new trade barriers—such as voluntary limits on exports of steel and cars to the United States—not strictly covered by GATT regulations. Recent negotiations, such as the Uruguay Round of trade talks that began in 1986, aimed to extend GATT rules to new areas of trade. These negotiations, however, have run into problems, and their ultimate success is uncertain.

As a result many countries have turned away from GATT toward bilateral or regional trade agreements. One such agreement is the U.S.-Canada Free Trade Agreement (USCFTA), which went into effect in January 1989. The USCFTA eliminated all tariffs on U.S.-Canada merchandise trade and reduced restrictions on trade in services and foreign investment, categories not covered by GATT. Economists have estimated that the USCFTA will increase Canada's national income by anywhere from 0 to 8 percent, the particular estimate depending on the assumptions underlying the analysis. The total U.S. gain is roughly equivalent to the Canadian gain, but the percentage gains in U.S. income are much smaller because the U.S. economy is about ten times the size of Canada's. The United States also has a free trade agreement with Israel and is, together with Canada, negotiating to bring Mexico into a North American Free Trade Agreement (NAFTA), and it has contemplated bilateral or regional trade agreements with other countries in Latin America, Asia, and the Pacific. Free trade zones have recently been established in parts of South America as well.

The advantage of such bilateral or regional arrangements is that they promote greater trade among the parties to the agreement. They may also hasten global trade liberalization if multilateral negotiations run into difficulties. Recalcitrant countries excluded from bilateral agreements, and hence not sharing in the increased trade they bring, may then be induced to join and reduce their own barriers to trade. But these advantages must be offset against a disadvantage: by excluding certain countries these agreements may shift the composition of trade from low-cost countries that are not party to the agreement to high-cost countries that are.

Suppose, for example, that Japan sells bicycles for $50, Mexico sells them for $60, and both face a $20 U.S. tariff. If tariffs are eliminated on Mexican goods, U.S. consumers will shift their purchases from Japanese to Mexican bicycles. The result is that Americans will purchase from a higher-cost source, and the U.S. government receives no tariff revenue. Consumers save $10 per bicycle, but the government loses $20. If a country enters such a "trade-diverting" customs union, economists have shown that the cost of this trade diversion may exceed the benefits of increased trade with the other members of the customs union. The net result is that the customs union could make the country worse off.

Another concern is that greater reliance on a bilateral or regional approach to trade liberalization may undermine and supplant, instead of support and complement, the multilateral GATT approach. Hence, the long-term result of bilateralism could be a deterioration of the world trading system into competing, discriminatory regional trading blocs, thereby stifling world trade. Just such a disastrous experience in the thirties prompted the creation of the current multilateral trading system and makes its repair and refurbishment today an urgent task.

About the Author

Douglas A. Irwin is a professor of economics at Dartmouth College. He has formerly served on the staff of the President's Council of Economic Advisers and the Federal Reserve board.