----------------------- Page 1--------------------------------------------- Page 2----------------------THE P O L I T I C A L E C O N O M Y WORLD T R A D I N G SYSTEM ----------------------- Page 3----------------------This page intentionally left blank ----------------------- Page 4----------------------The Political Economy of the World Trading System The WTO and Beyond BERNARD M . H O E K M AN M . KOSTECK I OXJORD UNIVERSITY PRESS ----------------------- Page 5----------------------Second Edition MICHEL O F TH E Second Edition

OXPORD UNIVERSITY PRESS Great Clarendon Street, Oxford 0x2 6DP Oxford University Press is a department of the University of O xford. It furthers the University's objective of excellence in research, sch olarship, and education by publishing worldwide in Oxford New York Auckland Cap e Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid M elbourne Mexico City Nairobi New Delhi Shanghai Ta ipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Ox ford is a registered trade mark of Oxford University Press in the UK and in certain other countries Pu blished in the United States by Oxford University Press Inc., New York Bernard M. Hoekman and Michael M. Kostecki, 2001 The moral rights of the author have been asserted Database right Oxford University Press (maker) First published 2001 All rights reserved. No part of this publication maybe reproduced, stored in a retrieval system, or transmitted , in any form or by any means, without the prior permission in writin g of Oxford University Press, or as expressly permitted by law, or under term s agreed with the appropriate reprographics rights organization. Enquiri es concerning reproduction outside the scope of the above should be sent t o the Rights Department, Oxford University Press, at the address above You must not circulate this book in any other binding o r cover and you must impose this same condition on any acquirer British Library Cataloguing in Publication Data Data available Library of Congress Cataloging in Publication Data Hoekman, Bernard M., 1959the political economy of the world trading system : the WTO and be yond / Bernard M. Hoekman and Michel M. Kostecki p. cm. Includes bibli ographical references and index. 1. International economic relations. 2. General Agreement on Tariffs and Trade (Organization) 3. World Trade Organization. 4. Internatioanal trade. 5. Tariff. I. Kostecki M. M. II. title. HF1359 .H64 2001 382 dc21 00-068686 I SBN 0-19-829434-4 ISBN 0-19-829431-X (Pbk.) 7 9 10 8 6 Printed in Great Britain on acid -

free paper by T.J. International Ltd., Padstow, Cornw all ----------------------- Page 6----------------------To Adriaan, Alexandre, Isabelle, and ----------------------- Page 7----------------------This page intentionally left blank ----------------------- Page 8----------------------PREFACE Starting as an obscure trad e agreement, unknown to most citizens of par- ticipating countries, by the early 1990s the General Agreement on Tariffs and Trade (GATT) had bec ome a prominent institution. The Uruguay Round of multilateral trade neg otiations, held under its auspices during 1986-93, played an im portant role in raising its public profile, catapulting it into the limeligh t for the first time in its history. The Uruguay Round led to the crea- tion of the World Trade Organization (WTO), and expanded the coverage of the multilateral trading system to include trade in services and int ellectual property rights. At the time the first edition of this book was being written (1993-4), no readily accessible, yet compr ehensive, introduction to the economics and politics of the t rading system existed. The GATT was a rather reclusive in- stitu tion. Information about its operation was not easy to obtain . Many documents were confidential, with distribution restricte d to government officials. This situation changed dramatically subsequent to the establish- ment of the WTO and the concurrent em ergence of the Internet. A plethora of WTO documents and reports can now be downloaded freely from the WTO home page (www. wto.org). Greatly expanded coverage of the institu- tion in the press both p rint and online also makes it much easier than in the past to remain u p-to-date with respect to WTO-related events. At the same time, inte rest in the WTO has increased. The WTO is repeatedly at the center of hig hly visible and public disputes on issues that go beyond trade and concern large groups of people. Examples are disputes between th e US and the European Union (EU) on the use of hormones in beef, and dis putes between the US and other WTO members regarding the extra-territorial ap- plication of US laws. Some argue strongly that the institution needs to ex- pand its mandate and develop clear rules of the game in these areas, others argue equally vehemently that it needs to be scaled back. As in the first edition, the bulk of the material in this book is devoted to systemic and conceptual questions relating to the functioning of the trading system. What matters in this connection is not o nly an understanding of the rules, but also the political and economic forces that sculpted them, and the incentives for countries to abide by them. G overnments are not necessarily the social welfare-maximizing entit ies found in introductory economics textbooks, but develop policy s ubject to the pressures of a variety of interest ----------------------- Page 9----------------------viii Preface groups. A political econ omy approach helps to understand how the WTO functions, wh y the GATT was very successful in reducing tariffs, and why it has pr oven much more difficult to expand the reach of multilateral disci- plines to domestic policies that have an impact on trade. This seco nd edition is almost a complete rewrite. It updates all data and ref erences to the rapidly expanding literature, including relevant Internet web sites. All chapters have been revised extensively, and a number are new. A significant amount of new material on the operation of the WT O has been added. This includes discussions of the dispute settlement Thomas

mechanism, the outcome of sectoral negotiations undertaken since the conclusion of the Uruguay Round in 1994, the experience w ith the process of accession, par- ticipation by developing countries, t he role and interests of nongovernmen- tal organizations in the trading sys tem, concerns regarding the governance and legitimacy of the WTO, and the need for multilateral rules on invest- ment and competitio n. More boxes and examples have been incorporated into the text to relate the operation of the trading system to the real-wo rld economic interests that underpin and are affected by it. A new annex has been added providing a succinct introduction to basic economic concepts and tools that are helpful in unde rstanding the effects of trade policy in- struments and key WTO disc iplines. To enhance the readability of the book we have kept footnotes to a mini- mum and avoided the use of endnotes altogether. This implies that readers will not find detailed references to WTO cases and do cuments. Information on all WTO dispute settlement cases discussed in t his book can readily be found on the home page of the WTO and in the spe cialized works cited at the end of each chapter. There is an immense legal liter ature on WTO issues and cases one objective we had in writing this book was to complement the many legal articles and books by focusing mor e on the policy, economic and development-related aspects of the trading syste m. We owe a substantial intellectual debt to those who have written o n vari- ous aspects of the multilateral trade regime, to many members of the WTO secretariat, both past and present, as well as to numerous trade n egotiators, government officials and scholars. Some of the material used in this book draws on joint work and interactions with numerous co lleagues and friends, including Kym Anderson, J. Michael Finger, Joseph Fran cois, Peter Holmes, Michael Leidy, Patrick Low, Aaditya Mattoo, Petros C. Mavroidis, Patrick Messerlin, Carlos Primo Braga, Jayanta Roy, Kamal Sag gi, Maurice Schiff and L. Alan Winters. We are indebted to Petros C . Mavroidis for reading and commenting on drafts of both the first and second editions of this book, to Mark Koulen for identifying sins of co mmission and omission in the penultimate draft of the ----------------------- Page 10----------------------Pre face ix manuscript, to Maarten de Groot, Maria Kasilag, and Francis Ng for pulling together da ta and preparing the figures, and to Lili Tabada for helping to put together the Index. We are also grateful to Marco Bronckers, Rashad Cassim, Bil l Davey, Alan Deardorff, Ishac Diwan, Alice Enders, Philip English, Simon Evenett, Mike Finger, Gary Horlick, Henrik Horn, Bob H udec, Serafino Marchese, Will Martin, Keith Maskus, Aaditya Mat too, Patrick Messerlin, Costas Michalo- poulos, Marcelo Olarreaga, Pier Carlo Padoan, David Palmeter, Carmen Pont-Viera, Garry Pu rsell, Frieder Roessler, Andre Sapir, Richard Snape, T.N. Srinivasan, Bob Stern , David Tarr, Diana Tussie, John Whalley, John Wilson, Alan Winters, Jamel Zar rouk and B.K. Zutshi for helpful comments, discus- sions and sugges tions along the way. Last but not least, we are indebted to Mari a Kasilag for her invaluable assistance in preparing the came ra-ready copy of the manuscript and finalizing the index, to Yvett e Fischer, Rebecca Martin, and Ana Rivas for helping bring the proje ct to fruition and to the University of Neuchatel for financial suppor t. None of the above is responsi- ble for the views expressed in this volum e or any inaccuracies. That respon- sibility is ours alone. B.M.H. M.M.K. ----------------------- Page 11-----------------------

This page intentionally left blank ----------------------- Page 12----------------------CONTENTS LIST OF i LIST OF BOXES xvii LIST OF ABBREVIATIONS xix Introduction FIGURES xv LIST OF TABLES xv

1 PART I: THE GLOBAL TRADING SYSTEM 1. The Trading System in Perspective 9 1.1. Trade and Glob al Integration 9 1.2. Trade and Trade Agreements in History 19 1.3. Functions of the Multilateral Trading System 25 1.4. From GATT to WTO 37 1.5. The Challenge of G lobal Cooperation 41 1.6. F urther Reading 44 PART II: THE INSTITUTION 2. The World Trade Organization 49 2.1. Scope, Functions and Structure of the WTO 50 Decisi. on-Making 56 2.2 2.3. Transparency: Notificati on and Surveillance 61 2.4. Acces sion 65 2.5. The WTO and other International Organizations 68 2.6. Nongovernmental Actors and the WTO 69 2.7. Conclusion 72 2.8. Further Reading 72 3. Dispute Settlement and Enforcement of Rules 74 3.1. The Wto Dispute Settlement Procedures 74 3.2. Operation of the System 78 3.3. Systemic Issu es 87 . The Domestic Dimensions of Enforcement 92 3.4 3.5. Conclusion 96 3.6. Further Reading 98 ----------------------- Page 13----------------------xii Contents 4. Ov erview of Negotiating Rounds 100 4.2. Multilateral Trade Liberalization 108 4.3. Interest Groups and Lobbying Activity 120 4.4. Reciprocity and the Mechani cs of Negotiations 122 4.5. A Typology of Key Aspects of Trade Negotiations 135 4.6. Further Reading 141 PART III: THE MULTILATERAL TRADE AGREEMENTS 5. Trade i n Goods 145 5.1. Tariffs, Para-Tariffs and Indirect Taxes 147 5.2. Quantitative Restrictions and Import Li censing 154 5.3. Customs Clearance-Related Provisions 156 5.4. Subsidies 169 5.5. State Trading Enterprises 179 5.6. Technical Regulations and Product Standards Negotiating Forum 100 4.1.

185 Measures

5.7.

Sanitary and Phytosanitary Measures 195 5.8. Trade-Related Investment 201 5.9. Conclusion 205 5

.10. Further Reading 206 6. Sector-Specific Multilateral Trade Agreements 208 6.1. Agriculture 208 6.2. Textiles and Clothing 226 6.3. The Inf ormation Technology Agreement 231 6.4. Conclusion 233 6.5. Further Reading 235 7. Trade in Services 237 7.1. Conceptual and E mpirical Issues 238 7.2. Ba rriers and Potential Gains from Reform 242 7.3. The Uruguay Round Negotiations 248 7.4. The GATS 250 7.5. Sector-Specific Negotiations and Agreements 258 7.6. Electronic C ommerce 263 7.7. The Challenge of Expanding the GATS 266 7.8. Conclusion 271 7.9. Further Reading 272 ----------------------- Page 14----------------------Contents Protection of Intellectual Property 274 8.1. Intellectual Property and International T rade 274 8.2. International Conventions and GATT History 280 8.3. The Uruguay Round N egotiations 283 8.4. WTO Rules on Intellectual Property Rights 285 8.5. Implementation Concerns and Challenges 290 8.6. Conclusion 297 8.7. Further Reading 299 PART IV: HOLES AND LOOPHOLE S 9. Safeguards and Exceptions 303 9.1. Renegotiation of Concessions 308 9.2. Waivers 309 9.3. Emergency Protection and V ERS 311 9.4. Antidumping Actions 315 9.5. Measures to Countervail Subsidized Imports 330 9.6. Trade Restrictions for Balance of Payments Purposes 335 9.7. Infant Industry Protection 338 9.8. General Exceptions 339 9.9. Conclusion 341 9.10. Further Reading 343 10. Regional Integration 346 10.1. Motiv ations for Regional Economic Integration 347 1 0.2. GATT Article XXIV: Preferential Trade Agreements 352 10.3. GATS Article V: Economic Integration 355 10.4. Trading Blocs and the Trading System 356 10.5. Conclusion 365 10.6. Further Reading 367 11. Plurilateral Agree ments 369 11.1 G xiii 8.

overnment Procurement 36 9 11.2. The Civil Aircraft Agreement 380 11.3. Conclusion 381 11.4. Further Reading 381 PART V: CHALLENGES FOR TH E TRADING SYSTEM 12. Integrating Developing Countries and Economies in Transit ion 385 12.1. Special and Differential Treatment 385 ----------------------- Page 15----------------------xiv Contents 12.2. Changing Attitudes Towards the Trading System 391 12.3. Develop ing Country Participation in the WTO 391 12. 4.Implementation of Multilateral Agreements 396 12.5. Expanding Membership 403 12.6.Conclusion 408 12.7. Further Reading 410 13. Towards Deeper Integration ? The 'Trade and' Agenda 413 13.1.Contestabilit y of Markets as a Criterion 414 13.2. Foreign Direct Investment Policies 418 13.3.Competition Law 425 13.4. Trade Facilitation 434 13.5.Environmental Policies 441 13.6. Social Policies and Labor Standards 448 13.7. Domestic Regulation 453 13.8.Co nclusion 455 13.9. Further Reading 458 14. Legitimacy, Coherence and Governance 461 14.1. Industry and Trade Policy Formati on 462 14.2. NGOs and Civil Society 466 14.3.Governance of the Wto 471 14.4.Cohe rence of National Policies 47 4 14.5.Conclusion 477 14.6. Further Reading 478 15. Whither the Trading System? 477 ANNEXES Annex 1: GATT/WTO Membership, 2000 485 Annex 2: E 487 REFEREN conomic Effects of Trade Policy Basic Concepts CES 505 INDEX 541 ----------------------- Page 16----------------------LIST OF FIGURES 1.1 Regional shares in world trade, 10 1.2 Developing countries in manuf 11 1.3 Trade openness, 1970-97 12 1.4 Shares of FDI in GDP by regio n 13 1.5 Risk and return in emerging markets, 1994-5 35 2.1 The WTO Structure 52 3.1 Major issues in the WTO Di spute Settlement 80 3.2 Information Collection an d Transmission: The Status Quo 93 3.3 Information Collection: A Survey Model 94 4.1 The negotiation space a nd the set of feasible outcomes 117 6.1 Implications of a 40 p ercent reduction in agricultural trade barriers 222 9.1 Use of safeguard instruments, 19 48-93 305 10.1 Regional agreements notified to 1998 actures

GATT and WTO, 1948-98 346 13.1 Diversity versus Uniformity in Rules 417 13.2 Interaction in International Trade 429 ----------------------- Page 17----------------------LIST OF TABLES 1.1 Factor intensity of exports, 1 988 and 1998 14 1.2 The Relative Importance of Imports of Parts and Components 14 1.3 From GATT to WTO: A ch ronology 39 1.4 Patterns of protec tion, 1995 (percent) 43 2.1 Decision-makin g in the WTO 57 2.2 Top twenty traders, 1999 59 3.1 Users of Dispute Settlement (April 1994-March 1999) 79 4.1 Tr ade rounds and selected ministerial meetings, 1947-2000 101 4.2 Negotiating techniques and formulae 125 5.1 Tariff bindings for industrial products 1 50 5.2 Countries using preshipment inspection, April 1999 163 5.3 Share of state-owned enterprises in GDP, 1978-91 182 6.1 Post-Uruguay Round tariffs, various country groups, 2005 (%) 220 6.2 Import-weighted average tariffs in agriculture, 1995 (%) 221 6.3 A chronology of managed trade in textiles and clothing 227 7.1 Trade in services by modes of supply, 1997 240 7.2 Top 15 service traders and countries with hig hest relative specialization in cross-border service exports, 1997239 7.3 US Trade in commercial services, 1994 (US$ billion) 2 41 7.4 Format and example of a schedule of specific commitments 256 7.5 Sectoral coverage of specific commitments (%) 257 7.6 Precommitments to future financial services liberalization 260 7.7 Selected developing country precommitments in basic telecommunications 262 8 .1 IPRs: instruments and related international agreements 28 0 8.2 Estimated static rent transfers from TRIPs implementation, 1995 292 9.1 Frequency of use of safeguard provisions 307 9.2 Safeguard measures (1995-9) 314 9.3 Antidumping actions (1995-9) 316 9.4 Motivations for dumping 319 9.5 Countervailing duties (1992-9) 331 11.1 GPA Thresholds for coverage of procurement cont racts (SDRs) 374 11.2 Indicators of GPA performance, 1983-92 (%) 376 12.1 GATT and developing countries 386 12.2 Developing Country Participation in Dispute Settlement 395 14.1 Examples of NGOs Active on WTOrelated Issues 468 ----------------------- Page 18----------------------LIST OF BOXES 1.1 Changes in Global Productio n Sharing 15 1.2 Why liberalize trade ? 26 1.3 Why liberaliz e on a reciprocal basis? 32 2.1 The Di rector-General, 1948-2005 55 2.2 The Trade-Policy Review Mechanism 63 2.3 The International Chamber of Commerce and the WTO 70 3.1 Settlement of disputes 76 3.2 The Bananas Case in the WTO 82 3.3 The Kodak Fuji case and Article XXIII nonviolation disputes 86 4.1 The WTO and the Streets of Seattle 106 4.2 The Prisoners' Dilemma in trade pol icy 109 4.3 Lobbying for NAFTA 113 4.4 Integrative versus Dist ributive Bargaining and the WTO 115 4.5 Interest Groups

and nd jor 2 157

the WTO Bananas Case 121 4.6 Nominal a effective rate of protection 132 5.1 Ma GATT Articles 146 5. What is the Harmonized System? 5.3 Product Strategy and Customs Classification 158 5.4 Origin Rules and Antidumping 166 5.5 The Revised Kyoto Convention 168 5.6 EU-US Mutual Recognition Agreements 191 5.7 The SASO International Conformity Cert ification Program 193 5.8 International trade and sanitar y and phytosanitary restrictions 196 5.9 South African TRIMs in the Automotive Sector 204 6.1 Why poor countries tax, and rich countries subsidize agriculture 210 7.1 Services are different 239 7.2 Major provisions of the GATS 251 8.1 Noix de Coquille de Saint-Jacques and Chimas Whisky 275 8.2 Sections 301 and 337 of US Trade Law 278 8.3 Major provisions of the TRIPs agreement 285 8.3 Kalbe Farma of Indonesia 296 9.1 National security and the US Helms-Burton Act 341 10.1 Intra-industry trade and pressures for prot ection 350 10.2 Pressures for protection: FTAs and customs unions 360 10.3 Rules of origin in free trade agreements 362 12.1 Unilateral preferences are uncertain 391 ----------------------- Page 19----------------------xviii List of Boxes 12.2 Developing countries a nd dispute settlement 394 12.3 The integrated framework for technical assistance for LDCs 399 12.4 The cott on industry and China's accession 405 12.5 R ussia and the accession process 407 13 .1 US State-level Regulatory Competition 431 13.2 DHL and Customs Procedures 435 13.3 Pre-1914 Trade-Related Inter-Governmental Organizations 438 13.4 Economic effects of recycling requirements 445 13.5 The Shrimp-Turtles case 446 13.6 Labor Standards and US Labor Unions 450 13.7 GMOs and the Biosafety Prot ocol 456 14.1 Government-Business Inter action in Selected Countries 463 14.2 Philfoodex of the Philippines 465 14.3 The Uruguay Round FOGS negotiation 475 ----------------------- Page 20----------------------LIST OF ABBREVIATIONS ACP African, Caribbean and Pacific (Lome convention) ACWL Advisory Centre on WTO Law AD antidumping AMS aggregate measure of support APEC Asian-Pacific Economic Cooperation ASEAN Association of South-E ast Asian Nations ATC Agreement on Textiles and Clothing (WTO) Bene lux Belgium, Netherlands and Luxembourg BIT Bilateral Invest ment Treaty BOP balance of payments BTN Brussels Tariff Nomenclature CAP Common Agricultural Policy (EU) CCC Cu stoms Cooperation Council CCCN Customs Cooperation Council Nomencla ture CEEC Central and Eastern European country CGE com putable general equilibrium (model) c.i.f. cost, insurance and fre ight CMEA Council of Mutual Economic Assistance CRTA Commi ttee on Regional Trade Agreements (WTO) CTE Committee on Trade and t he Environment (WTO) CTH change in tariff heading COMECON se e: CMEA CVD countervailing duty DSB Dispute Settlement

Body (WTO) DSP dispute settlement procedures (WTO) DSU Dispute Settlement Understanding (WTO) ECE Economic Commission for Europe (UN) ECOSOC Economic and Social Council (UN) ECJ European Court of Justice (EU) EDI electronic data interchange EEC European Economic Community EFTA European Free Trade As sociation ECSC European Coal and Steel Community EU European Union FAO Food and Agricultural Organization (United Nation s) FDI foreign direct investment f.o.b. free on board F SC foreign sales corporation (US) ----------------------- Page 21----------------------xx List of Abbreviations FTA free trade area FTAA Free Trade Area of the Americas GATS General Agre ement on Trade in Services GATT General Agreement on Tariffs and Trade GMO genetically modified organism GPA Agreement on Government Procurement GDP gross domestic product GSP Gen eralized System of Preferences GTAP Global Trade and Analysis Project HS Harmonized Commodity Description and Coding System ICC International Chamber of Commerce ICTSD International Centre for Tr ade and Sustainable Development IECC International Express Carriers Conference IFIA International Federation of Inspection Agencies ILO International Labor Office IMF International Monetary F und INR initial negotiating right IPRs intellectual proper ty rights ITA Information Technology Agreement (WTO) ITC I nternational Trade Centre (UNCTAD and WTO) ITO International Trade O rganization ISO International Organization for Standardization LD C least-developed country MAI Multilateral Agreement on Investment MEA Multilateral Environmental Agreement MENA Middle East and North Africa MFA Multifibre Arrangement MFN most-favored-nation MRA mutual recognition agreement MTN multilateral trade negotiation NGO nongovernmental organizati on NTB nontariff barrier NTM nontariff measure NAFTA North American Free Trade Agreement NATO North Atlantic Treaty Org anization OAU Organization for African Unity OECD Organi zation for Economic Cooperation and Development OMA orderly marketin g arrangement OTC Organization for Trade Cooperation PPM Production and processing method PSI preshipment inspection ----------------------- Page 22----------------------List of Abbreviations xxi QR quantitative restriction R&D research an d development RCA revealed comparative advantage RIA regional integration agreement ROO rules of origin SADC Southern African Development Community SCM subsidies and coun tervailing measures SPS sanitary and phytosanitary S&D special and differential treatment SDR Special Drawing Right SG S Societe Generate de Surveillance SITC Standard Intern ational Trade Classification STE state-trading enterprise TABD Trans-Atlantic Business Dialogue TBT technical barrier to tr ade TMB Textiles Monitoring Body (WTO) TPRB Trade Policies Review Body (WTO) TPRM Trade Policies Review Mechanism (WTO) TRIM trade-related investment measure TRIPs trade-related in tellectual property rights TRQ tariff rate quota TRS t echnical regulations and standards UK United Kingdom UN United Nations UNCITRAL United Nations Committee on International T rade Law UNCTAD United Nations Conference on Trade and Development UND P United Nations Development Programme USSR Union of Soviet Socialist Republics USTR United States Trade Representative VER voluntary export restraint VIE voluntary import expansio n WCO World Customs Organization WHO World Health Organiza

tion WIPO World Intellectual Property Organization WTO d Trade Organization WWF Worldwide Fund for Nature ----------------------- Page 23----------------------This page intentionally left blank ----------------------- Page 24-----------------------

Worl

Introduction Established in 1995, the World Trade Organization (WTO) administers the trade agreements neg otiated by its members, in particular the General Agreement on Tariffs and Trade (GATT), the General Agreement on Trade in Services (GATS), and the Agreement on Trade-related Intellectual Property Rights (TR IPs). Total world trade in goods, services, and intellectual prop- erty s tood at US$6.8 trillion (thousand billion) in 1999, of which services and int ellectual property accounted for some US$1.4 trillion. The WTO's rules and principles establish a framework in which this exchange takes place. The disciplines and rules are negotiated among members through periodic rounds of multilateral negotiations and ad hoc or permanen t interaction in various WTO fora. The WTO builds upon the organizational structure that had developed under GATT auspices as of the early' 1990s. Since its creation in 1947, the GATT progressively developed into a system of great complexity. Initia lly largely limited to a tariff agreement, over time, as average tari ff levels fell, the GATT increasingly came to focus on nontariff trade p olicies and domes- tic policies with an impact on trade. Its success was refl ected in a steady ex- pansion in the number of contracting parties. By the end of the Uruguay Round (1994), 128 countries had joined the GA TT. Since the entry into force of the WTO, another twelve countries have acced ed, bringing the total to 14 1 as of December 2000. Suggestions made during the Uruguay Round negotia- tions that 'GATT is dead' sit oddly with these signs of p opularity. The underlying philosophy of the WTO is that open markets, nondis- crimination and global competition in internation al trade are conducive to the national welfare of all countries. A rational e for the organization is that political constraints prevent gov ernments from adopting more efficient trade policies, and that through the reciprocal exchange of liberalization commitments these political constraints can be overcome. The WTO differs in a number of important respects from the old GATT. These difference s have potentially important implications for the functioning of the trading system, in particular for developing and trans ition economies. The GATT was a rather flexible institution. Bargainin g and deal-making lay at its core, with significant opportunities for countries to 'opt out' of specific disci- plines. This is mu ch less the case under the WTO. The rules apply to all membe rs, who are subject to binding dispute settlement procedures. This is attractiv e to groups seeking to introduce multilateral disciplines on a variety of subje cts ranging from the environment and labor standards to compe- titio n and investment policies to defenders of animal rights. But it is a ----------------------- Page 25----------------------2 Introduction source of concern to grou ps who perceive the (proposed) multilateral rules to be inappropriate or worry that the adoption of specific rules may affect detriment ally the ability of governments to regulate domestic activities and deal with market failures. The WTO attracted a significant amount of at tention, much of it critical, during its first five years of operatio n. Public opposition to the WTO is to some extent a reflection of the increasing speed at which global integration is occurring. Over the pas t two decades the volume of international trade has doubled and the crossbord

er

flow of foreign direct investment has grown 10 times faster than world production (WTO, 1999). These trends coincided with mo re liberal trade policies and acceleration of deregulation and market-oriented reforms. Only one employee in 10 is currently working in countries that are largely separated from the w orld market, compared to two-thirds some two decades ago (Dicken, 1998). M ultinational corporations have assumed a much greater role in the world econom y. In 2000, about 75 million people were employed by foreign affiliates of multinational compa- nies, of which about one fifth were locat ed in developing countries (Hirst and Thompson, 1999). These devel opments have been beneficial from an economic point of view , but they have also given rise to fears of a loss of na- tional sovereignty a nd concerns about the ability of countries to handle ex- ogenous shocks. The financial crises that erupted in the late 1990s in East A sia and Russia, and the contagion effects experienced by Latin American and East European countries are a case in point. A number of minis terial meetings of the WTO were accompanied by vio- lence and demonstration s by groups spanning the nongovernmental organi- zation (NGO) community and l abor unions seeking to limit or to expand the reach of multilateral disc iplines. Contradictory demands by these groups pose a great chal lenge for WTO members. High-profile street protests during the Seattle WTO m inisterial helped scuttle efforts to launch the so-called 'mil lennium round'. The mass media reports surrounding that poorly prepared conference could have a lasting impact on public perceptions of the WTO. The public relations challenge was illustrated in a 1999 Swiss TV pro- gram where a small boy is scared to go to sleep because 'there is a WTO un- der my bed'. Such a scene would have been unimaginable a decade ear lier. Although opposition to the GATT and the Uruguay Round was quite inten se at times giving rise to posters representing the institution as a 'GATTzilla' (referring to the cartoon monster Godzilla) it never reached the point where a TV producer could feel comfortable assuming it impacted on the fears of children. Although efforts to libe ralize trade have always been opposed sometimes very vocally by domestic groups who stand to lose from greater competi----------------------- Page 26----------------------Introduction 3 tion (farmers in high-income countries are a good exampl e), the terms of the debate surrounding the WTO now extend well beyond t he traditional trade liberalization agenda. Understanding how the WTO work s, its strengths and weaknesses, and what might be done to make the institutio n a more effective tool of multilateral cooperation is vital. Many of the WTO' s critics have seri- ous misconceptions about the organization, while many of those who are seeking to expand the WTO's mandate appear to be ignorant of basic princi- ples of good economics and political economy. At th e same time, some of the criticism reflects deeply held beliefs and concerns. Ma ny of the issues cannot (or should not) be dealt with by the WTO and clai ms of sins of commission or omission are therefore often inapp ropriate. But some issues can and should be laid at the door of the WTO. There are governance, legitimacy, and transparency problems that must be addressed. The public relations prob- lems the WTO confronted in the late 1990s were partially of its own making. In early 2000, the Internet home page of Public Citizen's Global Trad e Watch which opposes the WTO prominently misquoted Renato Rug- giero, the WTO Director-General during 1996-9, as havi ng stated that 'We 1 are writing the constitution of a single global econom y'. Although an inac- curate attribution, speeches emanating from the WTO l eadership did suggest the organization was a major facilitat or of globalization. Such strong claims which overstated what t

he WTO does, can and should do served to needlessly mobilize opposition t o the organization. Our goal in this book is to provide a succinct des cription of the multilat- eral trading system's principles, rules a nd procedures, as well as a political economy-based discussion of how it functions. It is not a negotiating his- tory who did what and when although the results of negotiations and ministerial meetings are discussed at some length. Being a n introduction, this book cannot be more than a starting point. Guide s to further reading are provided at the end of every chapter. Readers inte rested in pursuing specific issues are invited to consult the lis ted works, the bibliography, which in- cludes works that may not be ci ted in the text, and the web sites of the major think tanks and interna tional organizations that maintain active research programs in inte rnational economics.2 1 In the speech concerned, Mr. Ruggiero cited the law professor John H. Jackson. The relevant passage stated that 'John Jackson has described the multilateral trade system as a "constitution for the world e conomy"' (see WTO Press/91, downloadable from www.wto.org). 2 Useful sites wi th downloadable documents and links to many other sites include H arvard University's global trade negotiations home page (www.cid.harva rd.edu/cidtrade), the World Bank (www.worldbank.org/trade), the Internationa l Centre for Trade and Sustainable Develop- ment, (wwW.ictsd.org), and the Ins titute for International Economics (www.iie.com). ----------------------- Page 27----------------------Introduction The book has five parts. Part I presents a brief historical overview of the evolution of the trad ing system and introduces the basic functions of the trade regim eand the challenges that confront it (chapter 1). Part II turns to th e WTO. Chapter 2 describes the organizational structure of the WTO , its scope and functions. WTO dispute settlement and enforcement pro visions are discussed in chapter 3. Chapter 4 analyzes the role of the WTO as a fo- rum for negotiations. Special attention is given to the conce pt of reciprocity, this being a central element of multilateral trade negotia tions (MTNs). Part III discusses the three multilateral agreements. Chapter 5 describes the GATT rules on tariffs, quotas, subsidi es, customs procedures, and product standards, and discusses the political economy rationale underlying them. Chapter 6 turns to the m ajor sector-specific agreements that have been ne- gotiated under GAT T auspices, in particular agriculture and textiles and clothing. B oth are sectors that have a long history of protectionism in many countries, a nd much remains to be done to lower barriers to trade to levels that appr oach the average prevailing in other sectors. Chapters 7 and 8 dis- cuss trade in services and the GATS, and the agreement on TRIPs, respec- tively. In Part IV, we describe and assess the major 'holes and loopholes' in the WTO. The various mechanisms allowing for the reimposition of trade barri- ers are discussed in chapter 9, which summarizes the rules on a nd the eco- nomics of the use of instruments of contingent prote ction. These have been very important in dealing with domestic political pressures and allow- ing the pursuit of noneconomic objectives. In practice t hey have often been abused, to the detriment of both national and global welfare. Chapter 10 deals with one of the most important excepti ons to the most-favored-nation rule allowed by the WTO: regional integration agr eements (RIAs). Almost all WTO members are participants in one or mo re RIA, raising serious ques- tions about the relevance of the WTO's nond iscrimination principle. Chapter 11 discusses the provisions of the WT O allowing for the negotiation of so- called plurilateral agreements, wh ich apply only to those members that sign them. The most important of the se is currently the Agreement on Govern- ment Procurement. Part V lo oks to the future. Chapter 12 discusses the evolving role of de- vel oping countries and economies in transition in the multilateral 4

trading system, and the concerns that these countries have regarding its op eration. Chapter 13 discusses a number of the issues that are likely to be o n the ne- gotiating agenda for some time to come, including competi tion (antitrust) policy, labor standards, trade facilitation, invest ment and environmental policies. Chapter 14 turns to the issue of go vernance of the trading system, the role of NGOs and the importance of ensuring domestic transparency of ----------------------- Page 28----------------------Introduction 5 trade and investment policies. Chapter 15 concludes with some fin al remarks on the future of the WTO and the challenge of international cooperation in the trade area. Annex 1 provides a listing of WT O members. Annex 2 summarizes the economics of major trade policy ins truments and many of the issues dis- cussed in the book. It covers ta riffs, quotas, subsidies, externalities and mar- ket failure, price discr imination (dumping), trade preferences and discrimi- nation, and rent see king. Although the discussion in the volume is deliber- ately nontechnical , we hope inclusion of this material will assist students of international relations, economics and business, as well as the interested r eader, to better understand the economic effects of alternative policy in- struments. ----------------------- Page 29----------------------This page intentionally left blank ----------------------- Page 30----------------------PARTI THE GLOBAL TRADING SYSTEM ----------------------- Page 31----------------------This page intentionally left blank ----------------------- Page 32----------------------1 The Trading Syste m in Perspective Although economic theory suggests that countr ies should pursue liberal trade policies and exchange goods and services on the basis of their com- parative advantage, in practice most nations actively intervene in interna- tional trade. Since 1947, the GATT has been the major focal point for indus- trialized country gove rnments seeking to lower trade barriers. In the proc- ess, an ever mo re complex network of rights and obligations regulating in- ternational trade relations emerged. Progress towards liberalization of trade was fitfu l at times, often involving two steps forward and one step ba ck. None the less, recurring MTNs and the positive demonstration effects o f the success of outward-oriented development strategies aimed at integration into the world economy resulted in a steady decline in the average level of protection in most countries. The principle s and disciplines of the GATT helped governments to liberalize trade and to resist pressures for protection. This in turn helped foster eve r-greater integration of the global economy through trade. 1.1. TRADE AND GLOBAL INTEGRATION At the beginning of the new century, the value of global trade in goods and services exceeded US$7 trillion (t housand billion). At US$6 trillion, trade in goods accounted for the lion's share of global flows, followed by trade in commercial service s, which reached the US$1 trillion mark in 1992, and had grown to US$1.5 trillion in 1999 (WTO, 2000). Data on trade in knowledge, as measured by payments of royalties for use of trademarks, patents, and so forth, is incomplete, but has been estimated to account for at leas t US$75 billion (Karsenty, 2000). Global trade flows are dominate d by exchanges within and between the three major regions of

the global economy (the so-called triad): Europe, North America, and East Asia. Trade flows involving other parts of the globe are relatively s mall, accounting for some 15 percent of world trade (Figure 1.1). Int ra-EU and intra-North America trade accounts for 52 percent of in- dustrial trade (shaded area, Figure 1.1). All 48 least-developed coun tries to- gether accounted for only 0.5 percent of world trade, reflecting the small size of their economies and very low per capita incomes. Their share has actually fallen over time it stood at 1.7 percent in 1970. South Asia and Sub-Saha ran Africa each represent just over one percent of world trade. ----------------------- Page 33----------------------The Trading System in Perspective Intra-EU and intra-North America trade Source : Computed from UN Comtrade database. FiG. 1.1 Regiona l shares in world trade, 1998 Although the trade shares and trade-out put ratios of many of the poorest countries has fallen, in the la st thirty years many developing countries have expanded their share of world trade. Developing countries have also shifted increasingly to becoming produ cers and traders of manufactures. The share of manufactures in total exports o f developing countries reached 70 percent in the 1990s and is projected to rise to 80 percent in 2005. Some 40 percent of all developing country export s are destined for other developing countries (Figure 1.2). Trade to GDP or openness ratios have also expanded rapidly for most de- veloping countries (Figure 1.3), driven by unilateral (autonomous) economic reforms includi ng liberalization of trade that were pursued during the 1980 s and 1990s. These reforms were often supported by the in ternational financial organizations, in particular the World Bank and the IMF. As dis- cussed later in this book, the GATT played at best a marginal role in this process. Until the conclusion of the Uruguay Round, its impact was largely restricted to inducing OECD countries t o reduce trade barriers. ----------------------- Page 34----------------------The Trading System in Perspective 11 Commodity shares of merchandise exports from developing countrie s Share of developing country merchandise exports to other developing count ries Source: Hertel and Martin (2000). FIG. 1.2 Developing countries in manufactures ----------------------- Page 35----------------------The Trading System in Perspective Source: World Bank SIMA database. FIG. 1.3 Tr ade openness, 1970-97 A substantial proportion of global trade i n manufactures, especially be- tween OECD countries, comprises intra-industry trade the exchange of similar, differentiated product s. Intra-industry trade ratios are frequently above 0.6 for OECD countries, and have risen to similar levels for dynamic developing and transition economies. This is one reflection of the process of globalization, which increasingly involves the fragmentation of p roduc- tion of a good across many different countries. ----------------------- Page 36----------------------The Trading System in Perspective 13 In 1997, intra-industry trade ratios for Isra el, Brazil, Korea, Chinese Taipei and the Czech Republic stood at 0.66, 0.54 , 0.61, 0.60, and 0.68, respectively. Much of this trade involves trade in semi-finished goods and components that are process ed further after importation and re-exported subsequentl y. Global outsourcing practices have resulted in increasing fragmentation or splintering of the production process. So-called glob 12 10

al production networks have expanded rapidly, in pa rt driven by rapid growth in FDI flows (Figure 1.4). Of the US$6 trillion trade in goods, some 40 percent is intra-firm, Source: Yeats (1997). FIG. 1.4 Shares of FDI in GDP by region involving exchanges between affiliated firms. An estimated 30 percent of global trade in manufactures comprises components (Yeats 1997). The rapid in crease in the share of trade in manufactures that consists of compone nts and parts is one striking illustration of the process of globalizat ion of pro- duction. 1 Calculated at the 3-digit SITC level, using the UN Comtrade database and the Grubel-Lloyd definition o f intra-industry trade (1-1 1 Xi - Mi / (Xi + Mi ) where X and M are ex ports and imports of commodity i. This index ranges between 0 (no intra-indus try trade) and 1 (all trade is intra-industry). ----------------------- Page 37----------------------14 The Trading System in Perspective The facto r content of trade has also changed significantly. Just a decad e ago, many developing country exports were predominantly natural resource and unskilled-labor intensive. In East Asia and Latin America, in particu lar, the importance of technology and human capital inputs increased rapidly, whereas South Asia began to exploit its endowments of unskilled labor and shift away from natural resou rce intensive products (commodities) (Table 1.1). The outlier, as is the case for most indicators, is Sub-Saharan Africa. TABLE 1 .1 Factor intensity of exports, 1988 and 1998 Natural Unskilled Technology Human Resource Labor Capital 1988 1998 1988 1998 1988 1998 1988 1998 Industrial Countries 22.5 17.9 9.8 9.7 39.4 45.2 28.3 27.1 Developing Countries East Asia 27.2 16.8 30.5 24.0 23.8 42.6 18.5 16.6 South Asia 50. 2 15.9 35.9 81.2 7.9 2.2 6.1 0.6 Latin America 67.0 42.4 5.8 9.3 13.4 25.4 13.8 22.9 Sub-Saharan Africa 78.3 79.0 6.0 5.9 6.6 7.7 9.1 7.4 E. Europe 8c C. Asia 38.0 37.6 23.9 18.4 20.2 21.3 17.8 22.7 M. East 8c N. Africa 80.3 65.6 3.7 8.0 13.1 22.0 2.9 4.3 Source: UN Comtrade and The World Bank. TABLE 1.2 The Relative Importance of Imports of Parts an d Components Regional and Product Sh are of Parts and Components Group (SITC) In Product Group Imports (%) 1985 1996 East Asia General Industria l Machinery (74) 8.7 13.3 Office Machinery (75) 32.5 47.2 Telecommunications (76) 43.0 71.8 Electric Machinery (77) 33.3 25.2 Road Vehicles (78) 25. 1 35.6 Other Transport Machinery (79) 8.4 19.3 East Asia (All Products) 19.5 25.1 OECD Europe (All Products) 21.5 23.4 North America (All Products ) 23.5 22.9 Note: Totals incl ude listed product groups and Power Generating Equipment (71), Spe cial In- dustry Machinery (72) Metal Working Machinery (73) and Misc. Manufa ctures. Source: Ng and Yeats (1999). In many respects the East Asian countri es took the lead in pursuing trade- driven development strategies. For ex ample, Ng and Yeats (1999) find that ----------------------- Page 38-----------------------

The Trading System in Perspective 15 East Asian global exports of components grew at an annual rate of 15 per- cent during 1984-96, more than four percentage point s above the growth rate for all goods, accounting for 25 percent of all exp orts in 1996 (Table 1.2). Moreover, exports of components to other Ea st Asian markets grew even faster (about 20.9 percent). As a result, the sha re of all parts and components exports destined for regional markets almost doub led from 25 to 46 percent. (Box 1.1). This illustrates another phenomenon the increasing pace of re- gionalization of the world economy. Although potentially incompatible with the process of globalization of production, it reinforces the process if driven by economic forces and regional economies maintain an open policy stance towards trade with the rest of the world. Box 1.1. Changes in Global Production Sharing The geographic fragmentation of manufacturing pro cesses has long been a major and evolving process. One of its earlier fo rms involved the production of primary commodities in developing (and some developed) countries, shipment of these goods to (large ly) industrial nations for further process- ing, and then the re-export ation (in part) of the processed product back to the primary commodit y producer or third countries. As an example, tin ores might be mined in Thailand or Malaysia, shipped to Japan for refinement and further manufacture and re-export. In part, these production sharing trade flows were based on comparative advantage, but factors such as esca - lation of industrial country trade barriers contributed to this exchange p at- tern. The magnitude of such traditional production sharin g trade has been eclipsed by international exchange of manufactured parts and components. A comparison of the value of East Asian trade in traditional inputs agri- cultural raw materials, ores, minerals and nonf errous metals and unproc- essed foodstuffs like cocoa and c offee beans with manufactured compo- nents reveals that in 1984, Asi an imports of traditional inputs were more than double those of man ufactured components. By 1996, component im- ports were US$67 billion high er. At 20.4 percent, the average annual growth rate for components over this period was about two and one half times greater than tha t for traditional products. A similar pattern is observed for Asian expor ts (see Box Table). ----------------------- Page 39----------------------The Trading System in Perspective Trade Flow Value (US$bn) Growth (%) 1984 1996 1984 -96 East Asian Imports Traditional Production Inputs 39 .2 98.9 8.0 Manufactured Components 17.9 165.6 20.4 East Asian Exports Traditional Production Inputs 17.0 37.6 6.8 Ma nufactured Components 33.0 177.8 15 .1 Source: Ng and Yeats (1999). Trade expansion and the growth in production sharing is by no means restricted to East Asia. P rocessing trade played an important role in the re- orientation and expansion of trade between Central and Western Europe (Hoekm an and Djankov, 1997). It is also important for a number of Latin American and North African countries. Examples inc lude the Dominican Republic (where processing trade accounts for over 80 percent of all ex- ports), El Salvador (49 percent), and Tunisia (67 percent) (WTO, 2000). This is driven in part by au tonomous reforms to facilitate trade, including the creation of expo rt processing zones, and in part by preferential tariff treat- ment by major partner countries. Available data suggest there is a s trong positive correlation between above average export growth and th e share of processing trade in total exports. These are just several dimensions of the multi-faceted process of global integration that 16 and Product

has been occurring. Cross-border trade and investment flow s have been a major engine of the process 'machines' that allow coun- tries to transform one set of goods and services into another set t hat they value more highly. The increase in trade openness and cross-b order invest- ment is beneficial for world welfare. There is a positive relationship between openness and economic growth. In a widely cite d article, Sachs and Warner (1995) conclude that open developing co untries grew by an average of 3.5 percentage points faster than a compar ator group of closed economies. Ben- David (2001) shows how a si gnificant and sustained rise in post-Second World War European export -output ratios (compared to the prewar period) was associated with a sustained increase in the average growth rate. Sus- tained eco nomic growth is crucial in reducing poverty. East Asia, the devel- oping re gion that has relied on trade the most intensively as part of its development strategy, has seen a number of countries catch up wi th the in- dustrialized nations in terms of per capita income and significantly reduce the number of people living in poverty. However, not all countries have been successful in integrating into th e world economy. Nor is openness a sufficient condition for economic growth. B en-David and Papell (1998) examine the post-Second World War gr owth ----------------------- Page 40----------------------The Trading System in Perspective 17 path of 74 countries and conclude that 46 experienced a significant slow- down in economic growth rates during the period, even though openness ratios were ri sing. Relatively few countries have been able to attain and sus- tain grow th rates that were high enough to result in convergence with the per capita income levels of industrialized nations. Indeed, cou ntry groups with the largest income gaps in 1960 have not shown any 'cat ch-up' conver- gence. Income gaps between the majority of countries appear to be increas- ing rather than decreasing. Reasons for this are complex , but one common factor that characterizes incidences of convergence is the intensity (depth) of trade integration. Countries that trade intensivel y with each other tend to exhibit a relatively high incidence of incom e convergence (Ben-David, 2001) Of course, there is much more to the story than trade and trade policy, even though a liberal trade and investme nt regime is a crucial element. Very much depends on compleme ntary policies that define the business environ- ment investment i n human capital (education), infrastructure, and the qual ity of public and private sector governance. Much also depends on fun- da mental endowments such as location. Small land-locked countries sur- rounded by other low-income countries will inh erently face much greater challenges than countries th at are in close proximity to large industrialized economies.2 Although t he term globalization is used incessantly, the world e conomy still is far from being integrated. As of the turn of the century, o nly 5-6 per- cent of the labor force in OECD countries was involved in t he production of goods for developing country markets. The OECD share of the capital stock in the developing world did not exceed 11 pe rcent, an amount that consti- tuted less than two percent of the capital stock of the rich nations (World Bank, 1999). Truly global i ndustries such as electronics, aerospace or some consumer good branc hes coexist with a much larger set of industries that retain a regional or purely national character (Dicken 1998). Moreover, the glo bal economy remains characterized by severe restrictions on the interna- tio nal movement of labor. Even within the high-income country group, labor 2 Ther e is a vigorous academic debate on the relationship between openness and grow th. For example, Dani Rodrik, a leading critic of the literature cited earlier

, has argued that data and methodological weaknesses do not allow stro ng conclusions to be drawn (Rodrik, 1997, Rodri- guez and Rodrik, 1999). Sceptics agree there is a positive association between openness an d growth, but are not convinced the direction of causality is correct-i t may also be that growth leads to openness. There is more agreement th at a necessary condition for sustained growth is that countries have po licies that allow access to technology at world market prices. This in- cludes trade policies that encourage imports of capital equipment a nd knowledge, as well as establishment of conditions that are conducive to i nvestment. ----------------------- Page 41----------------------18 The Trading System in Perspective 3 tends t o be less mobile than it was in the nineteenth century. There are few signs t hat government policies will become significantly more welcoming to wards liberalization of the temporary movement of service providers, let alone reduce barriers to labor mobility more generally (Ghosh, 1997). Even abstracting from policy, country-specific business practices and t echnologi- cal factors (such as the need for on-site tailoring of products) continue to favor domestic trade over international transactions. Empirical evidence suggests that international borders have a much more restrictive effect on economic interaction than internal borders separating regions within a country. Among OECD nations the negative impact of international borders is in some cases twenty times higher than for intra-state borders ( Helliwell, 1999). Nevertheless, the process of global integr ation has progressed rapidly since the 1980s, and can be expect ed to continue. Science, technology and a growing component of cultural l ife have become genuinely borderless. Ad- vances in telecommunications and informatics industries and steadily de- creasing transportatio n costs reduce the tyranny of distance. English has become t he first second language of the world. Globalization, like any major technologic al change, gives rise to adjustment costs. The process is exposing serious flaw s in national systems of social assistance, environmental protec- tion o r tax laws. Interest groups have raised the alarm about ne gative im- pacts on the environment, indigenous knowledge, workers r ights, national values and local communities. Global integration has cultural and social ramifications as well as economic dimen sions, and these must be recognized and managed. On the other ha nd, there is an enormous opportunity for eliminating pover ty, hunger, wars, and economic injustice. Bolstering mul- tilateral c ooperation to attenuate negative effects in instances where there are cross-border spillovers and to assist in the realization of the benefits of global integration is a major challenge for governments enter ing the twenty- first century. International cooperation to maintain open markets is a vital component of any strategy to raise global li ving standards. 3 As is the case regarding the link between trade openness and growth, there is also a large literature investigating whether the current level of global integration is comparable to that achieved in the pre-World War One period. Space constraints prevent a discussion of th is lit- erature. See Held et al. (1999) for an overview of the debate. ----------------------- Page 42----------------------The Trading System in Perspective 19 1.2. TRADE AND TRADE AGREEMENTS IN HISTORY Trade has always played an important role in economic development. The type of trade that occurs has evolved over time as technological and i nstitu- tional innovations led to a decline in transaction costs. Such innovations include 'hard science' inventions such as the sailing shi

p, the steam engine, development of railroads, aircraft, container shipp ing, and refrigeration, as well as 'soft' inventions such as the creation of markets, mechanisms to ex- tend credit to traders, and the develop ment of contracts and procedures to enforce them. International t rade and international trade agreements have often gone hand i n hand. From a historical perspective the policy stance preferred by economists unilateral free trade has been applied relatively rarely, most notably by Great Britain in the second half of the nineteent h century. Ab- stracting from instances where discriminatory trade poli cy was imposed by a dominant (colonial) power, the historical re cord illustrates that trade agreements between sovereign states have fre quently been used to overcome barriers to trade. Even in the case of imp erial expansion and the pursuit of formal or informal empires by metropolitan powers, trade agreements sometimes were an im portant instrument. Examples in the nineteenth cen- tury were trade treaties negotiated between Britain and Latin American countrie s such as Brazil and Argentina (Gallagher and Robinson, 1953). Sometimes trade agreements have been a key element in the process of eco - nomic integration of independent territories a noteworthy e xample was the German customs union (the Zollverein), which was a key buildi ng block of what is now the Federal Republic of Germany. A characteristic of colonial expansion was the application of metropolitan systems of law and protection of property rights to 'associated' territories indeed, a defining c haracteristic of an empire is that control extends beyond foreign to domestic policy (Doyle, 1986). This was a fundamental dimension of the Roman Empire a nd helped create the preconditions for a single, inte- grated economy. Pi racy was suppressed, roads built, and with sea and land substantially secure, commerce spread throughout the Mediterranean. The pottery, bronze, wine and oil of Italy were exchanged for African grain and eastern spices. Economies of scale led to large productive enterpri ses scat- tered throughout what was otherwise an overwhelmingly agricultur al world (Gibbon, 1776). The Iberian, Dutch and English empires of the sixteenth century and thereafter were of a different c haracter in that the depth of integration was less. More important were discriminatory trade policies that sought to mo- nopolize trad e or to restrict competition. For example, not able to compete with m ore efficient, Dutch shipping technology and constituting a less at----------------------- Page 43----------------------20 The Trading System in Perspective tractive ma rket for some colonial products, seventeenth century England imposed trade restrictions on its colonies. The trade of American colonies was often subjected to exclusivity requirements th rough a ban on trade with other states or through mandatory use of metropolitan shipping serv- ices and regulated through restrictions on colonial production. Often, regu lations prohibited local processing of goods or production of goods that co uld compete with output produced by the colonial power (Davies, 1997). Trade relations between European powers and Asian territories initiall y tended to be less dictated by the former, reflecting mor e powerful local states. The latter produced goods (such as spi ces) that were sought after in European markets, forming a natural basis for trade. Often European traders sought to obtain agreement on (or to impose) extra-territorial application of home country law to comm ercial transactions and the protection of property rights. Local rulers who s ought to limit the impact of a foreign presence on their control of society frequently were willing to accept such ext ra- territoriality. One form this sometimes took was the est ablishment of so- called treaty ports. Examples were Macao, Nagasa

ki, and Goa. These served as an air lock between international commercial re lations and the control of civil society more generally: From St. Paul's claim of civis Romanus sum against the subordinate patrimonial kingdom of Herod and the steelyard of the Hanse in London to th e immunities of European settlers in Alexandria, Tunis, Constantinople and S hanghai, foreign powers have demanded extraterritorial application o f their law over their nationals (both natural and legal persons). Th e outcome has often been the establishment of a regu- lated treaty port (Do yle, 1986: 202). Trade cannot prosper without legal secu rity of property rights and mechanisms to enforce contracts. One lesson from international trade rela- tions between states thr oughout history is that traders will seek to ensure that such mecha nisms are applied. This can be achieved through a variety of means full-fledged integration into a formal empire being the most far- reaching one; and free trade agreements and treaty ports being less far- reaching solutions.4 4 An interesting literatur e has emerged in the last decade exploring the emergence and main- tenance of legal norms in the absence of central authority. A conclusion th at emerges from these studies is that the threat of ostracising a member of a club who is reliant on repeated interaction with othe r members can have a powerful impact as an enforcement device. Govern- ment in volvement in contract enforcement is not necessarily required. See Benson (198 9), Mil- grom, North and Weingast (1990), Greif (1993), and Greif, Milgrom and Weingast (1994). ----------------------- Page 44----------------------The Trading System in Perspective 21 Trade Policy and Trade Agreements In general, motivations for activist trade policy can be divided into a number of types. First, revenue governments need income, and taxing t rade is of- ten the easiest method of collecting revenue. Taxation of t rade for revenue purposes has been a hardy perennial throughout reco rded history, and re- mains important for many developing countries. Of course, those who are subject to the tax have an incentive to l obby for exemptions and invest re- sources to induce the authorities to lo wer the tax burden. Taxes imposed by rulers and governments can constit ute an important motivation for con- quest or the negoti ation of tax treaties. Tax policy can have important effe cts on trade patterns. For example, in the fourth century BC, Rhodes was a key commercial power in the Eastern Mediterranean, controlling the neig hbor- ing seas and with a vibrant port. Rhodes charged a two percent tax on the value of cargo carried on all ships entering its harbor, including transit cargo. To divert shipping, Roman trader s lobbied for the creation of a free port in Delos. Once established, trade rapidly shifted away from Rhodes, and the port lost most of i ts harbor tax revenues. This tax competition proved very costly from a social welfare point-of-view: Rhodes used part of its tax proceeds to police the sea-lanes and prevent piracy. Without the revenu e, these activities declined, piracy increased significantly, an d trade became more costly (Adams, 1993: 83-4). A second motivation is mercantilist a belief that imports are bad and exports are good. This belief is generally based on the observation that im- p orts require the transfer of foreign exchange abroad (historically spec ie gold or silver), whereas exports bring in foreign exchange. The obje ctive of mercantilist policy is a trade surplus ensuring that the value of exports exceeds the value of imports. Mercantilism is often driven by nationalism, the perception being t hat trade surpluses and political power are closely linked. Mercantilist policy therefore tends to favor direct promotion of ex- ports and restrictions on imports through tariffs, quotas,

prohibitions, and state monopolies. The policy makes no economic sense. Starting with phi- losophers and economic thinkers such as David Hume, Adam Smith, John Stuart Mill and David Ricardo, it has been pointed out that imports are de- sirable and that exports are simply a w ay to pay for imports. Moreover, a trade surplus will have macroeconomi c effects that will act to push the bal- ance of payments into equ ilibrium.5 The theory of comparative advantage 5 The fal lacy of mercantilist thought regarding the need for a positive balance of trade inspired David Hume to develop his famous 'price-specie flow" mechan ism. This illustrated the point ----------------------- Page 45----------------------22 The Trading System in Perspective and free tr ade was developed largely in reaction to mercantilist thought and practice. Third, trade barriers frequently have been used as instruments for agri- cultural and industrial development. This was an importan t factor in the latter part of the nineteenth century, with France, the United States and Germany protecting infant industries behind high tariff walls. After 1870, continenta l European powers and the United States pursued activi st trade policies, including imposition of tariffs, to protect i nfant industries. French colonies relied heavily on discriminatory t rade policies such as tariff walls against the rest of the worl d, keeping British goods out of these markets. With France, Ge rmany and the United States becoming increasingly indu s- trialized, British trade dominance was eroded and British goods came to be diverted away from traditional export markets, initially the newly industri- alizing markets, and subsequently rest-of-the-world colonial territories. As a result, Britain also began to pursue preferential tr ade regimes and became more reliant on its own territories. Eventuall y this led to the adoption of a system of imperial preference s. Finally, trade policy is an instrument to redistribute income. By imposi ng barriers to trade, some segments of society gain at the expense of other groups. Protectionism can constitute go od politics. It is a mechanism through which interest groups that support political parties or candidates can be compensate d in relatively non-transparent ways. Groups seeking prote ction will offer political support to the government (or to challengers in el ections) as a quid pro quo. It is often difficult to distinguish between these motivations for restrictive trade policies. Revenue considerat ions prevail almost universally even free-trade Britain imposed s ignificant revenue tariffs. The implication of this is that one cannot ne cessarily determine from the average tariff or the mag- nitude of tari ff revenue collections how high trade barriers are. What mat- ters is the difference in the extent to which domestic and foreign products are taxed. If this difference is small, a country ca n be characterized as maintaining a liberal trade policy, even if tariffs are imposed. The connec- tion between mercantilism and infant industry protection is very strong both have strong nat ionalistic connotations, and both rest on very weak eco- nomic foundations (the economics of infant industry protection is discussed further in chapters 5 and 9). Formal trade agreements generally are concluded among countrie s seek- ing to obtain preferential access to markets. They go beyond establish ing the that trade surpluses and associated inflow of specie would drive up pri ces and result in a loss of export competitiveness. ----------------------- Page 46----------------------The Trading System in Perspective 23 'rules of the game' in areas such as contract enforceme nt and the like to ad- dress barriers to trade. Trade restrictions have b

een a perennial feature of international relations thr oughout history. One of the few exceptions was Great Britain. After the repeal of the Corn Laws (which restricted imports of wheat and other g rains) and the conclusion of the Cobden-Chevalier Treaty between Britain and France in 1860 (which greatly reduced tariffs), Britain maintained a free trade stance at home and in the overseas terr itories it controlled. This free trade policy applied to all sources of supply, not just British goods.6 Other major powers also liberalized trade. During 1862-7, France concluded a range of co mmercial treaties with virtually every major trading power in Europe ( with the exception of Russia) as well as with the United States. Thes e treaties included a most-favored-nation clause. As in each case the countries involved also negotiated treaties with each other and Great Britai n, the trade concessions granted were multilateralized. As of the late 1860s, France was at the center of an impressive network of trade agreements which substantially reduced protectio nist trade barriers throughout Europe (Curzon, 1965). The major exception during this period was the United States, whi ch maintained high tariffs on manufactures to support its industry. Much of this industry was located in the North of the country, wh ich implied that the agricultural sector concentrated in the South effective ly was obliged to transfer a share of its income to the North as it was forced to pay more for machinery and consumer goods. This i s an example of trade diversion that can be associated with the fo rmation of a customs union see chapter 10 and annex 2. A doubling of average tariffs in 1861 to 47 percent helped set off the civil war: an objective of the South was to escape tariffs through seces- s ion from the Union (Adams, 1993: 330). The nineteenth century was the period during which much of the intel- lectual debate about free trade emerged. There were two clear camps. Those in favor of free trad e included Adam Smith (The Wealth of Nations, 1776) and Da vid Ricardo (On the Principles of Political Economy and Taxation, 1817). Others argued trade barriers were required to supp ort infant indus- tries. Influential contributions here were Alexander Hamilton's Report on the Subject of Manuf actures(1791) and Friedrich List'sNational System of Poli tical Economy (1841). The ideas of Smith and Ricardo on the benefits of f ree trade and the principle of comparative advantage provided the in tellec- tual support for the free trade movement in Europe both on the Euro pean 6 British industry helped enforce this free trade stance. For exampl e, when the British govern- ment in India attempted to impose a small revenue ta riff in 1853-54, the British textile industry ensured that an equivalent exc ise tax was levied on Indian textiles (Doyle, 1986, p. 264). ----------------------- Page 47----------------------24 The Trading System in Perspective continent and in B ritain. Writings by Hamilton and List constituted a source of inspiration f or those who favored protection of infant manufacturing in- dustry in the United States and Germany, respectively. As is often the cas e, there was a time lag between the development of the theories and govern- ment action inspired by them. The British free trade movement emerged ha lf a century after the publication of Smith's works. US infant industry pro tec- tionism materialized a quarter of a century after the publi cation of Hamil- ton's Report. Despite the rise of infant industry prot ection in the major powers during the latter part of the nineteenth centur y, the global economy became signifi- cantly more integrated. Global trade expan ded much faster than global out- put. After the First World War, however, c ountries imposed more restrictive trade policies. To some extent this was in response to the United States, which was unwilling to partici pate in efforts during the 1920s to reestablish a more open global econo

my following the disruption to trade that had been caused by the war and war-time policies. As the US economy moved from re cession to depression following the 1929 stock market crash, the US Con- gress adopted the infamous Smoot-Hawley Tariff Act, rai sing average US tariffs on dutiable imports from 38 to 52 percent. This led US trading part- ners to impose retaliatory trade restriction s and engage in rounds of com- petitive devaluation of their curre ncies. A domino effect resulted, as trade flows were diverted t o relatively unprotected markets, forcing down prices, giving rise to protectio nist pressures there, and thus leading to higher trade barriers. At the end of the Second World War, decision-makers were deeply influ- enced b y the lessons of the post First World War period. They perceived the need fo r establishing mechanisms to avoid both competitive devalua tion and the excessive use of trade barriers to guarantee the national mar ket to domestic producers (Gardner, 1969). The negative consequences of the be g- gar-thy-neighbor policies of the early 1930s were still very vivid in 1945. They inspired the US willingness to pursue the type of international cooperati on it had spurned in the 1920s and early 1930s and actively su pport multilateral liberalization efforts, including efforts to ne gotiate the International Trade Organization (ITO) and the GATT. In the A nglo-American view, the postwar international economic system was to be constructed in such a way as to remove the economic causes of frictio n which were believed to have been at the origin of the Second World War. An important element in this vision was the establishment of a stable world ec onomy that would provide all trading nations with nondiscriminatory access to m arkets, supplies and investment opportunities. There was a strong perception that there was a positive cor----------------------- Page 48----------------------The Trading System in Perspective 25 relation between trade and peace, and, as impo rtant, between nondiscrimi- nation and good foreign re lations (Bailey, 1932).7 In the US, the Reciprocal Trade Agreem ents Act of 1934 had already initiated a shift to a more liberal trade policy stance through the adoption of the unconditional MFN principle, albeit firmly grounded in the principle of reciprocity. This policy was extended after the Second World War and incorporated into the draft char- ter of the ITO and the GATT. 1 .3. FUNCTIONS OF THE MULTILATERAL TRADING SYSTEM Multilateral cooperation am ong sovereign nations often occurs through the creation of institutions. Because a central authority is absent in international rel ations, political scientists have developed the concept of a regime, defined a s 'sets of implicit or explicit principles, norms, rules, and decisio n-making procedures around which expectations converge in a given area of interna- tional relations' (Krasner, 1983: 2). The principles and pro cedures imply ob- ligations, even though these are not enforceable through a hierarchical legal system. Regimes reflect patterns of cooperation over time among members that are based on the existence of shared interes ts. The multilateral trading system is a good example of a regime. Two viewp oints are helpful in under- standing the role of the trading system. The first is to regard it as a mecha- nism for the exchange of trade policy commi tments. The second is to view it as a code of conduct. The System as a Forum for Exchange The basis of international c ooperation is communication and the exchange of information on national policy objectives and allowing for identification of the p otential detrimental impact of policies on foreign economies. This is an important function of any international regime, and is a vital aspect of the multilateral trading system (chapter 2). However, the WTO i s more than a forum for communication, it is a forum for the exchange of liberalization commitments. That is, it is a market. Bargainin

g and negotiation are the main instruments used to reduce barriers to trade and agree to rules of be- 7 The academic literature on the relationship between trade and the probability of war has a rgued that this may go either way. For example, two countries that are on oppos ing sides of the globe and do not trade at all are less likely to go to war than two neighbouring states that trade a lot. However, Mansfield (1994) h as concluded that, controlling for other factors, there is a ro bust negative relationship between the volume of trade between country pairs a nd the prob- ability of a war between them. ----------------------- Page 49----------------------26 The Trading System in Perspective havior. MTNs are mechanisms to facilitate the reciprocal exchange of market access commitments. Whether there is an economic rationale for trade restric tions depends largely on the market power of a country. A small country that c annot influ- ence prices on world markets will generally lose from imposing trade barri- ers, and therefore has much to gain from multilat eral agreement to lower trade barriers. Indeed, such countries should pur sue liberalization unilater- ally. That other countries also reduce barriers is icing on the cake (see Box 1.2). In contrast, large countries may be able to change the terms of trade the price of their exports relative to the price o f imports in their favor by restricting trade. However, for the world as a who le the imposition of trade restrictions by one or more countries can onl y reduce welfare. Large coun- tries thus may find themselves in a so-called Pris oners' Dilemma situation: it is in each country's interest to impose restrictions, but the result of such individually rational behavior is inefficient (see chapter 4). All countries end up in a situation where t heir welfare is lower than if they applied free trade 8 policies . Both small and large countries therefore have an incentive to coop- erate and agree to reduce or abolish trade barriers. Trade and trade liberali- zation is a positive-sum game. Box 1.2. Why liberalize trade? The central concept underlying trade is opportunity cost. Producing (con- suming) something comes at the cost of not producing (consuming) some- thing else. An i mportant economic theorem states that there are gains from trade associate d with minimizing opportunity costs through the division of labor (sp ecialization). Consider a simple example. Suppose the peopl e of Plains, who are good at raising animals (say cows), must also spend time growing wheat (at which they are less good than in ra ising cows). Each hour spent growing wheat has a high opportunity cost in t erms of cows forgone, but there is no choice but to devote the time r equired to grow wheat. Sup- pose the people of Agria are good at farming, but do not have much aptitude for raising cows. Agria will then have a high opportunity cost in terms of time not spent farming. If these two co untries/groups of people could trade with each other, they could concentrate on what each one does best. Econo- mists say that they would specialize acc ording to their comparative advan- tage. This will ensure that total output produced expands in both regions, 8 That is, lar ge countries need to take into account the possibility of retaliati on. Another problem is that if tariffs are not set at the optimal l evel, large countries may easily lose from activist trade policy even if other countries pursue free trade. ----------------------- Page 50----------------------The Trading System in Perspective 27 and that each is able to consume more wheat and beef and milk t han would be possible without trade. The decision what to specialize in depends on what one does best com- pared with the other things that could (or would have to) be done. The peo- ple of Plains might be bett er farmers than those in Agria, in that for every hour invested in far ming they get a larger harvest. However, as long as an hour spent by the p

eople in Plains on farming has a higher cost in terms of forgone cows than does an hour spent on farming in Agria, Plains should specia lize in cows. What matters is not absolute, but comparative advantage. Inte rnational trade provides nations with the opportunity to specializ e in production according to their comparative advantage. This suggests that countries interested in maximizing their wealth should not impose trad e barriers. This is certainly the case for small countries that are price-ta kers on world markets. A practical problem is that there are of- ten pol itical difficulties in liberalizing.access to markets, because some peo- ple will always lose from liberalization. In principle, such groups can be compensated, as the increase in total output and c onsumption is always larger than the losses incurred by those who must cha nge the economic ac- tivity they are engaged in. Actually compensating the losers is not always easy, however. It is also true that although a country will benefit from liber- alizing its trade, it is even b etter if trading partners do the same. This is one of the primary rational es for engaging in multilateral liberalization efforts and is the raison d'etre of the WTO: by making liberalization conditional on greater access to foreign markets, the total gains of liberalization inc rease and in the process liberalization becomes more feasible politically. Achieving multilateral trade liberalization is no trivial matter. In all countries there are numerous groups that have different preferences with respect to trade measures. Abstracting from revenue considerations, the structure of p rotection at any point in time is the result of the interaction betw een the demands expressed by various groups in society and the supply offered by governments. Attempts to alter this equilibrium and move towards a wel- fare-increasing reduction in protection will generate opposition by those groups that expect to lose from liberalization. Such losses are usually con- centrated in impo rt-competing industries, while the gainers consumers of the products concerned tend to be much more diffuse. This gives rise to a political economy problem. Those facing losses have a much greater indi- vidual incentive to organize and invest in lobbying against liberalization than th ose that gain from reform have to lobby for liberalization. Individual gain s are relatively small and dispersed among a large number of voters, ----------------------- Page 51----------------------28 in Perspective while losers reason why trade re9 strictions are imposed in the first place. A MTN can solve this problem by confronting th ose who gain from protection with another lobby that may be equally powerful : the set of firms that benefit from greater access to foreign markets. Similarly, by requiring reciprocal reductions in trade barriers, the pri soners' dilemma that in principle may confront large co untries can be overcome, again improving world welfare. Finally, by incl uding many prod- ucts in the negotiation, losers obtain some automatic compens ation through access to cheaper imports. Trade liberalization helps na tions to realize a more efficient utilization of their resou rces (production capacities). Trade liberalization has two essen- tia l effects. First, it brings about a reallocation of resources tow ards those activities in which the country has comparative advantage. Secondly, trade liberalization expands the consumption opportunities of countries, as more efficient production generates greater income and increased opportunities to buy goods and services from o ther countries. See annex 2 for an illustra- tion of the standard mechanic s of the gains from trade. A MTN is a market in the sense that countries come together to exchange market access commitments on a reciprocal basi s. It is a barter market. In contrast to the markets one finds in city are more The Trading System concentrated. This is the main

squares, countries do not have ac- cess to a medium of exchange: they d o not have money with which to buy, and against which to sell, trade p olicies. Instead they have to exchange ap- ples against oranges: tariff reductions for iron against foreign market access commitments for cloth. This makes the trade policy market less efficient th an one where money can be used, and is one of the reasons that MTNs can be a to rtuous process. A Code of Conduct for Trad e Policy One of the results of the market exchange is a code of conduct. The WTO contains a set of specific legal obligations regulating tr ade policies of mem- ber states. These are embodied in the GATT, the GATS, and the agreement on TRIPs. The rules and principles of the WTO constrain the freedom of governments to use specific trade policy instruments. They influence the balance between interest groups seeking protection and those favoring open markets in the domestic political marketplace. Industry associations, labor 9 In the case of developing countries that do not have a well-developed tax administration, taxing trade flows frequently has an i mportant revenue rationale as well. More generally, most people tend to be nationalistic in their thinking about economic matters. Trade polic y is by definition a nationalistic policy in that it discriminates against fo reign producers. ----------------------- Page 52----------------------The Trading System in Perspective 29 unions, regional authorities, consumer lobbies and government agencies all interact in determining the policy outcome. The WTO is somewhat analo- gous to a mast to which governments can tie themse lves to escape the siren- like calls of various pressure groups (Roes sler, 1985). It is a mechanism through which the political marke t failure that is inherent in many socie- ties both industrialized a nd developing can be corrected, at least in part, because reneging on libe ralization commitments requires compensation of affected trading part ners. This increases both the cost and the visibility of adopting i nefficient trade policies to placate domestic interest groups. How- ever, m uch depends on the will of governments to tie themselves to the mast. WTO rules and disciplines discussed at length in later chapters embody many holes and loopholes that governments can invoke if they desire to. Much also depends on whether it makes economic sense to tie oneself to the ma st. A necessary condition is that abiding by the rules is in th e national interest of members. As discussed subsequently, a number of e xisting WTO rules do not meet this test. The WTO embodies a rule-oriented a pproach to multilateral cooperation. This contrasts with what can be chara cterized as a results-oriented or man- aged-trade approach agreements on tra de flows, market share or interna- tional prices. The WTO establishes a fram ework for trade. It does not define or specify outcomes. Five principl es are of particular importance in under- standing both the pre-1 994 GATT and the WTO: (1) nondiscrimination; (2) reciprocity; (3) en forceable commitments; (4) transparency; and (5) safety valves . Nondiscrimination The principle of nondi scrimination has two components, the MFN rule and the national treatment principle. Both components are embedded in the main WTO ru les on goods, services and intellectual property. However, their precise scope and nature differ across these three areas, especially national treatment (see later chapters). The MFN rule requires that a product made in on e member country be treated no less favorably than a 'like' (very similar) good that originates in any other country. Thus, if the be st treatment granted a trading partner supplying a specific product is a five percent tariff, then this rate must be applied immediately and unc onditionally to the im- ports of this good originating in all WTO members. B ecause the initial set of contracting parties to the GATT was quite

small (only 23 countries), the benchmark for MFN is the best tre atment offered to any country, including countries that may not be a member of the GATT. Similar wording applies ----------------------- Page 53----------------------The Trading System in Perspective under the WTO. Disputes can be brought to the WTO alleging not just de jure violation of MFN, but also de facto violation.10 The na tional treatment rule is the second component of the nondiscrimi- natio n principle. It requires that foreign goods once they have satisfied whatever border measures are applied be treated no less favorably than like or directly competitive goods