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Introduction

economic transactions that are made between countries. Among the itemscommonly traded are consumer goods, such as television sets and clothing;capital goods, such as machinery; and raw materials and food. Othertransactions involve services, such as travel services and payments forforeign patents (seeservice industry). International trade transactions arefacilitated by international financial payments, in which the privatebanking system and the central banks of the trading nations play importantroles.

International trade and the accompanying financial transactions aregenerally conducted for the purpose of providing a nation withcommodities it lacks in exchange for those that it produces in abundance;such transactions, functioning with other economic policies, tend toimprove a nation's standard of living. Much of the modern history ofinternational relations concerns efforts to promote freer trade betweennations. This article provides a historical overview of the structure ofinternational trade and of the leading institutions that were developed topromote such trade.

Historical overview

The barter of goods or services among different peoples is an age-oldpractice, probably as old as human history. International trade, however,refers specifically to an exchange between members of different nations,and accounts and explanations of such trade begin (despite fragmentaryearlier discussion) only with the rise of the modern nation-state at theclose of the European Middle Ages. As political thinkers and philosophersbegan to examine the nature and function of the nation, trade with othercountries became a particular topic of their inquiry. It is, accordingly, nosurprise to find one of the earliest attempts to describe the function of

international trade within that highly nationalistic body of thought nowknown as mercantilism.

Mercantilism

Mercantilist analysis, which reached the peak of its influence uponEuropean thought in the 16th and 17th centuries, focused directly upon

Encyclopdia Britannica Article

international trade


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the welfare of the nation. It insisted that the acquisition of wealth,particularly wealth in the form of gold, was of paramount importance fornational policy. Mercantilists took the virtues of gold almost as an articleof faith; consequently, they never sought to explain adequately why thepursuit of gold deserved such a high priority in their economic plans.

Mercantilism was based on the conviction that national interests areinevitably in conflictthat one nation can increase its trade only at theexpense of other nations. Thus, governments were led to impose priceand wage controls, foster national industries, promote exports of finishedgoods and imports of raw materials, while at the same time limiting theexports of raw materials and the imports of finished goods. The stateendeavoured to provide its citizens with a monopoly of the resources andtrade outlets of its colonies.

The trade policy dictated by mercantilist philosophy was accordinglysimple: encourage exports, discourage imports, and take the proceeds ofthe resulting export surplus in gold. Mercantilists' ideas often were

intellectually shallow, and indeed their trade policy may have been littlemore than a rationalization of the interests of a rising merchant classthat wanted wider marketshence the emphasis on expandingexportscoupled with protection against competition in the form ofimported goods.

A typical illustration of the mercantilist spirit is the English NavigationAct of 1651 (seeNavigation Acts), which reserved for the home countrythe right to trade with its colonies and prohibited the import of goods ofnon-European origin unless transported in ships flying the English flag.

This law lingered until 1849. A similar policy was followed in France.

Liberalism

A strong reaction against mercantilist attitudes began to take shapetoward the middle of the 18th century. In France, the economists knownas Physiocrats demanded liberty of production and trade. In England,economist Adam Smith demonstrated in his book The Wealth of Nations(1776) the advantages of removing trade restrictions. Economists and

businessmen voiced their opposition to excessively high and oftenprohibitive customs duties and urged the negotiation of trade agreementswith foreign powers. This change in attitudes led to the signing of anumber of agreements embodying the new liberal ideas about trade,among them the Anglo-French Treaty of 1786, which ended what hadbeen an economic war between the two countries.

After Adam Smith, the basic tenets of mercantilism were no longerconsidered defensible. This did not, however, mean that nations


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abandoned all mercantilist policies. Restrictive economic policies werenow justified by the claim that, up to a certain point, the governmentshould keep foreign merchandise off the domestic market in order toshelter national production from outside competition. To this end,customs levies were introduced in increasing number, replacing outrightbans on imports, which became less and less frequent.

In the middle of the 19th century, a protective customs policy effectivelysheltered many national economies from outside competition. The Frenchtariff of 1860, for example, charged extremely high rates on Britishproducts: 60 percent on pig iron; 40 to 50 percent on machinery; and 600to 800 percent on woolen blankets. Transport costs between the twocountries provided further protection.

A triumph for liberal ideas was the Anglo-French trade agreement of1860, which provided that French protective duties were to be reducedto a maximum of 25 percent within five years, with free entry of allFrench products except wines into Britain. This agreement was followed

by other European trade pacts.

Resurgence of protectionism

A reaction in favour of protection spread throughout the Western world inthe latter part of the 19th century. Germany adopted a systematicallyprotectionist policy and was soon followed by most other nations. Shortlyafter 1860, during the Civil War, the United States raised its dutiessharply; the McKinley Tariff Act of 1890 was ultraprotectionist. The

United Kingdom was the only country to remain faithful to the principlesof free trade.

But the protectionism of the last quarter of the 19th century was mild bycomparison with the mercantilist policies that had been common in the17th century and were to be revived between the two world wars.Extensive economic liberty prevailed by 1913. Quantitative restrictionswere unheard of, and customs duties were low and stable. Currencieswere freely convertible into gold, which in effect was a commoninternational money. Balance-of-payments problems were few. People

who wished to settle and work in a country could go where they wishedwith few restrictions; they could open businesses, enter trade, or exportcapital freely. Equal opportunity to compete was the general rule, thesole exception being the existence of limited customs preferencesbetween certain countries, most usually between a home country and itscolonies. Trade was freer throughout the Western world in 1913 than itwas in Europe in 1970.


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The new mercantilism

World War I wrought havoc on these orderly trading conditions. By theend of the hostilities, world trade had been disrupted to a degree thatmade recovery very difficult. The first five years of the postwar periodwere marked by the dismantling of wartime controls. An economicdownturn in 1920, followed by the commercial advantages that accrued

to countries whose currencies had depreciated (as had Germany's),prompted many countries to impose new trade restrictions. The resultingprotectionist tide engulfed the world economy, not because policymakers consciously adhered to any specific theory but because ofnationalist ideologies and the pressure of economic conditions. In anattempt to end the continual raising of customs barriers, the League ofNations organized the first World Economic Conference in May 1927.Twenty-nine states, including the main industrial countries, subscribed toan international convention that was the most minutely detailed andbalanced multilateral trade agreement approved to date. It was a

precursor of the arrangements made under the General Agreement onTariffs and Trade (GATT) of 1947.

However, the 1927 agreement remained practically without effect.During the Great Depression of the 1930s, unemployment in majorcountries reached unprecedented levels and engendered an epidemic ofprotectionist measures. Countries attempted to shore up their balance ofpayments by raising their customs duties and introducing a range ofimport quotas or even import prohibitions, accompanied by exchangecontrols.

From 1933 onward, the recommendations of all the postwar economicconferences based on the fundamental postulates of economic liberalismwere ignored. The planning of foreign trade came to be considered anormal function of the state. Mercantilist policies dominated the worldscene until after World War II, when trade agreements and supranationalorganizations became the chief means of managing and promotinginternational trade.

The theory of international trade

Comparative-advantage analysis

The British school of classical economics began in no small measure as areaction against the inconsistencies of mercantilist thought. Adam Smithwas the 18th-century founder of this school; as mentioned above, hisfamous work, The Wealth of Nations(1776), is in part an antimercantilisttract. In the book, Smith emphasized the importance of specialization as


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a source of increased output, and he treated international trade as aparticular instance of specialization: in a world where productiveresources are scarce and human wants cannot be completely satisfied,each nation should specialize in the production of goods it is particularlywell equipped to produce; it should export part of this production, takingin exchange other goods that it cannot so readily turn out. Smith did notexpand these ideas at much length, but another classical economist,

David Ricardo, developed them into the principle of comparativeadvantage, a principle still to be found, much as Ricardo spelled it out, incontemporary textbooks on international trade.

Simplified theory of comparative advantage

For clarity of exposition, the theory of comparative advantage isusually first outlined as though only two countries and only twocommodities were involved, although the principles are by no means

limited to such cases. Again for clarity, the cost of production isusually measured only in terms of labour time and effort; the cost of aunit of cloth, for example, might be given as two hours of work. Thetwo countries will be called A and B; and the two commoditiesproduced, wine and cloth. The labour time required to produce a unitof either commodity in either country is as follows:

cost of production (labour time)

country A country B

wine (1 unit) 1 hour 2 hours

cloth (1 unit) 2 hours 6 hours

As compared with country A, country B is productively inefficient. Itsworkers need more time to turn out a unit of wine or a unit of cloth.This relative inefficiency may result from differences in climate, inworker training or skill, in the amount of available tools andequipment, or from numerous other reasons. Ricardo took it forgranted that such differences do exist, and he was not concerned withtheir origins.

Country A is said to have an absolute advantage in the production ofboth wine and cloth because it is more efficient in the production ofboth goods. Accordingly, A's absolute advantage seemingly invites theconclusion that country B could not possibly compete with country A,and indeed that if trade were to be opened up between them, countryB would be competitively overwhelmed. Ricardo, who focused chieflyon labour costs, insisted that this conclusion is false. The criticalfactor is that country B's disadvantage is less pronounced in wine


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production, in which its workers require only twice as much time for asingle unit as do the workers in A, than it is in cloth production, inwhich the required time is three times as great. This means, Ricardopointed out, that country B will have a comparative advantage in wineproduction. Both countries will profit, in terms of the real income theyenjoy, if country B specializes in wine production, exporting part of itsoutput to country A, and if country A specializes in cloth production,

exporting part of its output to country B. Paradoxical though it mayseem, it is preferable for country A to leave wine production tocountry B, despite the fact that A's workers can produce wine of equalquality in half the time that B's workers can do so.

The incentive to export and to import can be explained in price terms.In country A (before international trade), the price of cloth ought tobe twice that of wine, since a unit of cloth requires twice as muchlabour effort. If this price ratio is not satisfied, one of the twocommodities will be overpriced and the other underpriced. Labour willthen move out of the underpriced occupation and into the other, until

the resulting shortage of the underpriced commodity drives up itsprice. In country B (again, before trade), a cloth unit should cost threetimes as much as a wine unit, since a unit of cloth requires three timesas much labour effort. Hence, a typical before-trade pricerelationship, matching the underlying real cost ratio in each country,might be as follows:

country A country B

Price of wine per unit $ 5 1

Price of cloth per unit $10 3

The absolute levels of price do not matter. All that is necessary is thatin each country the ratio of the two prices should match thelabourcost ratio.

As soon as the opportunity for exchange between the two countries isopened up, the difference between the winecloth price ratio incountry A (namely, 5:10, or 1:2) and that in country B (which is 1:3)provides the opportunity of a trading profit. Cloth will begin to movefrom A to B, and wine from B to A. As an illustration, a trader in A,starting with an initial investment of $10, would buy a unit of cloth,sell it in B for 3, buy 3 units of B's wine with the proceeds, and sellthis in A for $15. (This example assumes, for simplicity, that costs oftransporting goods are negligible or zero. The introduction of transportcosts complicates the analysis somewhat, but it does not change theconclusions, unless these costs are so high as to make tradeimpossible.)


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So long as the ratio of prices in country A differs from that in countryB, the flow of goods between the two countries will steadily increaseas traders become increasingly aware of the profit to be obtained bymoving goods between the two countries. Prices, however, will beaffected by these changing flows of goods. The wine price in countryA, for example, can be expected to fall as larger and larger supplies ofimported wine become available. Thus A's winecloth price ratio of 1:2

will fall. For comparable reasons, B's price ratio of 1:3 will rise. Whenthe two ratios meet, at some intermediate level (in the example

earlier, at 1:21/2), the flow of goods will stabilize.

Amplification of the theory

At a later stage in the history of comparative-advantage theory,English philosopher and political economist John Stuart Mill showedthat the determination of the exact after-trade price ratio was asupply-and-demand problem. At each possible intermediate ratio(within the range of 1:2 and 1:3), country A would want to import aparticular quantity of wine and export a particular quantity of cloth.At that same possible ratio, country B would also wish to import andexport particular amounts of cloth and of wine. For any intermediateratio taken at random, however, A's export-import quantities areunlikely to match those of B. Ordinarily, there will be just oneintermediate ratio at which the quantities correspond; that is the finaltrading ratio at which quantities exchanged will stabilize. Indeed,once they have stabilized, there is no further profit in exchanginggoods. Even with such profits eliminated, however, there is no reasonwhy A producers should want to stop selling part of their cloth in B,since the return there is as good as that obtained from domestic sales.Furthermore, any falloff in the amounts exported and imported wouldreintroduce profit opportunities.

In this simple example, based on labour costs, the result is complete(and unrealistic) specialization: country A's entire labour force willmove to cloth production and country B's to wine production. Moreelaborate comparative-advantage models recognize production costs

other than labour (that is, the costs of land and of capital). In suchmodels, part of country A's wine industry may survive and competeeffectively against imports, as may also part of B's cloth industry. Themodels can be expanded in other waysfor example, by involving morethan two countries or products, by adding transport costs, or byaccommodating a number of other variables such as labour conditionsand product quality. The essential conclusions, however, come fromthe elementary model used above, so that this model, despite itssimplicity, still provides a workable outline of the theory. (It should be


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noted that even the most elaborate comparative-advantage modelscontinue to rely on certain simplifying assumptions without which thebasic conclusions do not necessarily hold. These assumptions arediscussed below.)

As noted earlier, the effect of this analysis is to correct any false firstimpression that low-productivity countries are at a hopelessdisadvantage in trading with high-productivity ones. The impression isfalse, that is, if one assumes, as comparative-advantage theory does,that international trade is an exchange of goods between countries. Itis pointless for country A to sell goods to country B, whatever itslabour-cost advantages, if there is nothing that it can profitably takeback in exchange for its sales. With one exception, there will alwaysbe at least one commodity that a low-productivity country such as Bcan successfully export. Country B must of course pay a price for itslow productivity, as compared with A; but that price is a lower percapita domestic income and not a disadvantage in internationaltrading. For trading purposes, absolute productivity levels are

unimportant; country B will always find one or more commodities inwhich it enjoys a comparative advantage (that is, a commodity in theproduction of which its absolute disadvantage is least). The oneexception is that case in which productivity ratios, and consequentlypretrade price ratios, happen to match one another in two countries.This would have been the case had country B required four labourhours (instead of six) to produce a unit of cloth. In such acircumstance, there would be no incentive for either country toengage in trade, nor would there be any gain from trading. In atwo-commodity example such as that employed, it might not be

unusual to find matching productivity and price ratios. But as soon asone moves on to cases of three and more commodities, the statisticalprobability of encountering precisely equal ratios becomes very smallindeed.

The major purpose of the theory of comparative advantage is toillustrate the gains from international trade. Each country benefits byspecializing in those occupations in which it is relatively efficient;each should export part of that production and take, in exchange,those goods in whose production it is, for whatever reason, at a

comparative disadvantage. The theory of comparative advantage thusprovides a strong argument for free tradeand indeed for more of alaissez-faire attitude with respect to trade. Based on thisuncomplicated example, the supporting argument is simple:specialization and free exchange among nations yield higher realincome for the participants.

The fact that a country will enjoy higher real income as a consequenceof the opening up of trade does not mean, of course, that every family


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or individual within the country will share in that benefit. Producergroups affected by import competition obviously will suffer, to at leastsome degree. Individuals are at risk of losing their jobs if the itemsthey make can be produced more cheaply elsewhere.Comparative-advantage theorists concede that free trade would affectthe relative income position of such groupsand perhaps even theirabsolute income level. But they insist that the special interests of

these groups clash with the total national interest, and the most thatcomparative-advantage proponents are usually willing to concede isthe possible need for temporary protection against import competition(i.e., to allow those who lose their jobs to international competition tofind new occupations).

Nations do, of course, maintain tariffs and other barriers to imports.For discussion of the reasons for this seeming clash between actualpolicies and the lessons of the theory of comparative advantage, seeState interference in international trade.

Sources of comparative advantage

As already noted, British classical economists simply accepted the factthat productivity differences exist between countries; they made noconcerted attempt to explain which commodities a country would exportor import. During the 20th century, international economists offered anumber of theories in an effort to explain why countries have differencesin productivity, the factor that determines comparative advantage andthe pattern of international trade.

Natural resources

First, countries can have an advantage because they are richlyendowed with a particular natural resource. For example, countrieswith plentiful oil resources can generally produce oil inexpensively.Because Saudi Arabia produces oil very cheaply, it holds a comparativeadvantage in oil, and it exports oil in order to finance its purchases ofimports. Similarly, countries with large forests generally are the majorexporters of wood, paper, and paper products. The supply availablefor export also depends on domestic demand. Canada has largequantities of lumber available for export to the United States, not onlybecause of its large areas of forest but also because its smallpopulation consumes little of the supply, leaving much of the lumberavailable for export. Climate is another natural resource that providesan export advantage. Thus, for example, bananas are exported byCentral American countriesnot Iceland or Finland.


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Factor endowments: the Heckscher-Ohlin theory

Simply put, countries with plentiful natural resources will generallyhave a comparative advantage in products using those resources. Arelated, but much more subtle, assertion was put forward by twoSwedish economists, Eli Heckscher and Bertil Ohlin. Ohlin's work wasbuilt upon that of Heckscher. In recognition of his ideas as described inhis path-breaking book, Interregional and International Trade(1933),Ohlin was a recipient of the Nobel Prize for Economics in 1977.

The Heckscher-Ohlin theory focuses on the two most important factorsof production, labour and capital. Some countries are relativelywell-endowed with capital; the typical worker has plenty of machineryand equipment to assist with the work. In such countries, wage ratesgenerally are high; as a result, the costs of producing labour-intensivegoodssuch as textiles, sporting goods, and simple consumer

electronicstend to be more expensive than in countries with plentifullabour and low wage rates. On the other hand, goods requiring muchcapital and only a little labour (automobiles and chemicals, forexample) tend to be relatively inexpensive in countries with plentifuland cheap capital. Thus, countries with abundant capital shouldgenerally be able to produce capital-intensive goods relativelyinexpensively, exporting them in order to pay for imports oflabour-intensive goods.

In the Heckscher-Ohlin theory it is not the absolute amount of capital

that is important; rather, it is the amount of capital per worker. Asmall country like Luxembourg has much less capital in total thanIndia, but Luxembourg has more capital per worker. Accordingly, theHeckscher-Ohlin theory predicts that Luxembourg will exportcapital-intensive products to India and import labour-intensiveproducts in return.

Despite its plausibility the Heckscher-Ohlin theory is frequently atvariance with the actual patterns of international trade. As anexplanation of what countries actually export and import, it is muchless accurate than the more obvious and straightforward natural

resource theory.

One early study of the Heckscher-Ohlin theory was carried out byWassily Leontief, a Russian-born U.S. economist. Leontief observedthat the United States was relatively well-endowed with capital.According to the theory, therefore, the United States should exportcapital-intensive goods and import labour-intensive ones. He foundthat the opposite was in fact the case: U.S. exports are generally morelabour intensive than the type of products that the United States


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imports. Because his findings were the opposite of those predicted bythe theory, they are known as the Leontief Paradox.

Economies of large-scale production

Even if countries have quite similar climates and factor endowments,

they may still find it advantageous to trade. Indeed, economicallysimilar countries often carry on a large and thriving trade. Theprosperous industrialized countries have become one another's bestcustomers. A main reason for this situation lies in what is called theeconomies of large-scale production (seeeconomy of scale).

For many products, there are advantages in producing on a large scale;costs become lower as more is produced. Thus, for example,automobiles can be made more cheaply in a factory producing 100,000units than in a small factory producing only 1,000 units. This means

that countries have an incentive to specialize in order to reduce costs.To sell a large volume of output, they may have to look to exportmarkets.

The smaller the country, and the more limited its domestic market,the more incentive it has to look to international trade as a way ofgaining the advantages of large-scale production. Thus, Luxembourg orBelgium has much more to gain, relatively, than the United States.Indeed, the advantages of large-scale production were one of themajor sources of gain from the establishment of the EuropeanEconomic Community (EEC; ultimately replaced by the European

Union), which was formed for the purpose of providing free tradebetween most western European countries.

Even a large country such as the United States, however, can gain insome cases by exporting in order to exploit the economies ofproduction lines. For example, the Boeing Company has been able toproduce airplanes more efficiently and cheaply because it is able tosell large numbers of aircraft to other countries. The importingcountries also gain because they can buy aircraft abroad at prices farlower than they would pay for domestically produced equivalents.

Technology

Technological development can also provide a distinctive tradeadvantage. The relatively advanced countriesparticularly the UnitedStates, Japan, and those of western Europehave been the principalexporters of high-technology products such as computers and precision


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machinery.

One important aspect of technology is that it can change rapidly. Thisis perhaps most obvious in the computer field, where productivity hasincreased and costs have fallen sharply since the early 1960s (seeMoore's law). Such rapid changes present several challenges. Forcountries that are not in the front rank, it raises the question ofwhether they should import high-technology products or attempt toenter the circle of the most advanced nations. For the countries thathave held the technological lead in the past, there is always thepossibility that they will be overtaken by newcomers. This occurred inthe second half of the 20th century when Japan advancedtechnologically in its automobile production to the point where itcould challenge the automobile leadership of North America andEurope. Japan quickly became the world's foremost producer ofautomobiles, and by the end of the 20th century, Korean automakerswere attempting to follow the Japanese example with the aggressiveexport of automobiles.

Technological advances also strengthen global trade in a generalsense: e-commerce (electronic commerce), for example, reduced theimpact of geographic distance by facilitating fast, efficient, real-timeties between businesses and individuals around the world. Indeed, atthe end of the 20th century, information technology, an industry thatscarcely existed 20 years earlier, exceeded the combined world tradein agriculture, automobiles, and textiles.

The product cycle

The spread of technology across national boundaries means thatcomparative advantage can change. The most technologicallyadvanced countries generally have the advantage in making newproducts, but as time passes other countries may gain the advantage.For example, many television sets were produced in the United Statesduring the 1950s. As time passed, however, and technological changein the television industry became less rapid, there was less advantagein producing sets in the United States. Producers of television sets had

an incentive to look to other locations, with lower wage rates. In time,the manufacturers established overseas operations in Taiwan, HongKong, and elsewhere. Concurrently, the United States turned to newactivities, such as the manufacture of supercomputers, thedevelopment of computer software, and new applications of satellitetechnology.

Romney Robinson


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Paul WonnacottEd.

State interference in international trade

Methods of interference

Regardless of what comparative-advantage theory may say about thevirtues of unrestricted trade, all nations interfere with internationaltransactions to some degree. Tariffs may be imposed on importsin someinstances making them so costly as to bar completely the entry of thegood involved. Quotas may limit the permissible volume of imports. Statesubsidies may be offered to encourage exports. Money-capital exportsmay be restricted or prohibited. Investment by foreigners in domesticplant and equipment may be similarly restrained.

These interferences may be simply the result of special-interest pleading,

because particular groups suffer as a consequence of import competition.Or a government may impose restrictions because it feels impelled totake account of factors that comparative advantage sets aside. It is ofinterest to note that insofar as goods and services are concerned, thegeneral pattern of interference follows the old mercantilist dictum ofdiscouraging imports and encouraging exports.

A company that finds itself barred from an attractive foreign market bytariffs or quotas may be able to sidestep the barrier simply byestablishing a manufacturing plant within that foreign country. This

policy of foreign plant investment expanded enormously after World WarII, with U.S. companies taking the lead by investing particularly inwestern Europe, Canada, Asia, and South America. Industry in otherdeveloped countries followed a similar pattern, with many foreigncompanies establishing plants within the United States as well as in otherareas of the world.

The governments of countries subject to this new investment findthemselves in an ambivalent position. The establishment of newforeign-owned plants may mean more than simply the creation of newemployment opportunities and new productive capacity; it may also

mean the introduction of new technologies and superior business-controlmethods. But the government that welcomes such benefits must alsoexpect complaints of foreign control, an argument that will inevitablybe pressed by domestic owners of older plants who fear a newcompetition that cannot be blocked by tariffs. This has been a pressingproblem for many governments, particularly insofar as investment by U.S.firms is involved, and it is a chief complaint of critics who viewglobalization as a form of economic exploitation. Some countries, such as


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the United Kingdom and Canada, have been liberal in their admissionspolicy; others, notably Japan, have imposed tight restrictions onforeign-owned plants.

Romney Robinson

Tariffs

A tariff, or duty, is a tax levied on products when they cross theboundary of a customs area. The boundary may be that of a nation ora group of nations that has agreed to impose a common tax on goodsentering its territory. Tariffs are often classified as either protectiveor revenue-producing. Protective tariffs are designed to shielddomestic production from foreign competition by raising the price ofthe imported commodity. Revenue tariffs are designed to obtainrevenue rather than to restrict imports. The two sets of objectives

are, of course, not mutually exclusive. Protective tariffsunless theyare so high as to keep out importsyield revenue, while revenue tariffsgive some protection to any domestic producer of the duty-bearinggoods. A transit duty, or transit tax, is a tax levied on commoditiespassing through a customs area en route to another country. Similarly,an export duty, or export tax, is a tax imposed on commodities leavinga customs area. Finally, some countries provide export subsidies;import subsidies are rarely used.

How tariffs work

Tariffs on imports may be applied in several ways. If they areimposed according to the physical quantity of an import (so muchper ton, per yard, per item, etc.), they are called specific tariffs. Ifthey are levied according to the value of the import, they areknown as ad valorem tariffs.

Tariffs may differentiate among the countries from which theimports are obtained. They may, for instance, be lower between

countries that have previously entered into special arrangements,such as the trade preferences accorded to each other by membersof the European Union.

Tariffs may be imposed in different ways, each of which will have adifferent effect on the economy of the country imposing them. Byraising the prices of imported goods, tariffs may encouragedomestic production. As expenditures on domestic products rise,domestic employment tends to do likewise. This is why tariffs are


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favoured by industries that find themselves pressed by foreigncompetitors. The tariff may also encourage tendencies toward amonopolistic market structure to the extent that it lessens foreigncompetition, with a resulting decrease in the incentive tomodernize or innovate. Because tariffs increase the price of animported commodity, they may also reduce its consumption. Thedecrease in demand could be large enough in relation to the world

market to force the price of the import down.

Measuring the effects of tariffs

It is difficult to gauge the effect of tariff barriers among countries.Clearly, the way in which import demand responds to changes intariffs will depend on a variety of factors. These include thereaction of producers and consumers to price changes, the share ofimports in domestic production and consumption, the

substitutability of imports for domestic products, and so on. Thereaction to tariff levels will differ from country to country as well asfrom commodity to commodity. Thus, the amount of a tariff doesnot necessarily determine its restrictive effect. Typically, suchcomparisons apply only to products for which tariffs are the majorprotective device. This is generally true for nonagricultural productsin developed countries (other strategies, such as import quotas, area common means of protecting agricultural commodities). Althoughtariffs on imported raw materials will protect domestic producers ofthose commodities, such tariffs will also increase the costs to

domestic manufacturers who use those raw materials. Theseconditions necessitate a distinction between nominal and effectiverates of protection.

The nominal rate of protection is the percentage tariff imposed ona product as it enters the country. For example, if a tariff of 20percent of value is collected on clothing as it enters the country,then the nominal rate of protection is that same 20 percent.

The effective rate of protection is a more complex concept:consider that the same productclothingcosts $100 on

international markets. The material that is imported to make theclothing (material inputs) sells for $60. In a free-trade situation, afirm can charge no more than $100 for a similar piece of clothing(ignoring transportation costs). Importing the fabric for $60, theclothing manufacturer can add a maximum of $40 for labour, profitmarkup, rents, and the like. This $40 difference between the $60cost of material inputs and the price of the product is called thevalue added.


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The same situation may be considered with tariffssay, 20 percenton clothing and 10 percent on fabric. The 20 percent tariff onclothing would raise the domestic price by $20 to $120, while a 10percent tariff on fabrics would increase material costs to thedomestic producer by $6 to $66. Protection would thus enable thefirm to operate with a value-added margin of $54the differencebetween the domestic price of $120 and the material cost of $66.

The difference between the value added of $40 without tariffprotection and that of $54 with it provides a margin of $14. Thismeans that the effective rate of protection of the domesticprocessing activitythe ratio of $14 to $40would be 35 percent.The effective rate of protection derived35 percentis greaterthan the nominal rate of only 20 percent. This will be the casewhenever the tariff rate on the final product is greater than thetariff on inputs. Because countries generally do levy higher tariffson final products than on inputs, effective rates of protection areusually higher than nominal ratesoften much higher.

The effective rate of protection also depends on the share of valueadded in the product price. Effective rates can be very high if valueadded to the imported commodity is a small percentage or very lowif value added is a large percentage of the total price. Thus,effective protection in one country may be much higher than that inanother even though its nominal tariffs are lower, if it tends toimport commodities of a high level of fabrication withcorrespondingly low ratios of value added to product price.

Nontariff barriers

Other government regulations and practices may also act as barriers totrade. Quotas or quantitative restrictions may prohibit the importationof certain commodities or limit the amounts imported. Such quotas areusually administered by requiring importers to have licenses to importparticular products. Quotas raise prices just as tariffs do, but, beingset in physical terms, their impact on imports is direct, with anabsolute ceiling set on quantity. Increased prices will not bring moregoods in. There is also a difference between tariffs and quotas in their

effect on revenues. With tariffs, the government receives the revenue:under quotas, the import license holders obtain a windfall in the formof the difference between the high domestic price and the lowinternational price of the import.

Another barrier is the voluntary export restraint (VER), noted forhaving a less-damaging effect on the political relations betweencountries. It is also relatively easy to remove. This approach wasapplied in the early 1980s when Japanese automakers, under pressure


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from U.S. competitors, voluntarily limited their exports ofautomobiles to the U.S. market. Like quotas, VERs limit the quantityof trade and therefore tend to raise the prices of imported goods. Inthis case, the VER made Japanese automobiles less available in theUnited States and raised the prices that U.S. consumers had to pay forthem, thereby making domestically produced cars more attractive.This approach also allowed Japanese exporters to charge higher prices.

As a result, the Japanese exporters, rather than U.S. importers,reaped much of the windfall from the VER. VERs are usually notvoluntary in any meaningful sense. In this example, the Japaneseautomakers agreed to a VER in order to avoid a U.S. import quota.

Still other barriers include state trading organizations and governmentprocurement practices that may be used preferentially. In the UnitedStates, buy American legislation requires government procurementagencies to favour domestic goods. Customs classification andvaluation procedures, health regulations, and marking requirementsmay also have a restrictive effect on trade. Japan, for example, has

restricted imports of U.S. apples on the grounds that the apples couldbe contaminated with the fire blight disease. Finally, excise taxes mayact as a barrier to trade if they are levied at higher rates on importsthan on domestic goods.

Protectionism in the less-developed countries

Much of the industrialization that took place in the late 20th centuryin some less-developed countries was characterized by the expansionof import-competing industries protected by high tariff walls. In manyof those countries, tariffs and various quantitative restrictions onmanufactured goods were high, but the effective rates of protectionwere often even higher, because the goods tended to be highlyfabricated and the proportion of value added in production afterimportation was low. While countries such as Taiwan, Hong Kong, andSouth Korea oriented their manufacturing industries mainly towardexport trade, they tended to be exceptional cases. More commonly,developing nations have mistakenly sought to compete withforeign-made goods for the domestic market. High protection in these

countries has often contributed to a slowdown in production, while theexport of primary commodities has discouraged expansion of exports ofthe more valuable manufactured goods. Although domestic productionof nondurable consumer goods fosters rapid economic growth at anearly stage, less-developed countries have encountered considerabledifficulties in producing more-sophisticated, value-addedcommodities. They suffer all the disadvantages of small domesticmarkets, in addition to a lack of incentives for technological


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improvement.

Bela BalassaTrent J. BertrandPaul Wonnacott

Arguments for and against interference

Revenue

Developing nations in particular often lack the institutional machineryneeded for effective imposition of income or corporation taxes (seeincome tax). The governments of such nations may then finance theiractivity by resorting to tariffs on imported goods, since such levies arerelatively easy to administer. The amount of tax revenue obtainablethrough tariffs, however, is always limited. If the government tries to

increase its tariff income by imposing higher duty rates, this maychoke off the flow of imports and so reduce tariff revenue instead ofincreasing it.

Economic development

Protection of domestic industry

Probably the most common argument for tariff imposition is thatparticular domestic industries need tariff protection for survival.Comparative-advantage theorists will naturally argue that theindustry in need of such protection ought not to survive and thatthe resources so employed ought to be transferred to occupationshaving greater comparative efficiency. The welfare gain of citizenstaken as a whole would more than offset the welfare loss of thosegroups affected by import competition; that is, total real nationalincome would increase. An opposing argument would be, however,that this welfare gain would be widely diffused, so that theindividual beneficiaries might not be conscious of any greatimprovement. The welfare loss, in contrast, would be narrowly andacutely felt. Although resources can be transferred to otheroccupations, just as comparative-advantage theory says, thetransfer process is sometimes slow and painful for those beingtransferred. For such reasons, comparative-advantage theoristsrarely advocate the immediate removal of all existing tariffs. Theyargue instead against further tariff increasessince increases, ifeffective, attract still more resources into the wrong


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occupationand they press for gradual reduction of import barriers.

Romney Robinson

The infant-industry argument

Advocates of protection often argue that new and growingindustries, particularly in less-developed countries, need to beshielded from foreign competition. They contend that costs declinewith growth and that some industries must reach a minimum sizebefore they are able to compete with well-established industriesabroad. Tariffs can protect the domestic market until the industrybecomes internationally competitive and, it is often argued, thecosts of protection can be recouped after the industry has reachedmaturity. In short, the infant-industry argument is based principallyon the idea that there are economies of large-scale production in

many industries and that developing countries have difficulty inestablishing such industries.

Advocates of such protection, however, can have their argumentsturned against them. While an individual country can, in somecircumstances, gain from protecting its infant industries, thisprotection is particularly costly for the international community asa whole. Where there are major advantages in large-scaleproduction, there are also large advantages in relatively freeinternational trade. By closing off markets, protection reduces theability of firms to gain economies of large-scale by exporting. If agroup of countries imposes infant-industry protection, it will splitup the market; each country may end up with small-scale,localized, inefficient production, thus reducing the prosperity of allof the countries. One way in which less-developed nations havetried to deal with this problem has been through the establishmentof customs unions or other regional groupings (seeInternationaltrade arrangements).

Infant-industry tariffs have been disappointing in other ways; theinfant-industry argument is often abused in practice. In many

developing countries, industries have failed to attain internationalcompetitiveness even after 15 or 20 years of operation and mightnot survive if protective tariffs were removed. The infant industry isprobably better aided by production subsidies than by tariffs.Production subsidies do not raise prices and therefore do not curtaildomestic demand, and the cost of the protection is not concealedin higher prices to consumers. Production subsidies, however, havethe disadvantage of drawing upon government revenue rather thanadding to it, which may be a serious consideration in countries at


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lower levels of development. (See alsoeconomic development.)

Bela BalassaTrent J. BertrandPaul Wonnacott

Unemployment

Tariffs or quotas are also sometimes proposed as a way to maintaindomestic employmentparticularly in times of recession. There is,however, near-unanimity among modern-day economists thatproposals to remedy unemployment by means of tariff increases aremisguided. Insofar as a higher tariff is effective for this purpose, itsimply exports unemployment; that is, the rise in domesticemployment is matched by a drop in production in some foreigncountry. That other country, moreover, is likely to impose a

retaliatory tariff increase. Finally, the tariff remedy for unemploymentis a poor one because it is usually ineffective and because moresuitable remedies are available. It has come to be generallyrecognized that unemployment is far more efficiently dealt with bythe implementation of proper fiscal and monetary policies.

National defense

A common appeal made by an industry seeking tariff or quota

protection is that its survival is essential for the national interest: itsproduct would be needed in wartime, when the supply of importsmight well be cut off. The verdict of economists on this argument isfairly clear: the national-defense argument is frequently a red herring,an attempt to wrap oneself in the flag, and insofar as an industry isessential, the tariff is a dubious means of ensuring its survival.Economists say instead that essential industries ought to be given adirect subsidy to enable them to meet foreign competition, withexplicit recognition of the fact that the subsidy is a price paid by thenation in order to maintain the industry for defense purposes.

Autarky

Many demands for protection, whatever their surface argument maybe, are really appeals to the autarkic feelings that promptedmercantilist reasoning. (Autarky is defined as the state of beingself-sufficient at the level of the nation.) A proposal for the restrictionof free international trade can be described as autarkic if it appeals to


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those half-submerged feelings that the citizens of the nation share acommon welfare and common interests, whereas foreigners have noregard for such welfare and interests and might even be activelyopposed to them. And it is quite true that a country that has becomeheavily involved in international trade has given hostages to fortune: apart of its industry has become dependent upon export markets forincome and for employment. Any cutoff of these foreign markets

(brought about by recession abroad, by the imposition of new tariffs bysome foreign country, or by numerous other possible changes, such asthe outbreak of war) would be acutely serious; and yet it would be asituation largely beyond the power of the domestic governmentinvolved to alter. Similarly, another part of domestic industry may relyon an inflow of imported raw materials, such as oil for fuel and power.Any restriction of these imports could have the most seriousconsequences. The vague threat implicit in such possibilities oftenresults in a yearning for autarky, for national self-sufficiency, for a lifefree of dependence on the hazards of the outside world.

There is general agreement that no modern nation, regardless of howrich and varied its resources, could really practice self-sufficiency, andattempts in that direction could produce sharp drops in real income.Nevertheless, protectionist argumentsparticularly those made in theinterests of national defenseoften draw heavily on the strength ofsuch autarkic sentiments.

The terms-of-trade argument

When a country imposes a tariff, foreign exporters have greaterdifficulty in selling their products. As their exports decline, they maycut prices in order to keep their sales from falling drastically. Thus, forexample, when a tariff of $10.00 is imposed, foreign exporters may cuttheir price by, say, $6.00. The foreign exporter is being taxed whenthe tariff is imposed; the other $4.00 is reflected in a higher price tothe consumer. The use of tariffs to tax foreign exporters in this way isknown as the terms-of-trade argument for protection. The terms oftrade represent the relative price of what a nation is exporting,compared with the price paid to foreigners for imported goods. When

the price of what is being exported rises, or when the price paid toforeigners for imported goods falls (as it may when a nation imposes atariff), terms of trade improve.

Balance-of-payments difficulties

Governments may interfere with the processes of foreign trade for a


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reason quite different from those thus far discussed: shortage offoreign exchange (seeinternational payment and exchange). Underthe international monetary system established after World War II andin effect until the 1970s, most governments tried to maintain fixedexchange rates between their own currencies and those of othercountries. Even if not absolutely fixed, the exchange rate wasordinarily allowed to fluctuate only within a narrow range of values.

If balance-of-payments difficulties arise and persist, a nation's foreignexchange reserve runs low. In a crisis, the government may be forcedto devalue the nation's currency. But before being driven to this, itmay try to redress the balance by restricting imports or encouragingexports, in much the old mercantilist fashion.

The problem of reserve shortages became acute for many countriesduring the 1960s. Although the total volume of internationaltransactions had risen steadily, there was not a corresponding increasein the supply of international reserves. By 1973 payment imbalances

led to an end of the system of fixed, or pegged, exchange rates and toa floating of most currencies. (See alsogold standard;gold-exchange standard.)

Romney RobinsonPaul Wonnacott

Contemporary trade policies

There are many ways of controlling and promoting international tradetoday. The methods range from agreements among governmentswhetherbilateral or multilateralto more ambitious attempts at economicintegration through supranational organizations, such as the EuropeanUnion (EU).

Trade agreements

The term trade agreementor commercial agreement can be used to

describe any contractual arrangement between states concerning theirtrade relationships. Trade agreements may be bilateral ormultilateralthat is, between two states or between more than twostates.

Bilateral trade agreements


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A bilateral trade agreement usually includes a broad range ofprovisions regulating the conditions of trade between the contractingparties. These include stipulations governing customs duties and otherlevies on imports and exports, commercial and fiscal regulations,transit arrangements for merchandise, customs valuation bases,administrative formalities, quotas, and various legal provisions. Mostbilateral trade agreements, either explicitly or implicitly, provide for

(1) reciprocity, (2) most-favoured-nation treatment, and (3) nationaltreatment of nontariff restrictions on trade.

Reciprocity

In a trade agreement, the parties make reciprocal concessions toput their trade relationships on a basis deemed equitable by each.The principle of reciprocity is extremely old, and in one form oranother it is to be found, implicitly at least, in all trade

agreements. The concessions may, however, be in different areas.In the Anglo-French Agreement of 1860, for example, Francepledged itself to reduce its duties to 20 percent by 1864. In return,Britain granted duty-free imports of all French products exceptwines and spirits. The principle of reciprocity implies only that thegains arising out of foreign trade are distributed fairly.

The most-favoured-nation clause

The most-favoured-nation (MFN) clause binds a country to apply toits partner country any lower rate of import duties that it may latergrant to imports from some other country. The clause may cover alist of specified products only, or specific concessions yielded tocertain foreign countries. Alternatively, it may cover alladvantages, privileges, immunities, or other favourable treatmentgranted to any third country whatever. The clause is intended toprovide each signatory with the assurance that the advantagesobtained will not be attenuated or wiped out by a subsequentagreement concluded between one of the partners and a third

country. It guarantees the parties against discriminatory treatmentin favour of a competitor.

The effect of the MFN clause on customs duties is to amalgamatethe successive trade agreements concluded by a state. If the ratesin different agreements are fixed at varying levels, the clausereduces them to the lowest rate specified in any agreement. Thus,goods imported from a country benefiting from MFN treatment arecharged the rate of duty applicable to imports from another country


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which, in a subsequent trade agreement, has negotiated a lowerrate of duty.

The coverage of the MFN clause can be considerably reduced by aminute definition of a particular item so that a concession, whilegeneral in form, applies in practice to only one country. A historicalillustration of this technique can be found in the German Tariff of1902, which admitted at a special rate

large dappled mountain cattle, reared at a spot at least300 metres above sea level, and which have at least onemonth's grazing each year at a spot at least 800 metresabove sea level.

The advantages granted under the MFN clause may be conditional orunconditional. If unconditional, the clause operates automaticallywhenever appropriate circumstances arise. The country drawingbenefit from it is not called on to make any fresh concession. By

contrast, the partner invoking a conditional MFN clause must makeconcessions equivalent to those extended by the third country. Atypical wording was that of the 1911 treaty between the UnitedStates and Japan, which stated that

in all that concerns commerce and navigation, anyprivilege, favour or immunity. . .to the citizens orsubjects of any other State shall be extended to thecitizens or subjects of the other Contracting Partygratuitously, if the concession in favour of that otherState shall have been gratuitous, and on the same orequivalent conditions, if the concession shall have beenconditional.

The conditional form of the clause may at first sight seem moreequitable. But it has the major drawback of being liable to raise adispute each time it is invoked, for it is by no means easy for acountry to evaluate the compensation it is being offered as in factbeing equivalent to the concession made by the third country.

The effect of the unconditional form of the MFN clause is, finally, to

wipe out any relevance that the principle of reciprocity may havehad to the purely bilateral preoccupations of the negotiatingparties, since the results of the bargaining process, instead of beinglimited to the participants, influence their relationships with otherstates. In practice, therefore, a country negotiating a tradeagreement must measure the advantages it is willing to concede interms of the benefits these concessions will provide collaterally tothat third country which is the most competitive. In other words,the concessions that may be granted are determined by the


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minimum protection that the negotiating state deems indispensableto protect its home producers. This sets a major limitation on thescope of bilateral negotiations.

Proponents of free trade consider that the unconditional MFN clauseis the only practical way by which to obtain the progressivereduction of customs duties. Those who favour protectionism areresolutely against it, preferring the conditional form of the clauseor some equivalent mechanism.

The conditional MFN clause was generally in use in Europe until1860, when the so-called Cobden-Chevalier Treaty between GreatBritain and France established the unconditional form as thepattern for most European treaties (seeRichard Cobden). TheUnited States used the conditional MFN clause from its first tradeagreement, signed with France in 1778, until the passage of theTariff Act of 1922, which terminated the practice. (The TradeReform Bill of 1974, however, in effect restored to the U.S.

president the authority to designate preferential tariff treatment,subject to approval by Congress.)

The Conference of Genoa, Italy, in May 1922 and the WorldEconomic Conference in May 1927 both recommended that tradeagreements include the MFN clause whenever possible. But theGreat Depression of the 1930s led instead to a rise of restrictions inworld trade. Imperial or regional systems of preference came intobeing: the Ottawa Agreements of 1932 for the BritishCommonwealth, similar arrangements for the French empire, and a

series of tariff and preference agreements negotiated in easternand central Europe from 1931 on.

The national treatment clause

The national treatment clause in trade agreements was designedto ensure that internal fiscal or administrative regulations wouldnot introduce discrimination of a nontariff nature. It forbidsdiscriminatory use of the following: taxes or other internal levies;

laws, regulations, and decrees affecting the sale, offer for sale,purchase, transport, distribution, or use of products on thedomestic market; valuation of products for purposes of assessmentof duty; legislation on prices of imported goods; warehousing andtransit regulations; and the organization and operation of statetrading corporations.


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Multilateral agreements after World War II

The conclusion of World War II spurred efforts to correct the problemsstemming from protectionism, which had increased since 1871, andtrade restrictions, which had been imposed between World Wars I andII. The resulting multilateral trade agreements and other forms ofinternational economic cooperation led to the General Agreement on

Tariffs and Trade (GATT) and laid the foundation for the World TradeOrganization (WTO).

The General Agreement on Tariffs and Trade

The General Agreement on Tariffs and Trade was signed in Genevaon Oct. 30, 1947, by 23 countries, which accounted for four-fifths ofworld trade. On the same day, 10 of these countries, including theUnited States, the United Kingdom, France, Belgium, and theNetherlands, signed a protocol bringing the agreement into force onJan. 1, 1948.

GATT took the form of a multilateral trade agreement that set forththe principles under which the signatories, on a basis of reciprocityand mutual advantage, would negotiate a substantial reduction incustoms tariffs and other impediments to trade, and the eliminationof discriminatory practices in international trade. As morecountries joined, GATT became a charter governing almost all worldtrade except for that of the communist countries.

The agreement also contained a variety of clauses providingexceptions to the rules in special situations. These includedbalance-of-payments disequilibrium; serious and unexpecteddamage to domestic production; the requirements of economicdevelopment or, subject to very broad reservations, of agriculturalpolicy; the need to protect domestic raw material production; andthe interests of national security. In addition, GATT rules permittedvarious departures from the MFN principle. For example, within theformer EEC, France could permit duty-free entry of goods from its

fellow memberssuch as Germany and Italywithout extending suchduty-free treatment to the products of non-EEC nations.

Prior to the creation of GATT's successor organization, the WTO,multilateral trade conferences, called rounds, were heldperiodically by GATT countries to resolve trade problems. Most ofthese took place in Geneva, former site of GATT headquarters andcurrent site of the WTO. At the time, the formula for multilateraltariff bargaining under GATT represented a major innovation in


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intergovernmental cooperation. In appraising the concessions thatthey could afford to make, this approach to GATT negotiationspermitted governments to account for the indirect advantages thatthey could expect from the full set of bilateral negotiations. GATTmade positive contributions to the growth of world trade, withthree GATT sessions seen as having particular historicimportancethe so-called Kennedy, Tokyo, and Uruguay rounds.

As the economic integration of western Europe progressed, someAmericans became concerned at the prospect of being excludedfrom these advances in trade policy. Pres. John F. Kennedy pursuedthe goal of an Atlantic partnership and secured special negotiatingpowers under the Trade Expansion Act of 1962. The act authorizedtariff reductions of up to 50 percent, subject to reciprocalconcessions from the European partners. This marked afundamental shift away from the traditional protectionist posture ofthe United States and led to the Kennedy Round negotiations inGATT, held in Geneva from May 1964 to June 1967.

The Kennedy Round continued the process of tariff reduction beguntwo decades earlier by the industrial countries. While developingcountries drew little immediate advantage from the Kennedy Roundnegotiations, they were able to obtain the addition of a new parttitled Trade and Development to the GATT charter, calling forstabilization, as far as possible, of raw material prices; reduction orabolition of customs duties or other restrictions that differentiateunreasonably between products in their primary state and the sameproducts in finished form; and renunciation by the advanced

countries of the principle of reciprocity in their relations withless-developed countries.

Maurice AllaisPaul Wonnacott

The next ministerial meeting of GATT opened in Tokyo on Sept. 12,1973, and was attended by representatives of ministerial orcomparable level from 102 countries. On September 14 the meetingclosed with the adoption of what came to be called the TokyoDeclaration.

The declaration differed markedly from previous GATT documentsin the inordinately large portion of its language devoted tostrengthening the negotiating position of the less-developedcountries. Specifically, the trade negotiations would aim atimproving the conditions of access for products of interest to suchcountries while ensuring stable, equitable, and remunerative pricesfor primary products. Tropical products would be given special andpriority treatment. The principle of nonreciprocity in negotiations


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between developed and less-developed countries, an establishedprinciple in GATT, was reaffirmed: the importance of maintainingand improving the Generalized System of Preferences (a provisionfor lower tariff rates) granted by developed countries toless-developed countries, as well as the need for special measuresand the importance of providing special, differential, and morefavourable treatment for less-developed countries, were

recognized. Special attention was to be given to the trade interestsof the least-developed countries.

The Tokyo Declaration was followed by several years ofmultinational trade negotiations that came to be called the TokyoRound, concluding in 1979 with the adoption of a series of tariffreductions to be implemented generally over an eight-year periodbeginning in 1980. Further progress was also made in dealing withnontariff issues. Most notably, a Code on Subsidies andCountervailing Duties was negotiated. This code had two mainfeatures: it listed a number of unacceptable subsidy practices, and

it introduced a requirement that formal procedures be followedbefore the imposition of countervailing duties on imports subsidizedby foreign nations. Specifically, before the imposition of acountervailing duty, an investigation had to establish thatcompeting domestic firms were being injured. The code was notsigned by all of the members, however, and the signing nationsagreed only to follow the prescribed rules before applyingcountervailing duties to the exports of other signatories. Thus,while the code represented progress in dealing with a new topic, italso represented a departure from the MFN principle: signatories

were not required to extend the benefits of the code to GATTmembers who did not sign the code.

A new set of negotiations was initiated at a conference in Uruguayin 1986. Because traditional tariffs were becoming much lessimportant, most of the attention was focused on other impedimentsto international transactions, such as those affecting trade inservices or intellectual property. The Uruguay Round led to thereplacement of GATT by the WTO in 1995. Whereas GATT focusedalmost exclusively on goods (though much of agriculture and textiles

were excluded), the WTO encompassed all goods, services, andintellectual property, as well as some investment policies. Thecombined share of international trade of WTO members came toexceed 90 percent of the global total.

Paul WonnacottEd.


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The World Trade Organization

As the successor to the General Agreement on Tariffs and Trade(GATT), the World Trade Organization (WTO) was established tosupervise and liberalize world trade.

During negotiations ending in 1994, the original GATT and all

changes to it introduced prior to the Uruguay Round of tradenegotiations were renamed GATT 1947. This earlier set ofagreements was distinguished from GATT 1994, which comprises themodifications and clarifications negotiated during the UruguayRound (referred to as Understandings) plus a dozen othermultilateral agreements on merchandise trade. GATT 1994 becamean integral part of the agreement that established the WTO. Othercore components include the General Agreement on Trade inServices (GATS), which attempted to supervise and liberalize trade;the Agreement on Trade-Related Aspects of Intellectual Property

Rights (TRIPS), which sought to improve protection of intellectualproperty across borders; the Understanding on Rules and ProceduresGoverning the Settlement of Disputes, which established rules forresolving conflicts between members; the Trade Policy ReviewMechanism, which documented national trade policies and assessedtheir conformity with WTO rules; and four plurilateral agreements,signed by only a subset of the WTO membership, on civil aircraft,government procurement, dairy products, and bovine meat (thoughthe last two were terminated at the end of 1997 with the creationof related WTO committees). These agreements were signed inMarrakech, Morocco, in April 1994, and, following their ratification,the contracting parties to the GATT treaty became chartermembers of the WTO. By the early 21st century, the WTO had morethan 145 members.

Critics of the WTO, including many opponents of economicglobalization, have charged that the organization underminesnational sovereignty by promoting the interests of largemultinational corporations and that the trade liberalization itencourages leads to environmental damage and declining livingstandards for low-skilled workers in developing countries. Some

WTO members, especially developing countries, resisted attemptsto adopt rules that would allow for sanctions against countries thatfailed to meet strict environmental and labour standards, arguingthat the sanctions would amount to veiled protectionism. Despitethese criticisms, however, WTO admission remained attractive fornonmembers, as evidenced by the increase in membership after1995. Most significantly, China entered the WTO in 2001, after yearsof accession negotiations, and many other countries were slated tojoin through accession in succeeding years.


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The Organisation for Economic Co-operation and Development

On April 16, 1948, 16 European countries responded to a U.S. offerof economic aid under the European Recovery Program by setting upthe Organisation for European Economic Co-operation (OEEC).

Although the immediate aim was to coordinate the distribution ofU.S. credits, the OEEC convention was also designed to foster freetrade between the members and allow their participation incustoms unions or similar institutions. The members by 1955consisted of Britain, France, West Germany, Italy, Spain, theBenelux countries, Austria, Denmark, Sweden, Norway, Switzerland,Portugal, Greece, Ireland, Turkey, and Iceland.

The OEEC did much to facilitate the recovery of intra-Europeantrade and particularly to abolish most of the quantitative

restrictions on imports within the area. On Sept. 30, 1961, it wasconverted into a new institution, the Organisation for EconomicCo-operation and Development (OECD), and membership wasextended to the United States and Canada. Japan joined in 1964,followed by Finland (1969), Australia (1971), New Zealand (1973),and others to total 30 OECD member nations by the beginning of the21st century.

The three fundamental aims of the OECD are to promote theeconomic growth of member countries, to contribute to theeconomic growth of less-developed countries, and to foster thegrowth of world trade on a multilateral, nondiscriminatory basis.Having little power to enforce its decisions, the OECD at the start ofthe 21st century served mostly as a consultative body, influencingtrade through its studies of such matters as the impact of socialpolicies, globalization, and protectionism.

Economic integration

Forms of integration

The economic integration of several countries or states may take avariety of forms. The term covers preferential tariffs, free-tradeassociations, customs unions, common markets, economic unions, andfull economic integration. The parties to a system of preferentialtariffs levy lower rates of duty on imports from one another than theydo on imports from third countries. For example, Great Britain and itsCommonwealth countries operated a system of reciprocal tariff


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preferences after 1919. In free-trade associations no duty is levied onimports from other member states, but different rates of duty may becharged by each member on its imports from the rest of the world. Afurther stage is the customs union, in which free trade among themembers is sheltered behind a unified schedule of customs dutiescharged on imports from the rest of the world. The 19th-centuryGerman Zollverein was a customs union. A common market is an

extension of the customs union concept, with the additional featurethat it provides for the free movement of labour and capital amongthe members; an example was the Benelux common market until itwas converted into an economic union in 1959. The term economicuniondenotes a common market in which the members agree toharmonize their economic policies generally, as is the case with theEuropean Union. Finally, total economic integration implies the pursuitof a common economic policy by the political units involved; examplesare the states of the United States or the cantons of the SwissConfederation.

Economic integration may be brought about by the political will of astate powerful enough to impose it, as under the Roman Empire or theEuropean colonial systems of the 19th century, or it may result fromfreely negotiated agreement between sovereign states, as was morecommon in the 20th century.

The attempts at economic integration made after World War II can beappraised only by reviewing them against the background of the longprocess through which, over the centuries, the nations of the worldhave progressively achieved economic integration. Thus, for instance,

the world's greatest power in the 17th century, France, was dividedinto a number of provinces separated from one another by variouscustoms barriers involving a multitude of duties, tolls, andprohibitions. Trade regulations and fiscal charges differed from oneregion to the next; there was not even a single system of weights andmeasures. Not until after the Revolution did the economic integrationof France really get under way.

Intranational integration

The United States

The economic integration of the United States was not achieved allat once, but as the result of a long process during which the powersof the federal authorities were constantly reinforced. TheConstitution empowered the federal government to regulate theconditions of trade with other countries and to set up a single


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system of duties. It also abolished the right of individual states tomaintain separate customs legislation and to issue their owncurrencies. It authorized the federal government alone to issuecurrency and established the principle of free movement ofpersons, merchandise, and capital between the federated states.But the conflict of interest between North and South was settledonly by the American Civil War, and although the economies of the

states can be considered as integrated for practical purposes, thereremain many economic and fiscal disparities among them.

The difficulties faced by the 13 original states should not beunderestimated. During the years prior to the adoption of theConstitution there were bitter trade disputes among the states,which imposed tariffs against each other and refused to accept eachother's currencies. Everything seemed to justify the words of acontemporary liberal philosopher, Josiah Tucker, Dean ofGloucester (England):

As to the future grandeur of America, and its being arising empire under one head, whether republican ormonarchical, it is one of the idlest and most visionarynotions that ever was conceived even by writers ofromance. The mutual antipathies and clashing interestsof the Americans, their differences of governments,habitudes, and manners, indicate that they will have nocentre of union and no common interest. They never canbe united into one compact empire under any species ofgovernment whatever; a disunited people till the end of

time, suspicious and distrustful of each other, they willbe divided and sub-divided into little commonwealths orprincipalities, according to natural boundaries, by greatbays of the sea, and by vast rivers, lakes, and ridges ofmountains.

Switzerland

The Swiss example is no less instructive. Although the Helvetic

Confederation emerged as a political entity in the 14th century, itseconomic integration was achieved, only after many vicissitudes,with the constitution of 1848. The terms of this documentestablished a common currency, set forth the principle of acommon protective system for the cantons, and provided for freemovement of goods and Swiss citizens throughout the nationalterritory. Swiss economic integration is all the more remarkable inthat it comprises peoples who speak four different languages.


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Integration of colonial empires

When the colonial powers of Europe founded their empires from the16th century onward, they attempted to monopolize trade with thecolonies and to turn it to their own profit. This policy involved fourmain restrictions: (1) The colonies were to trade exclusively with themother country. (2) They were not to undertake manufacturing;

transformation of raw materials into finished goods remained amonopoly right of the mother country. (3) Imports and exports of thecolonies were to be carried only in ships flying the mother country'sflag. (4) The mother country exempted colonial products from duty, orimposed lower rates.

This system, although progressively attenuated, applied in variousforms from the 16th to the 19th century. Based on force, it was to thebenefit of the home countries and detrimental to the economic growthof their colonies. (Seecolonialism.)

The Zollverein

The best-known example of the early customs unions is the GermanZollverein (literally, customs union). Even though Napoleon hadreduced the number of German states from 300 to 40 at the beginningof the 19th century, those that remained were isolated from eachother by their own customs systems. In addition, numerous internalcustoms barriers hampered trade within each state. At the same time,

there was no single external tariff, and the German industries that hadsprung up during the Napoleonic Wars were being crushed by Englishcompetition. These difficulties were at the root of the creation of theZollverein.

The starting point was Prussia's abolition of all internal duties and itsadoption of an external tariff in 1818. In the next few years a numberof other German states followed the Prussian example. Bavaria andWrttemberg set up a customs union in 1828, and by 1830 fourseparate customs unions were in existence. Prussia then sought tobreak up the local customs unions and attach them to a generalcustoms union, the Zollverein. The coverage of the Zollvereinincreased until, by 1871, it included all the German states.

In its first phase, from 1834 to 1867, the Zollverein was administeredby a central authority, the Customs Congress, in which each state hada single vote. A common tariff, the Prussian Tariff of 1818, shieldedthe member states from foreign competition, but free trade was therule internally.


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During a second phase, from 1867 to 1871 (following Prussia's victoryover Austria at Sadowa), executive power was wielded by a federalcouncil (Bundesrat) composed of governmental delegates, in whichdecisions were taken by an absolute majority. Prussia was entitled to17 of the 58 votes and held the chair of the council. Legislative powerlay with a customs parliament (Zollparlament) composed of deputiesdirectly elected by popular vote, and, like the council, taking

decisions by a majority vote. This arrangement transformed what hadbeen a confederation into a federal state.

After the victory over France and the proclamation of the Germanempire in 1871, the customs parliament and the federal council werereplaced by the parliament and the executive council of the empire.The federal state had become a nation.

The progressive destruction of a tangled maze of regulations,prohibitions, and controls set the stage for the subsequent rapiddevelopment of the German economy. Although economic integration

occurred before political unification, it would not have been possiblehad not many difficulties been swept away by irresistible pressurefrom Prussia with its military victories.

The Benelux Economic Union

In 1921 Luxembourg, a former member of the Zollverein, signed theConvention of Brussels with Belgium, creating the BelgiumLuxembourgEconomic Union. Belgium and Luxembourg thereby had the same

customs tariff and a single balance of payments since 1921.

The union was expanded after World War II to include the Netherlands.At the beginning of 1948 most import duties within the Benelux areawere abolished, and a common external tariff was put into operation.Exceptions were made, nevertheless, for a few agricultural products,and it was also felt necessary to introduce a system of quotas.

It was rapidly perceived that a simple customs union was inadequate,and a treaty on Oct. 15, 1949, set as its target the progressive and

complete liberalization of trade between the partners, systematiccoordination of their international commercial and monetary policies,and the adoption of a joint bargaining position in negotiations withother countries. Though the experiment was optimistically viewedeverywhere as the precursor of a wider European economicintegration, it faced difficulties arising from the very different postwarsituations of Belgium and the Netherlands. The two economies werecompetitive rather than complementary. Other problems arose inconnection with the free access of Dutch agricultural products to the


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Belgian market. Moreover, the Belgian economic system was moreliberal than the Dutch, where rigorous price control had long been astandard practice.

The development of Benelux received strong impetus from theformation of the European Economic Community in the 1950s. Whenthe Treaty of Rome in 1957 created the EEC, or Common Market, itspurred the members of Benelux to confirm and strengthen their ownintegration in the Benelux Treaty of Economic Union signed at TheHague on Feb. 3, 1958. The Hague treaty, however, contained littlethat was new, and in outline form it was no more than the codificationof results already achieved.

The Benelux Economic Union made all of its decisions unanimously,and all members of the union became founding members of the EU.

The European Coal and Steel Community

An important step in European integration was taken in May 1950 whenthe French foreign minister, Robert Schuman, proposed that a commonmarket for coal and steel be set up by countries willing to delegatepowers over these sectors of their economies to an independentauthority. The motive behind the plan was the belief that a neweconomic and political

int. tread

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