Singapore Economic Review Conference 2009Singapore Economic Review Conference 2009

Free Trade and the WTOFree Trade and the WTO

byby

Peter LloydPeter Lloyd

ThemeTheme

I want to address a set of issues which is I want to address a set of issues which is fundamental to the future of the world economy, fundamental to the future of the world economy, namely, restrictions on cross-border access to namely, restrictions on cross-border access to world markets for goods and services. world markets for goods and services.

The global economic crisis has shifted attention The global economic crisis has shifted attention away from these negotiations but arguably they away from these negotiations but arguably they will have as much effect on the world economy as will have as much effect on the world economy as the pace of recovery from the global economic the pace of recovery from the global economic crisis. crisis.

Singapore is a suitable locationSingapore is a suitable location

Singapore is a good place to review these issues. It has Singapore is a good place to review these issues. It has been a duty free port for almost all of the time since it been a duty free port for almost all of the time since it was established as the Straits Settlement in 1819.was established as the Straits Settlement in 1819.

Today Singapore production is more integrated into Today Singapore production is more integrated into world production chains than that of any other world production chains than that of any other economy. It has evolved from an entrepot economy to a economy. It has evolved from an entrepot economy to a Southeast Asian hub with goods passing through as Southeast Asian hub with goods passing through as part of a regional production chain, facilitated by part of a regional production chain, facilitated by services trade and organised by multinational services trade and organised by multinational corporations (see Hoon and Ho, 2001). corporations (see Hoon and Ho, 2001).

Free trade is bestFree trade is best

The unanimous view of trade economists The unanimous view of trade economists today is that free trade is the best policy for today is that free trade is the best policy for a small price-taking economy. Departures a small price-taking economy. Departures from free trade reduce national welfare. We from free trade reduce national welfare. We are all familiar with this story. are all familiar with this story. I want to argue that we still substantially I want to argue that we still substantially underestimate the gains from trade underestimate the gains from trade liberalisation. There are two major reasons liberalisation. There are two major reasons for this. for this.

Intra-industry tradeIntra-industry trade

Intra-industry trade has been steadily increasing and Intra-industry trade has been steadily increasing and spreading to all parts of the world economy. Brülhart spreading to all parts of the world economy. Brülhart (2008) calculated that, in 2006, it accounted for 44 per (2008) calculated that, in 2006, it accounted for 44 per cent of global goods trade. cent of global goods trade. Current cge models and other methods of calculating Current cge models and other methods of calculating gains underplay intra-industry effects by using the gains underplay intra-industry effects by using the Armington Assumption. New trade theory shows a Armington Assumption. New trade theory shows a variety of other effects – increased product variety and variety of other effects – increased product variety and quality, economies of scale and agglomeration. The quality, economies of scale and agglomeration. The New New trade theory of Melitz (2003) introduces New New trade theory of Melitz (2003) introduces further gains due to the exiting of low productivity firms further gains due to the exiting of low productivity firms and other firm level adjustments. and other firm level adjustments.

Trade liberalisation increases Trade liberalisation increases growth ratesgrowth rates

New Growth theory shows that trade liberalisation New Growth theory shows that trade liberalisation accelerates the rate of growth of liberalising accelerates the rate of growth of liberalising economies in several ways: increased savings economies in several ways: increased savings rates, lower costs of capital and intermediate rates, lower costs of capital and intermediate inputs, more productive R& D, etc. inputs, more productive R& D, etc.

Empirical evidence is remarkably consistent Empirical evidence is remarkably consistent across countries. Holding other growth-inducing across countries. Holding other growth-inducing factors constant, a 1 percentage point increase in factors constant, a 1 percentage point increase in the growth of exports is associated with a 1/5 the growth of exports is associated with a 1/5 percentage point increase in real GDP per capita. percentage point increase in real GDP per capita.

Trade is the engine of world growthTrade is the engine of world growth

Higher growth in single economies lifts the Higher growth in single economies lifts the growth rate of other countries through growth rate of other countries through increased demand for imports, improved increased demand for imports, improved technologies and other mechanisms. technologies and other mechanisms.

These growth effects of trade liberalisation These growth effects of trade liberalisation have been the main explanation of the have been the main explanation of the record rate of growth of aggregate world record rate of growth of aggregate world GDP over the last 25 years. GDP over the last 25 years.

Progress towards free trade in the Progress towards free trade in the GATT/WTO eraGATT/WTO era

Cross-border trade in goods and services has become Cross-border trade in goods and services has become much freer in the GATT/WTO era, though it is difficult to get much freer in the GATT/WTO era, though it is difficult to get comparable series for many countries. comparable series for many countries.

Figure 1 shows a series of the (unweighted) average tariff Figure 1 shows a series of the (unweighted) average tariff rates of 35 countries over the long period 1870 to 1990s.rates of 35 countries over the long period 1870 to 1990s.

Figure 2 shows times series of average tariffs rates in the Figure 2 shows times series of average tariffs rates in the US and Australia over the last 100 years. US and Australia over the last 100 years.

Figure 3 shows the nominal rate of assistance to farmers in Figure 3 shows the nominal rate of assistance to farmers in high-income and Developing economies. high-income and Developing economies.

Figure 2. Australian (solid line) and US (broken line) Tariff Rates

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Figure 3. Nominal rates of Figure 3. Nominal rates of assistance to farmersassistance to farmers

RegionalismRegionalism

Regional free trade agreements (RTAs) offer an alternative Regional free trade agreements (RTAs) offer an alternative route to trade liberalisation. In the limit, if all pairs of route to trade liberalisation. In the limit, if all pairs of countries signed RTAs that completely freed trade, there countries signed RTAs that completely freed trade, there would be global free trade.would be global free trade.

Everyone knows of the rapid spread of regional Everyone knows of the rapid spread of regional agreements since the early 1990. Medvedev (2006) agreements since the early 1990. Medvedev (2006) estimates that on average in 2002 countries have signed estimates that on average in 2002 countries have signed five agreements each. The number must now be six each.five agreements each. The number must now be six each.

How important is regionalism?How important is regionalism?

Some economists argue that regionalism is less important Some economists argue that regionalism is less important than indicated by the rapid increase in the number of than indicated by the rapid increase in the number of agreements. agreements.

The usual approach is to estimate the share of world trade The usual approach is to estimate the share of world trade which takes place between countries that have signed an which takes place between countries that have signed an RTA. (Medvedev, 2006) estimates this is 32 per cent. After RTA. (Medvedev, 2006) estimates this is 32 per cent. After allowing for tariff lines which have zero MFN rates, the allowing for tariff lines which have zero MFN rates, the share of world trade which is subject to preferences fall to share of world trade which is subject to preferences fall to 22 per cent. After allowing for non-satisfaction of strict 22 per cent. After allowing for non-satisfaction of strict Rules of Origin requirements, the share falls further to 11-Rules of Origin requirements, the share falls further to 11-15 per cent. 15 per cent.

Preferences are important!Preferences are important!

This calculation underestimates the importance of regional This calculation underestimates the importance of regional preferences. First, where a preferential rate exists, we preferences. First, where a preferential rate exists, we should look at the share of trade which is distorted. This should look at the share of trade which is distorted. This may be all trade in the item, not merely the trade entering may be all trade in the item, not merely the trade entering at the preferential rate. Second, tariff lines with zero MFN at the preferential rate. Second, tariff lines with zero MFN rates are predominantly imports of intermediate inputs. rates are predominantly imports of intermediate inputs. This trade increases the effective rate of protection of the This trade increases the effective rate of protection of the goods which are produced and subject to positive goods which are produced and subject to positive preferences. preferences.

Preferences are important!Preferences are important!What, therefore, should we do about regionalism? What, therefore, should we do about regionalism?

The gainersThe gainers

To answer this question, we need to know who are To answer this question, we need to know who are the gainers and losers?the gainers and losers?Countries that participate in RTAs have gained Countries that participate in RTAs have gained from trade discrimination with few if any from trade discrimination with few if any exceptions. The costs of trade diversion have exceptions. The costs of trade diversion have been exaggerated. This is borne out by cge been exaggerated. This is borne out by cge studies. We need also to add in all of the features studies. We need also to add in all of the features of RTAS that go beyond goods and services trade of RTAS that go beyond goods and services trade - freeing trade in capital and business labour, - freeing trade in capital and business labour, greater security of investments and protection of greater security of investments and protection of IP, etc. IP, etc.

The losersThe losers

The losers are countries outside the agreements. They lose because The losers are countries outside the agreements. They lose because of negative terms of trade effects as demand for their exports generally of negative terms of trade effects as demand for their exports generally falls. falls.

Developing countries’ participation in RTAs has, as a generalisation, Developing countries’ participation in RTAs has, as a generalisation, pushed import costs towards world prices and has improved their pushed import costs towards world prices and has improved their access to world major markets less than that of Developed countries. access to world major markets less than that of Developed countries. A few such as Mexico and Chile and the East European countries have A few such as Mexico and Chile and the East European countries have benefitted greatly. The Least Developed countries have benefitted benefitted greatly. The Least Developed countries have benefitted least.least.

This does not mean that that Developing Countries as a group have This does not mean that that Developing Countries as a group have lost from regionalism. For most of them, it means that they have lost from regionalism. For most of them, it means that they have gained less than richer countries. gained less than richer countries.

Changing WTO rules re RTAsChanging WTO rules re RTAs

How can the WTO rules be changed to increase the How can the WTO rules be changed to increase the gains and reduce the loses from trade discrimination?gains and reduce the loses from trade discrimination?There is one key change. The present rules, under There is one key change. The present rules, under Article XXIV, require for a free trade area that Article XXIV, require for a free trade area that

“…“…the duties and other regulations of the duties and other regulations of commerce…shall not be higher or more restrictive commerce…shall not be higher or more restrictive than the corresponding duties and other regulations than the corresponding duties and other regulations existing in the same constituent territories prior to existing in the same constituent territories prior to the the formation of the free trade area”. formation of the free trade area”. This needs to be amended to require a reduction in tariff This needs to be amended to require a reduction in tariff rates and other trade restrictions applying to MFN trade. rates and other trade restrictions applying to MFN trade. Unfortunately, no one has found a simple operational rule Unfortunately, no one has found a simple operational rule that would eliminate losses to outside countries. that would eliminate losses to outside countries.

““Multilateralising regionalism”Multilateralising regionalism”

Much of the recent discussion has taken place Much of the recent discussion has taken place under the banner of “multilateralising regionalism”. under the banner of “multilateralising regionalism”. This catchphrase covers a number of ideas, This catchphrase covers a number of ideas, including the coalescence of existing RTAs into including the coalescence of existing RTAs into bigger RTAs (an Asia-Pacific Community?) and bigger RTAs (an Asia-Pacific Community?) and extending cumulation provisions in Rules of Origin. extending cumulation provisions in Rules of Origin. But it is a self-contradiction. The only true But it is a self-contradiction. The only true multilateralisation of preferences occurs if MFN multilateralisation of preferences occurs if MFN rates are lowered to Preferential rates. The only rates are lowered to Preferential rates. The only precedent here is ASEAN after the extension of precedent here is ASEAN after the extension of preferences in AFTA. preferences in AFTA.

New rules for PTAsNew rules for PTAs

The WTO could, if it wished, change the rules relating to the The WTO could, if it wished, change the rules relating to the establishment of RTAs. But it has shown no desire to do so. establishment of RTAs. But it has shown no desire to do so.

I suggest two simple changes that would increase the net benefits of I suggest two simple changes that would increase the net benefits of RTAs:RTAs:A waiver of ROOs in RTAs when partners’ MFN tariff rates are A waiver of ROOs in RTAs when partners’ MFN tariff rates are identical or differ by, say, 2-5 %identical or differ by, say, 2-5 %A requirement that all preferential rates be zero. This would reduce A requirement that all preferential rates be zero. This would reduce trade costs due to multiple tariff rates. trade costs due to multiple tariff rates. These changes could be done unilaterally by participating countries. These changes could be done unilaterally by participating countries.

The best step the WTO could take to reduce the costs of trade The best step the WTO could take to reduce the costs of trade discrimination is to succeed in the Multilateral Trade Negotiations. discrimination is to succeed in the Multilateral Trade Negotiations.

Advancing the MTNs at the WTOAdvancing the MTNs at the WTO

The current Doha Round negotiations have stalled. This The current Doha Round negotiations have stalled. This has led to a lot of soul searching inside and outside the has led to a lot of soul searching inside and outside the WTO. WTO.

Some economists have suggested the WTO concentrate Some economists have suggested the WTO concentrate on safeguarding its rules and the world rely on unilateral on safeguarding its rules and the world rely on unilateral liberalisation to lower trade barriers. But unilateral liberalisation to lower trade barriers. But unilateral liberalisation has always been selective; the US, EU and liberalisation has always been selective; the US, EU and Japan have rarely cut tariffs unilaterally, and it has been Japan have rarely cut tariffs unilaterally, and it has been more focused on tariffs than ntms. Moreover, we need more focused on tariffs than ntms. Moreover, we need multilateral reductions in trade barriers to reduce the impact multilateral reductions in trade barriers to reduce the impact of preferences in RTAs, and to tighten rules in areas such of preferences in RTAs, and to tighten rules in areas such as subsidies, government purchasing and anti-dumping as subsidies, government purchasing and anti-dumping action. action.

Causes of Negotiation FailureCauses of Negotiation Failure

After the July 2008 failure, the Director-General outlined the negotiation After the July 2008 failure, the Director-General outlined the negotiation problem in the following terms:problem in the following terms:

““Three principal constraints today represent a challenge to our Three principal constraints today represent a challenge to our work: the first is the bottom-up approach, under which work: the first is the bottom-up approach, under which

members must themselves always take the lead in tabling members must themselves always take the lead in tabling negotiating proposals and compromise solutions; the second is negotiating proposals and compromise solutions; the second is the the concept of a “single undertaking”, which implies that in a concept of a “single undertaking”, which implies that in a round of round of negotiations with 20 different topics, nothing is agreed negotiations with 20 different topics, nothing is agreed until all is until all is agreed; and the third is the decision-taking by agreed; and the third is the decision-taking by consensus, which is consensus, which is reasonably close to unanimity.”reasonably close to unanimity.”

The first allows Member governments to pursue their own objectives The first allows Member governments to pursue their own objectives which are generally mercantilistic, pushing for improved export access which are generally mercantilistic, pushing for improved export access and resisting all attempts to lower their own import barriers. The last and resisting all attempts to lower their own import barriers. The last two give a veto to those members who do not agree with a result in any two give a veto to those members who do not agree with a result in any area. These three features operating together have made negotiations area. These three features operating together have made negotiations very difficult in many areas.very difficult in many areas.

Some suggestionsSome suggestions

Abandoning the Single Undertaking in Abandoning the Single Undertaking in negotiationsnegotiations

Reviving the “critical mass” modalities used in Reviving the “critical mass” modalities used in the ITA and services agreements after the the ITA and services agreements after the Uruguay RoundUruguay Round

Using the modalities and formulae of the Using the modalities and formulae of the Uruguay RoundUruguay Round

Confining negotiations to OECD and larger Confining negotiations to OECD and larger trading DCs, giving other DCs and all LDCs a trading DCs, giving other DCs and all LDCs a free ride. free ride.

A fundamental problemA fundamental problem

The WTO lacks a clear objective and, because of this, it lacks a vision The WTO lacks a clear objective and, because of this, it lacks a vision of where it is heading. The Preamble to the Marrakesh Agreement has of where it is heading. The Preamble to the Marrakesh Agreement has two objectives: reciprocal reductions of tariffs and other barriers to two objectives: reciprocal reductions of tariffs and other barriers to trade and “eliminating” trade discrimination. trade and “eliminating” trade discrimination.

The WTO has failed abysmally to pursue the second of these. The first The WTO has failed abysmally to pursue the second of these. The first is vague and has led to directionless incrementalism. is vague and has led to directionless incrementalism.

The lack of progress in MTNs means that trade liberalisation in the The lack of progress in MTNs means that trade liberalisation in the world economy at present depends on regional actions, which the world economy at present depends on regional actions, which the WTO is supposed to eliminate, and unilateral actions, which are WTO is supposed to eliminate, and unilateral actions, which are outside its control and diminishing. outside its control and diminishing.

A new objectiveA new objective

The WTO desparately needs a new The WTO desparately needs a new objective.objective.

It should, in my opinion, adopt the objective It should, in my opinion, adopt the objective of free trade. This implies the removal of all of free trade. This implies the removal of all border measures that restrict trade. As well, border measures that restrict trade. As well, free trade is non-discriminatory trade. free trade is non-discriminatory trade.

Developing countries tooDeveloping countries too

This objective should apply to all members, Developing This objective should apply to all members, Developing Countries and Developed Countries alike. Countries and Developed Countries alike. One of the bad features of the Doha Declaration is the One of the bad features of the Doha Declaration is the interpretation of Special and Differential Treatment for DCs interpretation of Special and Differential Treatment for DCs as “less than full reciprocity in reduction commitments”, or as “less than full reciprocity in reduction commitments”, or LTFR as it known in WTO-speak. LTFR as it known in WTO-speak. Simulations done by the World Bank, using cge models, Simulations done by the World Bank, using cge models, show that proposed WTO scenarios would benefit DCs to a show that proposed WTO scenarios would benefit DCs to a greater extent than the Developed Countries, and most of greater extent than the Developed Countries, and most of the gains come from cuts in their own border barriers rather the gains come from cuts in their own border barriers rather than improved export market access. than improved export market access.

Concluding remarksConcluding remarks

Adoption of a clear objective of “free trade” is not going to Adoption of a clear objective of “free trade” is not going to happen in the foreseeable future. Economists have won happen in the foreseeable future. Economists have won some of the battles in the cause of free trade in many some of the battles in the cause of free trade in many countries but they have not yet won the war.countries but they have not yet won the war.

Meanwhile trade discrimination is increasing and Meanwhile trade discrimination is increasing and multilateralism has stalled. multilateralism has stalled.

Agur (2008) explains both trends in terms of the increase in Agur (2008) explains both trends in terms of the increase in the US trade deficit from around 1 % in early Nineties to the US trade deficit from around 1 % in early Nineties to more than 6 % of GDP. more than 6 % of GDP.

Thus, the present international trade environment is mixed. Thus, the present international trade environment is mixed. The WTO has succeeded in holding trade restrictions in The WTO has succeeded in holding trade restrictions in the global economic crisis period at almost where they the global economic crisis period at almost where they were (cf the Great Depression) and the DSP has contained were (cf the Great Depression) and the DSP has contained trade disputes. But the failure to maintain multilateral trade trade disputes. But the failure to maintain multilateral trade liberalisation is switching off the engine of growth in the liberalisation is switching off the engine of growth in the world economy. world economy.

The job of trade economists is to persist with analyses of The job of trade economists is to persist with analyses of the obstacles to trade liberalisation and proposals to the obstacles to trade liberalisation and proposals to accelerate the movement to free trade. accelerate the movement to free trade.