Lecture 2: Trade, WTO and Regional trade agreements

the puzzle of trade policy

• almost all economists agree that free trade is welfare enhancing

• We can make ourselves richer (on whole)

• All we have to do is eliminated barriers to trade

• They whey does trade protection persist?

American car export to EU example

• At the border, the EU will charge you 10% on the price of
  the car = tariff

• You need to prove that the vehicle meets EU CO2
  emission standards (different from US standards)

• Meet EU airbag standards (US
  airbags are broader because people don't wear seatbelts) = non-tariff barriers

types of trade protection

• tariffs

• Quotas

• Non-tariff barriers

types of trade protection: tariffs

a tax on imported goods

Types of trade protection: quotas

a limit on the amount of goods that can be imported by a nation or globally (rare today bc WTO doesn’t allow quotas)

Types of trade protection: non-tariff barriers

everything else

• Industry subsides

• Consumer and environmental safety standards

• Industry insurance programs

• Laws to protect regional products

• Industry lobbies and law makers can get very creative

*industries can get creative on how to protect itself

Why are there still so many barriers to trade?

1. Economically, free trade can be a prisoner's dilemma, and countries have economic incentives to protect without coordination

→ All countries could be better off from coordinated liberalization

2. Other, non-economic concerns, especially for non-tariff barriers:

• Consumer safety

• Environmental protection

• National Security Concerns
  → Not clear that liberalizing these would enhance welfare

1.An economic prisoners dilemma

It Takes Two to Trade:

Few governments liberalize unilaterally.

• Gains from trade are only guaranteed if other states also liberalize:

• 'If you liberalize and another state doesn't, comparative advantage might not be realized and one state may be worse off

  • Some states may be better off imposing a tariff if liberalization is not reciprocated.

    • (Or at least politicians can be better off by catering to domestic interests.)

• While trade is jointly beneficial, sometimes it is more beneficial to exploit others' open markets while you keep your market closed

  

Nash equilibrium

neither country can unilaterally make themselves better of

Prisoner dilemma ex.

• LL: China could make itself better off by protecting —> incentive to defect

• PP: neither by themselves can make themselves better off unilaterally

Prisoners dilemma

• Collectively, they both would do better by staying silent

  • Yet, each has an incentive to rat out his accomplice

• Defection is the best response whether the accomplice stays quiet or defects = "dominant strategy"

  • No matter what the other does, you want to talk—> dominate strategy

    • Always better off if you defect

• Both defect, although they would be much better off if they both stayed silent

• Cooperation made easier through bargaining and institutions

To get to cooperation, countries need to bargain

• Because states won't liberalize unilaterally, they instead seek liberalization through formalized agreements.
  However, this brings new problems.

• Sometime states can disagree over the distribution of trade's benefits and want to make sure they're not getting the "worst deal ever signed, ever!"

Two questions in bargaining

1. Can an agreement be reached at all?

2. Where does it fall?

What prevents a successful bargaining?

• No mutually beneficial gains to be made:

  • status quo is already at one country's policy ideal point how things are —> one country is already happy with how things are

  • Preferences incompatible (can be the case for non-tariff barriers, think of airbags and seatbelts!)

• Information problems:

  • Countries don't know others' ideal points, level of resolve or patience —> Everyone has incentive to defect

  • Incentive to misrepresent

• Inability to credibly commit to the agreement Implementation mistrust

• Outside options

where does it fall? Bargaining power

• An agreement will fall somewhere along the "contract curve", i.e. the set of "efficient" agreements acceptable to all parties.

• A state's bargaining power plays a role in where along the curve it lands

  • More power = more close to your ideal point

• Not all about providing a public good

• States still want to maximize benefits (either economic or political)

  • E.g. EU/US agricultural markets are heavily protected, yet we can sell our manufactured goods almost anywhere.

step 1: cooperation and bargaining

• Further away from 0 = more protectionist

• SQ = status quo

• US/EU liberalizing their agriculture moves them further from their ideal point —> wont do this without getting something back

Step 2: cooperation and bargaining

• Points along circle: just as happy with any point than SQ

• Overlap: joint gains

• Where is it effecticent for the agreement to fall?

Step 3: cooperation and bargaining

• Efficient agreement is anywhere where the circles meet

• Efficiency: can now not make one country better off without making the other worse off

Step 4: cooperation and bargaining

• Bargaining power: who can pull the agreement closer to their preferred point —> tends to go to point E bc they are bigger and have more power

Bargaining power: Determinants

• Market size/trade volume:

  • States that have a strong interest in EU markets may accept more demands from the EU than states that gain less from EU markets

• Patience:

  • Are you willing to walk away from a deal and wait for the next negotiation round?

• Attractiveness of Outside Options:

  • No, Britain cannot replace trade with the EU with trade with other countries

How can we resolve these barriers? Facilitating cooperation

Several Factors make cooperation and bargaining easier:

• Small # of states, or one hegemon to back the system

• Information to monitor compliance

• Repeated interaction (tit for tat)

  • Ability to punish defectors

  • Reciprocity

  • Incorporate long-term gains into decision making

• Linkage of policies Issue linkage

  • Tie compliance to other issues like security

    • Won’t defect on trade agreements bc they need them for other things too and if they do they might not have access to these things anymore

International institutions (WTO or RTAs) can help with some of these...

How can we resolve these barriers? International institutions

• Provide mechanisms to aid trade cooperation

  • Set standards of behavior

  • Monitor and enforce compliance

  • Reduce transaction costs

• Often based upon the principle of reciprocity (iteration and tit for tat)

  • Concessions granted by one state are matched by others

• Can take many forms

  • Global Organisations (WTO)

  • Regional Organisations (NAFTA, CARICOM, MERCOSUR, EU CU)

  • Bilateral

GATT

General Agreement on Tariffs and Trade (GATT), 1948-1994

• 23 members by 1948

• Created with other Bretton Woods institutions (IMF, World Bank)

• Lasts until 1994, replaced by the WTO

WTO

World Trade Organization (WTO), 1994 - today

• Includes Updated General Agreement on Tariffs and Trade (GATT)

• Uruguay Round Added Agreements on New Areas (Services, Non-Tariff Barriers, Intellectual Property Rights...)

• Still, can't agree on trade on agricultural and other goods protected by strong interest groups in Western world.

3 elements of WTO

1. Established common principles and rules

2. Repeated intergovernmental bargaining process

3. Dispute settlement mechanism

WTO: common principles and rules

• Market liberalism - more trade is better

• Nondiscrimination:

  • Most favored nation

  • National treatment

WTO: most favored nation (MFN)

All countries are treated as the closest trading partner

Article 1: If you liberalize trade for one country, you have to liberalize it for all WTO members

WTO: national treatment

Behind the border, foreign goods have to be treated the same as domestic goods

Article 3: Prohibits regulations and other policies that give domestic firms an unfair advantage

WTO: exceptions to MFN

• Regional trade arrangements

  • Free-Trade Area (e.g., NAFTA)

  • or Customs Union (e.g., EU)

• Generalized System of Preferences (from 1960s):

  • Developed countries can apply lower tariffs for developing countries than for their peers

    • Tool to encourage development

WTO: General exceptions

Deviate from rules if necessary from certain things

• necessary to protect public morals;

• necessary to protect human, animal or plant life or health;

• relating to the importations or exportations of gold or silver

• imposed for the protection of national treasures of artistic, historic or archaeological value;

• relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption;

Legal or illegal: the netherlands lowers tariffs on cheese imports from Switzerland, but not from America

illegal —> violates MFN

Legal or illegal: the Netherlands lowers tariffs on cheese imports from Switzerland as part of a free trade agreement with Switzerland, but not from America

legal —> exemption of free trade agreements

Legal or illegal: the Netherlands mandates that all American cheese has to be stacked on the bottom shelves at supermarkets

Illegal —> violates national treatment

intergovernmental bargaining process

• Changes require unanimity

  • All members have to agree (although in practice the biggest countries often heavily influence the smaller ones)

• Often a "single undertaking": Nothing is agreed until everything is agreed

  • Facilitates issue-linkage and trading off concessions

  • Can lead to stalemates

WTO agreements

Not just tariffs, but a lot of trade-related issues, e.g. Uruguay Round gave us:

• GATS: General Agreement on Trade in Services

• TRIPS: Agreement on Trade-Related Aspects of Intellectual Property Rights

• TBT: Agreement on Technical Barriers to Trade

• SPS: Agreement on Sanitary and Phyto-Sanitary Measures

• Agriculture Agreement

• Agreement on Subsidies and Countervailing Measures

• …

Why did Doha round fail?

• 2002 - ?

• Main objective: economic development

• Ambitious agenda:

  • All WTO members participated

  • Required consensus for completion

  • "Nothing is agreed until everything is agreed"

  • Most controversial part: agriculture and removal of developed countries' subsidies

  • Also on the agenda: tightened anti-dumping rules, intellectual property, environmental protections, trade facilitation, "special and differentiated treatment"

• Reasons for failure:

  • Unwillingness of US, EU and Japan to reduce support for agriculture

    • US and EU had outside options —> did not stay at Doha table

  • Pits developed vs developing countries for the first time

  • Too many cooks spoiling the broth - many countries willing to derail negotiations

Dispute settlement mechanism

• A standard upon which to adjudicate and punish violations of WTO agreements

• Allows for legal reciprocation of victim states

  • Other firms or sectors can see new restrictions

  • Can be good for violators (a scape goat)

• Under GATT, a defendant could block actions

• Under WTO, this cannot happen

  • Need unanimity to block

dispute settlement mechanism: ex. Compliance

• In 1995, Costa Rica sued the US through the World Trade Organization because of an import restriction on underwear.

• Costa Rica won! The US complied with the ruling.

• Why did the US comply?

  • Costa Rica is tiny and has no army!

  • Who cares if they don't like US policy?

Short-term incentives to disobey rules can be outweighed by the long-term benefits provided by an institution.

Dispute settlement mechanism: unresolved

• Both Airbus and Boeing receive subsidies from their governments

• Disputes at the WTO for 16 years and counting...

• Both have launched numerous cases against the other, with a lot of retaliation and subsidies are still in place

Dispute settlement mechanism: ineffective ex

• In 2003 Antigua and Barbuda dispute US measures relating to gambling and betting services

• Panel report in 2004 find US is indeed violating WTO law on trade in services

• Appellate Body largely upheld panel decision in 2005

• Antigua and Barbuda won right to $21 million annually in compensation until US laws are changed

• US refuses to pay

• Antigua got right to use trade sanctions to recoup losses

• Antigua didn't use that option - would hurt Antiguan economy a lot more than the
  US

Why states (sometimes) like the WTO

• The WTO lets you lose.

  • This is an easy way to shift blame away from politicians onto the WTO

  • Lets politicians avoid scorn of special interest lobbies.

• States can get creative with retaliation

  • US steel tariffs, EU retaliates with tariffs on Bourbon and Harley-Davidsons

• The WTO makes exceptions. If it requires too much, states may defect from cooperation

Does the WTO work?

• Did it increase trade?

  • Maybe, the jury is still out.

  • WTO members do engage in more int'l trade

  • It is unclear if states that joined would have liberalized unilaterally and traded just as much

• States bring few cases to the WTO

  • Still it might act as a deterrent to imposing trade barriers

will the WTO last?

• Appellate Body necessary to conclude dispute settlement
  cases

• Usually has 7 members, appointed by WTO countries, 3 per appeal

• US has been blocking appointments since 2018, it is now down to 0 member - essentially defunct

• Long-standing Issues between US and Appellate Body:

  • Especially controversial: AB's interpretation of the Antidumping/Countervailing Duties Agreement

WTO take away

• Cooperation is hard because of the anarchy of the international system

• The WTO aids trade cooperation by providing a forum for bargaining, monitoring behavior and an enforcement mechanism through institutional reciprocity

• WTO progress has been stalled because of diverse interests and domestic politics

Regional trade agreements

• Global bodies are limited and require cooperation and consent of many members —> Difficult to reach agreements

• States may seek regional trade agreements with more important trade partners instead.

  • Most trade is concentrated with a few partners.

• In the past two decades, we've seen an explosion of regional trade agreements

• Can be as few as two members (bilateral), but trend towards mega-regional deals (e.g. TPP, RCEP)

• Easier to implement because they require fewer members

  • Remember the more actors, the harder cooperation.

  • Powerful states can shop around for the best deal

    • Don’t get what you want to the WTO level, you an dictate regional trade agreements to get a better deal

  • Makes it easier to ease into free-trade policy.

    • More acceptable than joining the WTO for many domestic interests

Regional Trade Agreements: 2 types

1. Free trade agreements —> most common

2. Customs union —> EU

Regional trade agreements: free trade agreements

NAFTA, CPTPP

• Eliminate tariffs among members

• Separate trade policies with non-members

• Most RTA are Free trade agreements

Regional trade agreements: customs unions

EU

• Eliminate tariffs among members

• Common trade policy with non-members

Are RTA’s a problem for global trade?

Problem: Trade Diversion

• Could shift trade away from non-RTA members, e.g. from China-US to Mexico-US

• Thereby prevent FULL realization of comparative advantage.

• Favors states with a strong bargaining position.

• Biases trade rules in favor of states with large markets (The EU/US!).

• States can exercise "outside options"

Benefit: Trade Creation

• Create new trade that wouldn't have occurred before

• Might be "stepping stones" to multilateral agreements

Nobody knows which of these effects dominates - very hard to measure; Hard to tell bc we do not know what the world would look like without the WTO —> counter factual

TTIP and TPP

• two megaregional agreements:

  • TTIP = Transatlantic Trade and Investment Partnership (US-EU)

  • TPP = Trans-Pacific Partnership (US, Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam)

• Neither went into force, although TPP was eventually turned into CPTPP without the US, UK recently joined

What happened to TTIP and TPP? Simple answer

• Negotiations occurred between 2013-2015 and would have been implemented in 2016

• Trump happened

What happened to TTIP and TPP? Goes much deeper than that

• Protests all across the world

• TTIP was already put on ice before
  Trump entered office —> by Europeans

• Sister Agreement CETA (EU-Canada) had to be renegotiated, because of a referendum in Wallonia

Problem: liberalization far beyond tariffs

• Tariffs between many of the treaty partners already low

• Instead, agreements now often:

  • Try to harmonize standards and regulations

  • Introduce controversial rules to further investment (esp. Investor-State-Dispute Settlement Mechanisms)

  • Introduce stricter intellectual property rights protections (good for Pharmaceutical industry, but probably not for consumers)

• WTO already criticized by environmentalists and consumer groups for its rules, but RTAs often go much further

Example of controversies

who’s afraid of chlorine chicken and hormone beef?

• EU’s citizens strongly opposed to potential harmonization with US standards on food safety

  • Protectionism?

  • Legitimate concern

Hegemonic Stability Theory

• Idea that one dominant actor can shoulder the burden of enforcement for all

  • Either benevolently (Kindleberger - The World in Depression)

  • or Selfishly (Krasner - "State Power and Structure of Trade").

• In our most recent case it is the United States (Previously the UK).

  • US benefits tremendously from trade liberalization (especially after WWII)

  • US was willing to incur the costs of mobilizing and monitoring enforcement of the rules

• Now the US power has declined, perhaps no one state is willing to provide the public good of trade liberalization

  • COLLECTIVE ACTION PROBLEM!

  • Will we be entering a time with less free trade? Yes, we are seeing signs of this