The Economics of International Trade - History of FTAs and GATT - Essay Example

HISTORY OF FTAs AND GATT As viewed through the looking glass of Favoured Nation Principle A historical account of FTAs and GATT and how the two compared with each other when viewed from the perspective of Most Favoured Nation principle The Economics of International Trade Right from the early days of history, as the concept of state as a sovereign unit of authority started taking a firm shape; trade between two states became an economic necessity. Athens and Sparta fought the Peloponnesian War for twenty seven years way back in 431-404 BC, China and Great Britain fought a series of Opium Wars more recently during 1839–1842 and 1856-1860 when the economic necessity associated with international trade acquired different and sharply contrasting perspectives between the trading partners. Without getting into the extremely onerous task of passing an ethical or a moral judgement on the motivations of warring partners, it can safely and certainly be declared that trade between two sovereign entities has always been a necessity that no state could ignore. Though international trade, like any other trade, leaves one participant more benefitted than the other, there can be no denying that all the partners stand to gain from a scenario where there is trade than when there is no trade at all. Each country would produce more of that commodity in which it has a comparative advantage thus creating an international marketplace where more of every commodity is available at a comparatively lower price. With more output at lower price, it is but obvious that citizens of trading countries not only attain a higher level of employment but also a higher real per capita income. (Hollander, 1979) But this scenario is possible only when trade between two countries is free from any barriers of protectionist tariffs and prices of commodities are decided through the interaction of genuine supply and demand; not influenced by either tariffs or subsidies. However, it has been observed that in most countries, the opponents of free trade (they take many hues, starting from industrialists who fear they would lose their monopoly position to trade unions that fear loss of jobs from foreign competition to political leaders eager to score a brownie point or two by raising cries of misplaced patriotism that get louder through large doses of artificially hyped up xenophobia) tend to swamp those in favour of free trade. It has been the general norm of international trade to have some form tariff barrier with industrialised countries generally maintaining tariff rates of 25% while developing countries favouring a higher protective barrier at 34% on manufactured items. (Chang, 2002) The proponents of Free Trade have come round to accept the reality of socio-economic pressure that every government faces and the World Bank also has conceded that some form of protective barrier is an inescapable reality in modern day international trade. The moot question, however, is what would be the acceptable limit of tariff and there has been an ongoing debate among numerous think tanks in the academic world with some propagating a maximum of 20% to others who claim that industrialised nations should never raise their barrier beyond 15% while leaving the developing nations to choose their own barriers that they deem fit to be sufficient to provide their fledgling industries some breathing space and some form of level playing field to counter the might of their vastly superior cousins in developed countries. The proponents of this sort of dual tariffs claim that this is the only way the developing nations can hope to come up in future to the level of developed nations. However, it has been observed that tariff barriers erected to support industrialisation that attempted to substitute imports in developed countries were not very successful. On the contrary, export oriented industrialisation as pursued by the so-called Four Asian Tigers of Hong Kong, South Korea, Singapore and Taiwan have actually generated considerable and perceptible economic development. But before accepting this to be a standard norm that all other developing countries should follow with unfailing vigour, one must state that each economy has its own peculiarities and typical problems that need to be tackled on a case-to-case basis and it is neither prudent nor possible to provide a blanket prescription for economic development through international trade. (Pugel, 2006) US and Free Trade United States had always appreciated the benefits of Free Trade and knew how its economy and citizens could potentially benefit from open markets in countries all over the world. But its entry into the world of Free Trade was more a quirk of history rather than a well pondered economic decision. As the American War of Independence gathered momentum, United Kingdom responded by blockading the ports of what would later become the United States of America. The Continental Congress retaliated by opening its ports to all countries of the world on 6th April 1776. However, such an open door policy did not prevail for long as leaders of the infant nation quite predictably rooted for protection of its infant industries. First US Secretary of Treasury Alexander Hamilton was in favour of high tariff barriers and his ideas were further propagated during the later part of 19th century by Henry Clay. But Right through the nineteenth century the Democrats went on arguing and for the most part convincing majority of Americans that a moderate tariff barrier would be the best prescription for the economy that was going through its turbulent adolescence. Things, however took a sharp reverse turn with the breaking out of Civil War and it would not be out of place to mention that Republicans under the leadership of Abraham Lincoln went ahead and imposed a 44% tariff regimen partly to recover the expenses of Civil War and partly to fund the rapidly expanding railways and protecting a handful of highly favoured industries. (Tyler, 1986) For those who would wince at such a high level of tariff it must be conveyed that even this level was surpassed when the highly controversial Hawley-Smoot Tariff Act was passed during early 1930s. A sizeable number of renowned economists are of the opinion that such an absurdly high protective barrier in effect prolonged the economic depression in US while Europe could wriggle out of its clutches within a comparatively shorter period since the European countries did not barricade their economies from the self healing forces of international economics. Most Favoured Nation Principle (MFN) – an overview United States has right through its history incorporated the policy of MFN in some form or the other while conducting international trade. Under this policy the host country treats national and international trading entities differently but accords same treatment to all international trading partners. There are two main variants of MFN Policy – conditional and unconditional. Conditional MFN Policy – This can be best understood through an example. Let us assume US has entered into MFN agreements first with Germany and then with Japan. The agreement with Germany include a lower tariff rate on machinery imported from that country in lieu of a preferential tariff rate that Germany has decided to accord to fertilisers imported from US. A subsequent trade agreement is signed between US and Japan where US will allow import of Japanese televisions at preferential rates of tariff as Japan has allowed entry of US computers in Japanese markets at a reduced rate of tariff. Under conditional MFN Policy, US can continue with these two treaties simultaneously where German televisions cannot be imported into US at concessional rates while Japanese machinery manufacturers cannot claim the concessions accorded to their German counterparts. Japan and Germany have to rework their agreements individually to get the benefits that the other country has. United States has mainly followed this pattern of MFN policy throughout its history till 1934 when the passage of Reciprocal Trade Agreements Act (RTAA) allowed US negotiators to use unconditional MFN policy as a tool of striking international trade agreements. (Hornbeck, 1910) Unconditional MFN Policy – Under this policy, US does not discriminate among its trading partners and each partner need not individually negotiate and bargain for preferential treatment for various items as a treatment accorded to one nation falling under the category of MFN is automatically conferred to all other members of this group. Thus when Japanese televisions start getting preferential treatment, Germany televisions would automatically get that benefit without any special effort on the part of the Germans. Japanese machinery manufacturers would also, needless to state, get the same preferential treatment that their German counterparts enjoy without, quite obviously, any special effort on the part of the Japanese authorities. The best part of unconditional MFN policy is that both Japan and Germany would start enjoying the additional concessions without having to provide any corresponding additional concessions on their part to avail of those. Thus a multilateral trading regime takes shape through a series of bilateral trade agreements under unconditional MFN policy. This has been the overwhelming experience of all developed countries since the Second World War came to an end. This concept has such a profound impact on policy makers throughout the world that it was incorporated in both GATT (General Agreement on Tariffs and Trade) and its successor, WTO (World Trade Organization) charters. (Gordon, 1965) Implementation of MFN Policy during 1934 – 1974 As Hawley-Smoot Tariff Act pushed the country deeper into the throes of financial depression, Reciprocal Trade Agreements Act (RTAA) of 1934 marked the beginning of a new era trade liberalisation in the US. The first novelty that struck ones eye was Congress absolved itself of the duty of setting up trade policies and passed it on to Federal Administration, most probably to avoid the opprobrium it had to suffer with the negative impact that Hawley-Smoot Tariff Act have had on the economy. The Administration used the provisions of RTAA to further international trade that constituted of both exports and imports and it realised pretty early that the one sided approach of only trying to increase American exports would not be able to deliver the results that the US economy badly needed at that hour. The first step thus taken was a lowering of the ultra protective tariff barriers that were preventing other nations from approaching the US markets. (Haggard, 1988) Europe in the meanwhile was witnessing the first but unmistakable signs of rise of Fascism in Germany and US used the provisions of unconditional MFN policy as a tool to grant multilateral concessions to its European partners while unobtrusively stitching up strategic alliances that held it in good stead as war clouds started banking in European skies. RTAA which was based on the tenets of equality of treatment, tariff rates that could be negotiated and settled upon by the executive and would become binding without the necessity of getting it ratified by the Congress, served as a platform on which subsequent progress towards liberalisation in the form of GATT took shape. But it must be mentioned that RTAA did not speak anything about dismantling tariff protection; all that it spoke was about reciprocity of treatment and unconditional MFN status which would be the guiding principles while negotiating bilateral deals. In fact, President Franklin D. Roosevelt placed the RTAA before the consideration of the Congress by labeling it as an economic measure targeted towards domestic economic recovery. There were still a sizeable number of members in the US Congress who supported protection and it would have created a furore if lowering of protectionist barriers was mentioned directly. However, Cordell Hull, the then Secretary of State Department, skilfully used the reciprocity clause to lower tariff barriers without agitating the Congress. The additional clause of unconditional MFN treatment further helped to spread the benefit of bilateral treaties to the overall gamut of international trade. State Department officials also used RTAA as a tool to further the cause of international security which was increasingly becoming jeopardised due to the rise of Nazi power in Germany. US went for special concessions for certain strategic European allies as Belgium, Switzerland and United Kingdom among others, while at the same time pressurised certain Latin American countries by refusing to negotiate bilateral treaties with them and withholding financial aid in the form of Export-Import Bank credits and similar other sops till those governments agreed to settle defaulting US debts and treat US direct investment in a fair and equitable manner and agree to implement political reforms in their respective countries. Thus economic power was being used with increasing frequency and more telling effect by the US State Department during the uncertainties that prevailed prior to and during the Second World War. RTAA was not explicit as to which countries would be eligible for bilateral trade agreement under the new regime of reciprocity and MFN policy. State Department took one step forward and extended the MFN treatment also to countries that were directly not involved in international trade with the US and by some skilful manoeuvring and reinterpretation of the clauses of RTAA identified Germany as the nation against whom retaliatory economic measures need to be taken at the earliest. Thus, by opening up its markets to even all those that were not so enthusiastic about opening up their markets to US products and by isolating Germany in the world of international trade, State Department took one giant step in cementing the Alliance which fought as a united front against Germany during Second World War. (Ratner, 1972) However, the principle of reciprocity in international trade did not achieve what was anticipated, and if viewed purely from the point of economic benefits, the gains were nothing remarkable. But State Department could successfully argue repeated extensions of RTAA till 1945 as it became absolutely convinced that not only did it serve as a potent tool in international diplomacy but also had all the ingredients necessary for setting up an international economic structure based on mutually beneficial trade and commerce in a post-Second World War scenario. In fact, the State Department had almost finalised the blueprint of a post war scenario of international cooperation as it became convinced that one of the main causes of the outbreak of Second World War was lack of proper economic coordination and cooperation between developed countries of Europe and the US. A lack of structured coordination and an inability to fully grasp the total extent of benefits that can be reaped if international trade is based on the principle of Comparative Advantage as propounded almost a century ago by David Ricardo, lead to a jingoistic attitude among nations that fostered an unhealthy trend of economic competition and consequent increase of tariff barriers. This misplaced economic nationalism was but a step away from the dangerous clutches of fascism. Determined to root away this evil so as to prevent recurrence of another World War, State Department sought to usher in an international economic order that was based on unconditional MFN treatment. The participating countries retained their prerogative of entering into bilateral trade agreements and implement steps they thought necessary to protect their domestic industries and social welfare programmes. It was thought to be the best of both worlds as it were as countries benefitted from international trade while ensuring that domestic industrial infrastructure was not sacrificed in the process. (Lake, 1988) President Harry Truman invited twenty four countries to Geneva in 1947 to sit together and negotiate multi-lateral trade agreements based on unconditional MFN principle. Twenty three countries accepted the invitation while Russia decided to opt out from this interim arrangement which, it was hoped, would finally be superseded by an authority under the aegis of United Nations. These countries went through the utterly laborious procedure of negotiating each item bilaterally between each other and as all of them had agreed to the principle of unconditional MFN status the bilateral agreements in effect became multi-lateral trade agreements known collectively as GATT. Nine nations that controlled almost eighty percent of international trade during that period agreed to implement GATT from 1st January 1948. (Milner & Yoffie, 1989) The State Department wanted to pursue a liberal policy as it realised that the time has come for US to take lead in international economy mostly because Europe was still suffering from the devastating hangover of Second World War. The officials realised that if US was indeed to be the leader of a new international economic framework of their choice, it must take the first step forward and, if necessary, offer concessions in excess of what was reciprocated by other GATT members. Thus, US entered an era of liberalisation where all protectionist restrictions of the past were retained to soothe the frayed tempers of many a Congress member intent on protecting American markets from international competition, but only on paper, while in reality a new found spirit of cooperation and transparency pervaded international trade and commerce. The GATT members set up a dispute settlement procedure and decided to solve all future conflicts through mutual discussion and coordination without becoming belligerent. Reciprocity obviously remained a very vital lubricant that was necessary to keep the vast wheel of GATT moving freely without any unseemly friction. (Rhodes, 1989) But everything did not happen immediately. As it was realised that the envisaged United Nations agency that was modelled in the lines of International Monetary Fund would not materialise because US Congress would never ratify such a proposition, GATT was amplified and through successive rounds of discussion it finally became a conglomerate of 125 nations controlling almost 90% of international trade when it was superseded by WTO in 1995. (Encyclopædia Britannica, 2008) Seven rounds of discussions were held between GATT members during its existence of nearly half a century and the most important among those discussions were the Kennedy Round that stretched from 1964 to 1967, the Tokyo Round where discussions went on for an even longer period of six years from 1973 to 1979 and, the Uruguay Round which witnessed mammoth discussions spread over eight years from 1986 to 1994. All these discussions together could reduce the tariff component in the market price which was 40% in 1947 (at the time of inception of GATT) to less than 5% in 1993. (WTO, 1998) More than 66 countries took part in Kennedy Round (named after late US President John F. Kennedy) and together they could slash $40 billion of tariffs and generally discarded the extremely laborious and time consuming act of bilateral negotiations as it was felt that GATT automatically ensured a multi-lateral trade pact between all members of this treaty. US played a proactive role in this round of talks and unilaterally provided concessions to its trading partners like countries of Western Europe and Japan without waiting for them to reciprocate. The main emphasis of US State Department was to provide impetus to its allies in Western Europe in their attempts at economic reconstruction and also to strengthen anti-Communist columns all across the continent of Europe and North Africa rather than providing protection to its domestic industrial sector. (Goldstein, 1988) Implementation of MFN Policy during 1974 – 2000 United States took the initiative right through 1950s and more so during 1960s to provide unilateral, unconditional MFN status to all member countries of GATT in an effort to build an international economic structure of free trade that would primarily reduce the possibilities of another major conflict like Second World War and secondarily allow US the opportunity to mark its stamp as the leader of world economy. In the process of providing unilateral benefits US most often ended up as the partner that had sacrificed more than what it gained and unconditional MFN being the accepted policy of GATT, many nations enjoyed the benefits of lower tariff for entry in US markets without having to provide a similar benefit to it. Thus it became a lopsided situation over time where US had not been getting the benefit of reciprocity it should have got had all members achieved same rate of economic growth, and each one of them opened up their economies to the same extent as US did. Though there were occasional murmurs of discontent, the overall robust health of the US economy was enough of a placebo to keep all discontent at bay. But as US experienced an economic downturn during 1970s and 1980s the earlier murmurs of discontent gradually snowballed into loud clamours demanding a relook at the liberal policy US had been following till then. The ire of US Congress seemed to be directed particularly towards Japan who they felt took maximum advantage of liberal US policies and had become a serious contender to US supremacy in several sectors of the economy without however opening up its economy for US producers to have a free and fair share of its domestic markets. Neither did it modulate its imports to make US its dominant trading partner while ensuring that most of its products reached US shores to serve the ever expanding markets over there. Congress members rightly felt let down and proceeded to formulate several retaliatory measures citing patriotic reasons of protecting US interests against the predatory designs of an unfair trade partner. It was suddenly a repeat show of early 1930s with calls of protectionism getting louder by the day. However successive administrations of Gerald Ford, Jimmy Carter, Ronald Reagan, George H. W. Bush, and Bill Clinton adroitly handled the clamour and kept US firmly on course towards liberalisation. The success of GATT depended largely on transparency between partners and by the time negotiations of Kennedy Round came to an end US discovered to its dismay that though tariff barriers had come down significantly, other barriers in the form of import licensing, countervailing duties, local content rules, just to name a few, in effect maintained the same level of restrictions to entry in overseas markets as earlier high tariffs used to do. Though US did not react to these provocations, the basic tenet – transparency – on which the entire GATT regime was built on, was gradually losing its sheen and credibility. In fact, Tokyo Round of discussions actually took upon the issue of Non-Tariff Barriers but little was achieved and US markets were soon flooded with attractive Japanese cars that provided stiff competition to US auto industry which saw its sales diminishing with alarming rapidity and approached Congress for relief. It responded by legislating The Trade Act of 1974 that allowed the International Trade Commission of US to impose quotas, tariffs and other restrictions that might be necessary to protect a domestic industry from unfair competition from abroad. Such a protection would at the most be available for a period of five years from the date of application of such quotas, tariffs and other restrictions. But by 1980, the US auto industry found such restrictions to be of little help and again approached the Congress. The Congress was more than willing to come forward to help the beleaguered US auto industry, but it would have vitiated the environment of GATT to a point of no return. The State Department realised it pretty early and foiled all attempts of the Congress by intelligently playing the reciprocity card. Regan administration even went out of its way to obtain a voluntary export restraint commitment from Japan when US-Japan auto dispute was at its peak and the clamour for retaliatory tariff imposition was at its shrillest thereby managing to adhere to US commitment of unconditional MFN treatment to GATT members. (Irwin, May 1995) During the last two decades of the previous century regional trade agreements became another major hurdle to the principle of equality in US foreign trade commitments. Regan administration started actively pursuing regional trade agreements and successive administrations of Bush (Sr.) and Clinton also followed up the agenda well after the Uruguay Round had begun in 1986. The think tanks in State Administration claimed that regional trade agreements would not violate the basic principle of equal treatment to all trading partners that has been the cornerstone of GATT. On the contrary, these policy makers declared that regional trade agreements would in effect strengthen the overall regimen of GATT as these agreements would address problems that could not be adequately focussed on under GATT regime as intellectual property rights, various non-tariff barriers and issues related to agriculture. Whatever, the policy makers might have said the fact remained that any regional trade agreement quite surely violated the basic principle of unconditional MFN treatment and such agreements with Israel in 1985 and with Canada in 1987 marked a decisive change from the international trade policy US had adhered to till then. Clinton who was the US President during that period however ensured that Uruguay Round of negotiations between GAAT members concluded successfully and at the end of this round of negotiations GATT boasted of one hundred and eleven countries that established WTO as a natural progression of GATT. However, regional trade treaties have come to stay as was evident from the enactment of North American Free Trade Agreement (NAFTA) between US, Canada and Mexico – the three largest countries in the American continent, in 1992. The agreement envisaged a free trade bloc between these three countries somewhat in line with European Community that mutually eliminated tariffs among them to accelerate trade and commerce to a good measure. It took almost a year to iron out the creases and after legislatures of all the three countries ratified the agreement, it went into effect from 1st January, 1994. (Encyclopædia Britannica, 2008) MFN Policy and Human Rights During this period of twenty five years (1974 – 2000) the US Congress also tried to use the purely economic tool of awarding MFN status to a country to further its agenda of human rights. A case in point is the famous Jackson-Vanik Amendment to the 1974 Trade Act that prohibited granting MFN status and any form of financial assistance or line of credit to any country that did not have a free market economy or restrict emigration in certain cases. The aim was to prevent Russia from restricting emigration of Jews from that country but as repeatedly articulated by the then National Security Advisor Henry Kissinger this amendment failed to have the desired impact. In fact many believe that behind the scenes diplomacy would have surely served the cause in a much better manner. But whatever may be its effect on emigration of Jews from Russia; this amendment most certainly introduced an element of human rights which was hitherto not present in US trade policy. (Eckes, 1999) It became a burning issue when MFN status of China was debated especially after the massacre at Tiananmen Square on June 1989. (Boudreau, 1993) China as it stood was already enjoying unconditional MFN status right from the first commercial engagement that began in 1979, a decade before Tiananmen Square happened, in spite of the fact that it was not a member of GATT. The MFN status of China was subject to annual review by the US President that had to be done in accordance with various provisions laid down by Trade Act of 1974 and of course the Jackson-Vanik Amendment to it. After the massacre in 1989 when several thousand student protesters were butchered by Chinese troops, members of the Congress tried to put a hold on the MFN status of China citing the provisions of Jackson-Vanik Amendment but Bush Sr.’s administration gathered enough support in 1990 in the both the Houses to get the MFN status of China renewed for another year. But subsequently the issue got more complicated as Senators tried to include not only the issue of human rights but a whole range of other political and economic issues that had to be considered by the government before renewing the MFN status of China for another year. There were however some genuine concerns as China’s abysmal record of protecting intellectual property rights and there was enough pressure from the textile lobby that felt insecure at the flooding of markets by cheap Chinese textiles that made the matter rather delicate for Bush and Clinton administration. (Schaefer, 1998) Clinton in particular had a long running battle with human rights groups as he was unwilling to let go of the immense economic opportunity of exploring vast Chinese markets and the almost limitless potential the US Corporations had of investing in those untapped markets in a country that boasted of highest population in the world. Finally a mid-way compromise was settled upon in the form of delinking MFN status from the issue of human rights and violation of intellectual property rights. While China was granted MFN status to maintain continuity in US trade policy, violation of human rights was taken up in real earnest through diplomatic channels. (Wang, May 1993) It was still a regular annual hurdle that the Administration had to overcome in order to continue providing MFN status to China. It continued for the next five years up to 1999 when China became a full-fledged member of the newly set up WTO and achieved a permanent MFN status. Conclusion Though US remained committed to the principle of providing unconditional MFN status to members of GATT, there was hardly any appreciable activity in this regard during the early 1990s. In fact, the authority to finalise a trade agreement that administration had was revoked by the Congress after Uruguay Round of discussions were over and Clinton administration did not make any moves to reclaim it. The US government showed a lethargic attitude not only towards GATT but also towards the newly signed NAFTA agreement and did not make any move to provide leadership to the other two signatories. The Latin American nations that were hopeful that NAFTA would very soon include them also started to feel disappointed about the lack of interest on the part of USA. But a phenomenal expansion of US economy during this period pushed all issues of trade agreement into the backburner as possible benefits that might be obtained through concessions accorded to a particular trading partner suddenly seemed too insignificant given the huge progress the entire economy started making with IT sector taking the lead. Thus both Congress and State administration shifted their focus from trade to finance as the next high profile foreign economic policy issue. References Boudreau, D. G. (1993). Beyond Tiananmen Square: China and the MFN Debate. World Affairs 153 , 140–147. Chang, H. J. (2002). Kicking Away the Ladder. Anthem Press. Eckes, A. E. (1999). U.S. Trade History. In U.S. Trade Policy: History, Theory, and the WTO. New York: Armonk. Encyclopædia Britannica. (2008). General Agreement on Tariffs and Trade (GATT). Encyclopaedia Britannica 2008 Ultimate Reference Suite . Chicago: Encyclopædia Britannica. Encyclopædia Britannica. (2008). 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