9_world_trading_system.pdf

FEB13085 International Trade Policy The World Trading System Aksel Erbahar Erasmus School of Economics BLOK 3 - 2023-2024 1 / 21 Introduction I Globalization is driven by individuals and firms, but governments set the rules, which can fundamentally change the outcomes. I History: GATT in 1948 (only...

FEB13085 International Trade Policy The World Trading System Aksel Erbahar Erasmus School of Economics BLOK 3 - 2023-2024 1 / 21 Introduction I Globalization is driven by individuals and firms, but governments set the rules, which can fundamentally change the outcomes. I History: GATT in 1948 (only 23 nations), then became WTO (123 nations, now 164) in 1995: multilateral agreements to regulate international trade. I Purpose: Reduce tariffs, eliminate NTBs → increase market access (shallow integration). Reciprocity and non-discrimination are key. I The latest round of WTO negotiations, the Doha Round (began in 2001), failed. I The Trump administration refused to appoint new judges to the WTO’s Appellate Body (in charge of dispute settlement). 2 / 21 Introduction I Proliferation of free trade agreements. I The Transatlantic Trade and Investment Partnership (TTIP) between the US and the EU: focus on streamlining standards, give firms legal rights to challenge government policies (deep integration). I The Trans-Pacific Partnership (TPP): “NAFTA on steroids.” Signatories: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, USA, Vietnam (deep integration). 3 / 21 Origins of the GATT system I Motivation to establish formal trade rules arose in the aftermath of the Great Depression of the 1930s. I Part of the blame is on the US: Smoot-Hawley tariffs of 1930 (average tariff jumped to almost 50%). I Countries engaged in “beggar-thy-neighbor” policies through protectionism that left the world as a whole worse off due to cross-border externalities. I After WWII, world leaders decided that rules of international trade should be set cooperatively to prevent another economic “disaster.” I GATT was signed in 1947 with reciprocal reductions in tariffs (through bindings) that were applied to all signatory countries (only 23 nations). 4 / 21 The WTO I There were many rounds of negotiations before the Uruguay Round that expanded the number of GATT signatories and resulted in more tariff reductions and elimination of NTBs. I The Uruguay Round of negotiations that began in 1986 resulted in the establishment of the WTO in 1995 with new agreements on dispute settlement, agriculture, clothing, services, investment, and intellectual property (with 123 signatories). I The two core tenets (reciprocity and MFN) continued to be crucial with one additional tenet: dispute settlement mechanism (DSM). I WTO has been generally successful in shallow integration, but... 5 / 21 Doha Round failure I The Doha Round was launched in 2001 with the purpose of: 1. 2. 3. 4. liberalization of trade in agriculture liberalization of trade in manufactures liberalization of trade in services (GATS) expansion of intellectual property regulation (TRIPS) I Overall, developing countries argued that they were asked to offer more than what they can get from developed countries. I The Doha Round is now “dead.” Too many members, too many interests → the end of successful multilateral negotiations? 6 / 21 Purpose of a trade agreement I What is the problem that trade agreements might solve? I Addressing beggar-thy-neighbor policies such as terms-of-trade externalities (unilaterally attractive but mutually destructive). 7 / 21 Terms-of-trade externalities I Free trade is optimal for a small country (with perfect competition). I Nevertheless, governments’ political objectives can result in tariffs even for a small country. I Free trade might not be optimal for large countries, even without political objectives → governments might want to impose tariffs due to terms-of-trade (ToT) gains. 8 / 21 Trade agreements I A trade agreement would be valuable if it results in Pareto improvements relative to the Nash equilibrium. I In fact, Nash tariffs are inefficient (mutually beneficial trade agreement is possible), and both governments can gain from reducing their tariffs below the Nash levels (reciprocal trade liberalization is necessary for mutual gains to be possible). I Trade agreements allow countries to escape from a “terms-of-trade-driven prisoners’ dilemma” (Bagwell and Staiger, 2010). 9 / 21 Trade agreements Effects of an import tariff imposed by a large country Export supply curve shifts up, resulting in an overall welfare gain (or loss) for the home country (e − b − d), and a welfare loss (e + f ) for the foreign country. World as a whole loses (b + d + f ). 10 / 21 Trade agreements Terms-of-trade-driven prisoners’ dilemma Assuming e − b − d > 0, the only Nash equilibrium of this game is the lower-right quadrant where both countries have negative payoffs. 11 / 21 Design of GATT/WTO I The design of GATT/WTO has three key elements: 1. Reciprocity: if A wants to get $10M worth of market access from B, then A must supply $10M worth of its own market access: what you get is what you give ⇒ reciprocity is achieved if only if the changes in trade policies of both countries leave the world relative price unchanged. 2. Non-discrimination a.k.a. the MFN (most-favored nation) principle: all trading partners must face the same trade barrier. 3. Enforcement and dispute settlement mechanism: trade barriers of a country can be effectively challenged. 12 / 21 Exceptions to the MFN principle I Article XXIV of the GATT/WTO states that: “Accordingly, the provisions of this Agreement shall not prevent [...] the formation of a customs union or of a free-trade area [...].” I Free-trade agreements (FTAs) such as NAFTA eliminate tariffs within the area, whereas customs unions (CUs) such as the EU, in addition to eliminating tariffs, maintain a common external tariff schedule. I FTAs that include several countries within a region are also called regional trade agreements (RTAs). 13 / 21 Prevalence of RTAs 14 / 21 Source: European Commission (http://ec.europa.eu) 15 / 21 FTAs I These agreements do not obey by the MFN rule, which means that they have externalities on the “outsiders.” I This can create inefficiencies even for the signing parties through trade diversion. 16 / 21 Trade diversion example 1 Suppose that the EU was imposing a tariff t on textiles. With this tariff, the EU imports only from India (D1 − S1 ), as Turkish textiles exporters cannot compete with the low-cost Indian producers. After the EU-Turkey customs union, however, Turkey grabs the market as its price without the tariff is lower than the Indian price with the tariff, increasing EU imports (D2 − S2 ). Consumers gain a + b + c + d, producers lose a, government loses c + e, so the country as a whole loses e − b − d. 17 / 21 Trade diversion example 2 Suppose that the US was imposing a tariff t on auto parts (that it does not produce). With this tariff, the US imports from Mexico (Q2 ) and China (Q1 − Q2 ). With NAFTA, the Mexican export supply curve shifts right, and US imports of Mexican auto parts rise (Q3 ) and US imports of Chinese auto parts decline (Q3 − Q2 ). Even though the total amount of imports is the same, tariff revenues decline! Since domestic price does not change, there are no changes in consumer surplus, but government loses a + b + c, so the country as a whole is worse off. 18 / 21 Trade diversion example 2 The example above showed that the US loses due to trade diversion, but this need not be the case. Suppose that NAFTA causes the Mexican export supply curve to shift dramatically, then equilibrium imports occur at point D at PCHN , where Mexico eliminates China from the US import market for auto parts. Even though there are no government revenues anymore, the US consumer surplus is higher, and the country as a whole gains e: trade creation vs. trade diversion. 19 / 21 Enforcement and dispute settlement I How are the rules enforced? The agreement must be self-enforcing since there is no world-jail for offenders. I From a repeated-game perspective, the fear of authorized retaliation makes sure that the agreement is self-enforcing. 20 / 21 Dispute settlement There have been more than 600 disputes initiated within the WTO dispute settlement framework. Source: Calculations using data from the WTO Secretariat (https://www.wto.org/english/tratop_e/dispu_e/dispu_status_e.htm). 21 / 21