Understanding the World Trade Organization
by Marcus Noland, Peterson Institute for International Economics
Paper summarizing speech given on the WTO to the D.C. League of Women Voters
February 16, 2000
© Peterson Institute for International Economics
We tend to assume that our world constantly progresses, that conditions are always improving or advancing. That is not necessarily the case. World economic integration in the 1890's, or globalization as we now label it, was surprisingly advanced, quite comparable to that of the 1990's. At the end of the 19th century, trade was very free. Goods moved freely across borders. There was tremendous population movement. Tens of millions of people left other parts of the world, mainly Europe but also to a certain extent Asia, to settle in North America and other so-called areas of new settlement. Financial markets were relatively well integrated. Millions of British pounds (the key currency of that era) moved across national borders. The Economist magazine published stock market indexes not only for London, but for New York, Buenos Aires , and other key markets. That world was underpinned, in economic terms, by the gold standard and British hegemony. It would take nearly a century to re-attain that level of economic integration achieved by the end of the nineteenth century.
This "globalization" of a century ago began to fail at the beginning of the 20th century. It ended with the First World War. Attempts to revive it after the First World War were unsuccessful. As countries around the world came under economic pressure in the period after the First World War, they erected trade barriers.
In 1922, the United States passed the Fordney-McCumber tariff, the largest single increase in the US tariff rates. The US Constitution grants the Congress the prerogative to regulate international commerce. Thus, individual Congressmen were in a position to literally trade votes over individual tariff lines and they did. A Congressman from Texas might have approached a Congressman from New York offering to vote for a higher tariff on chemicals in return for his vote for a higher tariff on cotton. There was a horse-trading process by which individual Congressmen struck deals to get higher tariffs to protect workers and industries in their respective constituencies. The end result was the huge Fordney-McCumber tariff increase.
The situation worsened when the Great Depression struck. The United States and other countries began raising their tariffs in an attempt to divert national demand away from imports and toward domestically produced goods.
As the United States and other countries imposed these tariffs to try to keep national demand internal, the volume of world trade spiraled downward. To illustrate the resulting contraction of world trade volume, Mr. Noland referred to the Kindleberger spiral, a visual display of the contraction of trade over the months following January 1929. (It is the creation of Charles Kindleberger, a retired professor of economics at M.I.T.) Using twelve spokes of a wheel for the months of the year, the volume of world trade in any given month is measured along that month's spoke. The higher the trade, the further out on the spoke it is displayed. The lower the trade volume, the closer it appears to the wheel's center. In January 1929, the volume of world trade was about 3 trillion dollars. As countries began imposing trade barriers, the volume of world trade spiraled downward toward the center. By March 1933, approximately the time Hitler came to power in Germany, the volume of world trade had fallen to less than $1 trillion. Along that downward spiral, the United States imposed the infamous 1930 Smoot-Hawley Tariff. Smoot-Hawley proved to be the last time individual Congressmen would trade votes over tariffs.
This collapse of world trade and the world economy at the onset of the Great Depression coincided with a rise in extremist movements all over the world. Given the disastrous subsequent history, we have come to view the maintenance of world trade and an integrated world economy as essential to the maintenance of world peace.
By the time Franklin Roosevelt was elected President of the United States, in 1932, world trade was sharply reduced and still declining. Seeking to reverse this process, Roosevelt sent Secretary of State Cordell Hull abroad to negotiate lower tariffs. The approaching war in Europe made it extremely difficult to reach agreements with European countries. Cordell Hull managed, however, to negotiate a few trade agreements mainly with Latin American countries, which remained largely outside the war.
Following World War II, the architects of the post-war world sought to create a new international trade system, a set of rules of the road, to prevent this kind of collapse from ever happening again. They devised a set of rules governing how nations would regulate their international commerce. An International Trade Organization (ITO) was designed to enforce the rules. However, when the US Congress rejected the ITO in 1950, the ITO was stillborn.
The General Agreement on Tariffs and Trade (GATT), negotiated in 1947, was a treaty containing reciprocal obligations to reduce tariffs following the pattern of US bilateral treaties negotiated by Cordell Hull. GATT was never intended to become an organization. It was supposed to depend on the ITO for its organizational context and secretariat services. Nevertheless, it managed to fill the void left by the failed ITO and emerged as the de facto international trade organization.
GATT is a set of bilateral agreements among countries around the world. It is basically a global generalization of what the United States started in the 1930's. A major weakness of the GATT as a world trade organization was that it had no real enforcement mechanism. If a country broke a bilateral agreement with another country, nothing could be done. There were some rules for enforcement but they were basically dysfunctional. Furthermore, the GATT system survived by taking sensitive areas of trade outside the rules. When member countries' internal political pressures or special-interest demands became overwhelming, the "rules" were ignored. Thus, both agriculture and the textile and apparel industries were taken outside the rules.
From the late 1940's through the mid 1980's, the imperfect GATT system was surprisingly successful due to ingenious and highly pragmatic leadership. The US Congress chose to shield itself from domestic special-interest demands for tariff protection by delegating its Constitutional prerogative over international trade to the President. Basically, Congress told the President to go out and make the trade deals and promised to pass them. There followed a series of international trade negotiations or "rounds," approximately one each decade, during which bilateral agreements were reached. Congress ratified them.
That system of coherent but weakly enforced rules on the global level and Congressional acquiescence to Executive Branch leadership on the national level began to come apart in the 1980's. The United States was running very large trade deficits as well as unprecedented budget deficits. A Republican President and a Democratic Congress were wrangling over economic restructuring while failing manufacturing industries, especially in the "rust belt" and the upper mid-West, sought protection from international competition. The Democratic Congress grew restless and began to reassert its Constitutional prerogative to regulate trade. There followed a series of Congressional initiatives that were basically protectionist.
The Reagan Administration sought to counter this protectionist trend by calling for a new round of global trade negotiations. The new round opened in Punta del Este, Uruguay in 1986, and is therefore known as the Uruguay Round. Negotiations dragged on from 1986 until 1993.
The Uruguay Round came to grips with a number of festering trade issues. Regional trade pacts, such as the US-Canada Free Trade Agreement, which would later be generalized as NAFTA, were on the rise. Agriculture and the textile and clothing industries remained outside the GATT system and needed to be addressed. Countries wanted some coherent regulation of the growing trade in services, an area that had never come under the GATT. Producers of high tech and innovative products in countries such as the United States wanted protection for intellectual property rights. They wanted rules to stop the pirating of their products, including books, records, movies, pharmaceuticals and electronics. Finally, there was a need for an improved system to settle trade disputes. Under the dysfunctional GATT dispute-settlement procedures, the loser in a case could simply block any kind of quasi-judicial GATT judgement finding it out of compliance with treaty obligations.
By 1993, compromises had been negotiated in all of these areas. Agriculture, politically sensitive in all countries, had been negotiated but the result was a political compromise, essentially between the United States and the EU, that allowed both parties to continue practices that were not consistent with GATT rules. Textiles and apparel were to be brought back under the GATT, although completion of liberalization in these industries was back-loaded. It was to be phased in over ten years. Most of the real liberalization has yet to occur. Trade in services became subject to a new General Agreement on Trade in Services (GATS), although GATS fell short of what the US wanted. Protection was provided for intellectual property rights. Some very mild protection for investment was introduced—not as much as the US wanted but as much as could be gotten in the context of the negotiations.
Finally, the dispute settlement system was vastly improved and the WTO was established to adjudicate claims of treaty violation. Thereafter, a country found to be in violation of its treaty obligations by the WTO would either have to bring its offending practices into compliance or face WTO-authorized retaliation by the injured country. Countries could no longer violate trade treaty obligations with impunity. The GATT continues to exist as a substantive agreement, establishing a set of disciplines on the trade policies of its members. The WTO itself does not embody substantive rules regarding government policies-it is simply a formal institutional structure under whose auspices members negotiate and implement their trade agreements.
Trade issues in agriculture and services were not satisfactorily resolved during the Uruguay Round. Having made little progress on trade in agriculture and remaining fundamentally in violation of GATT rules, the US and the EU agreed not to bring trade cases against each other over violations in agricultural trade for a period of ten years. This is known as the "peace clause." The "peace clause" is due to expire in 2003. Because of the "peace clause" and US dissatisfaction with the services agreement, the Uruguay Round ended with a "built-in agenda" for further negotiations. It was specified in the Uruguay Round agreement that the organization would reconvene to address agriculture and services issues.
The "built-in agenda" was the reason for convening the WTO trade Ministerial meeting in Seattle at the end of November. Seattle did not occur because of a ground swell of public support for further trade liberalization around the world. In fact, most developing countries felt that the Uruguay Round had saddled them with tremendous obligations that they were having trouble implementing. The last thing they needed was a new set of obligations to implement. Promised technical assistance to the developing countries had not been forthcoming. They found themselves to have undertaken obligations making them subject to punishment for noncompliance, yet they literally did not have the technical capacity or money to institute required changes. Nevertheless, the "built-in agenda" loomed. The approaching expiration of the "peace clause" and the risk of an EU-US agricultural trade war in the offing meant that new negotiations were urgently needed.
Once underway, new negotiations were not going to be limited to the "built-in agenda," i.e., agriculture and services. Anti-dumping laws, a Canadian innovation enthusiastically adopted by the US and more recently elsewhere around the world, have been a major irritant to many countries, especially the developing countries, which argue that they are too often used to protect domestic producers from legitimate import competition. (Economists point out that the way in which anti-dumping provisions are implemented produces economically irrational results.) The Europeans and the Japanese wanted to explore ways of dealing with this problem through competition policy or, to use US terminology, anti-trust measures. The US did not want to address this issue. Developing countries were unhappy about investment protections, limited though they were, permitted in the Uruguay Round agreement while the rich OECD countries were pushing for further investment protections after failing to reach an agreement among themselves at OECD-sponsored talks a couple of years ago. Regionalism-sorting out how regional trade agreements such as NAFTA are to fit fairly and legally into this global system-needed to be addressed. Finally, there were the new social policy issues, labor standards, human rights and protection of the environment-headline issues in the US but not necessarily elsewhere in the world. And not to be forgotten, there were the normal tariff-cutting deals that are always on the agenda in a trade round.
The Seattle Ministerial was a fiasco. Street protests, police tear gassing, fist fights and inability of foreign delegates to even enter the building where the meetings were held made headline news. Foreign delegates were outraged by the abuse to which they were subjected. Some negotiators from developing countries regarded their bad treatment as an intentional attempt by the US government to physically intimidate foreign delegations-a quite plausible tactic in many of their own countries. Foreign delegates got their backs up. Although little reported by the press, there was a substantive fiasco as well. The fundamental conflict between the EU and the US over agriculture could not be overcome.
Finally, President Clinton arrived telling everyone that he thought it might be a good idea to use trade sanctions to enforce workers' rights in other countries. His comments sabotaged efforts underway to find a compromise. There had been a compromise proposed by the EU, accepted by labor according to sources in the AFL-CIO, and even by developing country delegations, such as the Indian delegation, that have traditionally been very skeptical regarding this issue. President Clinton's comments scared people off.
From an insider's perspective, Seattle marked the debut of the developing countries as highly organized assertive players pursuing their own trade interests. Believing that they had been taken to the cleaners in the Uruguay Round, the developing countries were determined not to let that happen again. Coalitions formed among developing country delegations. It is clear that the developing countries as a block have to be taken seriously in the future. OECD countries will no longer be able to strike a deal and expect the rest of the world to acquiesce to its terms.
The Seattle debacle leaves us with the prospect of an agricultural trade war in 2003 when the "peace clause" expires. Moreover, there is new recognition, based on Seattle, that if the US and, to a secondary extent, the EU want to pursue the linkage of environmental objectives and labor standards to trade, they will have to do something to woo the developing countries. Confidence-building measures or, in economic jargon, down payments will be needed to persuade the developing countries to enter into serious negotiations on these issues. Recognizing this, the EU and, secondarily, Japan have been trying to organize new low-key negotiations with a much narrower agenda. Such mini-negotiations would focus on down payments, to convince the developing countries of our good faith, and on the "built-in agenda," agriculture and services. Hopefully, once underway, such negotiations might also deal with competition policy, investment and the newer labor and environment issues.
While the EU and Japan have been trying to initiate new talks, the US has remained relatively passive for two reasons. First, President Clinton has been unable to win "fast-track" negotiating authority from Congress. Because the US Constitution gives the Congress the prerogative to regulate international commerce, when the President through his Office of the US Trade Representative (USTR) negotiates new trade agreements, Congress could normally amend those agreements. Obviously, other countries would not negotiate with the US knowing that very sensitive compromises worked out at the WTO might be altered by the US Congress. Therefore, to make US negotiations credible, Congress has for the past twenty-five years committed itself for specified periods of time to vote on trade agreements in a simple yes/no manner without any possibility of amendment. This is called "fast-track" negotiating authority. President Clinton's last two attempts to win "fast-track" negotiating authority from Congress have failed. The President is unlikely to win "fast-track" authority during an election year and the next administration will not complete the appointment of new officials and gear up for serious trade negotiations before May or June of 2001. The US is simply not ready to play.
The second reason for US passivity concerning new trade talks is that the President's immediate trade priority is to win permanent "normal trade" status for China. China is the battle in which he will spend his political capital. He will not use his political capital on "fast-track." Nor will he use it to repair the damage inflicted on the WTO in Seattle.
China is not a member of the WTO and does not enjoy permanent "normal trading" status. To become a member of the WTO, China must, of course, apply. To succeed in gaining membership, it must then negotiate bilaterally with the countries that are already members to reach agreements on tariffs, agriculture, services, etc. When negotiations are completed, the WTO Secretariat will compile them into a document called a "protocol" embodying the best possible deal that any WTO member got. This is the origin of the phrase "most-favored nation." For example, if China agreed to a 10% tariff on watches with country A and a 5% tariff on watches with country B, both country A and country B would get the better deal, the 5%. Moreover, so would all of the other member countries. They would get the best deal that any member was able to negotiate. The US has reached a bilateral agreement with China though neither the US nor the Chinese government has released the contents of that agreement. The EU is the last major player that must negotiate with China. Those negotiations are going on now.
China is, of course, a "specified" Communist or non-market economy subject to the Jackson-Vanik Amendment, an artifact of the Cold War, passed in the 1970's to encourage the former Soviet Union to permit the emigration of Jews. Thus, it is among the countries which the President, if Congress so demands, must certify annually to be meeting certain obligations. Until the 1989 Tiananmen Square massacre this was a pro forma process. Since 1989, annual Presidential certification of China to grant it "most-favored nation" status or what is now called "normal trading relation" status has been politically rancorous. Yet, Congress has always certified China and, in the last several years, Congressional margins supporting the Administration have grown larger.
When China accedes to the WTO, the US must grant China permanent "normal trading status." Should the US fail to grant China "normal trading relation" status, we would violate our WTO obligations to another member country and China has made it clear that it would not accept a continuation of the annual renewal of certification—a dubious practice under WTO rules. China insists that its "normal trading" status be made permanent.
The upcoming Congressional vote for or against permanent "normal trading relation" status for China is not a vote to permit China to accede to the WTO. That decision was made by President Clinton when he signed the bilateral agreement with China late last year. The US has already signed off on China's entry into the WTO. China is going into the WTO as soon as it reaches an agreement with the Europeans.
The political priority accorded to the upcoming China vote is demonstrated by President Clinton's avowed commitment to seek Congressional approval of permanent "normal trading" status for China before the WTO protocol is drafted, i.e., before Chinese negotiations with the EU are completed and, therefore, before we know what the final deal will be. There is, of course, no risk in going ahead with an early vote, treating this as a bilateral deal with China, because the worst terms would be those that we have already gotten from the Chinese. If the EU were to win better terms from the Chinese, we would get whatever terms the Europeans had managed to negotiate. Although the Congressional leadership seemed unenthusiastic when, in his State of the Union message, President Clinton proposed such early action, it is possible that the US will vote on permanent "normal trade relations" for China this year.