2.1: Introduction

Chapter2

Global Trade Developments

The Theoretical Aspect

From the first Chapter, it is apparent that the importance of international trade

has increased over the decades. Along with the increase in the international

trade, the world has also experienced an increase in the trade restrictions also.

However, at the same time, the realisation that free trade is the first best policy is

also observed. So, to create a free trading environment, GATT came into

existence, which ultimately got transformed into the World Trading

Organisation (WTO). But liberalisation through the GATT/ WTO seemed to be a

lengthy process. This, as commonly believed has led to the emergence of the

Regional Trading Arrangements - trade liberalisation within a group of

countries.

The structure of the chapter is as follows. Section two (2.2) deals with the theories

of international trade. The third section (2.3) discusses the significant arguments

in favour of trade restrictions. That is followed by discussion on forms of trade

restrictions in the fourth section (2.4). The comparison between a free trading

environment and a restricted one is made in section five (2.5). The sixth section

(2.6) draws an outline of the formation of GATT/WTO. Lastly, section 2.7

discusses, very briefly, the emergence of the Regional Trading Arrangements.

2.2: Theories of International Trade

International trade, in simple terms can be defined as trade among nations.

Hence, the question, which immediately comes to, the mind is-why do nations

engage in trading?

14

To answer the question as to - why do nation trade, different theories have

developed over the years. The question can be put in a different form-what

induces nation to trade among themselves and how do they decide which goods

to export and which good to import.

In this chapter, in the first section, we deal with the theories, which have tried to

answer the above-mentioned question.

At this point, let us digress for a while and discuss some aspects of economics at

the micro level. Looking from the standpoint of producer, the objective is profit

maximisation. A producer will choose his production level, given the market

price and his cost structure, so as to maximise his profit level. If he has the option

of choosing among markets, he will go and choose that market which fetches

higher price for his commodity.

The level of production of any kind in the economy is decided by the production

levels of the individual producers of that commodity. So, at the back of the total

economy also, lies the individual economic agent. So, given an opportunity, they

will not hesitate to sell their products in another country, if they get a better

price. Then what restricts them from doing so? The restriction arises because

selling product across national boundaries requires the backing of the policy ·

regime of the relevant countries.

That is, it is the country as a whole that takes the decision whether to allow

movement of goods and services into and out of the country or restrict then. So,

we can call a pre-trade or no-trade situation as a period of total restriction to

trade.

The theories of international trade as mentioned before deal with the situation of

a country opening up its economy, that is, the transformation of the economy

from a restricted to a completely open one. So, they discuss first the rationale for

15

a country to and thus the benefits from completely opening up and allowing

absolutely free movement of goods and services into and out of its economy.

They compare this situation, that is, post-trade situation with the pre-trade one -

a situation of absolute restriction.

Trade theories at different point of time have attempted to explain the rationale

behind the trade pattern experienced. This Section presents with these trade

theories as developed over the decades.

Tracing back the history, the mercantilist view of trade can be claimed to be the

firsttheory having made some observations regarding international trade.

According to that theory, the country should export goods as much as possible as

that would fetch gold for the country. However, the theory was against import of

goods into the country as that implies drainage of wealth out of the country.

The first properly formulated theory attempting to answer the mentioned

question is the Theory of Absolute Advantage. In 1776, Adam Smith noted that,

if a country could produce a good cheaper than other countries, it had an

absolute advantage in the production of that good. So to maximise national

income and welfare, countries should produce and export surpluses of what they

have absolute advantage in, and buy whatever else they need from the rest of the

world. Thus, specialisation, and hence efficiency, would be encouraged as a

result of the increased competition and scale economies. However, the question,

which comes at this point, is that "What if a country had absolute advantage in

all products, or even worse, in no products at all?" According to the theory, the

former country need not trade, while the latter could not trade.

Forty years later, David Ricardo unambiguously answered the question, which

has become one of the most important ideas in international economics.

According to him, for two countries to get engaged in trade among themselves,

the absolute advantage is not necessary. Trade is possible between them, as long

16

as each has a comparative advantage in the production of one good versus

another. In other words, incentives for trade would exist even when one country

has absolute cost advantage in everything or another country has the absolute

cost advantage in nothing. The key~ he noted, was that a country should have

the ability to produce one good, relative to another good, that is different from

another country's relative ability to produce the same two goods.

The Ricardian theory of comparative advantage relies on some important

assumptions. Some of the more significant ones are

1. Production technologies in both countries exhibit constant returns to

scale;

2. Factors of production can be easily and costlessly moved from one

sector to the other as the country specialises through trade, and there is

a fixed supply of the fact01:s of production;

3. The underlying market structure driving production is based on perfect

competition; and

4. There is no technological innovation, and there are no technological

spill-overs. Moreover, the basis for one country's comparative

advantage over another (that is, what causes the differences in

production efficiencies) is left undeveloped in this model.

Clearly, some of these assumptions-in particular, assumptions (3) and (4)-are

strong. Despite these strong assumptions, however, few theories in the course of

the history of economic thought C• .uld gain the same importance as that of the

principle of comparative advantage - notably in the way it has influenced

academics, policymakers, and the international laws and institutions that govern

the structure and conduct of international trade. Moreover, the simplicity and

elegance of the underlying insight have outlived the numerous criticisms that

have been labelled against it.

17

~-· ..

According to Ricardo, free movement of goods would lead to complete

specialisation in production of the item in which the particular country enjoys

comparative advantage. This would ultimately lead to increased global

production along with increased welfare level for the respective countries.

So, we find that free movement of goods between the countries resulted in the

increase in welfare for both the countries free trade increases the welfare.

Drawing upon the work of Eli Heckscher, Bertil Ohlin took the Ricardian model

a significant step further, by linking the source of a country's comparative

advantage to the endowment of its factors of production. This theory, known as

the Heckscher-Ohlin model of international trade (or simply, the H-0 model) is

probably the most widely accepted form of the comparative advantage theory

today.

The H-0 model focused on two assumptions:

1. Goods differ in how much they use of certain types of factor of

production-that is, different goods have different factor intensities; for

instance, the manufacture of textiles is labour intensive, while the

manufacture of semiconductors is capital intensive.

2. Countries differ with respect to their factor endowments; for instance,

one might reasonably argue that India has an abundant supply of

labour relative to capital, while the reverse is true of the US.

Further, according to H-0 theory (as in Richardo) the assumption is that markets

are perfectly competitive and factors are perfectly mobile. However, the

assumption of constant returns to scale is relaxed here in order to allow for

decreasing returns to scale. Putting these assumptions together, the main

proposition of the H-0 model is the following: A country exports those goods

that use intensively its relatively abundant factor of production. That is,

18

countries export those goods thafthey are best suited to produce, given their

factor endowments.

Using the examples above, H-0 would argue that a country such as India would

export labour-intensive goods (and import capital-intensive goods), while a

country such as the US would export capital-intensive goods (and import labour­

intensive goods).

As with Richardo' s theory of comparative advantage, there are some potential

weaknesses underlying this theory:

1. Endowments are supposed to be given, when they can often be created

(for example, through innovation), in other words, H-0 assumes a

static supply of factor endowments.

2. If some countries kept to their static endowment-determined

advantages, they might be stuck with a second-rate economy in the

long run.

In an empirical insight that later came to be known as the "Leontief Paradox,"

economist Wassily Leontief found that, contrary to predictions suggested by the

H-0 model, US exports were less capital intensive than US imports. However,

the central insight of H-0 regarding the link between factor endowments and

factor intensity remains widely accepted.

So, we find that participation in trade increases welfare of the country. At this

point, it needs to be mentioned that all the countries were referring to the pre­

trade and post-trade situations and post trade situation is a situation of

absolutely fee trade. But, in real world we find that countries definitely engaged

in trade among themselves, but that is not absolutely free movement of goods

and services into and out of the country. They practised, what is known as

restricted trade. The question which arises is that if free trade increases welfare,

i.e. the participating countries gain from practising free trade, why do countries

19

go for a restricted trade environment. There are various reasons for this. The

reasons can be broadly categorised into three main categories:

1. Static Arguments (Reasons) for Protection

2. Dynamic Arguments (Reasons) for Protection

3. Strategic Arguments (Reasons) for Protection

The significant and dominating arguments for protection under each of the

category are discussed in section 2.3.

2.3: Arguments for Protection

We have seen that the traditional theories of trade are propounders of free trade.

But an interesting point is that the incentives of protection lies in these theories

itself. The incentives are found in the two most significant and extensively

discussed theories of International trade - the Richardian and the Hechsher­

Ohlin Theories. The theories hav~. some powerful implications. The first major

implication of free trade is factor price equalisation. International trade tends to

equalise factor prices across the trading countries. The reason is simple. The

more trade that occurs in a particular good from a country, the greater the

demand for the factors used intensively in the production of that good and the

less the demand for other factor. As a result, the price of one of the factors will

be driven up and the other driven down. The exact opposite will happen in the

other country. As a consequence, factor prices will be driven toward

equalisation in the two countries. For example, in the country that exports

labour-intensive goods, the relative wages of labour will rise. Similarly,

international trade will tend to drive the costs of capital closer together in the

countries that trade.

The second major implication has come to be known as the Rybczynski Theorem.

An increase in the endowment of one of the factors will reduce the production of

goods that intensively use the other factor. For example, of the US is capital rich,

and innovation increases the productivity of capital, then labour-intensive

20

l

~

industries in the US will get hurt. Again, the reason is simple. With an increase

in its capital endowment, the US can now produce and export more capital­

intensive goods of the economy (and, by definition, the capital-intensive sector

use relatively less labour). Indeed, in developing countries that specialise in

labour-intensive goods, the reverse implication is even more surprising. An

increase in the productivity of labour-for example, through better education and

training or better provision of health care-will hurt capital-intensive sectors in

those economies.

If these two implications are true, then we are likely to observe demand for

protection from the effects of free trade from precisely those sectors in the

economy that are hurt. Thus, demands for protection are likely to come from

segments that represent labour in capital-intensive economies, and segments that

represent capital in labour-intensive economies. This may explain why, in

countries such as the US, labour unions often strongly oppose agreement such as

NAFTA. It may also explain why developing countries tend to be the ones that

usually have stricter controls on c;ross-border capital flows. But this suggests

another important corollary to the factor price equalisation and Rybczynski

theorems: Demands for protection are most likely to arise from the less efficient

sectors in an economy.

This takes us to another implication of comparative-advantage theories, an

implication that has come to be known as the Stolper-Samuelson Theorem: Any

protection-for example, a tariff-will increase the income of factors of production

used intensively in the good that receives protection; in the process, the relative

income of the factor of production used in the other good will fall. For example,

in countries such as the US, there will be cries for-and hence the incentive for­

protection from labour-intensive sectors; such policies will prop up incomes in

those sectors, but in the process they will hurt the capital-intensive sectors and

hence capital. The reverse will be true in labour-intensive economies such as the

THESIS 382.9

M8968 Mu

lllllllllllllllllllllllllllllll TH10403

21

developing countries: Efforts at protecting capital (for example, capital controls)

would actually end up hurting labour in those economies.

There are three main insights to take away from this discussion. In the first

place, the incentives (and some might argue, the logic) for protection are inherent

in arguments for free trade. Secondly, demands for protection will usually arist:

from the less efficient sectors in an economy. Lastly, protection will usually end

up hurting the more efficient sector in an economy.

These implications, lead to equally powerful incentives, and in some cases,

commonly used arguments to justifv demand for protection, that is a restricted

trading environment

So, now we discuss some of the most commonly used arguments in favour of a

protected trading regime, grouped under three categories -

1. The Static Arguments for Protection

2. The Dynamic Arguments for Protection

3. The Strategic Arguments for Protection

2.3.1: Static Arguments for Protection

i. Domestic distortions

The traditional theory propoundi1·c; free trade is based on the assumption that

both domestic and international market for goods as well as factor markets are

perfectly competitive. But this does not fit to the real world situation. This is the

basis of this domestic distortion argument for trade protection. It deals with the

case that domestic economy does not operate under conditions of perfect

competition. · Instead the economy is subject to a number of market failures

which can be grouped as imperfections in goods markets, and imperfections in

factor markets. According to this argument, when such distortions exist, that is,

when market does not allocate resources in a Pareto efficient way, the

22

government should use trade restrictions to offset the impact of already existing

distortions.

It is well known that Pareto efficient allocation involves three aspects of

allocative efficiency. One refers to efficiency in the use of inputs and is usually

represented by the marginal rate of transformation in production (MRT). The

second is related to efficiency in consumption and is represented by the marginal

rate of substitution in consumption (MRS). The third is related to social

efficiency, implying that marginal social cost equals marginal social benefit for

each input or consumption good. In the open economy there is another aspect of

allocative efficiency, referring to the marginal rate of transformation through

trade (or the foreign marginal rate of transformation) which is given by the

world relative prices (p*). Thus fc!" efficiency we must have domestic relative

prices (p) which will ensure that:

P=MRTs=MRSs =p*

Where the subscripts refers to the social marginal rates.

Whenever prices are not what is needed for efficiency, we can talk about marke;­

failure or domestic distortions. Some sort of intervention is possible to correct the

market, to bring about a new equilibrium with improved efficiency.

Two representative cases of such market failure are discussed below.

a) Distortions in the Domestic goods market

Domestic goods market distortio~~ imply all those situations when domestic

relative commodity prices do not reflect the marginal rate of transformation.

This could be assigned to the external (dis) economies which are reflected in the

inequality of social and private marginal costs. Let us consider a case where

Home country has two sectors, an exportable sector of food products, F anc.~

importable sector of cloth, C. Let there exist an externality in the food sector thus

giving rise to market failure. This externality in production is not reflected in its

23

l private cost of production. In other words, given the externality, the private cost

of producing food is lower than the social cost, and the domestic relative prices

do not reflect the true (social) marginal rate of transformation in production.

Given distorted domestic prices, Home reveals comparative advantage in good

F. More specifically,

MRTs < p* < pp

Where the p* is the free trade price and

P p reflects private marginal costs.

Under free trade Home would increase its output of food, export some of it and

finally reach a point on the indiffere?ce curve that is lower than under autarky.

In such a case free trade may cause a decline in welfare compared to autarky.

The externality which caused domestic prices to depart from the social marginal

rate of transformation induces Home to specialise in the 'wrong direction', that is

in the good in which it does not have comparative advantage. The true

comparative advantage might have indicated a need for specialisation in good C.

The market failure argument for trade barriers suggests that an introduction of a

tariff on imports of good C could stimulate production of that good and result in

an increase in Home's welfare (compared to free trade with domestic distortion).

A tariff will indeed cause production gain and an increase in output of C but at

the cost of consumers who will suffer consumption loss. In addition such a tariff,

even if prohibitive, will never transform good C in an exported product, as long

as the externality exists. Thus the more appropriate intervention (first best

policy) would be to tax production ofF and/ or subsidise production of C so that

the domestic relative price is brought closer to the world relative price. When

these are equalised Home can engage in welfare-improving free trade.

b) Distortions in factor markets

24

Distortions in factor markets may be of different forms, such as differentials in

wages among industries (which are not caused by differences in skills) and

unemployment on the labour market side, or rationing in capital markets. Each

of these has been seen as a possible justification for some form of protection to

domestic production. Whatever the actual cause of distortion, the effects are first

to push the PPF inwards, and second to distort relative costs so that even. along

this inner frontier the private and social marginal costs differ. Suppose that the

wage in (manufacturing) sector Cis different from the wage in (primary) sector

F, but both are equal to the value of the respective marginal productivities. As a

consequence, Home's production point will not be along its true PPF. Instead it

will lie at some point on the inner PPF. Given the world relative price p*, and

assuming that the present distortion has no effect on the relative commodity

prices, Home will produce at point P on the inward PPF.

Consequently it will consume at a lower indifference curve than is potentially

achievable in the no-distortions world. Obviously, intervention here is needed to

put the economy back to its true frontier. Would a trade barrier do this? Not

really. The first best policy is to use a combination of tax and subsidies on the

use of factors of production so as to equalise the wage rate.

If this distortion were coupled with the goods' market failure, the level of welfare

could be even lower. Then a return to the optimum for Home would require first

a correction of the wrong specialisation along the inner frontier (this is the case of

goods' markets failure) and then the correction of the wage differentials.

ii. The Optimum Tariff

Tariff imposition leads to an increase in the domestic price of the imported good,

which in turn results in the decrease in consumption and thus demand. For a

large country, the decreases in demand leads to a significant decrease in the

world demand of the particular good, thus affecting the international price. So,

25

by imposing tariff, the large country can draw the terms of trade in its favour. So,

for a large country it is always possible to find a tariff such that this country's

welfare is higher than under free trade. This tariff is known as the optimum

tariff. So, for a large country free trade is not the first best policy. If it can impose

tariff at the optimum level , a protected trading regime increases the welfare.

However, the possibility of retaliation always exists. This is probably the reason

why we rarely witness the imposition of tariffs solely for the reason of

improving a country's terms of trade. However the theoretical possibility of

optimum tariffs makes large countries in the world more prone to accept trade

liberalisation through multilateral tariff cuts than on a unilateral basis in which

case, as the theory says, they lose.

iii. Revenue Generation

When a county imposes tariff, it receives revenue. This is one of the rare 'non­

protectionist' arguments for the introduction of tariffs. Both import and export

tariffs (taxes) generate revenue to the Government and this is cited as the reason

for their introduction. It does not mean, however, that revenue generation will

be the only effect because tariffs can cause protective and other distortionary side

effects. But for some governments, in particular in developing countries, the

need to raise revenue may outweigh the negative effects. Tariffs are not the

optimal instrument for raising revenue. A better policy would be a general

income tax or value added tax. Dixit (1985) shows that the same revenue could

be collected with a lower efficiency loss by introducing a combination of

domestic taxes levied neutrally with respect to domestic and foreign products.

The efficiency loss is generated because of the impact tariffs have on domestic

relative prices and because of the resulting inward-oriented bias.

Moreover, when tariffs are already in place and when revenue generation would

imply an increase in tariff rates the total amount of revenue may not increase by

much. That will of course depend on the price elasticity's of demand and supply.

26

If the import base declines sharply on the increase in the tariff rate, revenue may

be only slightly higher with a higher tariff rate as compared to the initial rate.

There is a specific rate of tariff which assures that tariff revenue will be

maximised. This rate is called the maximum revenue rate of tariff and in general

this rate is higher than the optimum tariff rate, which maximises a country's

welfare.

The revenue-generating tariff, despite all its weaknesses, remains very popular

as a means of raising revenue in many countries; in developing countries it is

probably the most favoured instrument. There are at least two reasons for this.

One, and the more important, is that tariffs are easier and less expensive to

collect than domestic taxes on consumption and income. Some studies show that

administrative cost of levying tariffs, including taxes on exports, is no higher

than 3 per cent of revenue collected while the corresponding costs for value

added tax and income tax are estimated at 5 and 10 per cent, respectively (World

Bank, 1988). This is particularly important for the countries with

underdeveloped tax systems (such as transition and developing economies).

They may have no other successful means for raising revenue but trade taxes.

But it should be emphasised that even in these countries the total economic and

social cost caused by trade taxes are certainly much higher than the pure

administrative cost and they should be encouraged to switch to domestic

taxation as soon as possible. While they may be forced to maintain trade taxes

for revenue-generating purposes they are strongly advised to use the lowest

possible rate uniform for all sectors so to minimise the bias in the trade regime.

The other reason why some governments may wish to use tariffs to raise revenue

is when they think foreigners will pay such tariffs. This is of course again the

large country case where it has the market power to change its terms of trade.

Even if temporarily successful, this revenue-generating instrument would not be

27

popular with trading partner countries whose income has been used to increase

welfare of the large country.

iv. Other Arguments

Some of the other significant arguments given to justify a restricted trading

regime which fall sunder the category of static arguments are discussed below

briefly.

a) The balance of payments argument

Trade restrictions in the form of import tariff or QRs are often used to rectify

external imbalances (i.e. current a/ c imbalances), specially under fixed exchange

rate regime when governments are not very keen on changing the value of

domestic currency. Import barriers were particularly popular in cases where

governments felt that imbalances were only transitory so that other adjustment

policies were deemed unwarranted. However it was not uncommon for

governments to use import barriers (and export promotion) simply to postpone

necessary adjustment policies, therefore causing even more distortions in already

unbalanced economic conditions. The important negative consequence of using

import restrictions instead of devaluation is an increase in costs for export

producers and the reallocation of resources from export to import substituting

industries (in the longer run). The gains from international trade, and also

national welfare, will be reduced.

With the switch to a flexible (floating) exchange rate regime, the effectiveness of

import barriers to remedy external balances has been further reduced. Under the

flexible exchange rate regime, the reduced imports caused by import barriers will

prompt a currency appreciation offsetting the effect of import restriction (with

domestic currency having higher purchasing power, imports will start rising

despite tariffs; only in case of quotas will imports be controlled but then

revaluation will have effects on the level of domestic prices).

28

However, trade barriers imposed for balance of payments purposes do not really

work. Thus a country facing an external balance problem should seek a more

direct instrument to cure the problem. Usually, fiscal instruments combined

with monetary policy will work better. In more difficult cases, restructuring

policies will be needed to address the root of the problem.

b) The income-redistribution argument

According to Edward Leamer (1993, p. 436): 'Every trade barrier that I have ever

seen is a device to transfer income from one group to another, or perhaps more

frequently to stop the transfer of income that would otherwise take place.' Thus

redistribution of income seems to be an subliminal message in all trade

instruments irrespective of the declared primary objective assigned to the trade

restriction.

The most obvious redistribution taking place with trade barrier is between

consumers and producers, with the former being on the losing end. Given this, it

is hard to accept the usual assumption that the government assigns equal value

to all subjects in the country when it designs economic policy. On the contrary, it

seems that some or all of the trade restrictions are implemented with the ultimate

goal of either redistributing income to the social groups which are 'valued' more

by the government or to prevent a redistribution of income that would harm

such groups.

Irrespective of what might be the underlying motivation of the government, by

applying the specificity rule we know that trade restrictions are not the most

efficient instruments to do the job. An income tax (which could be designed to

be flat or progressive) is a much better means of redistributing income without

causing misallocation of resources. Also it is much easier to control whether

redistribution is going into the right direction and not being appropriated by

interested groups. In addition, as we know from the application of the specific-

29

factor model, trade protection does not treat factors of production equally in the

short and in the long run. While in the short run factors employed in the

protected activity will indeed benefit, in the long run these benefits will accrue

only to the scarce factor.

c) The employment and protection of domestic labour argument

Preservation of employment (or reduction of unemployment) together with the

need to protect domestic labour from unfair competition from abroad are

probably the two most abused of all the arguments for trade restrictions. The

level of employment is an macroeconomic issue, depending in the short run on

aggregate demand and in the long run on the natural rate of unemployment.

Microeconomic policies like tariffs have little net effect on employment. Trade

policy should be thus debated in terms of its impact on efficiency, not in terms of

numbers of jobs created or lost in a particular sector.

When deciding whether or not to impose a trade restriction, the government

should always consider what general equilibrium effects may be caused by

protection granted to one sector. Thus when we impose trade restrictions to

imports on, say product A, we will create some additional domestic production

and employment in industry A and up-stream industries. But what happens

with industry B which produces an export good, not related to good A (or not

upstream to industry A)? The level of activity and employment in that industry

. will fall. Resources are being attracted to protected sectors which cause a slump

in the rest of the economy. Thus what we in fact are doing with trade barriers is

redistributing employment within the home economy and exporting some

unemployment to trading partners.

A related issue is whether international trade contributes to the demand shift

from less-skilled to more-skilled labour. This view is supported only by

anecdotal evidence. A more comprehensive analysis finds that neither

30

international trade through the Stolper-Samuelson process nor outsourcing by

multinationals are causing a shift in relative labour demand away from the

unskilled and toward the skilled and thus causing the wage divergence.

2.3.2: Dynamic Arguments for Protection

Dynamic Arguments for Protection implies those arguments which are sensitive

to time. One of the most significant argument in this category and also a most

discussed argument is the infant industry argument.

1. The infant industry argument

The infant industry argument has been the most used argument for protection in

practice, at least until the occurrence of strategic policy arguments. Moreover,

according to Baldwin (1969), the infant industry argument has long been

regarded as the major theoretically valid exception to the case for free trade. The

reason for protection arises from the belief that some industries require

temporary protection in order to develop into internationally competitive

industries. Once these industries are able to face the foreign firms, the protection

can and should cease.

2.3.3: Strategic Arguments for Trade Protection

Lastly we discuss the strategic argument of trade protection.

1. Import protection as export promotion

This case has been developed by Krugman (1984) who exploits the 'learning-by­

doing' phenomenon to justify protection of activities which are likely to become

internationally competitive only if granted some support. The special twist to

Krugman's case was that a protected activity becomes so competitive that it turns

out as an exporter-something completely unthinkable before. In the world of

perfect competition and constant-returns-to-scale, import tariffs can never turn

the goods from being import substitutes to being exportable goods? Hence

31

Krugman's 'import protection as export promotion' proved to be something very

novel and very 'catchy' among the advocates of an active trade policy. They

welcomed the Krugman's model as a 'watertight proof' for the benefits in export

sectors of a protected domestic market, which supposedly the exporters of the

Asian Tigers have enjoyed while their economies were transforming from

import-substitution-oriented to export-oriented economies ..

Consider two firms, one coming from each Home and Foreign economy.

Suppose these firms compete in any number of markets including their own.

The markets are fully segmented so that the possibility for arbitrage is excluded,

and in each market, Home and Foreign, a Cournot duopoly equilibrium

develops. Suppose each firms produces with decreasing costs reflecting

declining marginal costs as output rises. Starting from an initial equilibrium

situation, if the Home government imposes an import tariff, the consumption,

production scenario will change as follows. The import tariff increases the

delivering cost in the Home market for the Foreign firm, thus decreasing the

demand and ultimately production. The tariff on the other hand would lead to

an increase in the Home firm's output; its marginal cost decreases as a result.

Similarly the Foreign firm's marginal costs rises because its output falls.

The Home firm's production thus increases and that of the Foreign firm's

decreases. These shifts in turn increase the Home firm's sales and decrease the

Foreign firm's sales in the home market. These changes in the volume of sales

have repercussions on marginal costs. The Home firm's marginal costs keep

declining while the opposite is happening to the Foreign firm. This gradually

leads to a situation where there is an increased competitiveness for the home

produced product; the opposite holds for the foreign firm. Hence, ultimately a

situation is reached where by sheer shift in production the home firm acquire

competitiveness over the foreign firm in the foreign market also. At the new

equilibrium the Home firm has not only reinforced its advantage in the domestic

32

market but it also gained in the export market. This is where import protection

serves as an instrument of export promotion. The specific type of industries, which

were probably behind the development of this hypothesis are the industries

subject to fast 'learning-by-doing'. In such industries any support (including

tariffs) which enables them to cumulate large increases in output will enable

them to go far down the 'learning-by-dong' curve. This in turn could help them

to establish a dominant position in the domestic and, as we see here, in the

export markets.

The welfare effects for the Home country are ambiguous. The protected sector

has managed to become 'competitive' and to earn higher profits. The expansion

of the protected sector however occurred at the expense of other sectors,

including previously already competitive export industries. Resources are being

drawn to the sheltered sector from other sectors, causing them to contract: thus

the existent exports were probably hurt. In addition domestic consumers are

being charged higher prices since the monopoly power of the domestic firms has

increased. The welfare effects for the world economy are quite clear; an

increased concentration of production could only mean a reduction of welfare.

ii. Export subsidies under imperfect competition

A nation who engages in subsidising the exports shoots itself in the foot. How

does this conclusion change when competition becomes imperfect? The answer

was first outlines by Brander and Spencer (1985) and then extended and added to

by many advocates and critics of the strategic trade policy .

.. Brander and Spencer (1985) show that under the right circumstances, a pre-

announced export subsidy can raise the profits of domestic firms. This happens

because foreign firms decide to produce less. Since the profits of domestic firms

are raised by more than the amount of the subsidy, the national income is

33

increased. Although it is increased at the expense of the trading partners, the

world benefits because this policy reduces the overall monopoly power.

From the above discussion, it becomes clear that the incentives for protection

exist in the theory propounding free trade. As a consequence, the world has

experienced, for quite a long period, a protectionist regime for international

trade. As such there has been gradual developments of different forms of

protection which are discussed briefly in the following section.

2.4: Forms of Trade Restriction (Barriers)

This section deals with the common forms of protection used to restrict the free

movement of goods. The forms or measures used can be broadly divided into

two categories-

• Tariff Barriers to Trade

• Non-Tariff Barriers Trade

2.4.1: Tariff Barriers to Trade

Tariffs can be described as taxes levied on imported goods. So it is a sort of price

measure which restricts the entry of imported goods into the market by

increasing their price in the domestic market. It in fact works in an indirect way

of restricting the goods into the domestic market. The imposition of the tariff

increases the price of the imported good in the domestic market. This increased

price can become equivalent to the price of the domestically produced item,

thereby guaranteeing that the same does not become uncompetitive relative to

the imported item; it might become relatively more competitive also.

Tariff has been traditionally the main form of trade protection. This can be

levied as an ad valorem percentage of the value of imports or as a specific duty,

(e.g. as so many pounds per tonne) or as a mix of both.

34

The impact of the tariff is as described. The imposition, usually by increasing the

price of the imported item in the domestic market induces domestic consumers

to consume more of the domestically produced item and less of the imported

one. This in turn leads to an increase in the domestic production of the item and

a decrease in the imports. The producers gain in terms of increased production,

but the consumers land up paying more and thus the welfare decreases. The

government earns the revenue from the tariff collection. However, the more

efficient producer is replaced by a lesser efficient one thereby decreasing the

overall welfare. The so-called "deadweight" loss cannot be avoided. However,

this logic holds good in case of a small country and a perfectly competitive

market structure. As pointed out by Krugman because trade does not occur in

perfect markets, but in markets where imperfections and possible increasing

returns to scale exist, it is possible for governments to intervene in free trade via

a tariff to increase the welfare of that country. This tariff, known as the optimal

tariff, is one which raises a country's welfare by more than the losses caused by

protectionism. The ability of a country to impose an optimal tariff may arise

where a country is an important participant in the world market. In that case the

increase in the domestic price of the imported good with the imposition of the

price will decrease the domestic demand and also the international demand for

the good. This will lead to a decrease in the international price of the imported

item. On the other hand, as the domestic consumption of the domestically

produced good increases, the export surplus decreases, thereby affecting the

world supply and thus pushing up the price. So, the Terms of Trade moves in

favour of the Tariff imposing country. However, the infant industry argument

may not hold in this case as protection is not guaranteed.

It is unlikely that if one country imposes an optimal tariff others will sit idly by.

If country A's welfare has been increased, it must be at the expense of, say,

country B, which then imposes a retaliatory tariff. Thus is the beginning of a

35

tariff war and everyone is worse off. It has also been argued by Bhagwati (1987)

that governments do not possess the information to intervene correctly in the

market. They are unable to know for certain the position of the market without

intervention and if this information is not known with certainty, intervening may

make the country worse off. Even if the government thinks it knows everything

about the market. Krugman (1996) argues that there is a big difference between

knowing lots of facts and really knowing how a market works. Furthermore,

even if you can understand the market for one particular item, it is possible that

very little of that knowledge generalises to the market for another item, which is

in turn very different from a third one.

Moreover, trading relations are not just between two countries, as the models of

'new international trade' describe, and therefore the outcome once again is

uncertain. It is the danger and uncertainties of this intervention in either the

perfectly competitive or the imperfectly competitive market that led to the

establishment of GATT, whose major role has been to reduce the overall level of

tariffs between countries.

2.4.2: Non-Tariff Barriers to Trade

Non-Tariff measures are non-price measures to restrict imports and they take

various forms. Some of the commonly used non-tariff are quotas, Voluntary

Exports Restraints, Antidumping and Countervailing Duties, bans or restrictions

pertaining to and environmental clauses, etc. Non-tariff barriers are to some

extent difficult to quantify. One important question that can be raised before

going to a detailed discussion regarding some of the significant non-tariff

barriers is that why were they introduced in the first place? Is it only different

form of restricting trade? It is not so. The answer to this question has two steps.

The first step comes with the emergence of quota. We have already discussed

that tariff is a price measure of restricting imports and hence an indirect one. As

36

a result protection is not guaranteed through the imposition of tariff. So, quota

was introduced as a more direct measure for protection.

The next step comes with the emergence of the other NTMs. In this context the

mention of GATT becomes necessary. The reasons behind its formation have

already been discussed in the previous chapter. It has also been pointed out in

the previous chapter that tariff being the oldest and the most common form of

trade restricting measure became the primary target of GATT. The developed

world in the seventies, feeling the threat had to come up with some new forms of

NTMs to restrict the entry of goods into their domestic economy as tariff under

GATT proved to be inadequate to do the same.

In this section we discuss the most commonly used NTMs which have come up

over the years to restrict international trade.

i. Quotas

The most common form of non-tariff barrier is the quota, or a quantitative

restriction on the volume of imports. The motives for quantitative restrictions,

such as quotas, are similar to those used for the imposition of tariffs, that is, to be

protective of trade and for fiscal motives. They are protective in the sense that

quotas restrict the quantity of imports, and give fiscal gains through the raising

of revenue - the licences to import can be auctioned off in a competitive market.

Quotas, by fixing the quantity of imports into the domestic market ensures that

the remaining market is left to be catered by the domestic suppliers.

Examples of quotas in practice are the US and EEC quota arrangements with

Japan regarding cars, phased out during 1998, and the MFA with many Asian

nations covering textiles and fibres. MFA was in fact imposed by industrialised

countries against textile imports from developing countries. (This quota was

allowed by GATT for over forty years, until the recent round of negotiations).

37

Apart from quotas that exist at an EU level, countries within the EU have also

been able to negotiate their own quota arrangements. These nationally imposed

quotas were phased out entirely on 1 January 1993.

Although quotas are outlawed under the GATT, certain exceptions are allowed:

for example, with agricultural products, and in cases where governments need to

impose temporary protection to aid locally distressed industries, or when a

country has a balance of payments problem. Quotas can, therefore, be used by

one country in a discriminatory way to prevent imports from specific countries.

Whereas global quotas are relatively uncommon, country to country quotas are

more common. In addition, countries have found ways of imposing quotas

indirectly on others by obtaining agreements from exporting countries to

1voluntarily1 limit exports.

ii. Voluntary Export Restraint

A second type of quantitative restriction is the voluntary export restraint (VER)

or orderly marketing agreement (OMA). Through this the exporting country is

gently warned that it is better that it 11Voluntarily" restrains its exports to the

importing country. That is, the firm or country agrees with the importing

country to restrict the volume of its exports to a specified amount, over a given

period of time.

The main difference between a VER and a quota works like this. VERs are

administered by the exporting country and if, after the imposition of the VER,

there is a rise in the domestic price then foreign suppliers will also raise their

price. In other words, foreign producers gain an economic rent - a net transfer

from domestic consumers to overseas producers. On the contrary, if the

domestic price increases after the imposition of the quota, the importers bag that

price and not the exporters. Of course, offsetting the impact of this loss to the

domestic consumer is the impact of increased employment and output in the

38

domestic economy; although whether this is the most efficient way achieving

these gains, if there are any, is a moot point.

During the 1970s and 1980s, the VER was a common form of protection used

against Japan in products ranging from steel, to machine tools to automobiles, to

semiconductors, among others. Other examples of UK VERs have been on

footwear from Taiwan, Korea and Poland, and cutlery from Korea and Japan. To

be more specific, the EU has negotiated such VERs for steel, electronics,

automobiles, textiles and especially agricultural products. From the UK's point

of view, the VER arranged with Japan over car imports during the early 1980s

appears to have made little difference to overall car imports, as Japanese cars

were merely replaced by imports from the EU, which were not restricted. As an

illustration of the level and impact of the VERon Japanese cars into the EU, in

1994,990 000 units were imported. This was equivalent to approximately 8.1 per

cent of the total car sales within the EU. Although this suggests some success in

keeping Japanese cars outside of the EU, the response by the Japanese has been

to establish car plants within the EU, chiefly in the UK, and there have been calls

from other member states of the EU to have these also set against the VER

negotiated with Japan. The argument has abated somewhat following local

content rules applied to Japanese cars and the phasing out of the VER on -

Japanese cars by the late 1990s. Many other countries have volunteered to be

involved in this type of restriction to trade, including many poorer countries

such as Brazil, Mexico and Poland. Members of the EU have also joined this

'club' by agreeing to restrict exports of steel to the USA.

Many countries have been involved with the imposition of VERs, as Table 2.1

shows.

However, at present VERs are banned under the multilateral trading system.

iii. Antidumping

39

The 1970s and 1980s also saw the increasing application of another form on non­

tariff barrier, antidumping restrictions, particularly by the US and the European

Union (and usually against Japan and other exporting countries in the Far East).

This form of protection seeks to prevent exporters from "dumping" their

products, that is, selling their products at "less than fair value" in the importing

country. The net result is for the exporters' prices to be increased in the

importing country.

Dumping is described as selling for less abroad than in a domestic market.

Multilateral trade rules include some alternative definitions for cases where

domestic market prices do not exist. Price differentials between domestic and

foreign markets do not necessarily imply dumping as price discrimination is a

profit-maximising strategy implemented by firms operating in segmented

markets. Notwithstanding that, the legal definition of dumping is quite elastic

and as Finger (1992, p.122) stated, its operational definition is that 'dumping is

whatever you can get the government to act against under the antidumping law'.

Under the multilateral trade rules, anti-dumping duties can be used in case

dumping is causing, or threatening to cause, material injury to an import­

competing industry. The cases of harmful dumping include predatory dumping

and intermittent or sporadic dumping. Predatory dumping occurs when foreign

suppliers set the prices below cost with the objective of driving domestic

producers out of business. Once domestic firms are out of business, prices are set

at monopoly levels. In practice this type of dumping almost never occurs

because the preconditions for predatory dumping to be successful are hard to

meet: the foreign producer must have a stable monopolistic position in the world

market and domestic firms must face substantial re-entry barriers.

Intermittent or sporadic dumping is the disposal of occasional surpluses by

exporting them at exceptionally low prices (but not necessarily below cost). The

40

firm that decides to sell at such low prices in foreign markets has no plans to

eliminate competition; its production is probably affected by seasonal or other

cycles and the firm tries to cover as much of its predetermined costs as possible.

Depending on how flexible domestic producers are (and the domestic factor

markets as well), some injury might result from sporadic dumping. The question

remains, however, about the best policy reaction to it.

There is a third type of dumping which should not cause any concern. It is called

persistent dumping and it occurs when a producer practices price discrimination

between his own and foreign markets with an objective of maximising profits.

Thus the type of dumping continues on a long-term basis and does not (under

ceteris paribus conditions) involve raising prices by a foreign supplier at some

later stage. This type of profit-maximising pricing strategy requires at least three

conditions to be met: (1) markets must be separated without the possibility for

arbitrate, (2) price elasticity of demand in these markets must be different so that

demand is considerably less elastic in domestic vis-a-vis foreign markets, and (3)

industry must be imperfectly competitive so that firms can set the prices.

The consequence of 'dumping' by a monopolistic producer from Home is that

consumers in Foreign can obtain this good at a lower price than Home's own

consumers (note that consumers in Home have to pay higher price for this

product when the firm is engaged in exportation and thus in price discrimination

than when there is not trade). What cannot be directly shown is the potential or

real loss of domestic producers in Foreign; their marginal costs might be higher

than the costs of the export suppliers' from Home so that, under free trade,

domestic production shrinks and the domestic producer might claim an injury.

This is a situation which (in practice) usually calls for an introduction of anti­

dumping duties.

41

An anti-dumping duty is an ad valorem tariff imposed specifically on dumped

imports. The imposition of the duty leads to an increase in the price of the

imported good in the domestic market thereby protecting the domestic

producers.

It is obvious that anti-dumping duties in the case of persistent dumping do more

damage than good. Moreover the cases of predatory and sporadic dumping, the

traditional ground on which the introduction of anti-dumping duties was

defended, can be considered negligible. However advocates of anti-dumping

duties have come up with other reasons why anti-dumping should be justified.

Three rationales are suggested by advocates of anti-dumping (Leidy, 1995): (1) as

a means to help avoid the costs of temporary structural adjustments induced by

unsustainably low prices, that is, in the case of transitory dumping; (2) to help to

discourage maintenance of the various protectionist policies that segment the

markets and thus make dumping possible; (3) as a safety valve to vent

protectionist opposition and so take further steps toward greater multi-lateral

trade liberalisation.

All of these rationales have been contested by the opponents of anti-dumping

policies. In case of transitory dumping, there are at least two reasons why anti­

dumping should not be used. The first reason reefers to the ability of

governments to differentiate between temporary and permanent price changes.

If governments could do it, private businesses could too and therefore they

would typically not react on those transitory price movements. The second

reason refers to the mis-tailoring of anti-dumping. If anti-dumping is an

appropriate reaction to temporary price movements, then it should not be used

on a prolonged basis as it is current practice. Leidy (1995) talks about the

widespread practice where anti-dumping duties are used for a decade or more

even in the countries whose anti-dumping laws include five-year sunset

provision (therefore limiting anti-dumping duties to that period). For example,

42

in Canada among the anti-dumping duties in force on 30 June 1993,11 of 74 cases

had originated earlier than 1984. In the USA 61 of 268 duties in force in mid-1993

had original order dates prior to 1984, with a number of measures dating back to

the 1960s. In the EU 12 out of 16 measures reviewed in 1990 and 1992 were

renewed.

'Americans will probably have to pay higher prices for all kiwifruit until the turn

of the century if New Zealand is penalised for the single low-priced shipment at

the centre of a US dumping dispute' Games Bovard, New York Times, 10

February, 1992, as quoted in New Zealand Herald, 11 February 1992).

This anti-dumping case originated from a late 1990 shipment of kiwifruit

diverted to the United States after the Japanese importer changed its mind about

buying it. The Californian growers of kiwifruit (the California Kiwifruit

Commission) filed an anti-dumping petition before the US Commerce

Department and later before the International Trade Commission (lTC) claiming

that this shipment sale of kiwifruit at 'give-away prices' caused an injury to

Californian growers. In an investigation of the case the Japanese market was

used to determine 'the normal value' for kiwifruit because the New Zealand

market was considered too small to be used to determine the fair price.

Consequently in May 1992 Americans imposed a punitive 98.6 per cent anti­

dumping duty on imports of kiwifruit from new Zealand. Before anti-dumping

duties, New Zealand was holding 50 per cent of the American kiwifruit market

and the USA was New Zealand's third-largest market accounting for 8 per cent

of kiwifruit exports. Prices which New Zealand growers were forced to charge

after anti-dumping ruling were so much higher relative to competitors' prices

(i.e. Chilean and Californian producers) that it was expected that the New

Zealand share would drop markedly. Additional losses for New Zealand's

growers occurred because the Kiwifruit Marketing Board (KMB) had to divert

part of the exports to the European market, thus dropping the price there.

43

What about welfare effects on the US side? US consumers did certainly not gain

by being forced to pay more for New Zealand kiwifruit. With respect to the

effects on US producers they both gained and lost. They gained in the sense that

they stopped or slowed down an expansion of New Zealand exports. Their

losses arose from the fact the new Zealanders also stopped their effort to enlarge

the total US market for kiwifruit. Kiwifruit exports from new Zealand have been

under control of the KMB which was determined to expand the American

kiwifruit market. The KMB was spending a lot of money on advertising until the

anti-dumping duties were levied. Given the size of the market, it might have

been wiser for the Californian growers to snatch a part of the extra sale generated

by a marketing campaign rather than by punishing them. Since the New

Zealand growers are not subsidised by the government, their strategy did not

include prolonged sales at a loss. Maybe the Californians should have waited

for another kiwifruit season in New Zealand to start their anti-dumping action?

As far as the second rationale is concerned, it is hard to see how a protective

measure such as anti-dumping duties can discourage maintenance of other

protective measures. First of all markets are segmented not only because of trade

barriers but also because of other barriers to the flow of goods and services in a

form of limited spread of information, speed of transport, regulatory differences,

distribution system differences, partial pass-through of exchange rates and

similar. Secondly, anti-dumping policy (an any other barrier) facilitates collusive

market behaviour. Thus rather than opening the market for other firms, the

duties may help the firm(s) accused of dumping to consolidate market power in

both domestic and foreign markets and to successfully keep them separated.

While there is a real need for a 'safety valve' to vent protectionist demand in

almost all countries, it is a difficult matter to determine which is the lowest cost

method of providing one. As a matter of fact, GA TT's Article XIX with safeguard

provisions is doing nothing else but providing a kind of safety valve. Therefore,

44

there is no need to further the use of anti-dumping duties for this purpose,

particularly not as they are implemented currently. It seems that the first best

policy of dealing with dumping (persistent or otherwise) is within the

framework of a competition policy in which the most important criterion should

be the extent of (actual or threatened) injury to competition. Steps toward such a

solution were made at the level of two regional integration's. Under the Closer

Economic Relations between Australia and New Zealand the competition law

was extended to cover trans-Tasman dumping disputes. A similar solution was

found in the agreement on the European Economic Area (EEA) between the

members of the EU and the EFT A.

iv. Subsidies

The use of direct and indirect subsidies-that is, a government's attempt to lower

a firm's or industry's costs by direct or indirect use of public funds-is another

common form of non-tariff barrier. Famous examples of subsidies include the

case of Airbus in order to make Boeing a less competitive firm in the world wide

market for commercial airframes.

Production subsidies

Domestic producers may be encouraged by a production subsidy reducing costs

rather than raising the price faced by domestic producers. The subsidy will help

the producer to keep the market price at a lower level, thereby making the

product competitive.

Export subsidies and countervailing duties

Export subsidies are direct or indirect payment from government to domestic

producers-exporters enabling them to sell their goods in export markets at a

lower price than in the domestic market. The impact of an export subsidy is the

opposite to that associated with a tariff. With a tariff the domestic price of the

imported good is pushed above the world price. With an export subsidy the

45

domestic price of exports is pushed below the world price. It is presumed that

with lower prices exporters would be able to conquer a large share of the world

market. Because they obstruct fair competition, export subsidies are strictly

forbidden under the multilateral trading rules set by the GATT /WTO, except in

the case of agricultural goods. Many countries, however, reach for direct and

even more frequently indirect export subsidies in hope of gaining a large share of

world markets. Before showing the real effects of export subsidies, let us just

mention few examples of the indirect export subsidies that are frequently used.

Most often countries use differential credit conditions (in favour of exporters),

insurance of certain risks paid by the government, assistance in financing of

promotional activities such as trade fairs, advertising, or market research, tax

concessions to export-related R&D activities, etc. Subsidising of non-traded

activities (that is, subsidising production for local use only) is allowed under the

GATT rules.

The effect on production is symmetrical with the effect an import tariff would

have had. Effects on consumption are also symmetrical, that is the quantity of

domestically consumed cloth declines. Since the price which consumers have to

pay increases, it is clear that consumer surplus is reduced. In other words

government has to spend money when it engages in subsidising exports; in

contrast, import tariffs earn money for the government's budget. Thus

consumers are likely to lose twice in this case: once when they have to pay higher

price for cloth, and then again if (when) government increases taxes to finance

this export subsidy. Similar to tariffs, here also we have a deadweight loss. This

waste occurs because the cost of increasing output of the subsidised product

exceeds the export revenue. As Richardson (1992) put it, the nation which

grants export subsidies as shooting itself in the foot.

Under the multilateral trade rules, export subsidies as well as subsides that are

contingent upon the use of domestic over imported goods are prohibited. Any

46

other production subsidies or supports to cover losses to a domestic industry

that have at the same time detrimental effects on other countries may be ruled

inconsistent with the WTO obligations. The Uruguay Round Agreement still

allows for some subsidies, such as the subsidies on exports of primary products,

or the ones supporting research activities or disadvantages regions.

Countervailing duties - a fall out of Export subsidies

As in case of dumping, the country on the receiving end of the subsidised good,

although getting it at lower prices, is not overly happy, at least not its producers

of the same or similar goods. To offset the impact of export subsidies the

importing country has a. right to introduce so-called countervailing duties. A

countervailing duty is a tariff introduced by an importing country with the

objective of raising the prices of the subsidised products.

After Foreign introduces a countervailing duty to shift price back to the pre­

subsidy level, its consumer lose the entire surplus gained. Th demand for the

item also goes down. But the Foreign government earns revenue thus offsetting

some of the consumers' loss. However, Foreign as a nation loses.

In Home, government 'saves' some revenue: exports are reduced and less

money is needed for subsidy. Adding gains and losses across both countries

results in a welfare gain. This is just sufficient to neutralise the loss caused by the

subsidy. Thus the 'world's' welfare is unchanged. However, if we look at the

effects of policies, subsidy and countervailing duty in each country separately it

is easy to see that Foreign gains (duty revenue) and Home loses (subsidy bill). In

other words, duty in Foreign is effectively paid by Home's taxpayers.

Although the infant industry argument in the case of import tariffs is rarely

accepted as fully valid, the infant export industry argument in the case of export

subsidies has found quite a few supporters. Leaning on the findings of the 'new'

trade theory, advocates of this idea argue that it makes sense to give an export

47

subsidy to the young industry with export potential or to a strateg8ically

important industry to help it maintain an excess capacity. However attractive

these ideas sounds, there is a little evidence from real life about their

effectiveness as means of gaining competitive advantage. More importantly,

subsidies for this purpose are ruled out by multilateral trade rules. Despite being

outlawed by GATI/WTO, predatory dumping and export subsidies, as well as

the abuse of anti-dumping and countervailing duties are becoming increasingly

popular with governments in both developed and developing countries.

Nevertheless the USA and the EU are the most active parties with regard to

initiation of anti-dumping investigations.

v. Some other Forms of NTBs.

Governments also use other forms of non-tariff barriers: local content

requirements, technical standards and health regulations, and procurement

policies.

Health, safety and other standards relate to regulations of matters such as

consumer safety, health, the natural environment, labelling, packaging, quality

standards, and the like. The US, for instance, prohibits imports of many types of

agricultural products on such grounds; Japan refused to import US beef fed on

growth hormones, despite well-established research (and approval from the US

Food and Drug Administration) that these hormones pose on health risk.

Examples such as these are endless.

Countries normally have regulations related to the production and distribution

of products considered being hazardous to the health and safety of their citizens.

Often, however, these regulations are abused for protectionist purpose.

Multilateral trade negotiations so far have done a lot to harmonise differing

national standards, thus facilitating freer international trade. Under the Uruguay

Round Agreement on sanitary and phytosanitary measures each member will

48

continue to make a sovereign determination of its acceptable level of risk. A

country will set its own food safety, animal and plant health standards based on

risk. Alternatively, countries may use international standards. The Agreement

recognises the right of countries to maintain stricter standards than international

standards but these stricter measures must be scientifically justified.

Three international scientific organisations are recognised for their expertise in

setting standards. One of the long-term goals is to promote harmonisation based

on the standards of these organisations. Other important principles are

equivalency, risk assessment, and transparency. The principle of equivaiency

means that if an exporting country's measures ensure the level of health

protection desired by the importing country, then those measures should be

acceptable even if they are different from those used by the importing country.

Risk assessment refers to the technical assessment of the nature and magnitude

of risk. Transparency refers to the manner in which health-related measures are

formulated and adopted by countries. Countries should make information

regarding health requirements available to interested parties and should notify

them of any changes that may affect trade.

Government procurement policies: A type of non-tariff protection that was

common to all countries, (now forbidden under GATT) although in differing

intensity, is the favouritism of local producers as suppliers of goods and services

for government (local or national) departments. Typically governments are

constrained by domestic legislation to buy domestic goods or services even if

identical or similar foreign goods cost less (but not if they are substantially

cheaper). In addition, governments have at their disposal many techniques

aimed at precluding foreign producers from tendering for the supply of goods to

the public sector, in particular when it comes to the military (defence) sector.

This policy is aimed at supporting domestic production (which can be done also

by production subsidy). If the government purchase is small relative to the

49

domestic industry this policy should not cause greater distortion than is present

in any government spending (Vousden, 1990, p. 47-8). However if the

government purchases accumulate to a large proportion of domestic industry,

distortionary effects become significant. The final effect is that the cost of

providing public services increases, implying the redistribution of income

between domestic consumers (taxpayers) and producers.

Classic example is the US government's "Buy American" regulations to give US

producers up to a 50% price advantage on Defence Department contracts. Such

policies are common in almost every country.

The multilateral trade rules of the GATT were amended in 1979 (the so-called

Tokyo Code) to restrict these governmental preferences for local suppliers. An

agreement was reached (the GATT procurement code) by which countries that

signed the code would grant each other equal access to government contracts.

However, countries were given freedom to exclude whichever governmental

departments they wished from this agreement. Thus although the majority of

DCs were signatories to this code, many of their departments were not bound by

it.

One of the three agreements signed in Marrakesh in 1994 was an Agreement on

Government Procurement, leading some commentators to state that this

agreement was likely to be one of the major achievements of the Uruguay

Round. Following the Tokyo Code and its revision this agreement continues to

be based on the principles of national treatment, non-discrimination and

transparency at every step of the national tendering process. IT extends the

coverage of the initial code to almost all government procurements except that of

defence. In addition, the enforcement procedure was also significantly

improved. An opportunity is introduced for firms, which feel that they are being

unfairly treated in the tendering process to protest decisions made by

50

government departments (this procedure is known as 'challenge'). This is the

first time the GATT has given an opportunity for foreign firms to be directly

involved in enforcement procedures.

Tariff quotas: A tariff quota is defined as a tariff on imports which increases with

the amount imported. For example, imports of a commodity are free of tax up to

a specified amount, but beyond that point a tariff is imposed.

Multiple exchange rates:_Monetary authorities may sell foreign currency at

different rates of exchange depending on the use to which the currency is being

put. This can have effects similar to a tariff (see Corden 1971). Within this

category we should also include the case where trade in one commodity takes

place at a different exchange rate to the market rate. See Yeager (1976). for a

discussion of trade when countries deal with the 'black' or 'underground' market

rate rather than the official exchange rate.

Border measures and frontier formalities:_Border measures and frontier

formalities add to the bureaucracy at external borders, due to such things as the

different VAT rates, excise duties, monetary compensation amounts, bilateral

trade quotas, veterinary checks, different regulations and standards. Low

staffing at checkpoints also delays entry and adds to costs. As we have seen,

NTBs are used by most countries as a method of restricting trade, but within the

EU, as with other customs unions, we could point to additional methods.

Cartels and concentrations: It is possible for the nature of competition in markets

and the restrictions that might flow from these to inhibit free trade. These are

either restrictive arrangements between otherwise independent firms, or the

practices of dominant firms coupled with merger behaviour. In the case of the

former, price agreements may exist whereby firms in one member state, when

selling to another, agree on the prices they will charge for inputs, or even set up a

separate company- called a common selling syndicate- which will conduct the

51

exports sales of all the participants. These dominant firms could be in a powerful

position to persuade domestic firms to deal exclusively with them, and imports

and exports could be severely restricted.

vi. Newly Emerging NTBs.

Some of the new areas which are coming up in recent years to restrict imports

through non-tariff measures are environment, labour and social clauses.

Labour and social Clauses:

The interaction between trade policy and labour and social standards came into

the focus of international arena once again in April 1994 when some of the DC

governments (namely the USA and the EU) insisted on amending the declaration

from Marrakesh (the Declaration on the Uruguay Round). They wanted a formal

promise that the newly established WTO would get involved examining the

impact of labour standards and working rights on countries' competitiveness.

The USA have been unsuccessfully pushing for the inclusion of labour standards

in the multilateral trade talks since the early 1950s. they have been more

successful in linking trade to labour standards at the level of bilateral trade

arrangements (e.g. NAFTA), and even more so in their trade relations with

developing countries. For example, the legislation has been passed (section 301

and 301 super of the Omnibus trade Act of 1988) to enable the USA to condition

their presence in the preferential trade schemes, such as GSP or Multilateral

Investment Guarantee Agency, on a minimum set of internationally recognised

standards of workers rights, known as the core labour standards. These include:

the prohibition of forced labour, the prohibition of discrimination in

employment, the right to freedom of association, the right to collective

bargaining, and the prohibition of the exploitation of children in employment

(OECD, 1996, p.4). There is an understanding among the governments of the

USA, the EU and many other countries that these core standards should be

52

universally applied (most of these countries have signed and ratified the United

Nations and ILO conventions dealing with human rights and labour standards).

There are some other, mostly poorer, developing countries which hold that even

the above 'basic' standards do not apply equally to all countries at all times.

Instead, the application of any or all of the standards is dependent upon the level

of development and capacity of an economy to afford them. This is particularly

true in the case of applying some other(non-core) standards such as a minimum

wage, limitations on hours of work and occupational safety and health in the

workplace. Thus economies at different levels of development may have

different preferences about the basic standards, which implies that under laissez­

faire. The world will continue to have non-harmonised labour standards across

countries. Taking that different labour standards only reflect countries'

differences in productive resources, we have to conclude that this difference

provides yet another resource of gains from (free) international trade. Therefore,

any attempt to artificially close the gap (by harmonising multilaterally) will

reduce opportunities to gain from trade. Instead, free trade should be allowed to

provide countries with a growth-friendly environment (see Chapter 13 for more

details on the link between trade and growth). At a higher level of development

these countries would develop preferences for higher labour standards (and they

would be able to afford them) and thus harmonisation at the higher standard

level would take place 'naturally'.

A different view on the diversity in labour standards across countries comes

from some industries in the DCs which claim that producers in countries where

lower standards are permitted enjoy unfair competitive advantages. These

complaints are best known as the claims of 'social dumping'. It threatens the

working and social conditions in countries with higher standards because these

countries could be motivated to reduce the level of their standards thus 'racing

the law-standards-countries to the bottom'. Solution is seen in international

53

harmonisation of labour standards at a level acceptable to producers in DCs.

Krugman (1997, p. 118) clearly identifies what is the questionable in this request:

'The problem, one might argue, is not that countries have an incentive to set

standards too low in a trading world. Rather, it is that politicians, who respond

to the demands of special-interest groups, have such an incentive. And orL.:

might arg~e that this failu~e of the political morket, rather than distortions in

goods or factor markets, is what justifies demands for international

harmonisation of standards'. Trade policy is only a second best or even a third

best policy to remedy many economic ills. There is no particular reason wh··

trade policy should be used in a case of social dumping. In fact, trade

intervention is probably the least appropriate response. As always, the choice of

instrument depends on the objective. If the goal is higher standards and better

working conditions in the poorer countries, then it would be more efficiently

achieved by helping these countrL·_ ·-~raise their standards of living. If howevf'r

the objective is to shelter some interest groups in the DCs harmed by foreign

competition, this could be done with taxation and direct transfer of income

rath~r than through trade intervention.

Environmental Clauses

One of the significant emerging Non tariff barrier is the environmental related

restrictions imposed on the movem~nt of goods into the country. On one hand it

is a fact that the prot~ction of environment, maintenance of ecological balance

a!ld. protection of the endanger~d species are of utmost impotbnt:e. But the

problem arises when the danger;~ ''aggera!~d aP.d used as a weapon to restrict

trade among countries.

There are two conceptually different grouP8 o.f problems and related measures in

the area of environment and trade. One deals with a stage in the economic

process at which environmental damage occvts. Thus we differentiate bern.·ep ..

externalities that occur when products are being consumed and externalities

54

)'

when products are being produced. Consequently we must distinguish between .

product-related measures that address consumption externalities and production

and processing-related measures that address production externalities. Current

multilateral trade rules allow countries to impose domestic product regulations

on imports. They are in general not permitted to impose regulations related to

production processes unless similar domestic restrictions exist. The second

broad group of problems deals with the geographical locus of environmental

damage. There are environmental problems that are domestic in nature and

those that are international or transitional (global), such as acid rain, ozone

depletion and global warming. While, in a general opinion, a country with local

pollution should be left on its own to deal with the damage, in the case of global

damage it is suggested that cooperative agreement between polluters and non­

polluters might be more efficient than unilateral sanctions imposed on polluters.

Let us discuss some of these issues.

With respect of product-or consumption-related concerns it is clear that the sort

of measures typically used, that is, technical standards, eco-labelling, recycling

and packaging requirements and similar could easily be abused for the purpose

of protectionism. Evidence on the intensified use of such measures since the late

1980s (Sorsa, 1995, Figure 1) could be interpreted so as to support this claim or to

support the view that governments are becoming more environmentally

conscientious in trying to minimise environmental damage.

An important source of green protectionism is the sue of trade measures to deal

with local and/ or global environmental problems. According to Bhagwati

(1993a) local pollution which does not cross national borders should not be

anybody' s concern but the country's where it occurs, and she should deal with it

in acc.ordance with her own environmental laws. This is in contrast to the case

where a polluted river flows into a neighbouring country-only then does the

problem become international. This view, although logical, has been attacked by

55

many who claim that the case of local pollution may have significant impact on

international trade and therefore must become an international concern. This

problem lies at the bottom of many claims of so-called 'environmental dumping'

and we shall explore it a bit further. In order to do that we have to use the

concept of comparative advantage which hopefully will not create any special

difficulties.

The principle of comparative advantage, which says that a country should export

the goods which can be produced relatively more cheaply than abroad, is based

on fixed amounts of primary factors of production. The cost of use of these

standard factors enters directly into the product prices, or in more general sense

we use the concept of opportunity costs as the basket for all kinds of factors and

resources used in production. But never in the simple concept of comparative

advantage have we included environment as a factor of production. What

happens if we do? More recently, trade models have extended the definition of

factors to include the environment. The country is thought to be relatively

environment-abundant if it has a relatively large assimilative capacity.

Assimilative capacity is the capacity of the environment to absorb or tolerate

pollutants. It reflects the degree to which the environment will be affected by its

use or by the production of ecologically damaging products. For instance, the

lower the assimilative capacity, the more environmental damage will be caused

by the emission of a given amount of pollutants. The level of assimilative

capacity is influenced by the physical ability of water, air, and land to absorb

damage, and also by the level of pollutants the society is willing to tolerate

(Blackhurst, 1977). This tolerance, or a country's preference, with respect to

pollution is revealed in the environmental regulations and standards the society

chooses to impose. Since countries differ in their environmental preferences

(depending mostly on their level of income), the environmental regulations and

standards will differ greatly across counties; each country will keep more of the

56

industries whose pollution is relatively more preferred there than in other

countries. In general, a LDC would prefer to pollute (that is, produce and grow)

now and clean up later, while a highly industrialised country (although) having

the same assimilative capacity as the poor country) would prefer higher

environmental quality. Thus the environmental policy of the poor country (if

existent) will be more liberal than in the wealthy country, implying also a lower

cost of production of the environmentally sensitive goods. In other words, poor

countries would end up having comparative advantage in the environmentally

sensitive products vis-a-vis DCs. This is what leads some to believe that the

'fairness' of competition in the international arena may be affected. These fears

are predominant between business and environmentalists in the DCs who claim

that lower environmental standards in the developing countries would provide

grounds for unfair competition and would ultimately lead to the lowering of

standards in the DCs. Thus they insist that standards should be harmonised

'upward' before any further trade liberalisation takes place. Meanwhile they

treat the lower environmental standards abroad as 'eco-dumping' and call for

countervailing duties to be imposed on such imports from such countries.

Although trans-border environmental problems seem more complex to deal with

than the local problems discussed above, it is likely that the international

community will reach agreements on these issues sooner and easier precisely

because they concern the welfare of all (Bhagwati, 1993b). Some international

agreements have already been reached, such as the Convention on International

Trade in Endangered Species (CITES), the Montreal Protocol on Substances that

Deplete the Ozone Layer, the London Guidelines for Exchange of Information on

Chemicals and the Basle Convention on the Trans boundary Movements of

Hazardous Wastes. These environmental regulations clearly impede free trade.

The Convention on International Trade in Endangered Species (CITES) prohibits

the importation of ivory; the Basel Convention on Trans boundary Movements of

57

Hazardous Wastes and their Disposal also rules out trade in certain substances.

The Montreal Protocol has a different twist. This protocol was concerned with

ozone depletion and initiated the phasing out of CFCs. The treaty, however, also

allowed member countries to implement trade sanctions against non-member

countries. In addition, the convention prohibits imports of all products which

use CFCs in their production processes, such as computer components cleaned

with CFC-based solvents.

From the previous discussion the points that came out are that:

¢ Traditional theories on international trade are in favour of free

trade.

¢ However, the incentives of protection are found in those theories

itself.

¢ Hence, the international trading environment is quite a protective

one.

¢ Though, the benefits of free trade were not denied, yet various

arguments were offered to justify protection.

¢ As required, different forms of protection came up.

Despite all these, the view that free trade does not have any better

alternative has prevailed.

However, as with many other arguments in economics, the logic for free trade is

a conditional one. It simply says that, if a nation wants to increase its economic

efficiency, then the avenue for doing so is by focusing on its comparative

advantage and trading with other nations. But policymakers also often worry

about non-efficiency aspects of free trade-in particular, aspects such as

distributional (or "equity") considerations, short-term unemployment,

preservation of a "way of life". In the next section we thus make a comparison

between a free and a restricted trading environment.

58

2.5: Free Trade Vs Restricted Trade

To analyse the point whether free trade is the first best policy let us consider a

concrete example. As tariff has been the oldest and most widely accepted form

of trade protection, we consider a case of tariff imposition.

We consider a two-country, one-commodity partial equilibrium framework. The

home country (H) imports could x from the foreign country (F). If a tariff at the

rate tis imposed by H on X, the domestic price of X becomes:-

pd = (l+t) P*

Where Pd is the domestic price of X

P* is the international price of X

Obviously,

Pd>P*

By the amount t P*.

That is, imposition of tariff increases the domestic price of commodity X. The

increase in price, in one hand decreases the consumption of the imported

commodity, thus protecting the domestic industry. On the other hand, it

increases the demand for the domestically produced X, thus in turn helping the

domestic producers. Along with that it generates a revenue - the tariff revenue

for the government.

From this, it seems that the imposition of tariff increases the welfare.

But, the imposition of tariff leads t an increase in the price of the imported

commodity and the consumer lands up paying more for the product. This

decreases the consumer surplus, which does not get totally off setted by the

increase in producers surplus and the revenue generated.

Moreover, the picture presented holds true for a small country. That is, in other

words, protection to the domestic industry through the increase in the price of

59

the imported commodity by the amount of the tariff is guaranteed in case of a

small country. The underlying reason is that when the increase in price leads to

decrease in demand for the imported commodity, the decrease in insignificant to

affect the international price in case the tariff imposing country is small.

On the contrary, if the tariff imposing country is a large one, the decrease in

demand has a significant role in the world demand of the commodity and

pushes down the international price of the commodity.

A look at the relationship between the domestic price and the international price

after the imposition of tariff will make things apparent:

Pd=P*+tP*

Tariff works in the rationale that this tP* factor increases pd over P*. But if P*

itself starts falling, the movement of Pd becomes unpredictable and hence, we

cannot claim:-

Pd>P*

Instead we have a situation of

pd >=< P*

depending on the extent of the movement of P* as compared to t.

So though, tariff revenue is generated, yet the domestic industry protection

objective cannot be achieved. In addition to that, the introduction of a trade

restricting policy into the market framework itself has it welfare reducing effects.

However, for a large country, there is one particular rate of tariff, referred to as

the optimal rate of tariff at which, the welfare level is higher than the free trade

welfare level. But, in that case also, the incidence of tariff retaliation comes in the

way.

So, the conclusion, which comes out, is that free trade is the first best policy.

60

This holds true for any type of trade restriction. In case of quota and VER, the

decrease in the volume of trade decreases the welfare level. Subsidy of any form

is trade distorting, thus affecting the welfare level. Imposition of restriction

through social and environmental clauses also restricts trade, thus having an

adverse effect on welfare.

The above discussion boils down to the fact that a protectionist trading regime is

always welfare decreasing. As a consequence, a movement towards trade

liberalisation was observed after the Second World War. As is well known, the

trading regime prior to the Second World War had been highly restrictive. To

take the world out of such a protectionist trading regime, the General Agreement

Of Tariff And Trade came into existence, which ultimately got transformed into

the World Trade Organisation. In the next section we discuss the formation of

GATT and its ultimate development into WTO.

2.6: GATT and WTO - Redefining and Refining the Global Trading Arena.

To take out the global trading arena from the overhang of the protectionist

measures of the pre-second world war period and to give an early boost to trade

liberalisation, the GATT was established along with the other new multilateral

institutions dedicated to international economic co-operation-commonly known

as the Bretton Woods Institutions, - the world Bank and the International

Monetary Fund. In the light of the highly restrictive trading regime which

existed during the pre-second world period the formation of a global body

looking after the international trading regime pursuing for liberalisation was

thought of. Fifty countries agreed a draft Charter for an International Trade

Organisation (ITO) - a new specialised agency of the United Nations. The

Charter was intended to provide not only world trade disciplines but also

contained rules relating to employment, commodity agreements, restrictive

business practices, international investment and services. Although the ITO

Charter was finally agreed at a UN Conference on Trade and Employment in

61

Havana in March 1948, ratification in national legislatures proved impossible in

some cases. When the United States government announced, in 1950, that it

would not seek congressional ratification of the Havana Charter, the ITO was

effectively dead. In this background, GATT was established on a provisional

basis after the Second World War. Despite its provisional nature, the GATT '

remained the only multilateral instrument governing international trade from

1948 until the establishment of the WTO.

So, when GAIT played such an important role, a brief discussion on its gradual

development and impact on the world trade in necessary. Out of the fifty

nations, tariff negotiations were opened among the 23 founding GATT

'contracting parties11 in 1946. This first round of negotiations resulted in 45,000

tariff concessions affecting $10 billion - or about one-fifth of world trade. It was

also agreed that the value of these concessions should be protected by early - and

largely 11provisional11 - acceptance of some of the trade rules in the draft ITO

Charter. The tariff concessions and rules together became known as the General

Agreement on Tariffs and Trade and entered into force in January 1948.

The original GAIT contains 38 articles with three overriding aims:

1. to provide a framework for the conduct of orderly trading relations;

2. to encourage free trade and reduce the possibility of countries taking

unilateral action against others;

3. to reduce tariffs and quantitative restrictions.

Article I and II relate to the basic obligations of all contracting parties. Articles III

to XXIII are the code for fair trade, including the rules for anti-dumping, and

protection for balance of payments difficulties. Articles XXIV to XXV concern the

procedures for application and conditions for the amendment of articles. Article

XXXVI to XXXVIII, produced in 1965, deal, in the main, with trade of less

developed nations.

62

Although GATT may not appear to affect individual countries directly, it has a

number of indirect effects. In particular, by encouraging countries to lower their

trade restrictions with other member countries of the GATT, it enables some

organisations to achieve greater cost competitiveness and widen their markets.

In addition, it provides companies with consistency since they realize that they

can undertake longer-term trading contracts without them being disrupted on

the whim of a country's government.

The GATT agreement embodies three main principles: non-discrimination,

reciprocity and transparency.

1. Non-discrimination: countries should treat all their trading partners the

same way; for example, if the UK puts a tariff of 40 per cent on an

Australian import, it should not put a higher tariff on a similar good

imported from India. This is known as non-discrimination or most

favoured nation (MFN) treatment. Similarly, if the UK agrees a tariff

reduction with Australia, bilaterally, then this tariff concession should be

extended to all other countries. Any tariff reduction gained can almost

certainly be expected to be permanent. Therefore, the advantages of the

MFN treatment is that two countries, in bargaining for tariff reductions,

know that a later deal between one of the countries and third party will be

passed on. The process also helps small countries, which may have little

bargaining power. The growth of non-tariff barriers, as we shall see later,

has been an attempt to overcome the non-discrimination principle.

2. Reciprocity: if country A makes a 10 per cent reduction in tariffs on an

import from country B, country B should make a corresponding reduction

in tariffs on imports from country A. The MFN rule would then enable

these reductions to be transmitted between all GAIT nations. Reciprocity

63

recognises the existence of the 'free-rider' problem inherent with trade

liberalisation.

3. Transparency: countries should replace disguised and less quantifiable

protectionism with more visible tariffs. This includes quotas, which, as a

type of non-tariff barrier, generate uncertainty, which then acts as another

non-tariff barrier.

In its 47 years, the basic legal text of the GATT remained much as it was in 1948.

However, the basic objective was achieved through "plurilateral" - voluntary

membership agreements and continual efforts to reduce tariffs. Much of this was

achieved through a series of "trade rounds".

These trade rounds can be said to have resulted in considerable amount of trade

liberalisation , under the auspices of GATT - the Uruguay Round was the latest

and most extensive.

Although often lengthy, trade rounds offer a package approach to trade

negotiations, an approach with a number of advantages over issue-by-issue

negotiations. For a start, a trade round allows participants to seek and secure

advantages across a wide range of issues. Second, concessions which are

necessary but would otherwise be difficult to defend in domestic political terms,

can be made more easily in the context of a package which also contains

politically and economically attractive benefits. Third, developing countries and

other less powerful participants have a greater chance of influencing the

multilateral system in the context of a round than if bilateral relationships

between major trading nations are allowed to dominate. Finally, overall reform

in politically sensitive sectors of world trade can be more feasible in the context

of a global package - reform of agricultural trade was a good example in the

Uruguay Round.

64

Most of GAIT's early trade rounds were devoted to continuing the process of

reducing tariffs. T~e results of the Kennedy Round in the mid-sixties, however,

included a new GATT Anti-Dumping Agreement. The Tokyo Round during the

seventies was a more sweeping attempt to extend and improve the system.

The most lengthy round is the Uruguay Round. At this juncture it needs to be

mentioned that GAIT was particularly successful in dealing with tariff barriers

to trade, especially those associated with industrial products. (Table 2.2).

However, the reduction in tariff has been accompanied with an increase in the

popularity of NTB as a trade impediment. The situation was gradually getting

worse with regard to NIBs. EU and the USA started using anti-dumping and

anti-subsidy measures to a large extent to restrict imports. Moreover the slow­

down in the growth of world trade and the move by many industrialised

countries towards more of a service-oriented economy, and the role of

agriculture within trade relationships, required this round of GAIT talks to take

up a much wider range of issues. So, the eighth round of talk had a wider

portfolio to consider and many of the important parties had certain objectives to

achieve against certain concessions ready to offer (Table 2.2 and 2.3).

The WTO is different from GATT in a number of respects:

• The WTO is more global in its membership than GATT. Its membership

already comprises over 140 countries and territories, with many more

considering accession.

• It has far wider scope than GAIT, bringing into the multinational trading

system, for the first time, the trade in services, intellectual property

protection, and investment.

• It is a full-fledged international organisation in its own right, while GATT

was basically a provisional treaty by an ad hoc secretariat.

• It will administer a unified package of agreements to which all members are

committed, whilst GATT included a number of side issues, such as anti-

65

dumping measures and subsidies, whose membership was limited to a few

countries.

• It contains a much-improved version of the original GATT rules plus a lot

more. In other words, it uses the 1994 GATT rules, which were a large

improvement on the original rules.

• It reverses policies of protection in certain' sensitive' areas, which had become

tolerated under the old GATT system, such as export restraints on textiles

and clothing, and voluntary export restraints.

• The WTO's objectives are to oversee the tariff cuts (averaging 40 per cent) and

the reduction of non-tariff measures agreed at the Uruguay Round. It is to be

the guardian of international trade, examining on a regular basis the trade

regimes of individual members. In this respect it will examine proposed

trade measures and proposals by countries which could lead to trade

conflicts. Members of the WTO are also required to supply a range of trade

statistics, which will be kept on the WTO data base.

• Moreover, in WTO it is recognised that trade disputes are likely to arise and

thus adequate provisions have been made. The WTO provides for a disputes

mechanism for finding an amicable solution to the problems. If trade

disputes cannot be solved through bilateral talks, then the dispute will be

adjudicated under the WTO dispute settlement 'court'. Here panels of

independent experts are established to examine disputes in the light of WTO

rules and provide rulings. This tougher, streamlined procedure ensures

equal treatment for all trading partners and encourages parties to seek

independent jurisdiction of their case rather than resorting to individual

pieces of domestic legislation. This Dispute Settlement System under WTO is

one of the major developments over GAIT achieved in the Uruguay Round.

Table 2.4 indicates an overview of the disputes settlement in the WTO as of

April1996.

66

This speeded-up disputes settlement appears to be achieving results. For

example, in Table 2.4 the dispute between the USA and Japan regarding

'Measures concerning sound recordings' was resolved in March 1997. The USA

had complained in February 1996 that copyright should exist over the protection

of past performances and existing sound recordings in Japan under the TRIPs

agreement. The US complaint was based on the belief that the agreement

obligated WTO members to grant protection to past performances undertaken in

a WTO member state and existing sound recordings for a term of at least 50 years

from the end of the calendar year in which the performance took place or the

sound recording was made. In December 1996, Japan amended its copyright law

to provide this 50-year protection to past performances and existing sound

recordings. The USA has now withdrawn its WTO complaint.

From the above discussions, the following point become apparent:

• There exist certain incentives for protection embodied in the concept of free

trade. As a result, the world has experienced a protectionist trading regime in

the global trading scenario.

• But, the fact still remains that free trade is the first best policy.

• So, to take the world out of the protectionist regime and to liberalise the global

trading arena, GATT came into existence, which ultimately developed into the

World Trade Organisation (WTO).

In spite of the achievements of GATT I WTO so far in the field of trade

liberalisation, the fact that cannot be denied is that trade liberalisation under the

purview of GATT I WTO is a lengthy process. So, countries interested in a faster

track of trade liberalisation opted for the second available alternative- Regional

Trading Arrangements. These Regional Trading Arrangements go for

liberalisation of trade among the member countries at various degrees, which has

already been mentioned in the previous chapter. The issue which becomes

important at this juncture is that whether this trade liberalisation at the regional

67

level will help in Multilateral Trade Liberalisation or will dampen it. This is the

core content of this thesis. In the next section we mention a few words regarding

Regional Trading Arrangements.

The basic motive of GATT/WTO is to liberalise the international trade arena.

But, liberalisation on a global scale cannot be thought of within a short span of

time. But, countries have now come to realise the benefits of free trade. So, the

concept of Regional Trading Arrangements came. This basically means

liberalisation of trade among a group of countries. As in case of free trade, even a

trade liberalisation within a limited number of countries leads to an increase in

the level of welfare. That is countries participate in the regional trading

arrangements as they gain from various aspects and thus their welfare level

increases. The next section gives a brief overview of the Regional Trading

Arrangements, basically focussing on the reasons behind their formation.

2.7: Regional Trading Arrangements - One Step Forward to Globalisation?

The previous sections have brought out the fact that Free Trade is still the first

best Policy. Countries have increasingly started realising this fact. As a result the

global trading arena is experiencing a movement towards liberalisation. This has

lead to the formation of the GATT just after the Second World War. With the

gradual development of GATT the world trade got liberalised to certain extent

through decrease of the tariff. The decrease of the tariff lead to the emergence of

the non-tariff barriers. The underlying reason was that some of the countries still

wanted certain amount of restriction in the import of goods in the country. The

eighth round of GAIT negotiation took care of this issue. The most significant

outcome of the round was the creation of the permanent watchdog, the World

Trade Organisation. SO, we find that the zeal to liberalise the global trade, which

got initiated just after the Second World War, still continues. However, it has also

been experienced that factors have also come up to hamper the growth of the

68

process of liberalisation, making it a comparatively slow one. This is one side of

the picture.

On the other side, individual countries, realising the benefits of free trade have

increasingly got interested and involved in it. They have, however, also

experienced and thus realised that complete liberalisation of the global trading

arena through WTO is a long drawn process. This has resulted in the increase in

the interest of forming Regional trading arrangements.

A detailed discussion of the Regional Trading Blocs - the reasons for there

becoming so popular, the developments achieved, the theoretical and empirical

woks done and also some of the significant trading blocs will be made in the next

chapter.

69

Table 2.1: Voluntary Export Restraint Arrangements: 1987

Product o Steel

o Machine tools

o Motor Vehicles

o Televisions o Video tape

and cassette recorders

o Footwear

o Textiles and apparel

o Agricultural products

o Stainless steel flatware

Importing Countries ~ EU

~ EU ~ USA ~ Canada, ~ EU, ~ USA ~ EU, USA ~ EU, USA

~ Canada, EU France, Ireland UK, USA

~ Austria, ~ Canada ~ EU, ~ USA

~ EU, ~USA

~ EU, ~ Belgium ~ Netherlands

Exporting Countries ~ Australia, Brazil,

Republic, Finland, Poland, Romania, Sweden

Bulgaria, Czech Hungary, Japan, Slovak Republic,

~ Japan, Taiwan

~ Japana ~ Japan ~ Japanb ~ Japan, South Korea ~ Japan, South Korea·

South Korea

~ South Korea, Taiwan ~ South Korea, Taiwan ~ China ~ South Korea

~.

.........

~ Czech Republic, Slovak Republic, Romania

~ Singapore, South Korea ~ Maldives, Pakistan, Vietnam ~ Bulgaria, former Soviet Union,

Cyprus, Egypt, Malta, Morocco, Tunisia, Turkey, former Yugoslavia

~ El Salvador, Fiji, Haiti, Mauritius, Nepal, Taiwan, United Arab Emirates

~ Argentina, Australia, Austria, Brazil, Bulgaria, Canada, Chile, Korea, China, New Zealand, Norway, South Africa,

~ Uruguay ~ Japan, Australia, New Zealand ~ South Korea ~ South Korea

Notes=•Formal agreement ended in 1987. An informal understanding with regular bilateral consultations still exists. bformal agreement ended in 1985. Japan still sets export restraints. <Excludes VERs negotiated under a multifibre arrangement. Source: General Agreement on Tariffs and Trade, Trade Policy Review: The United States, 1992, The European Communities, 1991, Canada, '992, Japan, 1992, and Republic of Korea, 1992.

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Table 2.2: GATT Trade Rounds

Year Subjects Covered No. of Participating

Countries

1947 Geneva Tariffs 23

1949 Annecy Tariffs 13

1951 Torquay Tariffs 38

1956 Geneva Tariffs 26

1960-61 Geneva (Dillon Round) Tariffs 26

1964-67 Geneva Tariffs and 62

(Kennedy Round) Anti-dumping Measures

1973-79 Geneva (Tokyo Round) Tariffs, NTMs 102

and Framework Agreements

1986-93 Geneva (Uruguay Round) Tariffs, NTMs, Rules, Services, 123

IPRs, DS, Textiles and Clothing,

Agriculture, Establishmant of

WTO,etc.

Source: GAIT/WTO Documents

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Table 2.3: Uruguay Round trade-offs

Country

United States

European

Community

Japan

Developing

countries

Targets

Agriculture

TRIPs

Services

TRIMs

TRIPs

TRIMs

Services

Tariffs

NTBs

TRIMs

CVDs/AD

Safeguards

Textiles and clothing

NTBs

Safeguards

Agriculture

Tropical products

Natural

products

resource-based

Source: GAIT /WTO Documents

Concessions

Textiles and clothing

Tariffs

CVDsjAD

NTBs

Textiles and clothing

Agriculture

Safeguards

CVDs/AD

Agriculture

Services

TRIPs

Services

TRIPs

TRIMs

Tariffs

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Table 2.4: Dispute settlement in the WTO, April1996

Complainant Subject of complaint

Venezuela, Brazil United States-Standards for reformulated and conventional gasoline

Canada, Chile, Peru European Communities-Trade description of scallops

European Communities, Japan-Taxes on alcoholic beverages

Canada, United States

Philippines Brazil-Measures affecting desiccated coconut

Costa Rica United States-Restrictions on imports of cotton and man-made fibre

underwear

India

India

United States

Thailand

Canada

India

Unites States

Uruguay

United States

Ecuador, Guatemala,

Honduras, Mexico, USA

United States

Hong Kong

Sri Lanka

USA-Measures affecting imports of women's and girl's wool coats

USA-Measures affecting imports of woven wool shirts and blouses

Korea-Measures concerning the testing and inspection of agricultural

products

EC-Duties on imports of rice

Australia-Measures affecting the importation of salmon

Poland-Import regime for automobiles

Australia-Measures affecting the importation of salmonids

European Communities-Implementation of Uruguay Round commitments

concerning rice

European Communities-Measures affecting meat and meat products

(hormones)

European Communities-Regime for the importation, sale and distribution

of bananas

Japan-Measures concerning sound recordings

Turkey-Restrictions on imports of textile and clothing products

Brazil-Countervailing duties on imports of desiccated coconut and coconut

milk powder from Sri Lanka

Canada-Certain measures concerning periodicals

Turkey-Restrictions on imports of textile and clothing products

United States

India

Argentina, Australia, Hungry-Export subsidies in respect of agricultural products

Canada, New Zealand,

Thailand, United States

Source: GAIT/WTO Documents

73