November 22, 2019

The World Trade Organization Needs an Update

Reuters/Scanpix
WTO’s HQ in Geneva
WTO’s HQ in Geneva

The loss of trade rules increases economic instability.

The creation of the World Trade Organization in 1995 marked a new era of cooperation in international economic relations. Binding, enforceable global rules covering trade in goods and services facilitated rapid growth in international commerce. Since 1995, the dollar value of world trade has increased by a factor of 3.8 while the real volume of world trade has expanded by 270%. This far exceeds growth in world GDP, which has doubled over the same period.

Estonia joined the WTO in 2000, which marked another milestone in its far-reaching economic reforms after regaining independence. Like its subsequent membership of the European Union, WTO accession was an important step in consolidating Estonia’s ambitious and successful opening-up and reshaping of its economy. Estonia’s exports of goods and services have grown almost tenfold, from around 2.96 billion US dollars in 1995 to $22.78 billion dollars in 2018. Today, Estonia is well integrated with its neighbours and the wider world, and a leader in digital technology and policy.

Estonia’s successes exemplify the gains that have been made possible by the multilateral trading system. Predictably open international markets give businesses the confidence to invest with an eye to supplying the global marketplace, irrespective of the size of a country’s domestic economy. By providing a platform for negotiating, enforcing and monitoring the rules that keep markets broadly open, the WTO has made an important contribution to national economies, and to the global economy as a whole.

How the WTO Contributes to Trade and Development

Recent research shows that WTO membership affects countries’ trade performance more than previously thought. Joining the WTO or its predecessor, the General Agreement on Tariffs and Trade, raised trade between members by 171%. Trade between members and non-members has grown by 88% (Larch, Monteiro, Piermartini and Yotov, 2019).

The multilateral trading system has contributed to the expansion of international commerce and to development in multiple ways.

First, multilateral trade cooperation has achieved substantial tariff liberalisation. While the average tariff applied during the trade war of the 1930s was around 50% (Bagwell and Staiger, 2002), the average tariff applied by WTO members today is only around 9%, down from 11% in 1995. The core role of the WTO in underpinning and anchoring world trade growth is often overlooked. In fact, despite the explosion of preferential trade agreements (PTAs), over 80% of world merchandise trade still takes place on the basis of non-discriminatory MFN (Most Favoured Nation) tariffs. In addition, the requirement to set binding ceilings for tariffs gives businesses confidence that tariffs in target markets and at home will not rise sharply overnight, encouraging them to invest in export-oriented production and import sourcing. Research confirms that the stable and predictable trading environment the WTO has helped create led to new firms starting to export and charge lower prices (Feng, Li and Swenson, 2017). Because of competition, third-country exporters also lowered their mark-ups, making consumers the big beneficiaries from lower prices (Amiti, Dai, Feenstra and Romalis, 2017). For the US, research has estimated that reduced prices following China’s accession to the WTO increased consumers’ income by at least 0.8%, the welfare equivalent of an eight-percentage-point tariff decrease (Handley and Limão, 2017). WTO economists have shown how export growth following accession is faster in sectors in which tariff bindings lead to large reductions in trade policy uncertainty (Jakubik and Piermartini, 2019).

Second, the WTO’s legal framework, based on core principles like non-discrimination, science-based policy on food safety and product standards, and constraints on the use of subsidies has helped create a level playing field both for businesses and for countries. By balancing members’ use of policy measures to achieve domestic objectives with obligations to limit their potential trade-distorting impacts, these rules enhance transparency and reduce the scope for regulation to be used as a means of arbitrary trade restrictions. Farmers and manufacturers exporting can thus expect not to face unreasonable sanitary/phytosanitary or technical barriers to trade.

Third, the WTO increases transparency with regard to trade, which helps reduce costs associated with doing business across borders. Members’ legal commitments indicate in detail the limits on their use of tariffs and subsidies, while shedding light on market access conditions for different products. In addition, members have committed to sharing draft regulatory measures and standards before adoption, which creates the opportunity for trading partners to engage in dialogue if they think a proposed measure is more trade-restrictive than necessary. Economists estimate that approximately 6% of total trade barriers are information costs (Anderson and Wincoop, 2004).

Fourth, for countries that have joined the WTO over the past 25 years, the accession process has promoted domestic policy reforms and market-opening commitments. WTO accessions are often associated with significant increases in growth and investment, especially for countries that undertake substantial reforms. While the pickup in growth is typically sustained only for the first five years after accession, the economy is estimated to be permanently larger by 20% as a result of accession to the WTO (Tang and Wei, 2009).

Fifth, binding dispute settlement plays a central role in the WTO system. It enhances the credibility of the rules, provides a means for members to hold each other to account for perceived infractions, and reduces the scope for trade disputes to become politicised or pretexts for escalating tit-for-tat retaliation. The dispute-settlement system, which has been highly effective, is central to the WTO’s place as one of fundamental pillars of global economic governance. Many disputes are resolved before they reach the litigation stage, but once they do, compliance with rulings is very high, with around 90% of rulings having been fully implemented.

The predictable market conditions fostered by the WTO have combined with improvements in computing and communications technology to make it possible for businesses to disaggregate manufacturing production across countries and regions. Instead of consolidating production, processing and associated services within single geographical areas or even factories, firms were able to locate each activity or source from wherever it could be done most cost-effectively. This can be seen in the dramatic rise of Global Value Chains (GVCs) since the 1990s. The typical “Made in country X” labels in manufactured goods should today more fittingly say “Made in the World”. Many mobile phones, for example, are assembled in China but designed in the United States, with sophisticated inputs such as semiconductors and processors made in the Republic of Korea. Trade within GVCs today accounts for almost 70% of total trade (WBG et al., 2017). The rise of GVCs has been a key factor in enabling rapid growth in developing countries, while facilitating increased purchasing power and consumer choice in developed countries. Within GVCs, know-how and capital typically flow from developed to developing countries. This has enabled developing and emerging countries, especially in Eastern Europe and Asia, to increase their participation in trade and narrow the gap between domestic living standards and those in advanced economies. From 1995 to 2011, developing countries doubled their share in GVC trade from 16% to 33% (Kummritz and Quast, 2016). Estonia increased its participation in GVCs during this period by over 44%.

The WTO’s influence has extended far beyond formally negotiated commitments and rules; as countries witnessed the gains that came with greater integration into international markets, they autonomously lowered their own trade barriers.

Growth and Development Gains Threatened by Trade Tensions

The trade tensions seen in recent years have started to give us a taste of what the world might look like without the WTO. Unilateral tariffs and other trade measures have been met with retaliation in kind.

Even the WTO’s dispute-settlement system has been affected, with its Appellate Body facing paralysis. Amid differences of view among WTO members about the way the Appellate Body operates, the appointment of new members has been blocked for want of consensus. It is now down to only three members—the minimum required to hear an appeal—with two set to retire in December, which will render the body inquorate and unable to hear appeals. This would add to the uncertainty resulting from new tariffs and other trade restrictions. If trade disputes cannot be impartially resolved, the chances are increased that governments will take measures into their own hands and retaliate against allegedly offending parties. This could prompt counter-retaliation and escalation.

A growing body of economic analysis suggests that trade-related uncertainty about future market conditions is causing businesses to hold back on investment, diminishing future growth and productivity.

Economic policy uncertainty (as measured by the frequency of phrases related to such uncertainty in press reports) negatively correlates with trade at the global level. Trade-related uncertainty (a more specific indicator of trade tensions, based on reports by the Economist Intelligence Unit) was relatively low and stable for 20 years. As the China-US trade war escalated in 2019, it jumped tenfold from previous highs. The effects of this increased uncertainty are already visible. In August, as economic policy uncertainty reached a peak, worldwide export orders dropped to their lowest level since October 2012. The weakness of these forward-looking indicators suggests that uncertainty related to trade will continue to weigh on global commerce and output in the coming months. The WTO has recently lowered its forecasts for world trade. Merchandise trade growth in 2019 is expected to slow to 1.2%, down sharply from 3% in 2018 and 4.6% in the previous year. Trade is expected to pick up a bit in 2020, with moderate growth of 2.7%, but this would depend on a return to more normal trade relations.

Using the WTO Global Trade Model, a quantitative trade model used for medium-term projections, WTO economists have estimated the effects of a full-blown global trade conflict. In such a scenario, countries would raise tariffs on average by 32% from current levels. It is not a pretty picture: a 1.96% reduction in global GDP in 2022 (about 1.7 trillion dollars less) and a 17% reduction (or a decline of 3.9 trillion dollars) in global trade. For comparison’s sake, consider that global GDP fell about 2.1% and global trade 12.4% in the global financial crisis of 2008–9. Other academic studies have estimated that unconstrained trade conflict today could reduce GDP by more than what occurred during that crisis. And behind these aggregate numbers, the sectoral effects go into double digits in many countries. For instance, oilseed production in the United States is projected to fall by more than a third; motor vehicle production is projected to fall by 11% in the EU; and China is expected to suffer a 16% reduction in apparel production (Bekkers and Teh, 2019).

Households in economies large and small are being affected by the current trade tensions. There is already evidence that US tariff increases are being passed on to consumers, instead of forcing importers to lower the price they pay suppliers (Amiti, Redding and Weinstein, 2019; Fajgelbaum, Goldberg, Kennedy and Khandelwal, 2019; Cavallo, Gopinath, Neiman and Tang, 2019).

Cooperation or Fragmentation

In the absence of enforceable multilateral rules, it is conceivable that international trade will start to be increasingly governed by a patchwork of rules anchored in different regional trade agreements.

A world of diverging economic blocs would come with substantial costs. In the absence of shared rules and standards, businesses would have to spend money on complying with a wide variety of regulations if they wanted to trade outside their home bloc. Even within regional blocs, companies would have to deploy resources to prove compliance with rules of origin designed to keep out foreign inputs. Compliance costs would weigh heavily on larger businesses, and rule smaller businesses out of trade.

A multi-tiered regulatory world could emerge, in which some countries could be marginalised and the right of the strongest prevails. In principle, mutual recognition of standards could mitigate the negative trade effects of diverging regulatory standards. But there may be a lock-in effect when harmonisation occurs at the regional level, with large trade-diverting effects and reduced incentives for further liberalisation. There is also a scenario in which different standards are not interoperable, and efficiency gains—one of the core reasons to trade in the first place—are lost.

We are not yet in this fragmentation scenario. And if we make the right choices in the coming months and years, a brighter future awaits us. This will require updates to the WTO rulebook, much of which dates back to the Uruguay Round in the early 1990s—before the explosion of the internet or China’s accession to the WTO. Updating the system’s rules to keep up with the dynamic global economy it helped create would go some way towards easing the tensions surrounding trade.

The positive news is that WTO members are finding ways to advance. Reform has been moving forward since the 2013 accord on trade facilitation, and the expansion of the Information Technology Agreement two years later. At time of writing, members are working to harvest an agreement to curb fisheries subsidies. And since 2017, groups of like-minded members have come together to explore potential new rules on issues such as electronic commerce, helping small businesses to trade, and investment facilitation. These “joint initiatives” allowing countries who want to move forward—and those who want to wait—to do so.

Swiftly resolving the Appellate Body impasse will be critical to restoring certainty and cooperation to global trade relations. While multilateral consultations on a potential solution continue, some WTO members are exploring alternatives. Vietnam and Indonesia have agreed to abide by rulings made by initial panels in their disputes, without seeking to appeal. Meanwhile, the EU and Canada, as well as Norway and the EU, have agreed to an arbitration mechanism for bilateral disputes.

Conclusion

Estonia, for 15 years now a member of the EU, has been a strong supporter of rules-based trade and the WTO. For the WTO to continue serving as a basis for Estonia’s integration into the international economy, the ongoing reform process needs the vocal support of members such as Estonia.

The world needs this organisation more than ever. Without it, we would face a future of uncertainty, trade wars, lower growth, lower salaries and diminished job opportunities everywhere—in countries big and small, developed and developing. In our own national interests, we have to use this moment to strengthen global cooperation on trade.

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References

Amiti, M., Dai, M., Feenstra, R.C. and Romalis, J. (2017). “How did China’s WTO entry benefit US consumers?” (Revised title December 2018: “How did China’s WTO entry affect US prices?”). National Bureau of Economic Research Working Paper No. 23487.

Amiti, M., Redding, S.J. and Weinstein, D. (2019). “The impact of the 2018 trade war on US prices and welfare”. National Bureau of Economic Research Working Paper No. 25672.

Anderson, J.E. and van Wincoop, E. (2004). “Trade costs”. Journal of Economic Literature 42(3): 691–751.

Bagwell, K. and Staiger, R.W. (2002). “Economic Theory and the Interpretation of GATT/WTO”. The American Economist 46(2): 3–19.

Bekkers, E. and Teh, R. (2019). “Potential Economic Effects of a Global Trade Conflict”. WTO Staff Working Paper ERSD-2019-04.

Cavallo, A., Gopinath, G., Neiman, B. and Tang, J. (2019). “Tariff Passthrough at the Border and at the Store: Evidence from US Trade Policy”. National Bureau of Economic Research Working Paper No. 26396.

Fajgelbaum, P.D., Goldberg, P.K., Kennedy, P.J. and Khandelwal, A.K. (2019). “The return to Protectionism”. National Bureau of Economic Research Working Paper No. 25638.

Feng, L., Li, Z. and Swenson, D.L. (2017). “Trade policy uncertainty and exports: Evidence from China’s WTO accession”. Journal of International Economics 106: 20–36.

Handley, K. and Limão, N. (2017). “Policy Uncertainty, Trade, and Welfare: Theory and Evidence for China and the United States”. American Economic Review 107(9): 2731–83.

Jakubik, A. and Piermartini, R. (2019). “Share Benefits from Increased Market Access and Reductions in Trade Policy Uncertainty Following WTO Accessions”. WTO Internal Research Note.

Kummritz, V. and Quast, B. (2016). “Global Value Chains in Low- and Middle-Income Countries”. CTEI Working Papers 10-2016. Geneva: Centre for Trade and Economic Integration, The Graduate Institution.

Larch, M., Monteiro, J.-A., Piermartini, R. and Yotov, Y.V. (2019). “On the Effects of GATT/WTO Membership on Trade: They are Positive and Large after All”. WTO Staff Working Paper No. ERSD-2019-09.

Tang, M.K., and Wei, S.J. (2009). “The value of making commitments externally: Evidence from WTO accessions”. Journal of International Economics 78(2): 216–29.

World Bank Group (WBG), World Trade Organization (WTO), Institute of Developing Economies (IDE-JETRO), Organisation for Economic Co-operation and Development (OECD) and Research Center of Global Value Chains at the University of International Business and Economics (RCGVC-UIBE) (2017). “Global Value Chain Development Report 2017: Measuring and Analyzing the Impact of GVCs on Economic Development”. Washington, DC: The World Bank.

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