Trade Liberalization—The Global Approach

It is in the economic interest of countries to abolish tariffs and other trade restrictions, thereby liberalizing their foreign trade regime.

Yet it is a fact of political life that countries are extremely reluctant to do so, and that is mainly because the benefits from liberalization are thinly distributed among the millions of consumers, each paying a somewhat lower price, while the costs are heavily concentrated among firms and unions that lose protection from foreign competition. Reduction in protection appears to be as painful to a nation as tooth extraction is to the individual. Any country reducing its level of protection feels that it is giving away something valuable, and must obtain something in return from its trading partners. Tariff reduction and/or quota elimination came to be regarded as a concession to others, and is offered only when balanced by reciprocal concession. So the process has become a subject of prolonged international negotiations that usually last for years.

The organizational framework within which this bargaining is/was conducted is the International Trade organization (WTO), which superseded the less formal General Agreement on Tariffs and Trade (GATT), located in Geneva, Switzerland. Most United Nations members are also members of the WTO. The WTO is devoted to the promotion of international trade and the reduction of trade barriers. And since WWII, the GATT/WTO has conducted several sessions of tariff reduction known as “rounds,” under which average tariffs on industrial goods of most countries were reduced from 50 to under 5 percent. The United States occupied a leading role in the process. The last completed round of tariff reductions, known as the “Uruguay Round” was conducted during the years of 1986-1993, with the agreed tariff cuts of about 30 percent staged over five to eight subsequent years (as is usually the case). Current discussions at the WTO concentrate on non-tariff barriers. But the last session called the “Doha Round” was never brought to completion because of disputes between the member countries.

Apart from providing an institutional framework for the negotiations, the WTO also adjudicates the many trade disputes between member countries and oversees their compliance with trade rules. There are several trade rules such as the prohibition of export subsidies or the elimination of quotas on non-farm goods. But arguably the most important rule is prohibition of discrimination between sources of supply in international trade. This means that if the U.S. charges 3 percent tariff on, say, its car imports from one country, it must charge the same rate, and not higher, on car imports from all other countries. This is known as the Most Favored Nation (MFN) rule, which means that a country cannot charge a higher rate than it charges most favored suppliers.

It is easy to see that, as a signatory to this rule, the U.S. cannot charge a 45 percent higher tariff on Chinese or Mexican imports than it charges on imports from other trading partners, as suggested in 2016 by one presidential candidate. Such a size of duty increase is conceivable in anti-dumping or countervailing cases, but that applies only to an individual product or company, not to all imports from a country. But there are important exceptions to the rule, the most important ones being customs unions and free trade areas.

A Customs Union is two or more countries that abolish all or most restrictions on trade between themselves and set up a common and uniform tariff on imports from outsiders. The measure of discrimination against outsiders is the common external tariff. To qualify for an exception from the MFN rule, all or almost all restrictions on internal trade between members must be removed. There are dozens of customs unions around the globe; the most advanced one being the European Union of 28 European countries. They went well beyond a mere customs union and established free mobility of goods, services and people amongst themselves. They negotiate as one unit in the WTO, issue many social and economic regulations from their Brussels headquarters that affect the entire EU, and 19 of them formed a common currency, the Euro, and established a common Central Bank, The European Central Bank or ECB. A major issue facing the EU in mid-2016 is a vote in the U.K. on June 23 whether to exit the European Union. Such a move would have grave implications for the U.K., the EU, and the entire western alliance.

A Free Trade Area involves two or more countries abolishing all restrictions on trade amongst themselves (as in a customs union) but with each member retaining its tariff and other regulations on imports from outsiders. The measure of discrimination against non-members varies from one member country to another and equals the level of its protection on imports from outsiders. An important FTA involves the U.S., Canada and Mexico, known as the North American Free Trade Agreement (NAFTA).

Partly because of the failure of the WTO negotiations under the Doha Round, much attention is being paid to the regional approach to trade liberalization. It will be considered in next month’s column.

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Mordechai E. Kreinin

Mordechai E. Kreinin

Mordechai Kreinin is a University Distinguished Professor of Economics, emeritus at Michigan State University and past President of the International Trade and Finance Association. He is the author of about 200 articles and books about economics, including the widely used text, International Economics. He can be reached at kreinin@msu.edu or by cell phone at (517) 488-4837

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