Is the World Trade Organization Attractive Enough For Emerging Economies?: Critical Essays on the Multilateral Trading System

Is the World Trade Organization Attractive Enough for Emerging Economies?

Also by Zdenek Drabek CAN REGIONAL TRADING ARRANGEMENTS ENFORCE TRADE DISCIPLINE? GLOBALIZATION UNDER THREAT: The Stability of Trade Policy and International Agreements TRANSITION COUNTRIES AT THE CROSSROAD OF GLOBALIZATION AND REGIONALISM (Guest Editor) MANAGING CAPITAL FLOWS IN TURBULENT TIMES: The Experience of Transition Economies in Global Perspective (Co-editor) THE POLICY CHALLENGES OF GLOBAL FINANCIAL INTEGRATION (Co-author) REGIONALISM AND GLOBAL ECONOMY: The Case of Central and Eastern Europe (Co-editor) FINANCIAL SECTOR REFORM IN CENTRAL AND EASTERN EUROPE (Co-editor)

Is the World Trade Organization Attractive Enough for Emerging Economies? Critical Essays on the Multilateral Trading System Edited by

Zdenek Drabek

Selection and editorial matter © Zdenek Drabek 2010 Individual chapters © Contributors 2010 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6-10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2010 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN: 978–0–230–58184–5 hardback This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 10 9 8 7 6 5 4 3 2 1 19 18 17 16 15 14 13 12 11 10 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne

In memory of my parents

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Contents List of Illustrations

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Preface

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Acknowledgments

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List of Contributors

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Introduction Zdenek Drabek Part I

1

WTO Agreements – A Development-friendly Policy Instrument?

1. Development Implications of WTO Accession Procedures Will Martin 2. Toward A Development-friendly International Regulatory Framework for Foreign Direct Investment Theodore H. Moran 3. The WTO: A Sweet or Sour Chinese Banquet? Alice H. Amsden

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37 72

Part II WTO Membership and Economic Cooperation (Accession and Impact on Policies) 4. Effects of WTO Accession on Policymaking in Sovereign States: Lessons from Transition Countries Zdenek Drabek and Marc Bacchetta 5. Policy Anchors: Do Free Trade Agreements and WTO Accessions Serve as Vehicles for Developing-country Policy Reform? Michael J. Ferrantino 6. Regional Trading Arrangements and WTO Membership: Substitutes or Complements? Richard Pomfret

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Contents

Part III Impact of the WTO on Trade Flows of Goods 7.

8.

The Effect of Membership in the GATT/WTO on Trade: Where Do We Stand? Andrew K. Rose

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Does WTO Membership Make a Difference at the Extensive Margin of World Trade? Gabriel Felbermayr and Wilhelm Kohler

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Part IV Broader Costs and Benefits of WTO Membership 9.

Who Should Join the WTO and Why?: A Cost-benefit Analysis of WTO Membership Zdenek Drabek and Wing Thye Woo

10. The WTO Dispute Settlement System: How Have Developing Countries Fared? William J. Davey

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11. Costs of Implementation of WTO Agreements Sam Laird

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Index

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Illustrations Tables 1.1

Maximum final bound tariffs in agricultural and nonagricultural products 1.2 Cuts in simple average agricultural tariffs (%) 1.3 Cuts in simple average nonagricultural tariffs (%) 1.4 GATS commitments and EBRD measures of actual services liberalization 3.1 GDP growth rates and GDP per capita growth rates 4.1 Bound and applied import tariffs in selected transition countries 4.2 Indices of institutional quality, 1997–98 4.3 Indices of corruption, 1999 4.4 Measures of administrative corruption 4.5 Inward FDI stocks in transition countries, 1995–99 (as a percentage of GDP) 4.6 Tariff revenues in transition countries, 1991–99 (in percentage of imports) 4.7 Share of international trade taxes in total government revenues (as a percentage) 4.8 Costs of World Bank projects related to the implementation of three WTO Agreements Annex 4.1 WTO: Dates of accession and membership of transition countries 5.1 Timeline for U.S. FTAs 5.2 Completed WTO accessions as of December 2005 5.3 Distribution of time and complexity of accessions 5.4 Ongoing WTO accessions as of August 2006 5.5 Initial values of “Governance Matters” indicators 5.6 Observed changes in “Governance Matters” indicators 5.7 Difference of means tests 5.8 Summary of significant changes in governance indicators 5.9 Heritage Foundation scores 6.1 RTAs notified to the WTO in 2005 7.1 Replicating the impact of joint GATT/WTO Membership on bilateral trade 7.2 Benchmark estimates, effect of GATT/WTO Membership on bilateral trade ix

23 28 29 31 78 102 106 109 110 112 114 117 121 131 144 148 150 152 160 162 164 166 168 182 199 202

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Illustrations

7.3 7.4

Aggregate openness and GATT/the WTO Trade policy and GATT/WTO Membership: Panel measures 8.1 Existence of trading relationships: Multinomial logit estimates 8.2 Number of trading relationships: Poisson regression (panel estimates) 8.3 Export concentration as a function of WTO Membership and other covariates 8.4 Cross sectional estimation of the gravity equation 8.5 Panel estimation of the gravity equation Appendix 8.1 Summary statistics for Table 8.5 9.1 Cost of SPS-related World Bank projects 9.2 Costs of customs reform projects in selected countries 9.3 World Bank projects related to Intellectual Property Rights 9.4 Implementation costs of TRIPs-related activities 9.5 Costs of WTO-related projects in selected developing countries (In millions of current US dollars and as percentages of public expenditure on education) 9.6 Summary of key commitments by the Chinese government on WTO Membership 9.7 The ten most promising destinations for manufacturing FDI by Japanese TNCs over the following three years (Frequency, expressed as a percentage of a country’s identification by Japanese firms responding to annual surveys conducted by Japan Bank for International Cooperation, JBIC) 9.8 Survey undertaken in October 2001 of the 21 percent of Japanese TNCs that intend to move to China because of China’s accession to the WTO (survey by Japan External Trade Organisation, JETRO) 10.1 Result of disputes with consultation request prior to July 1, 2002 10.2 Unimplemented/contested disputes 11.1 Development dimensions of major WTO rules and disciplines

206 208 229 230 231 236 238 243 263 264 265 266

269 273

278

280 303 304 335

Figures 1.1 1.2

Simple average tariff rates in developing countries (%) India: Taxation of exports 1986–1997

17 20

Illustrations

1.3 5.1 5.2 7.1 7.2 7.3 7.4 8.1 8.2 8.3 8.4 8.5 8.6

GATS commitments compared to actual liberalization of services Mexico: FDI, net inflows, billion nominal dollars (Logarithmic Scale) Initial values, “Governance Matters” indicators Effect of GATT/WTO entry on aggregate openness, (X+M)/Y (+/–5 years around entry of 104 countries) Effect of GATT/WTO entry on trade policy Terms of trade at Uruguay round completion (Barter Terms of Trade, WDI, 2000 = 100) Terms of trade during 4 GATT Rounds The “corner-solutions” model of bilateral exports Potential export relationships 1966–2004 Potential bilateral relationships 1966–2004 Share of “trading vintages” in 2004 world trade Concentration of export destinations – Herfindahl index Transition probabilities for active/dormant trading relationships

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32 154 159 207 209 211 212 225 226 227 228 231 232

Boxes 4.1 Mongolia’s policy in the cashmere sector 4.2 Implementation of TRIPs Agreement in selected transition countries 4.3 Market disruptions in Moldova 9.1 Costs of foreign contingency measures for small firms: A case study of the shrimp industry in India 9.2 Costs of foreign contingency measures for industry: A case study of Pakistan

119 122 124

267 268

Preface Even though the title of this book contains the words “critical essays,” the book is not intended to be an attack on the World Trade Organization. On the contrary, we hope that the book will help strengthen the whole multilateral trading system by addressing some of the main criticisms against it. Most, if not all, of the contributors to this book are strong believers in the multilateral trading system and have worked hard to strengthen the design of multilateral rules and disciplines as well as their implementation. Some of us have taken our beliefs as far as our own professional careers by spending years working for the institution – in the Secretariat or as negotiators. In support of the WTO, we have for years been explaining to countries around the world the “10 Reasons Why Countries Should Join the WTO,” to paraphrase the infamous little WTO Secretariat’s pamphlet, which was distributed around the world. Admittedly, the pamphlet and the reasons presented in it were somewhat simplistic and naïve but we all believed in “The Public Good” that the WTO is supposed to deliver. However, whether it was because of weaknesses in the powers of persuasion of the presenters or the simplistic presentation of the pamphlet, our messages often missed their targets and did not have the desired effects. We continually encountered bursts of pessimism or outright skepticism about the benefits of the WTO and, mainly, its contribution to countries’ economic welfare. Then, when the academic profession joined in the debate with the controversial writings of professors Rose, Rodrik, and Amsden and highly erudite observers such as Mike Finger, a long-time supporter of free trade and the WTO, the picture began to change. Some of us realized that we needed a fresh look at the WTO system of rules and disciplines and the WTO negotiations, and that we also needed more work to affirm the true contribution of the WTO to countries’ economic welfare. In no other area of the multilateral trading system was the controversy about the role of the WTO more evident than in the links between the WTO and its contribution to the economic welfare of emerging economies and other developing countries. The criticism that most of us encountered had one common thread – it typically came from the emerging economies or from economists and other development specialists writing about problems of economic development. So, when the idea came up to put together the present collection of papers, it was inevitable that our concerns about the WTO must address the main concerns of developing countries. Those are (1) controversies about the contribution of the WTO to development, (2) the perception that the WTO negotiations are dominated by interests

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of rich countries, and (3) that the WTO is not an institution/instrument suited to being development -friendly. The contributions to this volume have one or more of those concerns as their main objective. The selection of contributions for this book by the editor was also driven by those concerns. The editor’s original idea was to include other chapters that would have further enriched the volume and enhanced the debate. Unfortunately, those plans could not be realized in the end, partly for personal and partly for financial reasons. However, we do hope that the book will at the very least reignite the debate about the role of the WTO: what it can and what it cannot do, what it does and what it does not do. We have witnessed a great deal of misunderstanding in those debates on the role of the WTO in opening new markets, stimulating efficiency and investment, attracting foreign investment, or affecting countries’ public choices – to name just a few key issues of economic development. These misunderstandings should be clarified as a matter of priority if the multilateral trading system is to survive. We also hope that the volume will provide new arguments and empirical evidence concerning the effects of the WTO on trade flows and about the prospects for emerging economies in multilateral trade negotiations and in the governance of the multilateral trading system.

Acknowledgments It is not usual to start with acknowledgments to contributors to a book but my expression of gratitude to contributors to this project is necessary. I am very grateful to all my friends and colleagues who have worked so hard to make this book a success. Unfortunately, they had to wait far too long to see the excellent products of their creative work in print. Some of the responsibility for the delay falls on my shoulders, as I was juggling several pieces in the air at the same time – as I have done all my life. Mea culpa. But most of the delays were beyond my control, which made the editorial work even more frustrating. We had to struggle with illnesses, job changes, misunderstandings, and overcommitments. I am deeply grateful to all the contributors for their patience, perseverance, and good spirits throughout the period when the book was in preparation. For all that – my most sincere thanks. Putting this book together was almost a single-handed effort by one person – without any institutional support, unlike other studies of this kind – and without any research and administrative budget. The project was launched with five papers that were presented at my panel at the Annual Meetings of the American Social Science Associations in Philadelphia, and the rest of the chapters were added to this volume on invitation. But I would never have succeeded without a support of others. Professor J.C. Brada of Arizona State University stepped in in the last minute to chair the abovementioned panel in Philadelphia, which I could not in the end attend because of a lack of funds from the WTO, my employer at the time. The panel received so much positive attention at the time I decided to expand the work of the panel into the present project. A substantial part of my administrative duties was carried out by Alex Riechel, a young and talented economist who took some time off in between his studies and his first big job as a stagier at the WTO. He was by far more than my assistant – undertaking proofreading, formatting, corresponding, and performing other functions of the editor. He was also very helpful in providing the empirical evidence for one of the chapters in this volume. All that effort was put in pro bono, for which I am very grateful and in his debt. Unfortunately, his time with me had to end in order to allow him to pursue his own career which left me in “the deep editorial waters” alone. I wish I could say how much I have benefited from the support of the WTO itself. Unfortunately, I cannot do so. Research continues to struggle within the WTO Secretariat, and the little that does exist is clearly directed toward meeting other aims and is more a matter of survival. However, I did benefit from individual encouragement and stimulating discussions with some of my former WTO colleagues including Jesus Seade, former Deputy xiv

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Director General of the WTO; Bill Davey, who has also contributed to this volume; Richard Eglin; Petros Mavroidis; John Hancock; and, of course, Marc Bacchetta, co-author of one of my chapters in this volume. I am particularly grateful to Marc who made me start thinking seriously about the problems discussed in this book. On the other hand, I could not wish for more from my family in this regard. My wife Sylvie, daughter Bianca, and son Alexandre could have justifiably claimed the time spent on this book for family activities but they did not. For that I am obviously greatly indebted to them and, for that reason alone, the book is also dedicated to them.

Contributors Zdenek Drabek (Editor) was a Senior Adviser at the World Trade Organization. Previously, he was a founder and chairman of Department of Economics at the University of Buckingham and co-founder of Joint Vienna Institute, a training institute of the World Bank, IMF, BIS, OECD, WTO, and EBRD. He taught at other academic institutions including the University of Oxford and the University of British Columbia and is presently a member of the Academic Advisory Board in the Faculty of Social Sciences of Charles University. He served as Chief International Trade and Finance Negotiator for the Czechoslovak Government (the Europe Agreements with the EU and in the Uruguay Round of GATT). Prior to his government appointment, he worked as a senior economist at the World Bank. He has been published widely in major professional economics journals and authored or co-authored 11 books. His latest books are Globalization under Threat and Can Regional Trade Agreements Enforce Trade Discipline? Alice H. Amsden is the Barton L. Weller Professor of Political Economy at MIT. She has served as a consultant with the World Bank, OECD, and various United Nations organizations and has written extensively on problems of industrial transformation in East Africa, East Asia, and Eastern Europe. Her recent publications include Beyond Late Development: Taiwan’s Upgrading Policies (2003, with Wan-wen Chu) and The Rise of “the Rest”: Challenges to the West from Late-Industrializing Countries (2001). She has been awarded the Leontief Prize for Advancing the Frontiers of Economic Thought by Tufts University’s Global Development and Environment Institute and named one of the Top 50 Visionaries by Scientific American. Marc Bacchetta is a counselor in the Economics Research and Statistics Division of the World Trade Organization, which he joined in 1996. Between 2002 and 2004, he worked at the World Bank Institute while on leave from the WTO. He holds a PhD from the University of Geneva, where he taught economics for six years. His research focuses on market access, adjustment to trade reforms, and accession to the WTO. William J. Davey holds the Guy Raymond Jones Chair at the University of Illinois College of Law, where he has taught since 1984. From 1995 to 1999, he was the Director of the WTO’s Legal Affairs Division. He is the author of Legal Problems of International Economic Relations (2002, with Jackson and Sykes), European Community Law (2002, with Bermann, Goebel and Fox), Pine & Swine: Canada-United States Trade Dispute Settlement (1996), and Handbook of WTO/GATT Dispute Settlement (1991–2000, with Pescatore xvi

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and Lowenfeld), as well as many articles on various international trade law issues. He serves as Associate Editor of the [Oxford] Journal of International Economic Law. Gabriel Felbermayr received his PhD in Economics from the European University Institute in Florence (Italy) in 2004. He has held teaching and research positions at the Universities of Linz (Austria) and Tübingen (Germany). His research focuses on the theoretical and empirical analysis of economic growth, as well as international trade and factor flows, and is published in international scholarly journals. In 2007, his work on transport infrastructure and trade was awarded the first Reinhard Selten Prize by the German Economic Association. In 2008, he joined the Department of Economics at University of Hohenheim (Germany). Michael J. Ferrantino received his BA from Northwestern University in 1980 and his PhD from Yale University in 1987. He joined the U.S. International Trade Commission in 1994, where he is currently Lead International Economist. His published research has focused on empirical topics in international economics, including non-tariff measures and trade facilitation, trade and environment, technological change, foreign direct investment, and intellectual property. His most recent book, “Quantitative Methods for Assessing The Effects of Non-Tariff Measures and Trade Facilitation,” co-edited with Philippa Dee, was published in 2005 by World Scientific Press for APEC. He has served on the faculties of Southern Methodist and Georgetown Universities. Wilhelm Kohler is Professor of International Economics at Eberhard Karls University Tübingen, Germany. He has previously held positions at Johannes Kepler University Linz, Austria, and the University of Essen, Germany. His research is focused on the theory of international trade and the economics of migration. He has published widely in scholarly journals on a variety of issues, such as quantifying the welfare effects of trade liberalization; the economic effects of accession to, and enlargement of, the European Union; and on the welfare and wage effects of international migration and offshoring. Sam Laird is Special Professor of International Economics at the University of Nottingham, a member of the academic council of the Trade Policy Centre for Africa where he is Visiting Professor. He is also a consultant for several international organizations and NGOs. He was formerly a senior economist with UNCTAD, the World Trade Organization, and the World Bank, as well as with the Australian Industry Commission. He has published extensively on trade policy, most recently on the experiences of developing countries in adjusting to trade reform. Will Martin specializes in analysis of trade policy reforms in developing countries, with an emphasis on reforms related to the WTO, and a regional

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focus on East and South Asia. He has written extensively on policy reforms in agricultural trade, textiles and clothing, and nonagricultural trade generally. He has a particular interest in using detailed data on trade barriers to build up a complete picture of the effects of trade barriers on trade and welfare. He has published widely in journals, and several books, including recent studies of global trade reform and of China’s accession to the WTO. Theodore H. Moran holds the Marcus Wallenberg Chair and Professor of International Business and Finance at the School of Foreign Service, Georgetown University. Dr. Moran is founder and Director of the Landegger Program in International Business Diplomacy. His most recent books include Does Foreign Direct Investment Promote Development (ed., 2005, with Blomstrom and Graham); International Political Risk Management: The Brave New World (ed., 2004); Beyond Sweatshops: Foreign Direct Investment, Globalization, and Developing Countries (2002); International Political Risk Management: Exploring New Frontiers, ed. (2001); and Foreign Investment and Development (1998). Richard Pomfret has been Professor of Economics at the University of Adelaide since 1992. He was previously Professor of Economics at the Johns Hopkins University School of Advanced International Studies in Washington, D.C., Bologna, and Nanjing. Professor Pomfret has acted as adviser on Central Asian topics to various international organizations (ADB, UNDP, ESCAP, and the World Bank). He has written 17 books, including Investing in China 1979–1989 (1991), The Economies of Central Asia (1995), The Economics of Regional Trading Arrangements (1997; paperback edition 2001), Constructing a Market Economy: Diverse Paths from Central Planning in Asia and Europe (2002), and The Central Asian Economies since Independence (2006). Andrew K. Rose is the B.T. Rocca Jr. Professor of International Business in the Economic Analysis and Policy Group, Haas School of Business at the University of California, Berkeley. He is also a Research Associate of the National Bureau of Economic Research and a Research Fellow of the Centre for Economic Policy Research. He has published around 60 papers in refereed economics journals, including the American Economic Review, the Quarterly Journal of Economics, the Review of Economic Studies, and the Journal of Finance. He was the managing editor of The Journal of International Economics from 1995 through 2001, and has been the faculty director of the Clausen Center for International Business and Policy at Haas since 1994. Wing Thye Woo is Professor in the Department of Economics, University of California at Davis. He is also Chang Jiang Professor at the Central University of Finance and Economics in Beijing, Senior Fellow at the Brookings Institution, and Director of the East Asia Program in the Center for Globalisation and Sustainable Development at Columbia University. He has published more than 100 articles in professional economic journals and

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books on economic issues of East Asia, international financial architecture, economic growth, and exchange rate economics. Professor Woo has advised a number of governments on macroeconomic and exchange rate management, state enterprise restructuring, trade issues, and financial sector development.

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Introduction Zdenek Drabek

I.1 “Problems, Misunderstandings, and Neglected Stories about WTO” The World Trade Organization (WTO) has been seen as one of the most important achievements of international economic cooperation in the postwar period. Membership of the WTO and of its predecessor, the General Agreement on Tariffs and Trade (GATT) has dramatically expanded over the years, and the organization now includes all of the larger countries with the exception of Russia, which is still negotiating its accession. The main attractions of the WTO are seen by their protagonists to be twofold – the WTO represents a platform for multilateral negotiations to improve access to markets for countries’ exports and to establish a set of legally binding trade rules and disciplines. The former expands the opportunities for countries’ exports and thus leads to improved conditions for economic growth. The latter provides for increased transparency and predictability of countries’ policy commitments – features that are of considerable importance for newcomers into world markets and for avoiding policy “backsliding.” However, not everything is as rosy as one would expect from the optimism of supporters of the WTO. Multilateral negotiations are becoming extremely slow and it is increasingly difficult to achieve consensus – the guiding principle of the WTO governance. There is visibly a considerable resistance on the part of many countries to concluding multilateral agreements without far stronger commitments by WTO Members to “special and differentiated” treatment for developing countries or without addressing the concerns of other WTO Members. There has been considerable disappointment among developing countries concerning their gains from trade following the liberalization of their trade regimes. Many countries have complained that the gains from trade have been far smaller than the countries had been “promised” or led to believe by politicians as well as by econometric forecasters in the final stages of the Uruguay Round negotiations. In brief, many WTO Members are not in a hurry to conclude the current Doha Round to 1

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the frustration of other members who have a strong interest in pushing the negotiations at a faster pace. In addition to the open discontent of a large number of countries with the existing multilateral trading system, the latter has been subject to a growing controversy even in the academic literature. The most serious criticism of the WTO has been targeted at four distinct areas of issues. First, the impact of the WTO accession/membership on policymaking, involving complaints by critics about the loss of sovereignty and policy independence of WTO Members.1 More specifically, the critics argue that membership of the WTO leads to a considerable reduction of space for policymaking, thus undermining poor countries’ abilities to design their progrowth and prodevelopment strategies. Second, the importance of the WTO as an instrument of international cooperation has been challenged in practice by the emergence and proliferation of regional trading arrangements. What is particularly surprising is that the WTO has not been more strongly defended by small emerging economies that have, one would have thought, most to lose from a weak multilateral trading system and from the pursuit of regional arrangements among more powerful developed countries.2 Third, the impact of the WTO Membership on trade flows is seen by some observers as negligible at best. The debate has been fuelled by extremely erudite writings of Professor Andrew K. Rose, who has found some support among his academic colleagues.3 Their arguments have been controversial and have led to a lively and divisive debate among both academics and policymakers. Finally, the advantages of WTO Membership have never been effectively supported by empirical evidence. There is clearly a great lack of information that would otherwise support the position of “multilateralists,” who have relied primarily on contributions and conclusions of economic theory. Fourth, some observers have been highly critical about the implementation requirements of WTO rules, which lead to high administrative costs for WTO Membership. Some of them have suggested that the costs of implementing WTO Agreements are “excessive” to the extent that they cost seriously jeopardize the developmental priorities of poor WTO Members. Others have criticized other financial implications of WTO Membership, thus casting doubt on the claims that such membership is unambiguously beneficial for countries. Notwithstanding a large number of newspaper articles, the publicity surrounding the failed WTO Ministerial Conferences in Seattle and Cancun, and frequently held public demonstrations against the WTO, there is a surprising dearth of a serious and critical analysis of the multilateral trading system in response to its critics. The debate has been almost entirely focused on problems of globalization or a variety of issues related to trade policy.4 The relatively new WTO system and agreement is only now receiving the specific attention of observers.

Introduction 3

I.1.1 The main questions and aims of the book This book will address some of the main concerns of critics of the WTO. Even though such criticism has come from different corners, the book will chiefly address those issues that are primarily related to interests of countries in emerging economies. It is the criticism of the WTO by these countries that is most serious and profound. The book concentrates on the elements of the criticism stated above. We ask the four following sets of questions: 1. “Do WTO Agreements seriously jeopardize the development objectives and policies of emerging (poor) countries and their ability to conduct independent trade and other economic policies?” This question is asked in response to the critics of WTO who call for more policy space for poor countries. 2. “What has been the pattern of WTO negotiations from the perspective of interests of small emerging countries? Does the outcome of the negotiations actually explain the reason why the multilateral trading system is not more strongly supported by small emerging economies? Could this be also the reason why those countries have embarked more actively on the formation of regional trading arrangements?” 3. “Do countries actually benefit from their WTO Membership in terms of improved trade performance? Given the controversy about those benefits in the academic literature, has the debate been advanced in addressing the most controversial issues?” 4. “Can we provide more convincing empirical evidence about the relative benefits of WTO Membership especially by looking more deeply into the question of the implementation costs? What other costs and benefits accrue from WTO Membership and how significant are they?” These four sets of questions give four separate but interdependent themes to the book – (1) “policy space,” (2) structure of multilateral trade agreements, (3) the impact of WTO on trade flows, and (4) other costs and benefits of WTO Membership. It is hoped that the book will give a better understanding of the role of WTO Membership in shaping development policies in developing and transition countries. The second objective of the book is to advance the debate about the net benefits of WTO Membership. This will be done by providing more empirical evidence, new arguments, and serious reviews of the debates. In contrast, we are not addressing issues raised by the critics with regard to specific WTO rules such as rules of origin, sanitary and phytosanitary measures (SPS), technical barriers to trade (TBT), etc. These issues are of a considerable importance and deserve their own space and a separate discussion. I.1.2

Approach

The effect of WTO Membership can be studied at both empirical and descriptive levels. Both are adopted in the book. The effect of the WTO

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on countries’ performances and their policies is to a large extent an empirical problem, which is the reason for adopting an approach that is partially based on empirical studies. However, an assessment of policy space in the WTO system of rules, disciplines, and governance also requires a rather different kind of analysis. For example, all three categories of the WTO system can generate various incentives that must be identified and assessed descriptively and analytically. Similarly, the rules and disciplines can perform regulatory functions that also require the adoption of a rather specific approach to analysis. This book is a collection of papers/studies on the four separate and distinct themes and subjects noted above. The book is not a text written by a single person as a free-flowing argument but is written by different scholars. Four of the chapters were prepared as invited presentations to the 2006 ASSA/AEA Meeting in Philadelphia. The rest of the chapters are all original in that they have been prepared specifically for the book.5 Notwithstanding some theoretical and descriptive parts of the project, most of our contributions are based on empirical analysis. We believe that the more empirical evidence is provided about the problems at hand, the further the debate about WTO can be advanced. The empirical chapters partially cover assessments of the effects of membership on trade flows but this approach is also adopted in a number of other chapters. However, only one chapter involves a fairly technical reading, since its author uses modern econometric techniques. All of the chapters are written by economists, with the exception of one chapter written by an international lawyer.

I.2 WTO Agreements – effects of WTO Membership on policymaking in emerging markets Much has been already said and written about the impact of WTO on policymaking. The issue is extremely broad and complex and can be addressed in different ways and styles. All of those approaches would justify a study of their own, which clearly would be beyond the scope of this book. In order to advance the debate, we have decided to narrow down our discussion of the issue even further. The impact of WTO Membership on policymaking is studied by looking at three different aspects of the WTO system. First, we provide an empirical assessment of the terms and conditions of recent accessions of sample of countries. Drabek and Bacchetta look at the conditions under which transition countries acceded into the WTO. The conditions include, for example, commitments concerning access to markets for goods and services, protection of intellectual property rights, food safety, regional trading arrangements, etc.6 Second, we examine the extent to which membership of the WTO and free trade agreements (FTAs) of countries represent “vehicles” for policy reform. In other words, we examine whether WTO Agreements can be seen as “policy

Introduction 5

anchors” or whether they are completely independent of the domestic political process. Michael J. Ferrantino and Professor Richard Pomfret look at the different trade agreements of a large sample of countries and relate them to processes of economic reforms in those countries. M. Ferrantino’s main findings include the following: (1) U.S. FTAs are generally negotiated much more quickly than WTO accession; (2) the length of time it takes to negotiate an FTA or accession varies widely and agreements between larger economies and economies with weaker initial policies appear to take longer; (3) recent U.S. FTA partners begin negotiations with a stronger policy environment than recent WTO accession candidates, indicating a selectivity phenomenon; (4) an analysis using the World Bank’s “Governance Matters” indicators shows no apparent relationship between the period of negotiation or engagement and improved governance, while the trade component of the Heritage Foundation’s Index of Economic Freedom does show a consistent pattern of improvement, but other subindicators are likely to deteriorate; and (5) particular experiences are likely to be highly country specific. The set of chapters looking at WTO Agreements from the perspective of their impact on domestic policymaking and “policy space” also includes a chapter by Will Martin of the World Bank, who looks at specific provisions of WTO Agreements and the extent to which they can be perceived as “development friendly.” His chapter suggests a focus on the impacts on development of accession under which binding commitments to reform may have a strong payoff but there is a need to be sensitive to the need for experimentation and to the costs of positive trade integration measures in acceding countries. The inclusion of measures allowing existing members to impose new barriers against acceding members raises serious concerns on equity and development criteria. Data from actual accessions suggests that trade liberalizations necessitated by accession were relatively small, except in a few countries with relatively high initial barriers.

I.3

The role of multilateral trade and investment cooperation

While one set of chapters looks at the question of WTO Agreements from the perspective of the impact of the WTO on domestic policymaking and “policy space” (viz. the discussion above), another set of chapters examines the reasons why countries enter into cooperative arrangements despite the fact that they will actually lose some of their “policy space.” WTO Agreements have been subject to mounting criticism by opponents of the WTO. The criticism has been of a particular type. Some critics have targeted the structure of the agreements, which they find biased against the interests of developing countries. Other critics question the agenda of current negotiations, on the same grounds.7 Thus, rather than looking at the agenda of the negotiations and agreements, our approach is to look at WTO Agreements as an instrument of international cooperation.

6

Zdenek Drabek

Professor Alice H. Amsden offers an unconventional look at assessing international agreements. She assesses the role of international cooperation from the perspective of political economy and the role of international bargaining. What she is essentially saying is that the development “friendliness” of WTO rules can be assessed by reviewing the forces that lead to the adoption of those rules in multilateral trade negotiations. She provides an analysis of political forces in the formation of some of these rules and points out the critical role of hegemonic powers in international negotiations. The additional issue that may affect the perception of international cooperation is the question of the type of international trade agreements. There is clearly a considerable difference between regional and multilateral agreements and the way in which they establish trade rules and disciplines. There is also a great deal of difference between both classes of agreements in terms of coverage of countries. Professor Richard Pomfret of University of Adelaide contrasts the multilateral trading system with regional cooperative arrangements by assessing the role of the latter as complements to, rather than substitutes for, the multilateral trading system. The author concludes that Regional Trade Agreements (RTAs) have generally proved to be poorly suited to promoting trade liberalization and have created, rather than resolved, trade disputes No assessment of international trade agreements from a “development” perspective would be complete without an analysis of international agreements linking trade and investment. Unfortunately, most studies of the WTO system from a development perspective have basically excluded any substantive treatment of international cooperation in the area of foreign investment. Perhaps the best known study of the kind is a paper by Professor Srinivasan but his work, like that of other researchers, has not looked at the possibilities for establishing a multilateral instrument to regulate foreign direct investment (FDI) from the perspective developing countries.8 Such an assessment is offered in this book by Professor Moran of Georgetown, who proposes an “ideal” international investment agreement that contains strong development provisions.

I.4 Empirical assessments of costs and benefits As noted above, empirical studies of the trade effects of the WTO started with a highly controversial study by Professor Andrew K. Rose of UCLA, Berkeley, who did not find any statistically significant evidence of a positive contribution by the WTO to growth of trade. Since the publication of the original study, several researchers have attempted to reestimate the effects including, for example, Shang Ji Wei, Subramanian, Jeffrey Frankel and others who have tried to fine tune the modelling exercise. Some of them have reached somewhat different conclusions, while others were more in line with Rose’s findings. The debate clearly continues.

Introduction 7

The contribution of this book to the debate is (1) to bring all the arguments and empirical evidence together, (2) to asses the state of the debate, and (3) to provide additional evidence in support of Rose’s findings. The book includes two chapters in which the authors look at different aspects of the debate. Professor Rose offers a review of the debate with a view to identifying the differences in positions and the weaknesses in the argumentation, modelling and data collection. Professors Kohler and Felbermayr offer a new “look” at the empirical evidence in an analysis of the effects of trade agreements on trade flows with the help of a novel methodology based on the so-called “extensive and intensive trade margins.” The authors provide some heuristic evidence and then base this model on a comprehensive panel data set, relying on Tobit estimation. They find that WTO Membership has been promoting, inter alia, world trade to a larger extent than Rose’s (2004) results seem to indicate. The impact of WTO is further assessed in the book with the help of other empirical studies. Drabek and Woo offer a cost-benefit analysis of WTO Membership, in which the focus is on the question of costs – an issue that has historically been neglected in debates. They address broader questions of the costs and benefits with the help of new data and some further evidence. The chapter is the first attempt of its kind to try to asses the costs and benefits arising from WTO Membership. The study is based on detailed evidence provided in some 40 country case studies that have been recently published by Cambridge University Press. However, the Cambridge study only provided detailed “country experiences” and made no attempt to evaluate the case studies in any systematic manner. In addition, the book includes a chapter in which Professor William J. Davey of the University of Illinois looks at the performance of one of the most attractive functions of the WTO – the trade dispute mechanism. The heart of the chapter considers the experience of developing countries in the system of dispute resolution and a preliminary evaluation is made in terms of how they have fared (1) in the specific cases in which they were involved and (2) in advancing their major trade policy concerns on both a subject and country-by-country basis. The chapter then briefly considers several possible reforms to the WTO system that would be of particular interest to developing countries. In other words, he is basically asking the fundamental question about the WTO – whether members have used the system effectively and benefited from it. He shows that developing countries have been to a large extent “losers” in that respect and provides his explanations of this phenomenon.

I.5

Where do we go from here?

Much of the literature concerning the link between WTO and emerging markets has been in the form of handbooks, pleas for changes to the existing multilateral trading system, or, at best, critical and analytical papers

8

Zdenek Drabek

addressing a very specific but narrow set of issues concerning the WTO. This book is an attempt to deal with broader criticism of the WTO in an analytical and polemical yet nonpartisan way. We hope that the book will advance the debate about the WTO among policymakers and trade analysts. It has been our intention to provide new empirical evidence about the costs and benefits of WTO Membership and an up-to-date review of the current state of the debate and the new treatment of trade flows generated by trade agreements. Similarly, the book includes a highly original work about the role of WTO Membership as a policy anchor – an issue that has to the best of our knowledge never been addressed in the academic literature. We also hope that this collection of essays is policy relevant and that the book will have interesting and useful policy messages. The study of the impact of the WTO on policymaking is relatively new and controversial among researchers and yet critical to policymakers. It is a fact that many policymakers in developing and transition countries believe that the WTO imposes highly restrictive rules that seriously impinge on their countries’ sovereignty and their ability to pursue independent development policies. Others basically argue the opposite – that the WTO tends to provide incentives for countries to adopt low standards – a “race to the bottom”. Perhaps the first ever study of those issues was Drabek and Bacchetta, which is reprinted in the book from the academic journal in which it first appeared. Moreover, questions about costs and benefits of WTO Membership must surely be of immense importance to all policymakers. A better understanding of why international trade agreements are signed is another area of concern to governments. The segment of the book dealing with the linkage between WTO rules and economic development is, therefore, highly policy relevant. Contrary to the standard perceptions and arguments of developing countries, policy space is not necessarily reduced as a result of accession to the WTO. As shown by Drabek and Bacchetta the conditions under which many developing countries have joined the WTO have been fairly loose – viz. low levels of bindings, WTO commitments far less “liberal” than actual policies pursued by those countries, and special provisions for least developed countries and other developing countries, etc. However, experiences are mixed as the examples of China and a host of other countries demonstrate. Even if policy space is reduced as a result of WTO accession, this may not necessarily be harmful for countries, as Martin argues in his chapter. “a bitter pill” is sometimes better than none at all. Further support comes from empirical evidence that has actually not been included in the collection of essays in this book. For example, Wei has recently argued, consistently with Martin, that countries acceding to the WTO under “harsher conditions (GATT Article XVIII) as compared to those acceding on the basis” of GATT Article XXVI have had a much better trade performance.

Introduction 9

On the most controversial issue of all – the effects of WTO Membership or accession on trade flows – the evidence continues to be mixed. The conclusion reached in this volume by Martin is somewhat similar to that of Rose, but fundamentally different from the conclusions of other mainstream economists. The issue remains as controversial as it has been until now and the dispute is not resolved. WTO Membership and accessions have generally been seen primarily from the perspective of their benefits to countries. However, as this and other studies show, WTO Membership also involves costs and these may be quite significant. The costs will clearly have to be considered not only by emerging economies but also but their “rich” counterparts. The former must assess the costs and the financial implications. The latter should consider ways in which they could better facilitate the former countries’ implementation of their commitments – through technical assistance and additional funding – and their response to the better access to external markets resulting from WTO Membership. However, the jury is still out on some of the controversial issues. The debate will undoubtedly continue about the empirical evidence and about the linkages between trade and development policies. The debate is not just desirable but also vital for the survival of the existing multilateral trading system. Given the collapse of the Doha Round in the summer of 2008 all of these issues have become even more interesting and important than they were when the debate started. In addition, given the proliferation of regional trading arrangements, a sensible resolution of those issues is even more critical for the survival of the WTO.

Notes 1. See, for example, Hoekman (2005a and 2005b) and Gallagher (2006). 2. Much of this argument has been widely publicized and discussed in the writings of Jagdish Bhagwati, Richard Cooper, and many others. 3. Professor Rose’s original articles were “Do We Really Know that the WTO Increases Trade?” NBER Working Paper No. 9273. Cambridge, Mass.: National Bureau of Economic Research (subsequently published in American Economic Review) and “Do WTO Members have More Liberal Trade Policy?” NBER Working Paper No. 9347. Cambridge, Mass.: National Bureau of Economic Research. For full references please see Chapter 6 below. 4. See, for example, Rodrik (1997) and Stiglitz (2006). 5. The only exception is a chapter that has been co-authored by the editor of this book with M. Bacchetta. 6. Those rules and disciplines include disciplines and rules concerning trade protection and protection of markets for foreign investment. They also include commitments in other areas such as intellectual property rights or rights of geographical origin, subsidies, safeguards, sanitary and phytosanitary rules, and disciplines regulating customs administration.

10 Zdenek Drabek 7. That criticism even comes from supporters of the multilateral trading system such as in Panagariya (2002). 8. See Whalley (1988), Srinivasan (1998), Hoekman and Martin (2001), and Hoekman, Mattoo, and English (2002).

References Gallagher, K. 2006. Putting Development First: The Importance of Policy Space in the WTO and International Financial Institutions. London: ZedBooks. Hoekman, B. 2005a. “Making the WTO More Supportive of Development.” Finance and Development: 14–18. Washington, DC: World Bank. Hoekman, B. 2005b. “Operationalizing the Concept of Policy Space in the WTO: Beyond Special and Differential Treatment.” Journal of International Economic Law 8(2): 405–24. Hoekman, B., and W. Martin. (Eds.) 2001. Developing Countries and the WTO: A Pro-Active Agenda. Oxford: Blackwell Publishers. Hoekman, B., A. Mattoo, and P. English. (Eds.) 2002. Development, Trade and the WTO: A Handbook. Washington, DC: The World Bank. Panagariya, A. 2002. “Developing Countries and Doha: A Political Economy Analysis.” The World Economy 25(9): 1205–33. Rodrik, D. 1997. Has Globalization Gone Too Far? Washington, DC: Institute for International Economics. Srinivasan, T.N. 1998. Developing Countries and the Multilateral Trading System. Boulder, CO, Westview Press. Stiglitz, J. 2006. “Social Justice and Global Trade.” The Eastern Economic Review (March)169(2): 18–22. Whalley, J. (Ed.) 1988. Rules, Power and Credibility. London, Ontario: Centre for the Study of International Economic Relations, The University of Western Ontario.

Part I WTO Agreements – A Developmentfriendly Policy Instrument?

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1 Development Implications of WTO Accession Procedures Will Martin

1.1

Introduction

Since the establishment of the World Trade Organization (WTO) in 1995, 21 countries or customs territories have joined the organization and one more, Vietnam, has met the requirements for accession. Of these, all are allowed to classify themselves as developing economies in the WTO, although one – Chinese Taipei – is classified as high income by the World Bank. Relative to the situation prevailing under the General Agreement on Tariffs and Trade (GATT), it seems to be widely believed that most new members have had to make substantial commitments to reform their trade regimes and to reduce the level of their tariffs. This has generated considerable controversy, since some new members have ended up with much more open trade regimes than existing members – a situation widely regarded as unfair. The first question addressed in this chapter is whether, and if so why, economies joining since the establishment of the WTO should be required to make larger commitments. The fundamental procedures for accession – the establishment of a Working Party to consider the application, and a combination of multilateral and bilateral processes resulting in a Report of the Working Party and a Protocol of Accession subject to approval by consensus – are, after all, a continuation of those under GATT. A second question examined in the chapter is what would be a desirable outcome from accession negotiations. Is the widely used criterion that new members should enter with a trade regime comparable to that of similar existing members the right one for evaluating the outcome of the accession process? Or should the criterion be the impact of the reforms on the economic development prospects of the new members? Or should it be the implications for the trading system of the conditions under which the new members join the organization? An informed assessment of the implications of accession for market access and trade creation must take into account the implications of accession for the tariffs, nontariff barriers, and services trade policies that the 13

14

Will Martin

new member countries will apply after accession. Indirect evidence from a gravity model provided by Subramanian and Wei (2003) suggests that the economies that have acceded to WTO since its establishment in 1995 have been substantially more successful in increasing their imports than other developing countries. While potentially powerful, this gravity model needs to be complemented by the measurement of changes in intermediate instruments such as tariff rates that might help to explain the finding and convince skeptics of its validity. Many studies, such as Drabek and Bacchetta (2004) have provided information on average applied rates prior to accession and average bound rates, but these alone do not provide a clear indication of the implications for applied rates after accession. Since the bindings are negotiated line by line, their impact on the distribution of applied rates cannot be determined simply by comparing averages. In Section 1.4 of the chapter we attempt to measure the effect of the binding commitments made on actual applied tariffs.

1.2 WTO rules and procedures on accession The basic WTO rules on accession are given in Articles XII to XIV of the Marrakesh Agreement Establishing the World Trade Organization (WTO, 1994: 15–16). As has frequently been noted, Article XII is very brief, with the fundamental principle being “Any state or customs territory ... may accede to this Agreement, on terms to be agreed between it and the WTO.” For a rule-based organization, the lack of rules on what is required for accession seems particularly striking. One of the few clear conditions given in Article XII – that decisions on membership should be made by a two-thirds majority of members – is routinely replaced with decisions actually made by consensus. A well-defined set of operating procedures has been defined under GATT and WTO to allow accession applications to be considered with some degree of consistency despite the absence of formal rules. They involve a series of formal procedures; informal precedents from earlier accessions; and a special set of guidelines on the Accession of LDCs (WTO, 2005a: 31). The formal procedures are discussed in Michalopoulos (1998) and WTO (2005a). They involve a number of steps, including: 1. Submission of the Application 2. Establishment of a Working Party 3. Submission of a Memorandum outlining the features of the trade regime 4. Follow-up questions on the trade regime 5. Meetings of the Working Party 6. Multilateral Negotiations on Rules

Development Implications of WTO Accession 15

7. Bilateral negotiations on market access (and sometimes on rules) 8. Preparation of a Protocol of Accession, Report of the Working Party, and Schedules 9. Approval of the Application One change in the rules governing accession between GATT and the WTO involved the potential for nonapplication of market access concessions. Under GATT Article XXXV, an existing Contracting Party could refuse to extend GATT concessions to a new Contracting Party (and vice versa) only if they had not negotiated bilaterally during the accession negotiations. Under WTO rules, this constraint has been removed, with the effect that an existing member can try to shape the offer of a new member through bilateral negotiations, while still retaining the potential threat of not providing the benefits of WTO Membership to the new member. While the effects of this change are not completely clear because both the new entrant and the existing member have the right of nonapplication at the time of accession, it seems that participants have viewed it as potentially important – evidently because of this rule, the United States did not conduct any bilateral negotiations with China in the talks between 1986 and 1995 on the resumption of China’s status as a Contracting Party to GATT. Another significant change was the abolition of the special arrangements for colonies of GATT Members in Article XXVI:5(c) of GATT, which had allowed many former colonies of European countries to become GATT Contracting Parties without any negotiations on their trade regimes. These special arrangements contributed to a situation where many members have higher trade barriers and lower coverage of GATT bindings than the original members of the WTO and, in particular, fewer constraints than the countries that joined the WTO after 1995. The changes in operating procedures between GATT and the WTO appear to have been fairly small. Why then does it appear that new members have faced so much more pressure for liberalization than earlier members and greater risk of having their rights diluted at accession? Part of the explanation is the end of decolonization among the original GATT Members. Most former colonies of European countries had obtained their independence well before 1995 and exercised their rights to become GATT Contracting Parties without a review of their policies.1 Another general stimulus to the demand for WTO Membership has been the perceived increase in the efficacy of the WTO dispute settlement system (Evenett and Braga, 2005), which holds the key to defending market access rights. Finally, a number of countries had a strong incentive to enter the WTO, because the Uruguay Round Agreement on Textiles and Clothing involved abolition of Multi-Fiber Arrangement (MFA) quotas applied against members of GATT/the WTO. For countries like China and Vietnam, this potentially involves an important increase in trade resulting only from actions by the

16

Will Martin

existing member importers, rather than – as in the usual case – by the acceding member. The importance of textile quota abolition as an incentive to join the WTO should not be underestimated. Ianchovichina and Martin (2004: 220) estimated that reforms undertaken after accession would lead to an increase in exports of apparel of 106 percent and in exports of textiles of 33 percent – increases much larger than the average export expansion of 17 percent. Another part of the explanation must surely arise from the greater interest of developing countries in trade reform. Between the early 1980s and the early 2000s, the average applied tariff in developing countries fell from over 30 percent to just over 10 percent, while the frequency of nontariff barriers and the severity of exchange rate overvaluation dropped dramatically (World Bank, 2003). The main stimulus to these reforms appears to have been the superior performance of the outward-oriented economies of East Asia relative to economies relying entirely on import substitution. In East Asia, much of this change toward outward orientation has not come about through complete liberalization, but through the use of partial liberalization measures such as duty exemptions for use in the production of exports,2 an approach that allowed export sectors to emerge less encumbered by political limitations on their rate of progress in reducing protection to the import-competing sectors. The expansion of such processing trade exports, which accounted for more than half of China’s trade in the 1990s, arose from provinces such as Guangdong that had not been important beneficiaries of the preceding import substituting phase of industrialization, and arose despite, not because of, import substituting protection. The dramatic overall reductions in developing country protection since the early 1980s, are shown in Figure 1.1. Simple average tariffs have fallen from over 30 percent in the early 1980s to around 13 percent in 2003, with most of the change coming not during the era of large scale structural adjustment in the 1980s, but since 1991. Within the context of the accession process, the nature of the commitments made by acceding countries is key to determining the outcome of the accession process. As noted by Kennett, Evenett, and Gage (2005), the WTO Secretariat identifies six types of commitments made by acceding countries: 1. statements of fact 2. obligations to abide by existing rules 3. obligations to abide by rules created by accession commitments (WTO-Plus) 4. obligations not to have recourse to WTO provisions (WTO-Minus) 5. transitional periods for bringing policies into compliance 6. authorizations to depart temporarily from rules or commitments.

Development Implications of WTO Accession 17 40 35 30 25 20 15 10 5

19 8 19 1 8 19 2 83 19 8 19 4 8 19 5 86 19 8 19 7 88 19 8 19 9 90 19 9 19 1 9 19 2 93 19 9 19 4 95 19 9 19 6 97 19 9 19 8 99 20 0 20 0 01 20 0 20 2 03

0

Figure 1.1

Simple average tariff rates in developing countries (%)

Source: www.worldbank.org/trade.

Much of the controversy about the accession process has focused on the WTO-Plus commitments, and WTO-Minus commitments. It is widely seen as unfair that countries should have to make commitments that go beyond those expected of existing members (WTO-Plus) or to forego rights available to other WTO Members (WTO-Minus). An alternative criterion of “what do these commitments do for economic performance” would, however, generally register these as a benefit for economic development. There is, however, a set of commitments in some recent accessions that unambiguously contradicts both fairness and economic benefit criteria. These are the commitments that give existing members rights to override WTO disciplines on their own policies in a way that allows them to introduce more trade restrictive policies. Clearly, these are likely to impair the economic performance and development prospects of both acceding countries and new members.

1.3

What makes sense for development?

Much of the concern about the accession process seems to have focused on the “inequities” between the requirements imposed on newly acceded members and existing developing country members. Given the inherent

18 Will Martin

subjectivity of this criterion and the fact that greater “fairness” in the form of higher tariff bindings and greater use of distorting trade policies frequently involves making both applicant and existing WTO Members worse off, a more useful criterion might be the extent to which the package of reforms associated with accession will contribute to economic development in the acceding country and to the future ability of the multilateral trading system to improve the environment for economic development. Such a package of reforms might seek consistency in the following areas: 1. Trade and economic policies consistent with WTO assumptions of a market economy; 2. Use of negative integration measures such as restrictions on tariff levels (tariff bindings) to reduce protection, to ensure the credibility of reforms, or to reduce the costs imposed by protection on consumers and exportoriented sectors; 3. A balance between disciplines and flexibility to ensure that there is policy space for experimentation and self-discovery (Hausmann and Rodrik, 2003); 4. Sensitivity to the costs and benefits of positive integration measures such as Trade-Related Aspects of Intellectual Property Rights (TRIPs) that require the development of costly institutions; 5. Limitations on existing members’ rights to introduce distorting measures incompatible with WTO rules; and 6. Implications for the future performance of the trading system. Each of these points is considered below: 1. The implicit assumption underlying General Agreement on Trade in Services (GATT) and GATS disciplines is of a reasonably competitive market economy.3 Clearly, the reliance of GATT on the use of tariffs only to provide protection makes no sense in a planned economy, where decisions on import and export levels are ultimately the responsibility of the planning authorities and prices play only an accounting function. The negotiations on China’s accession focused heavily on seeking assurance that economic agents would respond to market forces and that the actions of any remaining state trading entities, as in the petroleum sector, would be constrained by the price markups implicit in agreed tariff bindings. As Drabek and Bacchetta (2004) point out, a move to a stronger market orientation is helpful in moving to a more transparent economy with lower levels of corruption that is more attractive to domestic and foreign investors. Certainly, those involved in China’s accession negotiations to the WTO found that the focus on developing the regulatory framework for a marketoriented trade regime in China provided an important fillip to reforms. Reaching agreement on the interrelated package of reforms needed to

Development Implications of WTO Accession 19

transform a planned economy into a market economy is difficult and the WTO accession process provided the impetus for making the interrelated reforms needed for a successful transition in a situation where reform faced serious internal obstacles (Long, 2000: 27–9). Participants in the process observed that internal negotiations to build agreement on reforms took twice as long as those with WTO Members and that – once the reform process was initiated – the reforms to the laws governing the operation of trade went far beyond those narrowly required by the WTO with the objective of establishing a better-operating trade and economic system. 2. Extensive use of negative integration measures, such as the abolition of quotas and the imposition of limits (bindings) on import tariffs, tends to be helpful to development because trade policymaking in developing (as well as in developed) countries is bedeviled by asymmetries between the organizing ability of different groups (Olson, 1971). Trade policies tend to be used to generate costly transfers to favored groups, despite often very substantial overall economic costs. Negative integration measures tend, if anything, to save on administration costs and reduce corruption, with a regime of relatively low and uniform tariffs having much lower costs of this type than one involving high and variable tariffs and extensive use of import quotas and licenses. The need for government revenues may still act as a constraint on reform, although many countries have been able to maintain revenue collections from imports – especially when quantitative restrictions are replaced by tariffs – and/or through the introduction of Value Added Taxes (VAT) levied on both imports and domestically produced goods (Hood, 1998). While developing countries can reduce (and have reduced) their protection in order to become more internationally competitive, unilateral reductions in protection lack the credibility of a reduction backed up by a solid commitment not to reverse this reduction. Through its process of making binding commitments, the WTO allows countries to assure domestic and foreign investors putting fixed capital into risky activities that the policy reforms will not be reversed. In the absence of constraints such as those provided by tariff bindings, tariffs tend to vary substantially over time both at the sectoral level and in aggregate. This intertemporal variability of protection leads to higher costs of protection than would be suggested by average tariff rates over time. It also means that a tariff binding has a potentially substantial value even if it is set at a level above the initial level of protection, as in the case of the widespread “ceiling” bindings under GATT/the WTO. Francois and Martin (2004) found that the value of such ceiling bindings could be substantial in the case of agricultural commodities with high intertemporal variability of protection even in cases where the ceiling appeared to be well above the previously applied rate.4

20

Will Martin

A key problem with the use of import protection as a means to stimulate favored sectors is the fact that it imposes substantial direct and indirect taxes on exporting activities. As soon as we move from free trade to a regime involving protection, activities focused on production for the domestic and the export market have completely different incentives – becoming completely different activities from an economic point of view. The Effective Rate of Protection methodology is widely used to illustrate the distortion of incentives for producing for the domestic market. As is well known, the resulting distortions in favor of particular importcompeting activities in developing countries are frequently large and positive. The negative impact on incentives for export-oriented activities has received less attention. Figure 1.2 illustrates the nature of these incentives for exporting activities in India, an important original member of GATT/the WTO, before the commencement of reforms in 1986 and following substantial reforms in the early 1990s, by 1997. Even for broad aggregates like agriculture, agricultural processing, labor-intensive manufactures, capital-intensive manufactures, and services the effects are very marked. A key feature of this graph is the extent to which exports of the activities frequently most sought after by enthusiasts of industrial policies – capital-intensive manufactures and processing of raw agricultural products – are taxed by the protection regime. This reflects the higher shares of intermediate inputs in the cost structure of these activities and the high tariff rates on many of these intermediates. Another expressed concern with the GATT/WTO process is not that it has been successful in reducing protection in newly acceding members by

0 −10 −20 −30 −40 −50 −60 −70

K Intensive Manuf −35

Services

−3

Lab Int Manuf −23

−9

−45

−60

−16

Agric

Ag Proc

Resources

ERP 97

−5

−39

ERP 86

−14

−64

Figure 1.2 India: Taxation of exports 1986–1997

−6

Development Implications of WTO Accession 21

too much, but rather that it has had too little success in reducing protection in most developing country members. Rose (2004a and 2004b) finds little evidence either that GATT has been successful in reducing protectionist barriers at all, or that it has been successful in expanding trade. Subramanian and Wei (2003) find that it has been successful in expanding trade in the industrial country members of the WTO, and in the developing countries joining since the 1990s, but not in developing country members in general. 3. As regards balancing disciplines and flexibility, as emphasized by Hausmann and Rodrik (2003), there is a need for flexibility in order to promote experimentation as a way of identifying what will likely be a relatively small number of specific products in which the country will emerge with a strong cost advantage. However, in the WTO context, this need for flexibility must be balanced against the desirability of using the WTO’s disciplines as a stimulus to development. While import protection may play a role in promoting new activities, it is a relatively poor instrument because, as noted by Hausmann and Rodrik (2003: 630), it cannot distinguish between innovators and copycats, it discriminates against exports, and the removal of assistance is likely to be politically difficult. A policy of offering a little, targeted protection also raises serious credibility concerns. Unless these are managed very well, such protection is likely to set off a free-for-all as other groups sense a government’s willingness to provide this and begin pressing for more, in part because of the increase in their costs resulting from the protection given to the initially favored sectors. One option for dealing with these problems is to take advantage of WTO disciplines, in order to move to a protection regime involving low tariffs and credible commitments that these tariffs will remain low, and to seek policy options consistent with WTO rules to promote economic development. Such measures include exemptions for the costs of duties paid on inputs into the production of exports; rebates on taxes such as VAT levied on exports; and virtually all government investment in infrastructure, education, market support services, and basic research. Another approach to reducing the distortions created by protection regimes is to allow exporters duty free access to intermediate inputs used in the production of exports. In cases like China, Vietnam, and Taiwan (Wu and Chuang, 1998), this has been done with extraordinary success in developing a wide range of exports of finished goods, as part of a network of global production sharing. There are some concerns that this approach will inhibit further liberalization by reducing the pressure for lower protection from exporters (Cadot, de Melo, and Olarreaga, 2003). However, WTO rules on duty exemptions and drawbacks explicitly allow them even where the

22

Will Martin

cost-raising impacts of duties arise through their impacts on the prices of domestically produced inputs (WTO, 2003: 306). There are strong arguments against using import protection for “infant” industries. Such protection stimulates output in import-competing activities, but need not necessarily stimulate the technological change that is the central to growth and poverty reduction (Baldwin, 1969). In general, there is a strong case for using measures that target the problems facing young industries in developing countries – such as credit constraints, obsolete technology, poor infrastructure, and inadequate supplies of skilled labor – more directly. And GATT/the WTO leave unlimited policy space for interventions of this type. But, if one feels that some use of protection for infant industries is potentially desirable, as appears to be argued by Hausmann and Rodrik (2003) and is certainly argued by Chang (2005), then it seems preferable to achieve this outcome without complete rejection of the use of WTO disciplines on developing countries. Rather it would seem desirable to allow any such flexibility, subject to some disciplines on its use. What seems to be needed is to identify some approach that raises the cost of accessing such flexibility so that it will be used to a limited degree, hopefully avoiding or reducing the potentially great costs of a system of widespread protection. Negotiations do provide some such flexibility by requiring bilateral negotiations with all interested WTO Members. If acceding countries are sufficiently concerned about maintaining high protection in particular products, they must “pay” for them by offering larger concessions on other products. Despite this implicit price to be paid, acceding countries have, in fact, been able to maintain quite high bound duties on some products, as is evident from Table 1.1. Frequently, many of the reductions agreed by acceding countries have been in relatively low tariffs, rather than in peak tariffs, with the result that the standard deviation of applied tariffs and, potentially, the cost of protection have risen as a consequence of accession. This seems understandable when the political economy forces that underlie domestic protection decisions are confronted by market access considerations. Political economy forces tend to result in higher rates of protection in the sectors with relatively strong organizational ability, while partners in market access negotiations have an incentive to seek reductions in tariffs on goods with higher trade volumes, and hence typically lower initial tariffs (Anderson and Neary, 2006). 4. For the positive integration measures requiring the development or strengthening institutions need careful consideration, a key difference between the WTO and GATT 1947 is a substantial increase in the importance of commitments that require the development and strengthening of institutions. Unlike negative integration measures, agreements such as TRIPs require the establishment or strengthening of institutions. As Finger and Schuler (2001) have pointed out, the costs of meeting these requirements can be very substantial.

Development Implications of WTO Accession 23

Table 1.1 Maximum final bound tariffs in agricultural and nonagricultural products Agricultural (%)

NAMA (%)

Ecuador

85.5

40

Bulgaria

98

40

Mongolia

75

30

260

81

Kyrgyz Republic

30

20

Latvia

55

55

59

30

200

30

Panama

Estonia Jordan Georgia

30

20

Albania

20

20

200

20

55

25

Oman Croatia Lithuania

100

30

Moldova

25

20

China Chinese Taipei

65

50

500

90

Armenia

15

15

Macedonia, FYR

60

25

Nepal Cambodia Saudi Arabia

200 60 200

60 42.5 20

As Hoekman (2005) points out, current WTO rules are not designed to deal with the very different capabilities of different countries in implementing such policies. To the extent that developing countries are given greater flexibility than industrial countries, this is usually done by providing implementation periods that are uniform across developing countries without taking into account the very different circumstances of many developing country members. This issue has been a particular concern in the context of WTO accessions, because the members of Accession Working Parties are well aware that the leverage of members on candidate countries is much greater than their leverage on fellow members. There has thus been considerable emphasis on

24 Will Martin

requiring candidates both to make the legal changes required for WTO measures such as TRIPs and to implement them, whether or not this implementation is appropriate given the candidate member’s level of development. For the least developed countries, there have been some concessions, in line with the 2003 General Council Decision on the accession of the least developed countries (WTO, 2003), in the area of WTO rules and technical assistance. Least developed country (LDC) candidates, such as Cambodia, have provided detailed plans for the implementation of WTO-related legislation and enforcement mechanisms after accession and these have been accepted by their Working Parties, in lieu of completed legislation and implementation. Considerable attention has also been paid to ensuring that the technical assistance needed by least developed countries in order to implement WTO rules is available to them. Non-LDC candidates, such as Vietnam, receive no special consideration on issues such as the costs and timing of implementation, although donors have been very active in providing technical assistance. The problems faced by acceding countries in implementing WTO Agreements on positive integration seem to be more a reflection of inadequacies in the WTO architecture for dealing with positive integration measures than specific to the accession process. As Hoekman (2005) has argued, there is a strong case for redefining Special and Differential Treatment in a way that takes into account the wide diverse abilities of developing country members of the WTO to deal with the costs of positive integration measures and helps to determine meaningful responses to these problems. Such procedures would inevitably involve much sharper distinctions between developing countries than are provided under current interpretations of Special and Differential Treatment. 5. In the context of limitations on existing members’ rights to introduce distorting measures, a disturbing feature of China’s WTO accession (see Bhattasali, Li, and Martin, 2004) was the way in which existing members introduced policies that allowed them to override their WTO obligations in ways that infringed China’s rights as a WTO Member. In the case of China, these policies included rights for other members to impose “transitional” product-specific safeguards against China’s exports for up to 12 years (Article XVI of the Protocol and paragraphs 245–50 of the Working Party Report in WTO (2001)); rights to impose “safeguard” quotas against textile exports until 2008; and rights to use nonmarket economy procedures in antidumping investigations for up to 15 years (Article XV of the Working Party Report). While it is generally argued that WTO accession is a one-sided negotiation, with the applicant offering improved market access while existing members offer none, provisions of this type make it two-sided, with existing members effectively permitted to reduce the market access rights of the applicant and introduce additional inefficiencies into their own trade regimes. While it might have been argued that China’s accession was a special case

Development Implications of WTO Accession 25

given its size as a trading economy, it appears that this precedent is being used to threaten the same economic welfare reducing provisions against subsequent applicants for accession who pose no such systemic “threat.” Article XVI of China’s Protocol of Accession reserves the rights of other members to apply safeguards against any of China’s exports for up to 12 years from accession. These rights include poorly defined, but clearly extremely broad, rights of other WTO Members to introduce safeguards where they believe that products from China are being diverted from markets closed by this “safeguard” into their markets. This outcome was a particularly perverse effect of the most-favored-nation (MFN) principle. Once some members had negotiated market-restricting measures (the product-specific safeguard) in bilateral negotiations, the pressure to multilateralize them proved irresistible. Not only were otherwise WTO-inconsistent rights for all other members introduced, but further measures against the supposed diversion of exports from markets introducing these safeguards were also brought in. The negative effect of the MFN principle when benefits are being taken away was also highlighted by the outcome on textiles. When the countries that imposed textile and clothing quotas on China under the Agreement on Textiles and Clothing obtained the right to extend quotas under the “Textile Safeguard,” this was multilateralized, allowing members that had not previously imposed quotas under the MFA to introduce otherwise prohibited textile quotas. It might be argued that the accession of China is a special case, and that some additional restrictions on China’s rights were essential when introducing China into the world trading system, simply because of the country’s size and potential to affect the status quo. However, these reductions have established a highly undesirable precedent, which appears now to be being used against other developing countries (Oxfam, 2005). There seems to be a strong case, on equity and efficiency grounds, strongly to restrict the right of existing members to introduce additional distortions into their own trade regimes. WTO Members have rights, under time-tested procedures such as Article XIX safeguards, to restrict the access of new members to their markets should the political consequences of export increases from new members be politically unsustainable. The right to develop additional, discriminatory measures against exports from new members reduces the economic gains to both the new member and the existing member and was surely not envisaged in the design of the WTO Agreement, which provided for nonapplication of itself only under tightly restricted circumstances. 6. Accession negotiations are likely to influence the future performance of the WTO in influencing world trade in several ways. One important channel is through improving the credibility of new members’ trade regimes. Another is through the level and pattern of commitments on goods and services.

26 Will Martin

Reforms that ensure that new members’ trade regimes are market oriented and respect fundamental principles, such as the National Treatment principle requiring uniform treatment of imported and domestic goods once duties are paid, are clearly likely to help the operation of the WTO as a forum for future negotiations. Improvements in these respects increase the confidence of other members that commitments offered by the new members in future negotiating rounds will provide meaningful benefits. The setting of commitments on trade barriers in goods and services is also important because the GATT/WTO system generally works by exchanging “concessions” in terms of proportional reductions in tariff bindings – a process termed first-difference reciprocity by Bhagwati (2002) to distinguish it from reciprocity in levels, such as is encountered in free-trade areas, where tariffs on substantially all trade must be reduced to a common level of zero. One consequence of this process is that it becomes difficult to create balanced exchanges where the tariff rates of different members are radically different. As noted by Winters (1987), differences between the trade regimes of the industrial countries created considerable difficulties for obtaining the needed balance of perceived benefits of the Kennedy and Tokyo Rounds, and these were resolved in part by the costly approach of excluding many important products from the overall formula approach to liberalization. This problem is likely to be even more serious in the WTO, which seeks to achieve liberalization through reciprocal negotiations including developing countries as well as the industrial countries that dominated the earlier GATT negotiations. Because developing countries were generally exempted from obligations to bind tariffs or cut tariff bindings prior to the Uruguay Round, there are very large differences between active WTO Members in the coverage of their tariff bindings, the levels of their tariff bindings, and the gaps (binding overhang) between their bound and applied rates (Jean, Laborde, and Martin, 2006). These differences have been extremely important in the difficulties encountered in identifying an agreed approach to liberalization of both agricultural and nonagricultural products under the Doha Development Agenda. A key feature of accession has been requirements essentially to bind all tariffs. This is helpful for future negotiations since it makes clear the starting point for future negotiations. Another frequent practice in WTO accession negotiations on nonagricultural trade has been to set a target tariff binding of around 10 percent, creating a group of countries with tariff binding rates in the same broad order of magnitude, and to set the tariff bindings of the new members in a range somewhere between those of the industrial countries and other developing countries. However, whether this has helped to facilitate future negotiations is unclear. One reaction to the feeling that the accession countries have already undertaken “too much” liberalization has been strong pressure from recently acceded members for provisions allowing smaller tariff cuts for recently acceded member states (RAMS) (see WTO, 2005b: 11).

Development Implications of WTO Accession 27

1.4

How much liberalization has been undertaken?

Any overall assessment of the implications of WTO accession must take into account the extent to which the process has resulted in major changes in trade barriers. Accession involves many things, such as changes in rules and procedures and the abolition of nontariff barriers. However, reductions in tariffs are central to the WTO approach to liberalization, so it seems worthwhile to try to assess the implications of accession for the tariffs of acceding members. We also examine recent evidence from Eschenbach and Hoekman (2006) on the relationship between GATS commitments and reforms of actual trade policies for services. 1.4.1 Merchandise trade Because the treatment of agricultural and nonagricultural commodities differs substantially in the WTO, the standard practice for examining agricultural and nonagricultural tariffs was followed. Where the data were available in consistent formats, the final bound tariffs agreed at accession were compared with previously applied MFN tariffs for the same tariff line using the TRAINS data in the Tariff Cutting feature in the World Integrated Trade Solutions (WITS). Where the final bound tariff was below the applied rate, the applied rate was reduced to bring it into conformity with the WTO Agreement.5 The simple average of the initial and final applied rates was then taken to provide a simple, summary measure of the size of the cut in protection brought about by accession.6 The results of these calculations are presented in Table 1.2 for agricultural products, and in Table 1.3 for nonagricultural products. The third column in each table shows the year for applied rates used as the indicator of pre-WTO tariffs. The decision on the year to use is somewhat subjective, as some countries, such as China, made substantial reductions during the accession process as an indication of good faith.7 By the time of China’s accession, in 2001, the remaining required reduction in tariffs was much smaller, at around one-third of the initial levels calculated using the measures reported in this chapter. The sixth column shows the MFN tariff after all those tariffs requiring reduction have been reduced. There is no one-for-one relationship between the bound and the initial applied MFN rates, with the post-accession MFN applied rate frequently below the average bound tariff, and at least one case where an average bound rate above the average applied rate requires a reduction in the average applied rate. The seventh column shows the percentage reduction in the average applied tariff rate, while the last column shows the implied reduction in domestic prices of imported goods for given world prices.8 The results for agricultural tariffs presented in Table 1.2 show enormous variations in the experiences of acceding countries. Many acceding

Table 1.2 Cuts in simple average agricultural tariffs (%) Member

Year of accession

Applied Bound Initial MFN tariff year tariff (%) applied tariff (%)

Ecuador

1996

1996

25.0

Bulgaria

1996

2004

Mongolia

1997

na

Panama

1997

Kyrgyz Republic

Post MFN tariff (%)

14.4

14.4

36.0

na

18.4

18.9

na

5.0

1997

27.7

20.2

13.6

1998

na

12.3

na

7.01

Cut in tariff (%) Cut in price (%) 0.0

0.0

32.7

5.5 0.0

Latvia

1999

1996

8.8

8.2

8.2

0.0

Estonia

1999

1995

17.3

0.2

0.2

9.1

0.0

Jordan

2000

2000

23.7

25.7

20.6

19.6

4.0

Georgia

2000

1999

11.7

11.9

10.6

11.5

1.2

Albania

2000

1997

9.4

15.3

9.3

39.4

5.2

Oman

2000

1997

28.0

3.4

3.4

0.9

0.0

Croatia

2000

2001

9.4

13.9

9.5

31.9

3.9

Lithuania

2001

1997

15.2

9.4

8.6

8.2

0.7

Moldova

2001

1996

12.2

13.2

10.2

22.8

2.7

China

2001

1996

15.8

35.6

15.4

56.8

14.9

Chinese Taipei

2002

1999

15.3

16.7

13.0

22.0

3.1

Armenia

2003

2001

14.7

7.0

7.0

0.0

0.0

Macedonia, FYR

2003

2001

20.9

11.3

11.9

0.0

0.0

Nepal

2004

2002

41.4

13.6

13.7

0.0

0.0

Cambodia

2004

2003

28.1

19.5

19.5

0.0

0.0

Saudi Arabia

2005

2002

12.4

11.3

11.0

2.9

0.3

19.2

13.9

11.0

14.3

2.3

Average Note: na = not available

Table 1.3

Cuts in simple average nonagricultural tariffs (%)

Member

Year of accession

Applied tariff year

Bound tariff (%)

Initial MFN applied tariff (%)

Post MFN tariff (%)

Ecuador

1996

1996

21.26

11.5

11.5

Bulgaria

1996

2004

23.13

na

8.7

Mongolia

1997

na

17.3

na

na

Panama

1997

1997

22.9

11.0

6.4

Kyrgyz Republic

1998

na

6.8

na

4.7

Latvia

1999

1996

9.4

2.8

Estonia

1999

1995

7.3

0.05

Jordan

2000

2000

15.1

Georgia

2000

1999

Albania

2000

1997

Oman

2000

Croatia

2000

Lithuania

2001

Moldova

2001

Cut in tariff (%)

Cut in price (%)

0.1

0.0

41.8

0.0

2.3

17.0

0.5

0.0

20.0

0.0

21.6

14.4

33.3

5.9

6.5

10.4

6.4

38.3

3.6

6.6

16.0

6.6

58.8

8.1

1997

11.6

4.9

4.7

4.9

0.2

2001

5.5

4

3.9

3.0

0.1

1997

8.33

2.62

2.3

14.1

0.4

1996

6.0

4.2

na 10.5

China

2001

1996

9.1

21.9

9.1

58.6

Chinese Taipei

2002

1999

4.8

6.6

4.7

29.1

1.8

Armenia

2003

2001

7.5

2.3

2.2

4.7

0.1

Macedonia, FYR

2003

2001

6.2

13.4

7.8

42.0

5.0

Nepal

2004

2002

23.5

13.2

13.7

0.0

0.0

Cambodia

2004

2003

17.7

15.9

15.9

0.0

0.0

Saudi Arabia

2005

2000

10.5

12.0

4.9

59.6

6.4

11.8

9.7

6.8

25.0

2.5

Average Note: na = not available

30 Will Martin

members were not required to make any cuts in their agricultural tariffs, and the average reduction from the initial tariffs was only 14.3 percent for the members for which a calculation was feasible. However, some accessions, such as those of China, Albania, Panama, and Croatia, appear to have involved very substantial reductions in average agricultural tariffs.9 Overall, the reduction in domestic prices required by these reforms appears to have been very small, with an average reduction in domestic agricultural prices of only 2.3 percent. Even in the case of China, the large reduction in average agricultural tariffs would – if it were to be believed – have resulted in a decline in average agricultural prices of 15 percent (less any increase in world agricultural prices resulting from China’s increased demand). The apparently large cut in tariffs in Albania would have lowered average agricultural prices by around 5 percent. The reductions in average nonagricultural tariffs shown in Table 1.3 show some interesting patterns. In most accessions after Panama’s in 1997, acceding countries have been expected to introduce a bound tariff averaging 10 percent or less, with exceptions made for Jordan and the LDCs of Nepal and Cambodia. The consequent reductions in average applied tariffs ranged from almost 60 percent in Albania and China to zero in Ecuador and Cambodia, with an average percentage cut in tariffs of 21 percent. While this is much larger than the average reduction in agricultural tariffs, it translates into only a slightly larger average reduction in domestic prices of imported goods, at 2.5 percent. The large reductions in tariffs – and particularly nonagricultural tariffs – required of some acceding members are sometimes justified on the grounds that existing members have undergone eight rounds of multilateral tariff reductions and that new members need to make corresponding efforts. An alternative view, based on Rose (2004b) or Subramanian and Wei (2003), might be that there is no evidence that developing country members of GATT/the WTO have liberalized their trade regimes significantly during the course of these eight rounds. More realistically, it seems unlikely that such an equity-based criterion is useful. If the conclusion of Subramanian and Wei (2003), that accession countries have substantially increased their imports, is accepted, then the source of this increase in trade is an important question. Average reductions in the cost of imports of 2.3 percent in agriculture, and 2.5 percent in nonagriculture, seem very small to have generated substantial increases in import volumes. If there have been significant increases in the imports of the countries that have acceded as new members of the GATT/WTO system since 1996, then it seems likely that much of this increase has been as a consequence of improvements in the regulatory environment influencing trade in the new members. It seems unlikely that the tariff cuts alone would have been large enough to bring about significant increases in import volumes.

Development Implications of WTO Accession 31

1.4.2 Services trade policies A paper by Eschenbach and Hoekman (2006) compares the commitments made by acceding countries from Europe and Central Asia on services trade reform. They provide the information presented in Table 1.4 on the relationship between the level of GATS commitments made at accession by these countries, and the level of openness of actual policies. The level of GATS commitments presented in the first column of Table 1.4 takes into account the 155 GATS sectors, the four modes of supply identified under the GATS, and the concessions on Market Access and National Treatment. Unconditional commitments to liberalize are given a value of 1, while commitments subject to qualification are give a value of 0.5, and the results in the table are percentages of the possible total of 1,240 in each country. The measures of actual policies prepared by the European Bank for Reconstruction and Development (EBRD) range from 1 to 4.3 and indicate the degree of openness of the services trade regime.

Table 1.4 GATS commitments and EBRD measures of actual services liberalization GATS commitment

EBRD actual

Poland

24.5

3.4

Romania

25

2.94

Bulgaria

26.4

3.06

Czech Republic

30.8

3.4

Slovenia

31.1

3.17

Slovak Republic

31.6

3.1

Armenia

41.9

2.39

Macedonia

42.1

2.22

Estonia

44.3

3.44

Hungary

44.4

3.8

Lithuania

46.7

3.05

Croatia

49.3

3.17

Georgia

53.5

2.28

Latvia

59.1

3.11

Kyrgyz Republic

59.3

1.94

Moldova

78.4

2.33

32 Will Martin

In contrast with the situation with merchandise trade, where lower tariff bindings must bring about lower applied rates, and hence greater openness, there is no requirement that an increase in services commitments will actually liberalize trade in services. In fact, when the level of commitments for these countries is plotted against the actual level of services trade reform, in Figure 1.3, a negative correlation is evident. Many factors have contributed to the sharp differences between the pattern of commitments and actual trade reforms in the transition economies. Some of the countries with low services commitments were founding members of the WTO, some have set their policies more with a view to acceding to the EU, and some of the Central Asian states with the weakest institutions set high levels of commitments in the hope of moving relatively quickly despite the weakness of their institutions and policies. The situations where these countries have had difficulty meeting their objectives have contributed to the negative correlation evident in Figure 1.3. However, the overall picture strongly cautions against taking the level of commitments in acceding countries as an indicator of their level of actual liberalization.

4 3.5

EBRD openness index

3 2.5 2 1.5 1 0.5 0 0

10

20

30

40

50

60

70

80

GATS commitments Figure 1.3

GATS commitments compared to actual liberalization of services

90

Development Implications of WTO Accession 33

1.5 Conclusions The WTO’s accession procedures have attracted considerable concern on the grounds that they are unfair in requiring more concessions from acceding countries than from existing WTO Members. Unfortunately, there are major difficulties involved in using this criterion as a guide to policy, given the apparently uneven extent to which existing WTO Members have used the WTO to help address the pressures applied by special interests at home, and thus to liberalize their own trade policies. Rose (2004a and 2004b) has argued that the WTO has had little overall impact on the openness of existing members. Subramanian and Wei (2003) are more optimistic and conclude that the accession countries have stood out as successful in stimulating import growth relative to other members. An important question is about why the accession process appears to have become more rigorous since the establishment of the WTO. One reason is the abolition of the former colony provision that allowed newly independent countries to join the GATT without a review of their policies. A second is a procedural change involving nonapplication, which allows existing members to negotiate bilaterally, without giving up their right to threaten nonapplication of the benefits of the treaty. Third, and most important, is a sea-change in attitudes regarding trade in developing countries – with the sharp decline in tariffs throughout the developing world, countries are increasingly focused on approaches to stimulate foreign direct investment (FDI). We evaluate the WTO accession procedures against a number of criteria relevant to their impact on economic development, including: 1. their success in strengthening market institutions; 2. their use of negative integration measures to respond to the pressures for higher protection, and the balance between discipline and flexibility in retaining the option of higher market access barriers; 3. their attention to the potential costs of positive-integration measures, where the costs vary between countries in ways not adequately handled by current WTO procedures for special and differential treatment; 4. the problems arising from the increasingly-common practice of existing members using the accession process to allow themselves to introduce new trade barriers. This is clearly undesirable from a development view, as well as offending against any reasonable fairness criterion; and 5. their implications for the future performance of the trading system. The last section of the chapter examined the extent to which countries acceding to the WTO have reduced formal trade barriers, particularly

34

Will Martin

tariffs. The results suggest that the accession process has generally been much less successful in securing liberalization than would be suggested by the criticism (or praise) that it has received. The results suggest that the average reduction in import prices associated with liberalization would be only a little over 2 percent, raising questions about whether this is sufficient to explain the increases in trade of WTO accession economies relative to other members. In many cases, it seems that the procedures for accession have focused on achieving a target average level of bound tariffs – at least for nonagricultural products – rather than on the firstdifference approach to reciprocity that predominated in GATT negotiations, with the result that the size of the proportional reduction in tariffs required has depended very much on the level of the acceding economy’s initial tariff rates.

Notes 1. Cambodia was an interesting case, in which GATT offered the right to become a Contracting Party at the time of independence but the government of the day failed to ratify the Agreement. 2. In countries such as China, this has gone far beyond reliance on export processing zones since the mid-1980s. 3. Matejka (1990) points out that rules relevant for centrally planned economies were included in drafts of the Charter for the proposed International Trade Organization (ITO), but these were not included in GATT when the ITO failed. 4. One qualification on this finding is also evident. In the Uruguay Round, many industrial countries set their agricultural tariff bindings at high levels through the process of “dirty tariffication.” Now, MFN applied tariffs are frequently very close to these tariff bindings. There seems to be a risk that tariff bindings might help politicians seeking increases in applied tariffs to buttress their argument with the claim that “GATT made me do it.” 5. Unfortunately, the needed data were not available for Macedonia, Nepal, Panama, and Chinese Taipei when this comparison was done. In these cases, the change in the applied rate was made by comparing applied rates before and after accession. 6. Weighted average tariffs were also calculated, but these suffer from a well-known downward bias – higher tariffs lead to lower trade weights, with prohibitive tariffs having zero trade weights. 7. As argued in Ianchovichina and Martin (2004), China began reducing tariffs in earnest after 1995, when it became clear that she would be unable to resume her status as a Contracting Party in GATT, but would need to undergo a more rigorous accession process at the WTO. 8. This is defined as ∆t/(1+t) where t is the proportional tariff rate. 9. The case of China must be treated with particular caution. As shown by Huang, Rozelle, and Min (2004), there was little relationship between agricultural protection and agricultural tariffs prior to WTO accession, since many high tariffs were not applied, and export subsidies were the primary determinants of prices for cotton and maize.

Development Implications of WTO Accession 35

References Anderson, J., and J.P. Neary. 2006. “Welfare versus Market Access: The Implications of Tariff Structure for Tariff Reform.” Journal of International Economics 71; 187–205. Baldwin, R. 1969. “The Case against Infant-Industry Protection.” Journal of Political Economy 77(3): 295–305. Bhagwati, J. 2002. Going Alone: The Case for Relaxed Reciprocity in Freeing Trade. Cambridge, MA: MIT Press. Bhattasali, D., Shantong Li, and W. Martin. (Eds.) 2004. China and the WTO: Accession, Policy Reform and Poverty Reduction Strategies. Washington, DC: Oxford University Press and the World Bank. Cadot, O., J. de Melo, and M. Olarreaga. 2003. “The Protectionist Bias of Duty Drawbacks: Evidence from Mercosur.” Journal of International Economics 59(1): 61–82. Chang, Ha-Joon. 2005. Why Developing Countries Need Tariffs: How WTO’s NAMA Negotiations Could Deny Developing Countries A Future. South Centre and Oxfam. Drabek, Z., and M. Bacchetta. 2004. “Tracing the Effects of WTO Accession on PolicyMaking in Sovereign States: Preliminary Lessons from the Recent Experience of Transition Economies.” World Economy 27(7):1083–125 and reprinted as Chapter 4 in this volume. Eschenbach, F., and B. Hoekman. 2006. “On the Credibility and Effectiveness of Services Trade Commitments: The EU, Transition Economies, and the WTO.” Processed, Paris: Groupe d’Economie Mondiale, Institut d’Etudes Politiques and Washington, DC: the World Bank. Evenett, S., and C. Braga. 2005. “WTO Accession: Lessons from Experience.” Trade Note 22, Washington, DC: World Bank. Finger, J.M., and P. Schuler. 2001. “Implementation of Uruguay Round Commitments: The Development Challenge.” In Developing Countries and the WTO: A Pro-Active Agenda. Oxford: Blackwell. Francois, J., and W. Martin. 2004. “Commercial Policy, Bindings and Market Access.” European Economic Review (June) 48: 665–79. Hausmann, R., and D. Rodrik. 2003. “Economic Development as Self-Discovery.” Journal of Development Economics 72: 603–33. Hoekman, B. 2005. “Operationalizing the Concept of Policy Space in the WTO: Beyond Special and Differential Treatment.” Journal of International Economic Law 8(2): 405–24. Hood, R. 1998. “Fiscal Implications of Trade Reform.” In J. Nash and W. Takacs (Eds.). Trade Policy Reform: Lessons and Implications. Washington, DC: Regional and Sectoral Studies, World Bank. Huang, J., S. Rozelle, and Chang Min 2004. “The Nature of Distortions to Agricultural Incentives in China and Implications of WTO Accession.” In D. Bhattasali, Shantong Li, and W. Martin (Eds.). Ianchovichina, E., and W. Martin. 2004. “Economic Impacts of China’s Accession to the World Trade Organization.” World Bank Economic Review 18(1): 3–28. Jean, S., D. Laborde, and W. Martin. 2006. “Consequences of Alternative Formulas for Agricultural Tariff Cuts.” In K. Anderson and W. Martin (Eds.). Agricultural Trade Reform and the Doha Development Agenda. Basingstoke: Palgrave Macmillan and Washington, DC: the World Bank.

36 Will Martin Kennett, M., S.J. Evenett, and J. Cage 2005. Evaluation of WTO Accessions: Legal and Economic Perspectives. St. Gallen University, Department of Economics: Mimeo. Long, Y. 2000. “On the Question of Our Joining the World Trade Organization.” The Chinese Economy (Jan.) 33(1): 5–52. Matejka, H. 1990. “Central Planning, Trade Policy Instruments and How Centrally Planned Economies Fit into the GATT Framework.” Soviet and Eastern European Foreign Trade 26(1): 36–65. Michalopoulos, C. 1998. “WTO Accession for Countries in Transition.” World Bank Policy Research Working Paper 1934. Washington, DC: World Bank. Olson, M. 1971. The Logic of Collective Action. Cambridge, MA: Harvard University Press. Oxfam. 2005. “Do As I Say, Not As I Do: The Unfair Terms for Viet Nam’s Entry to the WTO.” Oxfam Briefing Note, www.oxfam.org/uk Rose, A. 2004a. “Do We Really Know that the WTO Increases Trade?” American Economic Review 94(1): 98–114. Rose, A. 2004b. “Do WTO Members Have More Liberal Trade Policy?” Journal of International Economics 63: 209–35. Subramanian, A., and Shang-Jin Wei 2003. “The WTO Promotes Trade, Strongly but Unevenly.” NBER Working Paper 10024. Cambridge, MA: National Bureau of Economic Research. Winters, L.A. 1987. “Reciprocity.” In J.M. Finger and J. Nogues (Eds.). The Uruguay Round: A Handbook for the Multilateral Trade Negotiations. Washington, DC: World Bank. World Bank. 2003. Global Economic Prospects and the Developing Countries. Washington, DC: World Bank. WTO. 2001. “Report of the Working Party on the Accession of China.” WT/ACC/ CHN/49. Geneva: World Trade Organization. WTO. 2003. “Accession of Least-Developed-Countries: Decision of 10 December 2002.” WT/L/508. Geneva: World Trade Organization. WTO. 2005a. “Technical Note on the Accession Process.” WT/ACC/10/Rev.3. Geneva: World Trade Organization, 28 November 2005. WTO. 2005b. “Doha Work Programme: Draft Ministerial Declaration.” WT/ MIN(05)/W/3/Rev.2. Hong Kong: Ministerial Conference, Sixth Session, 13–18 December. Wu, Chia-Sheng, and Shui-Chi Chuang. 1998. “Duty Drawback Mechanisms: The System in China and Recommendations for Costa Rica.” In J. Nash and W. Takacs (Eds.). Trade Policy Reform: Lessons and Implications. Washington, DC: Regional and Sectoral Studies, World Bank.

2 Toward A Development-friendly International Regulatory Framework for Foreign Direct Investment Theodore H. Moran

2.1

Introduction and overview

What kind of international regulations might help foreign direct investment (FDI) contribute most positively to the growth and welfare of host countries in the developing world? What kind of international regulations might limit FDI from doing damage? Since the contentious and ultimately unsuccessful attempt to negotiate the Multilateral Agreement on Investment (MAI) in the mid-1990s, there are seven areas where new discoveries clarify how FDI can make the most positive contribution to development, and do least harm.1 Each of the seven involves more – or less – regulation of the “policy space” developing governments have vis-à-vis multinational corporations. Two pertain to the work – or potential work – of the World Trade Organization (WTO). Three concern the functioning of regional trade agreements. 1. Regulation of Performance Requirements Imposed on Foreign Direct Investors 2. Enforcement of Labor Standards via Trade Agreements 3. Mandatory Compensation of Foreign Investors for Health, Safety, and Environmental Regulations 4. Arbitration and Dispute Settlement involving FDI 5. Restraining Corrupt Payments by Multinational Corporations MNCs 6. Signing Bilateral Investment Treaties (BITs) to attract FDI 7. Multilateral Regulation of Locational Subsidies to Investors How can international regulation in each of these areas be strengthened or reformed, altered or ignored, to enhance the benefits that FDI can bring to the developing world? Where would developing countries benefit from greater “policy space” in their relations with MNCs? Where would they not? 37

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In three areas, developing countries would actually benefit from less “policy space”: (1) less policy space to impose performance requirements on foreign investors; (2) less policy space to participate in bribery, corrupt payments, and nontransparency; and (3) less policy space to award tax breaks and locational incentives to attract foreign investors. In three, they would benefit from greater “policy space”: (1) greater policy space to avoid multilateral trade sanctions to enforce labor standards; (2) greater policy space to establish health, safety, and environmental regulations without paying compensation to foreign investors; and (3) greater policy space to engage in international arbitration that emphasizes conciliation with investors during cross-border financial crises. In one area – signing bilateral investment treaties – developing countries may be surprised to find that the presumed trade-off of less policy space for more foreign investment turns out to be largely nonexistent.

2.2

New discoveries in seven areas

The areas in which new evidence and new analysis has emerged about how international regulations might best channel foreign investor activities toward host country development are disparate, as are the fora in which such regulations might be embedded. This may be a blessing in disguise. The concluding section will argue that – in contrast to single, unified setting for the attempt to negotiate the ill-fated MAI – greater success might be contemplated from more decentralized and narrowly focused efforts to make progress. 2.2.1 Regulation of performance requirements imposed on foreign direct investors What kind of “policy space” do host countries in the developing world need in order to allow FDI to provide most benefit for their domestic economies? Would developing country interests be served by loosening, or tightening, current multilateral regulations – most notably, the Trade-Related Investment Measures (TRIMs) Agreement within the WTO? When the regulation of performance requirements first arose during the Uruguay Round of trade negotiations in the early 1980s, it was an open analytical question as to whether the imposition of domestic content, joint venture, and other technology-sharing mandates on foreign direct investors might be a help, or a hindrance, in using FDI to promote host country development. Since then, considerable empirical progress has been made in investigating the conditions under which FDI contributes most positively to host country growth and welfare and those under which it detracts from host country welfare and reduces domestic growth potential.

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2.2.1.1 Two distinct paths for FDI in manufacturing and assembly Later sections of this chapter will deal with some key issues in the regulation of FDI in extractive industries and in infrastructure. In this section, an accumulation of evidence about FDI in manufacturing and assembly during the past two decades shows that multinational corporate investment takes two quite distinct forms: FDI projects that are integrated into the parent’s global supply network have an impact more positive than conventional measurement techniques have indicated, whereas FDI projects that are undertaken for import substitution, often with explicit domestic content and other performance requirements, have an impact more negative than even critics and skeptics have assumed. An early indication of this distinction emerged from cost-benefit analysis of some 83 FDI operations in 30 countries over ten or more years (Encarnation and Wells, 1986). Project-by-project investigation (valuing all inputs and outputs at world prices) shows that FDI operations undertaken in a reasonably competitive environment – often oriented toward export markets – provide net welfare gains to the host economy, while FDI operations oriented toward protected domestic markets – structured to substitute local production for imported inputs – subtract from host welfare. The sectors represented in these 30 countries range from industrial equipment and machinery to chemicals and petrochemicals, pharmaceuticals, textiles, and agribusiness. Along the same lines, a detailed look at one African country (Kenya) that tried to use FDI for import substitution found only three of 35 foreignowned projects that generated benefits greater than their costs to the local economy (Wasow, 2005). More than half of the 35 drained foreign exchange from the host rather than saving hard currency expenditures. Many of the foreign-owned plants operated with excess capacity; if they had operated nearer to full capacity, however, the negative impact on host welfare would have been greater.2 The petrochemical sector shows the perverse interaction of domestic content requirements and trade protection. Production for the local market to substitute for imports leads to subscale plant size, resulting in high cost outputs such as plastics and fertilizers. Domestic content requirements divert indigenous production of oil and natural gas from exports to local use as petrochemical feedstocks. Investment in oil and natural gas suffers. Local industries using plastic and local farmers using fertilizers become less competitive. The host economy would be better off exporting the indigenous oil and natural gas and importing plastics and fertilizers. The negative consequences of domestic content and other host country performance requirements is more pronounced when the analytic comparison shifts from mere “export-oriented” FDI to a contrast with carefully woven multinational supply chains. International investors who build plants to be an integral part of their global competitive strategy construct facilities

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large enough to take advantage of all economies of scale. They operate with the most advanced production, quality control, management, and marketing practices. From a dynamic perspective, they upgrade these practices – in their own self-interest – to keep them at the frontier of their industry. At the same time, they place a high value on being able to control their operations. Domestic content requirements prevent tight coordination of production and hinder rapid changes in techniques and procedures. So do joint venture requirements. To give themselves maximum flexibility, multinational parents typically insist upon forming wholly owned or majority-owned subsidiaries with freedom to source inputs from wherever is most advantageous. Industry studies using firm-level microdata show two distinct patterns of operation: full-scale plants with cutting-edge technology closely supervised and constantly improved by the parent multinational and subscale plants with older technology and no links into the parent’s supply chain. Domestic content and joint venture requirements are a recipe for ensuring that FDI takes the latter form. When performance requirements such as these have been imposed in the automotive and electronics industries, foreign investors build boutique plants to assemble “kits” of knocked-down final products, leaving the least sophisticated parts and services to be provided by local suppliers. These car-parts-from-a-box or computer-parts-from-a-box operations are not only inefficient, but they are unable to serve as stepping stones to internationally competitive factories. Automobiles are hand-welded and computers are hand-soldered. These plants create some local jobs (at high cost to domestic consumers) but they do not provide dynamic learning to enable workers and managers to prosper without host country protection. The drawbacks turn out to be larger than what is conventionally called “tariff jumping” FDI. When Japanese auto companies built their first plants in the United States in the 1980s in order to hop over US trade barriers, for example, they brought full-scale operations with frontier technology. A strategy of import substitution via FDI in the developing world – in contrast – typically results in distinctly different production techniques in noncompetitive boutique plants. The results have not changed over time. General Motors’ (GM) 12,000 vehicle-per-year auto assembly joint venture in Hungary, where workers assembled Opel kits on individual jigs behind a 22 percent tariff wall, barely reached nine vehicles per hour – in comparison to 90 vehicles per hour at the parent’s highly automated 200,000 vehicle-per-year plants in the EU – before GM bought out its Hungarian partner, closed the assembly factory, and concentrated on a wholly owned 450,000 unit-per-year engine export facility with no domestic content requirements in preparation for Hungary’s accession to the EU. Prior to the North American Free Trade Agreement (NAFTA), Hewlett-Packard’s (HP) Mexican joint venture produced last-generation computers that met local content requirements, selling them with a 60–80 percent markup over world prices in a factory

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with insufficient scale to use modern composite materials (the computers had fiberglass cases instead). With the advent of informatics liberalization, HP ended the joint venture and built a wholly owned cutting-edge plant nine times larger, with freedom to source from wherever the parent could find the most low cost and reliable components. Contemporary evidence about the adverse consequences of imposing performance requirements like domestic content and joint venture mandates on manufacturing multinationals comes from China as well (Long, 2005). A survey of 442 MNCs operating in China shows that wholly owned or majority-owned firms are much more likely to deploy technology comparable to the most advanced used by the parent than 50–50 or majority Chinese-owned joint ventures. Some 32 percent of the wholly owned investors and 40 percent of the majority-owned investors operate with the most advanced techniques available to the parent; 23 percent of the 50–50 joint ventures and only 6 percent of the majority Chinese-owned joint ventures have access to these most advanced techniques. Domestic content requirements – in particular, in the auto industry – not only added to the cost of output, but precluded the foreign-owned assemblers from bringing in the latest products or production techniques until well after they had been introduced elsewhere. 2.2.1.2 Backward linkages and spillovers The strategy of imposing performance requirements on foreign investors has an ostensibly appealing logic, arising from a concern that without them multinational corporations might engage only in “screwdriver” operations without backward linkages or technology transfer into the host economy. But scale of operations and investor motivation have led in the opposite direction. Multinational investors using Singapore, Malaysia, and Thailand as the platform for computer, telecoms, and other electrical machinery production, without performance requirements, sought out local companies and provided blueprints, production advice, and advance payment for printed circuit boards and subassemblies to turn them into low-cost, reliable suppliers. The growth of the indigenous electronics industry in South East Asia followed a path of increasingly sophisticated contract-manufacturing to US, European, and Japanese multinationals. Domestic content requirements in the Mexican computer industry led foreign investors to place orders for a few thousand cables, resistors, keyboards, and other passive components that could be assembled in their boutique domestic-oriented plants. The liberalization of the informatics sector led IBM, Ericsson, and HP (see above) to buy much larger volumes of locally made components from more than 200 suppliers (foreign and indigenous) in the “Little Silicon Valley” cluster near Guadalajara. Along the same lines, the explosive growth of the domestic auto parts industry in both Mexico and South East Asia has followed the path of Original

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Equipment Manufacture (OEM) certification of local companies as suppliers to the multinational car companies. The thickening of backward linkages and the vertical transfer of production know-how and quality control procedures in Eastern Europe is proceeding along a similar course. A survey of 119 wholly owned or majority-owned affiliates of foreign investors in the Czech Republic shows 90 percent of them purchasing inputs from at least one Czech supplier while the median has a sourcing relationship with at least ten Czech suppliers and the top quartile with 30 (Javorcik and Spatareanu, 2005). One-fifth provided some type of assistance to the Czech companies from which they bought inputs, most frequently in the form of advance payment or other financing, next via employee training, and third through help with quality control. Other forms of support included helping with production technology, lending machinery or organizing the production line, assisting with financial planning or business strategy, and introducing suppliers to new buyers. The MNCs often insisted that suppliers obtain ISO 9000 quality control certification, and 40 percent of the Czech companies in the survey with ISO 9000 certification reported that they undertook the rigorous self-improvement in order to become suppliers to the foreigners. Thus, the benefits for developing countries from attracting foreign manufacturing investment that is integrated into the parents’ global sourcing system, and the drawbacks from hosting foreign manufacturing investment that is prevented by domestic content, joint venture, and mandatory technology-sharing requirements from being so integrated, are not limited to the static contrast in productive efficiency. From a dynamic point of view, the former enjoy “parental supervision” in ensuring improvements in management, quality control, and marketing are transmitted to host country affiliates on a real-time basis.3 Adding to this, externalities and spillovers in a vertical direction to local suppliers are greater in the former and fewer (or nonexistent) in the latter.4 A developing country strategy that allows foreign investors to operate free of domestic content and joint venture performance requirements enables the host economy to benefit from more than one given set of production opportunities. The more open approach provides a setting in which dynamic comparative advantage can take place, magnifying the contribution from FDI ten to twenty times over (Aghion and Howitt, 1998; Grossman and Helpman, 1991: chapter 7; Romer, 1994). As Costa Rica upgraded the skill level of its workforce, and attracted FDI to match, the country moved from one generation of FDI in coffee and bananas, to a second generation of FDI in textiles and apparel, to a third generation of FDI in electronics, semiconductors, medical devices, call centers, and business services (exporting more than $5 billion in 2005). 2.2.1.3 Reassessment of the “Korean model” Sometimes South Korea is held up as an alternative model to development via trade-and-investment liberalization (Birdsall, Rodrik, and Subramanian,

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2005: 136–53). Conventional wisdom depicts the “Korean model” as combining protected domestic companies with licensed technology to create competitive national champion firms in a self-sufficient fashion, with minimum reliance or dependence upon foreign multinationals. This characterization is a rough approximation of how South Korea built up two sectors – steel and shipbuilding – where production technology was relatively simple and stable. But it is inaccurate – and misleading as a guide for development policy – for industries where technology is more complex and dynamic, such as electronics. The key to the reassessment of the South Korean experience has been the discovery of the importance of contract manufacturing and OEM certification as the channel for upgrading indigenous firms’ capabilities (Hobday, 1995; 2000). Multinational investors from the US, Europe, and Japan created the initial industrial base for the electronics industry in South Korea in the 1960s and 1970s, and by the end of that period their South Korean subsidiaries still accounted for more than half of the country’s booming electronics exports. Indigenous South Korean firms grew up as suppliers to the foreign affiliates and attributed vertical production assistance from the multinationals who bought their inputs three times more often than licensed technology as a source of their companies’ success. In the 1980s South Korea did restrict foreign presence in the domestic economy, but contract manufacturing for multinational parents remained the principal source of production technology, quality control procedures, and marketing know-how. At the end of the decade, 50–60 percent of all South Korean exports of TVs and VCRs left the country via OEM contracts with Sony, Mitsubishi, Panasonic, Hitachi, Zenith, RCA, and Philips. The three most successful South Korean electronics companies – Samsung, Lucky Goldstar, and Huyndai – all began as suppliers to foreign multinationals, and 30 years later still exported 60 percent of their output via OEM relationships with them. The South Korean success story featured hard work, self-discipline, and learning-by-doing – but with intimate guidance and supervision from the leading international companies. The growth of the electronics sector in Taiwan shows important parallels with South Korea. Taiwanese companies grew up as suppliers of simple components to the wholly owned affiliates of IBM, Philips, and Hitachi, receiving instruction from them in how to produce low-cost, reliable printed circuit boards, power supplies, and monitors. The most successful Taiwanese computer manufacturers – ACER, Mitac, and Tatung – all originated as contract manufacturers to foreign multinationals, graduating from OEM suppliers of subassemblies to joint design and production of PCs for sale in international markets under the foreign label. Thus, the conventional view that South Korea (and Taiwan) followed a distinctly different path than the more open approach found in

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Singapore, Hong Kong, and other South East Asian electronics producers obscures the most important similarity across the entire group (Hobday, 1995; 2000). They all used the guidance and discipline imparted from vertical relationships with foreign multinationals, over decades, to move from being contract manufacturers, to OEM suppliers, to autonomous design specialists, and to – in a few cases – “own brand” participants in the international marketplace. In no case did they rise to prominence via mandatory domestic content, joint venture, or other technology-sharing requirements. These findings about the conditions under which FDI in manufacturing and assembly can make a positive contribution to host growth and development – as opposed to those conditions under which FDI in manufacturing and assembly can hinder and distort host growth and development – have a direct bearing on what kind of international regulation of FDI serves the interest of developing countries and what kind of international regulation of FDI does not. 2.2.1.4 The TRIMs Agreement in the WTO The centerpiece of multilateral regulation of FDI is the TRIMs Agreement in the WTO, which has required all members to refrain from imposing domestic content or trade-balancing requirements on foreign investors and to phase out those already in place. The evidence above demonstrates clearly that domestic content requirements in manufacturing and assembly fail to serve the interests of developing countries. The prohibition of these domestic content requirements should be seen therefore not merely as some demand from multinationals who need to be placated to make them happy (foreign investors who operate with domestic content requirements often in fact enjoy large profits from market protection against competition) – instead, domestic content requirements in manufacturing and assembly should be understood as an obstacle to host country development. Such domestic content requirements are plainly not a tool that helps a country to grow and should be eliminated from the toolbox altogether. Indeed, the self-interest of the developing world would be served by extending the TRIMs Agreement to a ban on mandatory joint venture or technologysharing requirements as well. At the 2005 Hong Kong Ministerial Meeting of the Doha Round, however, the multilateral trade community went in the opposite direction, weakening the current TRIMs text. Developing countries now have greater leeway to impose domestic content requirements upon foreign investors and to leave them in place for at least seven more years, and perhaps until 2020.5 The suggestion that this provision of “greater policy space” for regulation of FDI will help host governments – especially the poorest host governments – in their quest for growth is simply not supported by the preponderance of evidence that is available.

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Enforcement of labor standards via trade agreements

Many members of the nongovernmental organization (NGO) community and some elected political leaders – especially within the United States – have urged that trade agreements be used to ensure that countries observe core labor standards in multinational investor plants, subcontractor plants, and indigenous plants that export to international markets. MNCs in garments, footwear, toys, coffee, and other sectors have put in place internal systems to monitor labor practices at their plants and the plants of suppliers, but critics argue that this “voluntary” apparatus – even if independently audited – must be backed by the muscle that would come from potential trade sanctions for persistent violations. The International Labor Organization’s (ILO) Declaration on Fundamental Principles and Rights at Work of 1998 identifies four “core” labor standards. These are freedom of association and effective recognition of the right to bargain collectively; elimination of all forms of forced or compulsory labor; effective abolition of child labor; and elimination of discrimination in respect of employment and occupation. The proposal is that the WTO and ILO join together to enforce adherence to these core labor standards. How feasible might such a joint effort to ensure compliance with the four core labor standards be? How desirable – from the point of view of promoting development – is such an initiative? Is the trade-and-labor standards relationship an area where the “policy space” of developing countries should be constrained, expanded, or left alone? 2.2.2.1 Feasibility Looking first at feasibility, proponents point out that the ILO has more than half a century of experience in investigating complaints and adjudicating on what constitutes a violation of each of the four core labor standards. But a close examination of the attempt to define any one of the four – and operationalize it, so than an observer “knows noncompliance when he/she sees it” – reveals how far the world is from agreement on how to determine compliance or noncompliance so as to be able to instruct trade dispute panels and appellate bodies (National Academies of Science, 2004). ILO jurisprudence with regard to freedom of association and right to collective bargaining, for example – often considered the most basic of the four – illustrates the difficulties. To be effective in bargaining collectively, workers must to be able to put muscle into their negotiations with employers by threatening to strike without facing government-permitted retribution from their employers – such as hiring permanent replacement workers – if they carry out the threat. But the ILO – a coalition of government, labor, and business members – has consistently equivocated on this point. The ILO acknowledges that the ability of employers to fill the positions of striking workers with permanent replacements “poses a risk” to effective recognition of the right of collective bargaining but stops short of forbidding it.6

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Similarly, the ILO Membership has not been able to muster the consensus to deal with “closed shop” laws or “right to work” laws. “Closed shop” laws compel employers to hire only those workers who belong to a trade union and pay dues, which conflicts with workers’ freedom of association (ILO, 1994: 45–46, paragraphs 100–02). At the other extreme, “right to work” laws allow nonunion workers to enjoy all the benefits from labor contracts negotiated by unions, without paying dues, which undermines the ability of trade unions to organize. In each case, the ILO has refused – or been unable – to take a stand, allowing both (Tajgman and Curtis, 2000: 19). There are similar inconsistencies in specifying which organizations can “authentically” represent workers. Some countries’ laws provide for elected “works councils” or Labor-Management Councils (LMCs) distinct from unions. In the Philippines, the government began in the mid-1990s to promote the spread of LMCs to help mitigate the severe conflict that had earlier characterized labor-management relations – a practice that the ILO judged to be quite helpful (ILO, 1998: 23). In parts of Central America, some factories have “solidarity” associations of workers and managers that are set up as “mutual benefit societies,” with the employer making a financial contribution to provide loans for housing and education for the workers, and to promote “unity and cooperation” between workers and employers. The ILO has recognized that LMCs can provide an effective “voice” for workers and help to improve worker treatment, but, at the insistence of its trade union members, the ILO rules that a state is not in compliance if it allows LMCs to be initiated and funded by an employer even when the workers choose to participate in these worker-management arrangements rather than trade unions. There are numerous other areas in which ILO jurisprudence is clear but country practices in fact vary considerably. With regard to the right to strike, many countries disallow certain kinds of strikes (such as “sympathy strikes” or “protest strikes”). The ILO has ruled, however, that trade unions should be permitted to engage in protest strikes that are aimed at criticizing a government’s economic and social policies and to stage sympathy strikes when the initial strike is lawful (CFA Institute, 1996: paragraph 507; Tajgman and Curtis, 2000: 25). National legislation varies on the issue of whether a majority of the workers affected have to approve a strike, but, for the ILO, a requirement that the decision to strike requires a majority vote has curiously been found to be “excessive.”7 The three other core ILO labor standards show similar problems in defining what the state is required to do in order to be in compliance. Does compliance with the nondiscrimination labor standard prohibit offering jobs – or refusing to accept employment applications – on the basis of race, religion, nationality, tribe, or ethnic group? ILO jurisprudence permits explicit quotas in hiring even though many ILO Member States consider such practices highly objectionable.

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Does compliance with the child labor and forced labor standard require elimination of all forms of debt bondage? In some geographical regions, the provision of loans that are paid off by labor continues to be commonplace and forms a part of informal apprentice relationships. Is a state in compliance with the forced or compulsory labor standard if the government permits private work programs in prisons, requires participation in prison work programs as a prerequisite for parole, or even privatizes the prison system itself? ILO jurisprudence considers it impermissible for private contractors to employ prisoners, but many Member States (the U.K., U.S., and New Zealand) have thoroughly integrated private contractors and work programs into their prison systems. Struggling with how to define each of the four core labor standards is only the first step in evaluating compliance. Settling on an agreed definition must be followed with an assessment of government performance – both effort and effectiveness – in pursuing compliance (National Academies of Science, 2004). Respect for nondiscrimination, for example, requires protection against retaliation on those who file a complaint. Does this mean that those who might be discriminated against have access to legal services, even if they are poor? The definition of compliance soon turns on what constitutes an “adequate” level of subsidized legal counsel within countries that might be among the least developed. Prohibition of child labor requires inspection of factories to see if underage workers, with or without false documentation, are present – but does it also mean that access to affordable education be provided as an alternative to work, in order for a country to be in compliance? Thus – besides overcoming disagreements about what compliance means for the four core labor standards – there will have to be consensus on the degree to which a country’s performance can be “excused” for low levels of public sector expenditures or ineffective public sector results resulting from the country’s poverty and/or competing needs for available resources elsewhere. Even this brief overview of the challenges in determining compliance with the four core labor standards reveals that the world is far from agreement on how to determine compliance or noncompliance, so as to be able to inform or even instruct trade dispute panels and appellate bodies what constitutes guilt or innocence.8 The proposition that the WTO and the ILO are ready for a joint effort to enforce core labor standards is far off the mark. Movement toward creating the conditions in which WTO-ILO cooperation might be feasible would require, moreover, fundamental substantive changes in labor law in developed as well as developing countries, not least the U.S. In criticizing the adequacy of labor legislation in Central America and other parts of Latin America, some members of the House Ways and Means

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Committee, for example, have strongly objected to the substantive content of national laws in countries targeted for Free Trade Agreements with the United States (Levin, 2006; Levin, Rangel, and Becerra, 2003: 5). These laws do not limit voting on a strike to union voters, and do not automatically confer accelerated judicial review upon cases of workers dismissed for union activities or award them more than double severance pay. The Ways and Means Committee members objected to the absence of federal legislation allowing agricultural workers in general, and migrant agricultural workers in particular, to unionize and to elect foreign nationals as their leaders (e.g., Nicaraguan migrant agricultural workers in Costa Rica being organized and led by Nicaraguan nationals). They objected that some national laws (e.g., in Honduras) required that a firm have at least 30 workers to form a trade union. National laws do not prevent an employer from threatening to close or move a plant when faced with an organizing campaign. In Peru, labor regulations allow “the use of temporary workers to thwart union activities” (Levin, 2006: 3). A genuine multilateral dispute settlement mechanism would have to give comparable scrutiny to all Member States, including the U.S. But in the U.S., nonunion workers have a right to vote about going on strike (e.g., in right to work states); there is no expedited handling of antiunion dismissal cases; the National Labor Relations Board (NLRB) normally orders no more than reinstatement of the employee with back pay (a “make whole” remedy); and firms are allowed to hire permanent replacements for striking workers, and to allow those replacements to vote in an election decertifying the original union. Agricultural workers are exempted from the National Labor Relations Act (NLRA) (although some states, like California and Florida, provide for right to organize and collective bargaining under state law). There is a dollar volume of business necessary to establish federal NLRA jurisdiction under the Commerce clause. Employers threaten to move or close their plants when faced with union organizing campaigns, according to the International Confederation of Free Trade Unions (ICFTU), in more than 60 percent of the cases (ILO, 2000: 161). Appealing to ILO interpretations of what constitutes acceptable legislation – let alone acceptable levels of performance – would only reveal how far Western Hemisphere participants are from having in place a consistent basis for judging each other’s status regarding compliance. To cover the entire globe, a prodigious amount of negotiation would be necessary in order to come to agreement on how dispute settlement panels, and appellate bodies, should rule on what constitutes compliance – a challenge that would be multiplied many times over to formulate a multilateral jurisprudence for the entire WTO Membership. Saying “use ILO standards” or “let the ILO investigate” only works for simple problems in small states – simple problems in small, unassertive

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states (like Cambodia) that would never dream of pressing a case against a large trading partner. What is really involved in the inclusion of worker standards in U.S. Free Trade Agreements is not an attempt to expand multilateral jurisprudence but an effort to use unilateral arm-twisting to push other countries in a U.S.determined righteous direction. Whether hypothetical negotiations to move the members of the WTO toward congruence on the precise interpretation of what constitutes compliance would constitute a race to the top (a worldwide tightening of standards) or a race to the bottom (a worldwide loosening of standards) – more likely a slog toward the top, or a slog toward the bottom – is unknowable, but it is certain that U.S. provisions such as right to work laws and the right to hire permanent replacement workers would be central in the debate. The U.S. would have to begin by ratifying five of the basic ILO conventions that have never even been submitted to Congress and then proceed to rewrite federal, state, and municipal labor regulations along lines dictated by ILO jurisprudence. 2.2.2.2 Desirability From the point of view of developing countries and their workers, would it be desirable to include observance of core labor standards as part of WTO enforcement mechanisms? In current practice, the WTO system allows a Member State to file a complaint against another state for failure to fulfill its obligations on trade issues. This triggers an investigation and dispute settlement procedure. If the dispute settlement process fails to rectify the situation, the country bringing the complaint is allowed to suspend its obligations under WTO Agreements toward the country in violation and to impose quantitative restrictions or higher tariffs on that country’s exports. Would it help developing countries to secure better treatment for their workers if they allowed the same process if a Member State alleged that another state had failed to observe one or more of the core labor standards (or, more likely, showed a persistent pattern of failure to observe one or more of the core labor standards)? The first question that needs to be answered to evaluate a hypothetical WTO-based system is exactly where – at what level – might the enforcement action be directed?9 The most narrow option would be to target sanctions at the individual plant where the alleged labor standard violation occurred. This would put the WTO, or a WTO-ILO joint mechanism, in the business of plant-by-plant investigation. Actions taken to punish a plant found guilty by allowing one, several, or all WTO Members to impose tariffs or quantitative restrictions, then, would run the risk of causing the workers who were being mistreated to lose their jobs, in effect punishing the victims. If the penalty took the form of fines rather than trade restrictions per se, the imposition of a fine

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on the offending plant might well cause the owner to shut down or move operations (unless the fine were quite small) – since labor-intensive industries like garments and footwear are highly competitive at the production stage – producing the same outcome for those workers whose rights were being violated. Moreover, however injurious to the workers and owner at a particular plant, it is not clear that a narrow focus such as this would motivate much change in surveillance and enforcement of labor standards at the noncompliant country’s national level. A middle-range option might allow the trade sanctions or fines to be directed at the Export Processing Zone, or Free Trade Zone, or at the entire sector (footwear, apparel, or toys), where the violations occurred. The risk with this option is that the innocent (plants) will be punished along with the guilty (plants). Such collective punishment is not only objectionable in theory, but it would mean that exemplary owners and operators would find their operations penalized as well as noncompliant owners and operators. In the Philippines, for example, the Bataan Export Processing Zone (EPZ) has long had a record of poor labor practices. Reebok and Mitsumi invested there, however, and won national awards for labor-management relations, even as other companies engaged in reported violations of worker rights (ILO, 1998: 32). A WTO action against the entire Bataan EPZ would hit Reebok and Mitsumi along with the guilty miscreants. A WTO action against the entire footwear industry in the Philippines would similarly catch up companies with widely diverse labor practices in the resulting trade sanctions. A particularly perverse side effect of this approach is that socially responsible parent multinationals that typically promise preferential contracts to subcontractors who meet the parent MNC code of conduct would find this incentive for good subcontractor behavior taken away – if a WTO action could be taken against an entire EPZ or an entire sector, no parent MNC could assure subcontractors that they would be spared if they engaged in exemplary labor conduct. An even broader enforcement option – already common in WTO trade disputes – would allow the country that brings the case, and wins a guilty verdict against another country, to select products for retaliation from the entire roster of the guilty nation’s exports (Lawrence, 2003). This would be a potent tool to stimulate a target country to make a greater effort to enforce core labor standards. But this option would open the door to vast protectionist temptations within every WTO Member State. A successful labor rights case against garment factories in the Philippines – or China, for example – could block exports of auto parts, chemicals, processed agricultural products, machine tools, and industrial equipment. What union leaders in the developed world could resist the lure of searching for labor violations among footwear and toy producers in Mexico, India, Vietnam, Brazil, and Indonesia as a way of defending themselves against imports of products that competed with the output of their own members?

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A final irony for developing country workers is that the broader the hit list that a WTO labor case could target, the more the pressures within any given country to improve the treatment of workers would be undermined. The strongest force in raising labor standards is to increase the demand for workers, especially the demand for ever-more-slightly-higher-skilled workers. As the labor-intensive operations of foreign investors, subcontractors, and indigenous firms grow in sophistication – from textiles, to electronics, auto parts, and medical devices, for example – the self-interest of the employers pushes them to become more attentive to the need to attract and keep a better trained and better cared-for workforce. The result is higher wages, better working conditions, more on-the-job training, and a more contented labor force. What is striking is that the better worker treatment that appears first in foreign-owned plants with more sophisticated operations spills over into neighboring plants with lowest-skilled workers (Moran, 2002: chapter 3). In the Philippines, as the number of FDI firms exporting electronics, optical equipment, pharmaceuticals, machinery, and software overtook the number of firms exporting footwear and apparel, employers formed chambers of manufacturers (including foreigner and indigenous firms) to self-police the companies in their EPZs to prevent the kind of open labor discontent that had plagued the Bataan EPZ. In the Mactan EPZ, according to interviews conducted by Elizabeth M. Remedio, a researcher from the economics department at the University of San Carlos, companies that did not comply with national labor regulations received reprimands and one (foreign) firm that was unwilling to reform its ways – resulting in a strike – appears to have been expelled (Remedio, 1996). Similarly, data from the Dominican Republic and Costa Rica show that, as the number of EPZs grew and the composition of FDI shifted toward more sophisticated operations, improvements in worker treatment spread from higher- to lower-skilled plants in newer EPZs, and even from higher- to lower-skilled plants in older EPZs (Moran, 2002). It would hardly be in the interest of developing countries or their workers to put in place a WTO-based enforcement mechanism that could block this movement from worse to better observance of core labor standards. 2.2.3 Mandatory compensation of foreign investors for health, safety, and environmental regulations Protection of foreign investors against expropriation has become part of regional trade agreements (but not the WTO), as well as BITs. How expropriation is defined and when compensation is required have the potential to narrow the “policy space” host governments have to set environmental regulations, as well as health and safety standards. Is such “narrowing of policy space” desirable or objectionable, from the point of view of balancing host country interests in attracting investors

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through appropriate protections versus retaining freedom to ensure “sustainable development?” 2.2.3.1 Evidence from NAFTA Chapter 11 Dispute settlement under NAFTA Chapter 11 has been the principal forum for working out the scope of international regulation in this area. Here there has been important post-MAI recalibration between the rights of host policy makers and the rights of foreign investors. This recalibration is important for the growing number of BIT-based arbitrations as well. The protection of foreign direct investors in NAFTA Chapter 11 relies on dispute settlement procedures found in commercial law arbitration, as established by the International Center for the Settlement of Investment Disputes (ICSID), the ICSID Additional Facility, and the United Nations Center for International Trade Law (UNCITRAL). These differ fundamentally from WTO-type dispute settlement. The resolution of a WTO trade dispute takes the form of a judgment that a state party to the dispute must bring its policies into compliance with its WTO obligations, without any grant of retrospective relief. That is, WTO dispute settlement can require a member government to change its behavior looking forward but cannot award compensation to the winning party for damage from past misconduct. With commercial law arbitration procedures, in contrast, the goal is to make whole the damaged. In the 1970s, investment disputes involving compensation for direct expropriation, indirect expropriation, or “creeping” expropriation had a high profile in the relations between multinational corporations and host governments in the developing world. In the 1980s–early 1990s, the number of cases involving expropriation of any sort declined dramatically (Minor, 1994: 177–88). Over the course of the 1990s, however – with the completion of NAFTA and the attempted negotiation of the MAI – the issue of regulatory “takings,” or damage to a foreign investor’s profitability from changes in domestic policy within a host jurisdiction – reemerged as an area of contention. Expropriation of an investor’s property is widely permitted so long as the takeover is ordered to serve a public purpose, is nondiscriminatory, and comes with compensation. The issues for debate are what actions fall under the rubric of expropriation and when compensation is therefore required. Most countries afford authorities at the national and subnational level wide latitude in designing regulatory regimes without triggering a requirement for compensation, including use of what is called the nonconfiscatory exercise of police powers (good faith measures to protect public health, safety, and the environment, administered on a nondiscriminatory basis). In the U.S., however, the boundaries for constitutional protection of private property rights remain unsettled, with some arguing that any regulation that affects the current (or future) profit of a company be considered

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a “taking” that requires indemnification to the owner in the amount of those profits lost over the lifetime of holding the property (Rose-Ackerman, 1992; Rose-Ackerman and Rossi, 2000: 1435–95; van der Walt, 1997: 92). In the formulation of NAFTA Chapter 11, therefore – in the words of the chief negotiator for the U.S. – “the negotiators tried for some time to consider putting a line in the text that would distinguish between legitimate regulation on the one hand, bona fide and nondiscriminatory, and a taking on the other hand. We quickly gave up that enterprise. If the U.S. Supreme Court could not do it in over 150 years, it was unlikely that we were going to do it in a matter of weeks ...” (Price, 2001: 1–9). There has remained an apprehension therefore that regional trade agreements and BITs might be used to require host governments to reimburse foreign investors for the impact that any regulation to protect the environment, human health and safety, or other community interests might have on the profitability of their investment. While not formally limiting the right of host governments to regulate in the public interest, the threat from multiple suits could have a chilling effect on their efforts to design effective domestic regulations. Even in the United States, state and municipal authorities have pointed out that limited resources for compensating multinational corporations for the burden of health, safety, and environmental regulations might effectively tie their hands (Veloria, 2002). Under NAFTA Chapter 11, host authorities cannot be required to change whatever domestic health, safety, environmental, or other regulations they deem necessary to the public interest. But if an external arbitration panel finds in favor of a foreign investor, it can direct the host government to compensate the investor. Whether the compensatory process constrains the host’s efforts at regulation depends therefore on how expropriatory acts are defined. Article 1110 of NAFTA specifies three types of expropriation: (1) direct expropriation, (2) indirect expropriation, and (3) measures tantamount to expropriation. In the interpretation given in one case, the latter two include measures that do not directly take possession of investor property but which involve “interference” with the use of property which has the effect of depriving the owner, in whole or in significant part, of the use or reasonably to be expected economic benefit of property.10 If this interpretation were to hold, the assurance of fair and reasonable treatment for foreign investors may pose a significant threat to the design of host regulation unless it is clearly established that bona fine regulatory measures do not constitute an expropriation. Since the completion of the NAFTA negotiations, concern about regulation in the public interest has pushed the parties themselves toward circumspection about what actions would require compensation. Canada has been a leader in recommending limits to the scope of potential regulatory expropriations. The U.S., too, has tightened its interpretation. In an exposition of

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how an investor state dispute settlement might be handled in the U.S.-Chile Free-Trade Agreement, the U.S. proposed that regulatory measures that were “designed and applied” to achieve health, environment, and other public welfare objectives in a nondiscriminatory manner would not leave the host authorities liable for compensation. An annex to the CAFTA agreement asserts that rarely will a normal regulatory measure be expropriatory, but does not define what those rare circumstances are. 2.2.3.2 The 2005 Methanex case The most important breakthrough, however, came in the “final award” of the arbitral panel in the long-running case of Methanex vs. the United States on August 7, 2005.11 The Methanex case arises from an investment dispute between the Canada-based Methanex corporation and the United States.12 Methanex is a major producer of methanol, which is a key component of methyl tertiary butyl ether (MTBE), a chemical used to increase the oxygen content and thereby act as an octane enhancer in unleaded gasoline. The State of California argued in 1999 that MTBE was contaminating drinking water supplies and posed a significant risk to health and safety and to the environment. It issued an order banning MTBE by the end of 2002. Methanex argued that the ban was tantamount to expropriation of the company’s investment in the U.S., and sought almost $1 billion in compensation. The NAFTA tribunal conducted a detailed review of the process by which California enacted the legislative ban of MTBE. The panel concluded that the regulatory process had been science-based, subject to peer review, transparent, free from corruption, and in accord with due process. It rejected Methanex’s claim that the company’s property had been expropriated and that the owners were due compensation. Its broader finding is unequivocal: “As a matter of international law, a nondiscriminatory regulation for a public purpose, which is enacted in accordance with due process, and which affects, inter alia, a foreign investor or investment, is not deemed expropriatory and compensatory.” 2.2.3.3 Unsettled issues Despite the ostensible clarity of this ruling, debate in this area will continue, however, for several reasons. First, the decision in this case does not bind other tribunals. Arbitral judgments do not create formal precedents. But the likelihood that regulatory measures enacted for a public purpose in a nondiscriminatory manner in accordance with due process will require compensation will diminish as other tribunals adopt the same approach. Second, the “final award” in Methanex contained a complicating caveat: host country regulatory actions are not expropriations “unless specific commitments had been given by the regulating government to the then putative foreign investor contemplating investment that the government would

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refrain from such regulation.” But a host government may assure an investor regulatory stability, only to find that science subsequently discovers that an emission of a substance previously not thought to be harmful is in fact dangerous to public health. Would the host then be in breach of contract if the government (or its regulatory agencies) wrote new regulations to take into account this danger? Finally, there are outstanding issues surrounding what constitutes less favorable or discriminatory treatment. Environmental regulation in many countries – not least the U.S. – sets maximum levels of pollution in local air and water for new facilities while grandfathering older ones. As a result, a newer investor encounters tougher standards than previous ones, and may be denied a permit to operate if the investor merely aims to duplicate what is legal for its predecessors. If the prospective newer investor happens to be a foreign firm, could it have grounds for claiming less favorable or discriminatory treatment? So concerns about constraints on the ability to design public policies that cover foreign and domestic investors alike have not all been resolved, but – at least in the area of defining regulatory expropriation – progress has been made in ensuring appropriate “policy space” to host country authorities. Outside of NAFTA – in particular in BIT-based arbitrations – it remains to be seen, however, how restrictive the interpretation of “expropriation” might be. 2.2.4

Arbitration and dispute settlement involving FDI

Quite apart from regional trade agreements (like NAFTA Chapter 11, see above), dispute settlement involving developing country host governments and foreign direct investors relies upon the commercial law arbitration procedures observed in ICSID, the ICSID Additional Facility, and UNCITRAL. These procedures also occupy a central position in most bilateral investment treaties, and – in the post-MAI era – they have come to occupy a central position in the architecture through which multilateral lending institutions such as the World Bank and national agencies like the US Private Investment Corporation (OPIC) insure or guarantee the contracts and concessions of foreign direct investors in the developing world. The most prominent investment disputes in the late-1990s and early 2000s – such as the Dabhol investment dispute in India as well as the MidAmerica investment dispute in Indonesia – have relied on these commercial law procedures for adjudication. 2.2.4.1 Foreign investment in infrastructure and extractive industries There are rigorous reasons – associated with “market failure” – why official protection of international investment contracts and concessions on the part of the World Bank, regional development banks, and national political risk insurance agencies has a special role to play in launching many of the largest, most sensitive, and most important infrastructure and natural

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resource development projects. Such projects typically involve large fixed investments with a high degree of risk and uncertainty, requiring long and generous payback periods to be worthwhile. Once a project is launched, the foreign investor cannot credibly threaten to withhold crucial inputs or to withdraw. In contrast to FDI in manufacturing and assembly (see Section 2.1), where foreign firms maintain negotiating strength vis-à-vis host authorities via control over technology and marketing, foreign investors in infrastructure and extractive industries are extremely vulnerable to a “hostage effect” if the terms of their contracts are altered. Under such circumstances, foreign investors in these sectors demand highly favorable terms at the outset to compensate themselves (and their financial backers) for the risk and uncertainty, and host authorities agree to such terms in order to gain the project benefits even if tax and other accounting arrangements are structured to front-load high returns to the foreign owners. Once the project is successful and the initial risk and uncertainty have dissipated, the host authorities (or their rivals and successors) object to the initial contract terms and demand renegotiation, in a process first identified by Raymond Vernon as the “obsolescing bargain” (Vernon, 1971). More serious than mere political opportunism, the “obsolescing bargain” model predicts a tightening of contract terms – even if no formal nationalization takes place – that leads to systematic underinvestment on the part of foreigners, far below what is commercially feasible or socially optimal from the point of view of host countries in the developing world. Indeed, a systematic failure to be able to make “credible commitments” for capital-intensive long-term investment contracts has become an obstacle that private parties alone are not able to correct. Foreign investors calculate that such contracts are even more risky than otherwise might be the case, and insist upon higher initial returns to compensate them for the risk – a strategy that proves counterproductive by raising the likelihood that subsequent renegotiation of the terms will in fact take place, as a kind of selffulfilling prophecy (Wells and Gleason, 1995: 4455). Private political risk insurers can offer coverage to ensure that foreign investors are compensated when their initial contracts are breached, frustrated, or broken. But this promise of compensation is costly, and the revelation that a particular contract is covered may ensure that the investor is singled out to be squeezed. This market failure provides a rigorous justification for national and multilateral guarantees and political risk insurance. Host governments sign an agreement with the World Bank group (including the International Finance Corporation and the Multilateral Investment Guarantee Agency), the Asian Development Banks, or the Inter-American Development Bank, or with public sector agencies such as the U.S.’s OPIC or the U.K.’s Export Credit Guarantee Department (ECGD), specifying that investment disputes will be submitted to commercial law arbitration and the decisions respected by the host, or else the guarantor can pursue the host for remedy. Since

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developing country governments do not want to prejudice relations with these institutions, the coverage they provide is much more potent than what commercial political risk insurance supplies. Beyond offering compensation to the investor, national and multilateral political risk insurers provide deterrence against the workings of the obsolescing bargain. A host government in a developing country will be able not only to make credible commitments about its own treatment of a foreign investment contract; the host government becomes will also be able to tie the hands of its successors. More FDI in high profile, valuable, long-term projects – especially oil, mining, and infrastructure – becomes possible than would otherwise be feasible. 2.2.4.2 Misgivings about commercial law arbitration procedures The development strategy community has generally applauded the movement to arbitrate in foreign investor vs. host government disputes. Commercial law arbitration procedures represent a channel for disputes to be resolved via the rule of law rather than through crass political pressure of the strong against the weak (overt or covert). In recent years, however, the enthusiasm both for commercial law arbitration procedures and for the structure of public sector guarantees (national or multilateral) to foreign direct investors has waned. Increasingly critical scrutiny has been devoted to three questions: how to separate genuine political risk from commercial risk; how to expect host authorities to behave during regional financial upheavals that spill over into their economies; and how to avoid moral hazard on the part of investors who want the public to bail them out of overly optimistic projects gone awry. For infrastructure investments in particular, there has been a growing appreciation – since the Asian financial crisis of the late 1990s – of the need to reevaluate which parties should bear the burden of absorbing commercial risks associated with fluctuations in supply and demand for services and with fluctuations in exchange rates. To participate in booming Asian and Latin American markets, foreign investors in the power sector grew accustomed to insisting – as a condition of putting capital into infrastructure – that host authorities commit themselves to supplying inputs or purchasing outputs, as well as to guaranteeing the foreign exchange value of payments made in local currency. In settings in which host country economic growth seemed unending and demand for electricity grew at 8 percent per year (or more), power projects provided large benefits to the domestic economy while generating rates-of-return on the order of 30 percent per year to the foreign sponsors (Harvard Business School, 1997: 10). But how should the costs of adjustment be apportioned when the underlying assumptions for particular projects prove excessively rosy, or when economic fluctuations in the world economy move in an adverse direction?

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Following an odd legal logic, when host authorities found themselves unable to fulfill their contracts as a result of external changes in the international economy, their behavior came to be considered political acts (unwillingness to behave as promised) rather than commercial acts (inability to behave as promised). The MidAmerica corporation, for example, sought concessions to build geothermal power projects in Indonesia in the mid-1990s backed by take-or-pay power purchase agreements signed by the state utility Perusahaan Listrik Negara (PLN). The central government of Indonesia had the Ministry of Finance provide a supporting letter, promising that it would “cause” the national oil and gas corporation (Pertamina) and PLN to honor and perform the obligations they had signed up for with MidAmerica. Indonesian authorities had a record of sound macroeconomic management. But when the Asian financial crisis of 1997 (originating in Thailand) hit the Indonesian economy, the central government in Jakarta had to formulate a tough austerity program as a condition of receiving assistance from the International Monetary Fund, the World Bank, and the Asian Development Bank. As part of the budget cutbacks, Indonesia placed power facilities whose capacity was not needed immediately under review, including those of MidAmerica. In 1998, when PLN failed to accept and pay for the electricity under contract, MidAmerica took the case to arbitration. Over the course of 1999, two arbitration panels found PLN in breach of contract, and ordered the government of Indonesia to pay damages in hard currency. The panels took no note of the financial crisis or of the country’s need to use scarce dollars to import food and medicine. When Indonesia failed to comply, MidAmerica asked the OPIC to make good on its political risk coverage, triggering one of the largest claim payments in OPIC’s history ($290 million of the total arbitration judgment of $572 million against Indonesia) and prompting the U.S. government to seek recovery from Indonesia. This case is part of a pattern in which the line between commercial and political risk has become blurred (Kessides, 2004). Political risk has traditionally been defined as some set of deliberate acts on the part of host authorities undertaken in order to change the treatment of a foreign investor. Changes in market conditions over which the host country has little or no control and that impede its capability to meet its obligations form part of the broader category of commercial risk. But more than 90 percent of the political risk claims paid by Lloyds of London syndicates in the five years after the onset of the Asian financial crisis, according to a study by Berry, Palmer and Lyle, arose because a state buyer or supplier was unable to make good on its commitments in full and on time (Berry, 2003). The formal default derived from economic misjudgment or overcommitment, not from bad faith or malicious intent on the part of host authorities.

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The need to resharpen the distinction between political and commercial risk is all the more pressing because take-or-pay contracts signed by parastatal agencies in the developing world are typically denominated in dollars whereas utility payments by the local populace are made in local currency. Even though national or multilateral guarantee agencies categorically refuse to provide explicit exchange rate protection, they have discovered that when they insure these take-or-pay agreements against breach of contract they have implicitly exposed themselves to enormous currency risk (Kessides, 2004: 179). Official political risk insurers, working in conjunction with the commercial law dispute settlement institutions, must devise a framework for dealing with investment project difficulties that arise out of regional financial contagion rather than from deliberately hostile acts on the part of host authorities. Such a framework would provide a “force majeure” suspension of contractual obligations during a sudden economic collapse, along the lines already visible in normal commercial relationships. In a study of 20 infrastructure projects whose terms had to be changed, between 1990 and 2005, Erik Woodhouse found that the majority (11) involved a mutual “workout” between investor and host aimed at keeping the project viable over the longer term (Woodhouse, 2006). These 11 all featured some kind of cooperative renegotiation, including restructuring fuel supply provisions, refinancing project loans, or identifying other aspects of the original contracts that could be changed by mutual agreement. A change in how political risk contracts are interpreted and arbitrated would have the added appeal of eliminating the element of moral hazard that is evident in the current system. International power companies covered by official political risk insurance of the 1995–2005 vintage – like MidAmerica – have behaved differently from those that were not. Investors caught in a regional economic downturn – without multilateral or national political risk coverage against breach of contract – engaged in workouts as outlined above. In Indonesia, for example, Unocal and Jawa Power worked out a new timetable for bringing their power projects online as the host economy recovered, in contrast to MidAmerica’s exercise of the take-or-pay requirement in order to activate its OPIC claim. Current breach of contract coverage not only tempts an investor to walk away from a project once it is clear that the original assumptions were too optimistic, but leads the banks with a portfolio of insured infrastructure loans to withhold authorization for restructuring the original agreement. Finally, a new framework that pushes the parties toward a mutually acceptable work-out would broaden context within which the institutions of commercial law arbitration function. Along the same lines as is already happening in cases involving environmental law and investor protection (Section 2.3, above), current arbitration procedures that concentrate on the narrowest dimension of contract compliance – aimed at making the foreign

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investor “whole” ahead of every other priority for use of hard currency for a population in crisis – could evolve toward a more mediationlike process to determine what is the best outcome for all parties and what best serves the public interest. 2.2.5 Restraining corrupt payments by MNCs Bribery and corruption have long plagued the relationship between multinational investors and host governments in the developing world. Corrupt payments allow international companies to secure contracts and concessions on favorable terms, undermining the delivery of inexpensive goods and services and diverting revenues from public uses to private hands. 2.2.5.1 The OECD Convention against bribery Through 1995, many developed countries considered bribes paid abroad a normal cost of doing business and routinely allowed MNCs to deduct payments to host government officials in order to gain contracts or secure favorable treatment as a legitimate business expense. Then, in 1996, the OECD approved its Tax Recommendations on the Non-Deductibility of Bribe Payments and in 1999 the OECD-wide Convention on Combating Bribery of Foreign Public Officials in International Business Transactions was promulgated. Led by the U.S. – which has long considered itself the exemplar of good conduct, with the Foreign Corrupt Practices Act on its books since 1976 – the G8 at Evian in 2003 placed anticorruption high among the goals for common action on the part of developed states. The OECD Anti-Bribery Convention of 1999 has become the template for national antibribery laws in order to prosecute for corrupt payments from multinational investors to public officials in developing countries. As of 2006, all 30 OECD members and six nonmembers had enacted domestic legislation based on the OECD Convention that makes a payment from a home country company to an official in a host country a punishable offense. How effective is this OECD-centered framework turning out to be, and how might it be reformed and strengthened? Is this an area where the “policy space” of developing country governments – and developed country governments – needs to be expanded, contracted, or left as is? There are no exact data on how pervasive corrupt payments might be. The “resource curse” literature includes bribery on the part of extractive investors as one of the principal vehicles by which corrupt leaders divert revenues to their own pockets rather than spending them on social programs and development projects. National and international companies and business groups regularly accuse their rivals and competitors of engaging in corrupt payments. The 2002 Bribe Payers Index asserts – on the basis of allegations from 835 senior executives of international and domestic companies, chartered accountancies, binational chambers of commerce, and commercial banks and law firms, as compiled by Transparency International (TI) – that

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firms from Spain, France, the U.S., Japan, and Italy are most likely to pay bribes; firms from the Netherlands, Belgium, the U.K., and Germany less likely; and firms from Australia, Sweden, Switzerland, Austria, and Canada least likely (TI, 2002). International investors in the oil and gas industry rank high among sectors where corrupt payments were expected to be found. So do investors in power generation. But they are not at the top of the list. The oil and gas sector was third behind international companies participating in public works, and arms sellers and defense contractors. The international power generation sector came in seventh. TI devoted its 2006 Annual Report to corruption in the international health care system, including international companies providing drugs, hospital equipment, and medical services. The spread of OECD Convention-consistent home country legislation has not led to widespread prosecutions of international investors. Between 2003 and 2005, only three of the 21 largest capital-exporting countries reported that they were investigating major domestic firms for possible corrupt payments abroad (Center for Global Development/Foreign Policy Magazine, 2002–06). Lack of vigilance on the part of developed country authorities, the difficulty of conducting investigations and producing hard evidence, and insufficient protection for whistleblowers are among the most widely cited explanations. 2.2.5.2 New evidence of corrupt payments by MNCs Particularly worrisome, however, is the discovery of sophisticated structures, involving current-payoff-and-deferred-gift payments to relatives and friends of host country officials, used by U.S., Japanese, and European firms, that do not put the parent company in jeopardy of prosecution under any OECD-consistent home country legislation, including the US Foreign Corrupt Practices Act.13 The detailed evidence about these partnership deals with children and cronies of developing country rulers emerges from contractual arrangements devised by international companies to gain infrastructure concessions in Indonesia in the 1995–2003 period, but the payment configurations have more general applicability that may have led – or may lead – to their use in other industries and other countries as well. To avoid running afoul of developed country antibribery laws, no payments were made to host country officials themselves. Instead multinational investors would approach a family member or close friend of the ruler to create a partnership to own the target project (or respond in the affirmative when a family member or close friend inquired about forming a partnership), then loan that family member or close friend the capital required to “buy” an equity stake in the project, and pay a dividend to the family member or close friend larger than the annual amount required to service the loan. The partnership stake is a deferred gift – the loan to acquire the

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local partner’s equity is paid off with the proceeds of the dividend over time. The surplus above what goes to service the loan is a current payoff. In contrast to a legitimate equity partner, the family member or close friend has no resources of his/her own at risk, nor any requirement to repay the loan out of his/her own assets. The partnership stake enters the hands of the family member or close friend for free – the only “service” that he or she performs is to ensure the selection of the foreign-controlled partner company to receive the infrastructure concession. In some cases, the special local partner was paid a dividend starting as soon as the concession was won, before the project began any operations. Since no dividend would be forthcoming from an unsuccessful project, the family member or close friend would want to look closely to ensure favorable treatment for the project over its lifetime. 2.2.5.3 Three components of reform To be effective, international regulations to combat bribery and corrupt payments in the awarding of investment concessions and the negotiation of investment agreements require the tightening of the policy space for both developed and developing countries in three ways. First, the definition of bribery as contained in the OECD Convention – doing no more than criminalizing a payment to a public official by an international company to secure a contract – needs to be tightened. A convenient, and widely accepted, place to look for a remedy can be found in the OECD’s informal “Guidelines for Multinational Enterprises.” These contain, as the OECD admits, much broader scope than the narrow language of the Convention to Combat Bribery (OECD, 2003: 11). In defining bribery, the guidelines state “Enterprises should not, directly or indirectly, offer, promise, give, or demand a bribe or other undue advantage to obtain or retain business or other improper advantage.” “In particular, enterprises should ... not use subcontracts, purchase orders or consulting agreements as means of channeling payments to public officials, to employees of business partners or to their relatives or business associates.” All that would be needed to catch the structure described here is to add the phrase, “not use partnership arrangements.” Until tightening such as this is accomplished, the OECD Convention – and implementing legislation in the 36 states that have ratified the Convention – are not robust enough to reign in any but the most unsophisticated corrupt payments. Second, international commercial law arbitration procedures, as noted in Sections 2.3 and 2.5 (above) – ICSID, the ICSID Additional Facility, and UNCITRAL – need to affirm, or reaffirm, that plaintiffs who have obtained property by corrupt means will not have their property rights protected by arbitral tribunals. Following the reformed OECD guidelines, they should note whether payments were made, services performed, and capital placed

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at risk, or whether favors were rendered in return for a gift. Arbitration procedures should be evenly balanced: international investors should be protected against misconduct by host states; host states should be protected against misconduct by international investors. International law already contains precedents – just as domestic law does – to reject the validity of a contract acquired by corrupt means, thereby vitiating rights claimed by the investor (Kreindler, 2003: 209–60). In the Methanex investor-state arbitration (Section 2.3, above), for example, the tribunal recognized and avowed its capacity for finding a fact of corruption independent of whether allegations had been proven in earlier criminal trials.14 In this case, the tribunal ruled that the evidence introduced did not justify a finding of corruption. But the ruling supports the proposition that an investor who has obtained a contract via corrupt means cannot expect arbitrators to enforce the contract. These are the tribunals that need to use the tightened definition of corruption, as recommended above, to condemn partnerships with family members and cronies – backed by sophisticated loans-to-purchase-equityshares, overlapping payment arrangements, and deferred-gift mechanisms – as disqualifying elements in arbitration. Finally, corrupt payments of all kinds involving international companies and national authorities have to be more regularly and systematically exposed. The Extractive Industry Transparency Initiative (EITI) is perhaps the most advanced model endorsed by the international community thus far, pushing host countries to require all investors within a given host country to publish what they pay while host authorities simultaneously reveal how much they have actually received. Since 2003, the EITI has been endorsed by the World Bank, which created a multidonor Trust Fund to provide training for government officials and civil society organizations that might serve as monitors and auditors. The EITI can hardly be effective, however, unless host governments require that all investors – including state-owned companies and privately held companies from all countries (including Russia and China) – submit records of payments made to independent audit, which can then be matched with data on revenue receipts by host authorities that are also independently audited. Initiatives such as the EITI have to be expanded to other sectors, and the geographical coverage steadily enlarged.15 Taken together, these three recommendations – a tighter definition of corrupt payments, more widespread and transparent monitoring of payment streams, and the refusal to protect contracts obtained via corruption in international arbitration – would be a particularly potent combination. Even investors from home countries not known for tight enforcement of anticorruption regulations would think twice about using bribes if they understand that their rights will not subsequently be respected or enforced if they are ever discovered, challenged, and taken to arbitration.

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2.2.6 Signing Bilateral Investment Treaties (BITs) to attract foreign direct investment During the debate about the MAI, the importance of BITs as a key element in attracting FDI to developing countries was a virtually unchallenged article of faith. Multiple tests of this hypothesis in the years following have found – to the astonishment of many – virtually no empirical support. 2.2.6.1 Empirical tests The OECD was the first to test the relationship between investment promotion and the presence of bilateral investment treaties (UNCTAD, 1998). The OECD investigated whether the number of BITs signed by any given host had an impact on the amount of FDI that the host received. The study found no significant correlation between the number of BITs and increased flows of FDI. At the World Bank, Mary Hallward-Driemeier attempted a retest, examining bilateral FDI flows from OECD Members to 31 developing countries over two decades (World Bank, 2003: 129). This analysis revealed that countries that had signed a BIT were no more likely to be the recipient of additional FDI than were countries without one. Hallward-Driemeier then tested whether BITs might play the role of a signaling device, drawing the attention of multinational companies to a country for subsequent investment. But the three years following the signing of a BIT showed no increase in FDI in comparison to the three years preceding the BIT’s negotiation. Finally, investigating whether a BIT between two countries affected the relative amount of FDI from the first to the second, there was no statistically significant correlation. In the same vein, Bruce Blonigan and Ron Davies use panel data for bilateral country pairs over time.16 Once again they find that neither U.S. BITs or OECD BITs increase FDI flows from one to the other. It would be wrong to conclude that BITs operate without impact on host countries, however. There have been multiple arbitral settlements in which foreign investors have been awarded in excess of $100 million, according to diverse and sometimes decidedly onesided criteria – compensating foreign firms with unfinished ventures not just for expenditures already made but also for presumed profits extending in perpetuity, for example17 – without measurable benefit from the BITs in attracting greater FDI flows. 2.2.7 Multilateral regulation of locational subsidies to investors In contrast to the presumed importance of BITS in stimulating new foreign investment, conventional wisdom has held that MNCs do not plan the placement of their facilities according to tax considerations, and that developed and developing countries do not compete directly as sites for

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MNC plants. Recent econometric investigation shows both assumptions to be inaccurate in the current era. 2.2.7.1 The escalation of giveaways To be sure, it has long been clear that locational incentives – tax breaks, subsidies, free land, public-built plants and office space, and worker training grants – have been escalating (Thomas, 2000). Ireland transformed its economy with special treatment for multinational investors that could use the country to export into the EU. U.S. states from South Carolina and Alabama, to Texas and California, made generous offers first to those who would build auto plants in industrial parks, then to those who would locate biotech and software facilities in research parks. The provinces of Canada have tried to avoid competing with one another for investment, as have the countries of Europe, with growing contentiousness and declining success. Developing countries have expanded their offers of locational incentives to attract FDI as well. Some 85 percent of the governments in a survey of 45 developing countries offer tax breaks or tax holidays to multinational investors. (World Bank, 2005: 168–70) The deployment of incentive packages on the part of developing countries is typically less effective than developed country investment promotion agencies (Shah, 1995). But the scale of the effort is not necessarily smaller. EU Member States have provided international investors with as much as $180,000 per job created. Brazil has offered locational subsidies on the order of $54,000 to $340,000 per job (World Bank, 2005: 171). The revenue losses to the Vietnamese government from tax breaks granted to foreign firms are more than 0.7 percent of GDP. By the late 1990s the evidence began to show multinational investors paying greater attention to locational incentives in their siting decisions. Econometric analysis of evidence from 14 home countries and 34 host countries demonstrated that the responsiveness of international investors to locational incentives has been speeding up (Altshuler, Grubert, and Newlong, 1998). More recently, using data from 48 developed and developing countries, John Mutti has demonstrated that the competition between developed and developing country sites is increasing, especially for plants that compete in international markets (Mutti, 2003). Here the tax elasticity can be as high as three – that is, if tax policy reduces the cost of capital by 1 percent, MNC production in the manufacturing sector of the host country will increase by about 3 percent. 2.2.7.2 Prisoners’ dilemma vs. international constraints Competition in awarding investment incentives carries heavy costs to developed and developing countries alike. In a classic illustration of the prisoners’ dilemma, all players would be better off if they could agree to control their behavior but no one participant can act alone without leaving himself

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at a competitive disadvantage. The logical solution would be for developed and developing country governments to come together to limit – and perhaps to roll back – their giveaway programs. To be effective, however, a multilateral regime to govern investment incentives would have to cover subnational as well as national behavior, greatly complicating the problem of securing agreement and policing the result.

2.3 Prospects for progress? The agenda for reconfiguring the international regulatory regime for FDI in ways that are development friendly involves multiple actors stretched across widely differing fora. This has the virtue of bringing sympathetic new parties into the reconstruction process – working toward progress in a piecemeal fashion – in a way not possible during the MAI negotiations, while avoiding the alltoo-likely deadlocks or unwise trade-offs that plagued them (Graham, 2000). The attempt to discuss – let alone tighten – restrictions on performance requirements in the context of a multilateral trade agreement has seldom shown much promise. As the struggles over the Doha Round give way to a more energetic focus on bilateral and regional trade agreements, the number of countries and number of agreements in which the participants agree to refrain from the use of domestic content, joint venture, and other technology-sharing requirements is rising. Most Favored Nation (MFN) provisions within these bilateral and regional trade agreements may create a trajectory in which the counterproductive imposition of performance requirements on foreign investors declines. The prospects for reducing pressures to use sanctions in bilateral and regional trade agreements to enforce labor standards is more problematic. A realistic appreciation of the difficulty of formulating an effective international dispute settlement process, with shared definitions about obligations and shared standards for noncompliance, appears as distant as ever – in large part because large developed countries that wish to dictate required behavior to smaller, weaker nations are oblivious to the fact that a genuine multilateral system would oblige them to conform as well. Meanwhile, the search for ways to use labor rights violations in developing countries as an excuse to protect developed country industries remains strong, subject to shifting political winds. As for compensating foreign investors for health, safety, and environmental laws, there will be counterattacks to the Methanex decision. But, within NAFTA, the threat that hardline accusations of expropriation might be used by foreign investors to block regulatory progress may have passed its peak. The larger issue is how investor-state disputes evolve in BIT-based

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arbitrations. Complicating the process, not only is there no formal precedence (stare decisis), but many arbitrations continue to be carried out behind closed doors, completely out of the public eye (often it is virtually impossible to know that they have even taken place, let alone how they were settled). The reapportionment of commercial risks in international infrastructure transactions, with the attendant implications for foreign exchange exposure and moral hazard for investors, may take place in relative straightforward fashion, albeit slowly. Political risk insurers – including national political risk insurers – and multilateral lenders and guarantors have not enjoyed fronting for private investors intent on shifting business risk onto others under the rubric of political risk coverage. It is in the interest of insurers and guarantors to help to raise the consciousness of host authorities eager for infrastructure investment about the hidden dangers of signing concessions without adequate reflection about possible adverse outcomes. Under pressure from these new actors, the reform of commercial law arbitration procedures is more likely to make progress than in a general MAI-type negotiation where the MNC corporate legal community would simply veto any attempts at change. Progress in curbing corrupt payments by multinational investors to willing recipients around the world may be more difficult. The deferredgift-and-current-payment schemes recorded above illustrate amply how imaginative minds can keep ahead of criminal laws and criminal investigations. Nonetheless, it is possible that greater transparency, with shame for investors who are publicity conscious, and loss of arbitral protection for those who are not, may lead to improvement. An MAI-type negotiation, in contrast, would likely see this issue simply removed from the table by the lawyers representing international investors – witness the fact that more than 2000 BITs have been signed with no mention of bribery or corrupt payments whatsoever. On bilateral investment treaties, not only is it important to temper expectations about the power of BITs to augment international investment flows, but foreign investment dispute settlement under the BITs needs to evolve so that the definition of expropriation does not block regulatory reform, so that contracts obtained via corruption are not upheld and defended, and so that protection against hostile political acts is kept separate from shielding against the commercial risks of engaging in international business. Finally, on control and supervision of locational incentives, the case for mutual restraint is overwhelming. But the collective action problem – requiring agreement, supervision, and enforcement across federal, state, and municipal jurisdictions throughout the developed and developing world – may be simply insurmountable. It is sad to acknowledge therefore that expectation of progress here may remain fanciful!

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Notes 1. This analysis draws on Moran (2006–07). For this chapter, I have benefited greatly from comments from Howard Mann, Aaron Crosbey, and Monty Graham. The weaknesses that may remain are my own. 2. The analytics of why trade protection, domestic content requirements, or other restraints on competition are likely to lead to a proliferation of subscale and inefficient plants can be found in Eastman and Stykolt (1970). 3. For a systematic review of the evidence, see Moran (2001). 4. For rigorous identification and measurement of externalities, see Moran (2005). 5. World Trade Organization, Ministerial Declaration, Annex F (84), December 18, 2005. 6. Among countries with legislation that permits the hiring of replacements for striking workers, Your Voice at Work draws attention to Burkina Faso, Cape Verde, Central African Republic, Djibouti, Madagascar, Niger, and the United States (Geneva: International Labour Organization, 2000), p. 38. 7. In ILO jurisprudence there is no requirement that union members get to vote. 8. For more complete analysis of challenges – including sources of evidence and information – see National Academies of Science (2004). 9. For more detailed analysis, see Moran (2002). 10. International Center for Settlement of Investment Disputes, Metalclad Corporation vs. United Mexican States (Case No. ARB(AF)/97/1), Award rendered on 30 August (Washington, DC: International Center for Settlement of Investment Disputes, 2000). Available online at http://www.worldbank.org/icsid/cases/ mm-award-e.pdf. 11. Methanex Corporation vs. United States of America. In the Matter of An Arbitration under Chapter 11 of the North American Free Trade Agreement and the UNCITRAL, Arbitration Rules, Final Award of the Tribunal, August 7, 2005. 12. For background and interpretation, see Howard Mann, The Final Decision in Methanex vs. the United States: Some New Wine in Some New Bottles (Winnipeg: International Institute for Sustainable Development, August 2005). 13. For details, see Moran (2006–07) and Wells and Ahmed (2007). 14. See note 11. 15. The government of Finland expressed an interest in a similar initiative to cover investors in the forest and paper industries. The International Tropical Timber Organization promotes the sustainable management, use, and trade of tropical forest resources. The Kimberley Process Certification Scheme (KPCS) requires governmental and private diamond traders to ship their rough output with certification that they are not conflict diamonds. 16. Cosbey (2005) reviews the literature with more nuanced results. 17. Louis T. Wells, Jr. cites an award made for a project (never completed or tried out to see if it were commercially viable), in which the arbitrators required payment of both investment and estimated future stream of earnings for 30 years. This “double counting,” he argues, is like a US saver making a deposit in a bank that fails, and then being compensated by the Federal Depository Insurance Corporation for the deposit plus 30 years’ worth of interest. The saver could then deposit the award in another bank and hope that the latter fails as well. Besides being unfair, the perverse incentives of such a system of compensation are manifest. See Louis T. Wells, Jr. (2003).

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References Aghion, Philippe, and Peter Howitt. 1998. Endogenous Growth Theory. Cambridge, MA: MIT Press. Altshuler, R., H. Grubert, and S. Newlong. 1998. “Has US Investment Abroad Become More Sensitive to Tax Rates?” Working Paper No. 6383. Cambridge, MA: National Bureau of Economic Research. Berry, Charles. 2003. “Shall the Twain Meet? Finding Common Ground or Uncommon Solutions: A Broker’s Perspective.” In Theodore Moran (Ed.). International Political Risk Management: The Brave New World. Washington, DC: World Bank. Birdsall, Nancy, Dani Rodrik, and Arvind Subramanian. 2005. “How to Help Poor Countries.” Foreign Affairs (Jul./Aug.) 84(4). Center for Global Development/Foreign Policy Magazine. 2002–06. Commitment to Development Index. Washington, DC: Center for Global Development. CFA Institute. 1996. CFA Digest. Washington, DC: CFA Institute. Cosbey, Aaron. 2005. International Investment Agreements and Sustainable Development: Achieving the Millennium Development Goals. Winnipeg: International Institute for Sustainable Development and International Development Research Centre. Eastman, H., and S. Stykolt. 1970. “A Model for the Study of Protected Oligopolies.” Economic Journal 70: 336–47. Encarnation, Dennis J., and Louis T. Wells, Jr. 1986. “Evaluating Foreign Investment.” In Theodore H. Moran (Ed.). Investing in Development: New Roles for Private Capital? Washington, DC: Overseas Development Council. Graham, Edward M. 2000. Fighting the Wrong Enemy: Antiglobal Activists and Multinational Enterprises. Washington, DC: Institute for International Economics. Grossman, Gene M., and Elhanan Helpman. 1991. Innovation and Growth in the Global Economy. Cambridge, MA: MIT Press. Harvard Business School. 1997. Enron Development Corporation: The Dabhol Power Project in Maharashtra, India. Cambridge, MA: Harvard Business School. Hobday, Michael. 1995. Innovation in East Asia: The Challenge to Japan. London: Aldershot. Hobday, Michael. 2000. “East versus Southeast Asian Innovation Systems: Comparing OEM- and TNC-led Growth in Electronics.” In Linsu Kim and Richard Nelson (Eds.). Technology, Learning, & Innovation. New York: Cambridge University Press. International Labour Organization (ILO). 1994. Freedom of Association and Collective Bargaining. Geneva: International Labour Organization. International Labour Organization (ILO). 1998. Labor and Social Issues Relating to Export Processing Zones. Geneva: International Labour Organization. International Labour Organization (ILO). 2000. Observations on the United States Submitted by the International Confederation of Free Trade Unions (ICFTU), Review of Annual Reports Under the Follow-Up to the ILO Declaration on Fundamental Principles and Rights at Work. Geneva: International Labour Organization. Kessides, Ioannis N. 2004. Reforming Infrastructure: Privatization, Regulation, and Competition. Washington, DC: World Bank and Oxford University Press. Kreindler, Richard H. 2003. Aspects of Illegality in the Formation and Performance of Contracts. International Council for Commercial Arbitration Congress Series 11. The Hague: Kluwer. Lawrence, Robert. 2003. Crimes and Punishments? Retaliation Under the WTO. Washington, DC: Institute for International Economics.

70 Theodore H. Moran Levin, Sander. 2006. “Remarks of Representative Sander M. Levin on FTAs between the US and Latin America.” April 17, 2006. Washington, DC: Carnegie Endowment for International Peace. Levin, Sander, Charles B. Rangel, and Xavier Becerra. 2003. “Letter of Representatives Sander M. Levin, Charles B. Rangel, and Xavier Becerra to USTR on CAFTA,” Inside US Trade, November 7. Long, Guoqiang. 2005. “China’s Policies on FDI: Review and Evaluation.” In Theodore H. Moran (Ed.). Does Foreign Direct Investment Promote Development? Washington, DC: Institute for International Economics. Minor, Michael S. 1994. “The Demise of Expropriation as an Instrument of LDC Policy 1980–1992.” Journal of International Business Studies 25(1): 177–88. Moran, Theodore H. 2001. Parental Supervision: The New Paradigm for Foreign Direct Investment and Development. Washington, DC: Institute for International Economics. Moran, Theodore H. 2002. Beyond Sweatshops. Washington, DC: Brooking Institution. Moran, Theodore H. (Ed.) 2005. Does Foreign Direct Investment Promote Development? Washington, DC: Institute for International Economics. Moran, Theodore H. (Ed.) 2006–07. Harnessing Foreign Direct Investment for Development: Policies for Developed and Developing Countries Washington, DC: Center for Global Development. Mutti, John. 2003. Taxation and Foreign Direct Investment. Washington, DC: Institute for International Economics. National Academies of Science. 2004. Monitoring International Labor Standards: Techniques and Sources of Information, Report of the Committee on Monitoring International Labor Standards of the National Academies of Science. Washington, DC: National Academies of Science. Organisation for Economic Cooperation and Development. 2003. Anti-Corruption Instruments and the OECD Guidelines for Multinational Enterprises. Paris: Organisation for Economic Cooperation and Development. Price, Donald M. 2001. “NAFTA Chapter 11 – Investor-State Dispute Settlement: Frankenstein or Safety Valve?” Canada-United States Law Journal Supplement 26: 1–9. Remedio, Elizabeth M. 1996. “EPZs in the Philippines: A Review of Employment, Working Conditions, and Labour Relations.” Working Paper 77. Geneva: International Labour Organization. Romer, Paul. 1994. “New Goods, Old Theory, and the Welfare Costs of Trade Restrictions.” Journal of Development Economics 43. Rose-Ackerman, Susan. 1992. “Regulatory Takings: Policy Analysis and Democratic Principles.” In N. Mercuro (Ed.). Taking Property and Just Compensation: Law and Economics Perspectives of the Takings Issue. Boston: Kluwer Academic Publishers. Rose-Ackerman, Susan, and J. Rossi. 2000. “Disentangling Deregulatory Takings.” Virginia Law Review 86(7): 1435–95. Shah, Anwar. (Ed.) 1995. Fiscal Incentives for Investment and Innovation. New York: Oxford University Press. Smarzynska Javorcik, Beata, and Mariana Spatareanu. 2005. “Disentangling FDI Spillover Effects: What Do Firm Perceptions Tell Us.” In Theodore H. Moran (Ed.). Does Foreign Direct Investment Promote Development? Washington, DC: Institute for International Economics. Tajgman, David, and Karen Curtis. 2000. Freedom of Association: A User’s Guide. Geneva: International Labour Organization.

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Thomas, Kenneth P. 2000. Competing for Capital: Europe and North America in a Global Era. Washington, DC: Georgetown University Press. Transparency International. 2002. Bribe Payers Index. Berlin: Transparency International. United Nations Conference on Trade and Development. 1998. World Investment Report. New York: United Nations. van der Walt, A.J. 1996. The Constitutional Property Clause: A Comparative Analysis of Section 25 of the South African Constitution of 1996. Cape Town: Juta & Co. Veloria, Velma. 2002. “Statement During the International Investment Agreement Seminar Series.” May 23. Washington DC: National Policy Association and the Congressional Economic Leadership Institute. Vernon, Raymond. 1971. Sovereignty at Bay. New York: Basic Books. Wasow, Bernard. 2005. “The Benefits of Foreign Direct Investment in the Presence of Price Distortions: the Case of Kenya.” Draft, June. Wells, Jr., Louis T. 2003. “Double Dipping in Arbitration Awards? An Economist Questions Damages Awarded Karaha Bodas Company in Indonesia.” Arbitration International 4. Wells, Jr., Louis T., and Rafiq Ahmed. 2007. Making Foreign Investment Safe: Property Rights and National Sovereignty. New York: Oxford University Press. Wells, Jr., Louis T., and Eric S. Gleason. 1995. “Is Foreign Infrastructure Investment Still Risky?” Harvard Business Review (Sep.–Oct.): 44–55. Woodhouse, Erik J. 2006. “The Obsolescing Bargain Redux? Foreign Investment in the Electric Power Sector in Developing Countries.” Working Paper. Palo Alto: Stanford University Program on Energy & Sustainable Development. World Bank. 2003. Global Economic Prospect and the Developing Countries 2003: Investing to Unlock Global Opportunities. Washington, DC: World Bank. World Bank. 2005. “World Development Report 2005: A Better Investment Climate for Everyone.” Washington, DC: World Bank.

3 The WTO: A Sweet or Sour Chinese Banquet? Alice H. Amsden

3.1

Introduction

Trade is one of the longest surviving human activities, becoming more far-flung, varied and valuable over time. The rules governing trade – even free trade – have grown more complex with millions of new players and products, giving rise to the multilateral trade organization to serve as King Solomon. In theory, governance of international trade organizations takes the form of “One Country, One Vote.” In practice, whatever the formal rules, a strong leader sits atop and sets the agenda in a hierarchy resembling the Empire State Building. Bill Clinton’s Trade Representative, Charlene Barshevsky, unabashedly used the word “push” rather than “persuade” to describe America’s leadership: It is vital to the long-term prosperity and prestige of the United States ... to take full advantage of our strong global position and continue to push our trading partners for even more open markets and economic liberalization. If we abdicate our strength, we risk missing a prime opportunity to advance those policies and values that have been so instrumental in making our economy the strongest and most efficient in the world. (emphasis added, Barshewsky 1998) What seems to shape a superpower’s agenda in multilateral trade organizations is the share of its imports and exports in GDP (Gross Domestic Product). Measured by national income or domestic demand, the leader is ultra-large, which fact goes hand in hand with a small foreign trade share. The smaller the share of trade (net exports) in a leader’s GDP, as argued below, the less important trade is to the leader in economic terms, and the more important it is as a global political weapon. The troubles of the World Trade Organization (WTO) begin here, with the highly politicized leadership of the U.S., one of the biggest economies and one of the smallest traders, which sometimes cooperates with Europe and 72

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Japan, its closest allies, and sometimes disconnects from them. The WTO is bleeding because there is now mass exodus from its unyielding rules, and a rapid buildup of alternative trading organizations. The oddity is why the same leader, the U.S., was innovative as head of the General Agreement on Tariffs and Trade (GATT), and ideological as head of the WTO? Both eras were bipartisan, so no one political party deserves credit or blame. Republicans (Eisenhower and Nixon) were part of a Democratic deluge, and Democrats (Carter and Clinton) were part of a Republican rampage. Whichever the party in power, within each era foreign economic policy tended to be the same.

3.2 Leaders aren’t big traders An unstable oligopoly among “free-trade imperialists” such as Britain, France, and Japan gave way after World War II to duopoly, with competition for power down to only two colossal countries, the U.S. and the Soviet Union, both of whose economies were inward-oriented. After the fall of the Berlin Wall in the 1990s, and Russia’s plunge into anarchy, global power over trade became even more concentrated, resting in one place and one place only, Foggy Bottom. When asked in 2002 if the WTO was democratic, the European Union’s Deputy Permanent Representative in Geneva, Ian Wilkinson, replied: I don’t believe (the WTO) is undemocratic in that members come from democratically elected governments ... Well, in the case of the USA the needs of big business are a huge part of the process – and to a lesser extent the EC – in which case it is a bit of a mix ... There is going to be power play. People are paid to defend and promote the interests of their countries ... (The WTO) is not democratic in the sense that people can’t just come in and say what they think. (cited in Jawara, 2003: 2467) Not allowing members to say what they think is a bad omen; it stymies organizational learning, which ultimately lies behind the WTO’s fall. Exports (net of imports) in GDP in 1910 were approximately 15 percent in Japan, 8 percent in Russia, and only 6 percent in the US. However, 90 years later the share was 44 percent in the new Russian Federation, kept alive by raw material exports, 36 percent in the European Union (average for 25 countries), 34 percent on average for developing countries, and only 11 percent in India, Japan, and the US (Amsden, 2001: 727; UNCTAD, various years). Trade was relatively unimportant economically for a country like the U.S. because its domestic market was rich, still served largely by local industries and service providers. Every other country wanted to sell to the American consumer, increasing Washington’s bargaining chips. A small trade share in a big country’s GDP creates a certain leadership pattern. For one, the economic returns of trade to an inward-looking leader

74 Alice H. Amsden

become inconsequential relative to the political returns. It is certainly possible to benefit both economically and politically from the same trade policy. Besides, there is not always unanimity on trade among a country’s “Royalists” (Franklin Roosevelt’s term for the elite). After 2000, for example, the U.S. State Department probably would have preferred to pummel China (political motive), but the Treasury and multinational firms wanted to do business with it (economic motive). Still, politics tend to dominate, or intermingle with economic considerations, especially if the leader accesses foreign markets through multinational investments rather than imports and exports. To upgrade its own political power over trade, the U.S. championed the “free trade agreement” (FTA), which narrowed the WTO’s span of influence. FTAs give preferential treatment to select countries that are handpicked for political reasons, the very opposite of the WTO’s one-size-fits-all policy. The US signed free-trade agreements with Egypt and Jordan, for example, which had little to offer in the way of exports (Jordan even had to import Chinese labor to manufacture at all!), but much to offer in the way of allies. A bilateral FTA was negotiated between the U.S. and Kosovo. The American bilateral free-trade agreements that popped up all over Asia were designed to stop China in its tracks. Discrimination in the choice of partners created a queue of developing countries “eager” to sign on the line for an FTA with Washington. Based on this “evidence,” the FTA was proclaimed a popular success. Like the free-trade agreement, politics also triumphed over economics when it came to entry into the WTO. Whether or not a country traded heavily with the U.S. (China did, Russia did not), the U.S. played a dominant role in establishing the terms for politically pivotal countries to become new WTO Members. Secret, bilateral negotiations between the U.S. and China took roughly ten years, and Russian negotiations weren’t much shorter. Another effect of “big country, small trader” was relative ignorance. An inward-oriented trader like the US, with a small share of trade in GDP historically, may be expected to understand less about world trade than experienced hands, like many European countries, which have been trading with each other and their colonies for centuries. Good leadership depends on knowledge of the details of how exports are generated especially in developing countries with weak manufacturing bases, how trade flows are affected by new products, and how trade impacts on the balance of payments. But American trade organizations were not always adept in fine tuning global trade relationships. When, for example, American industry was fighting for its life against Asian industry in the 1980s–90s, and was running huge trade deficits, Washington presented South Korea with a list of 100 products to liberalize. South Korea dutifully complied, only to find itself sucking in imports from Japan, not the U.S.! There was no customization of the list by the US trade representative; the 100 products chosen reflected the most

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vociferous domestic lobbyists, not US comparative advantage. No wonder Japanese, not American, suppliers filled the breech! Unlike the US, a savvy trading country would also have aimed for equilibrium in its overall trade balance, not equilibrium in its balance with every trading partner that temporarily got the upper hand. A third issue concerns the behavior of a trade leader’s own national firms. A large country with a small trade share in GDP – but one that is large in absolute terms by world standards – may be expected to have relatively diversified exports, produced under relatively low market “concentration” (strong competition). This expectation differs from a smaller country with a large trade sector, whose lifeblood is specialized exports that are produced under relatively monopolistic conditions, such as the rare raw materials of Africa (bauxite in Ghana) or Swiss clocks. The greater the trade diversification and the less the domestic market concentration, the fewer the nails that stick up at home demanding government attention. This makes for a better multilateral trade leader: a large number of home industries, equally engaged in trade, can’t all be given special treatment, freeing the trade leader to pursue international rules that are more efficient and equitable for all. Economic rationality triumphs over political privilege. The US data do, in fact, show a high level of diversification and a low level of concentration. In 2003, the total number of products the US exported was 235, compared with an average 232 for all developed countries – not much difference. A “diversification measure” devised by United Nations Conference on Trade and Development (UNCTAD) was 0.25 for the US and an average of 0.34 for all developed countries. If a country’s measure equals one, its exports deviate completely from the world average – the country is highly specialized. The exports of the US were thus relatively diversified, and also exhibited low concentration: 0.08, compared with 0.11 for all developed countries and 0.54 for, say, a small, specialized country like Gibraltar. Still, lobbying for trade privileges by America’s top exporters was like water is to fish. The idea that a relatively diversified and competitive trade sector dampens lobbying is not borne out by what goes on inside the WTO’s Washington delegation. Lobbying by American companies in the WTO has probably strengthened, not weakened over time. Lobbying rose with more Japanese competition, more threats to agroindustries from Brazil’s ranches and Argentina’s pampas for example, more patent activity, more globalization of services, and almost a doubling in the GDP share of net exports from 6 percent to 11 percent. The third hypothesis – that leadership is less political if vertical integration and competition are high – does not appear to hold. Washington subsidized declining industries (textiles, steel, and agriculture) as well as the tallest tools in the shed, from finance and pharmaceuticals to telecommunications. The WTO urged 40 developing countries, without patent protection, to respect patents based on the logic that this would give

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an incentive to the pharmaceutical giants to innovate drugs needed to fight Third World diseases. But the trend towards more special products has been weak (Lanjouw, 2000: 2498). Increasingly, then, leadership in the WTO supported policies that were not necessarily compatible with economic development, equity, or efficiency for the average WTO Member. Instead, the target of interest was the boardrooms of the world’s biggest businesses. Finally, a big country with a small trade share tends to access foreign markets through means other than exports. Instead of exporting to a foreign market, it may invest in it and produce locally. Its investment may be “indirect” (banks lend or sell bonds) or “direct” (multinationals open “green” plants or buy up local companies). U.S. multinationals were the kings by far, ranging from oil exploration to fast foods, from GE to Microsoft. In 1997, according to a UN World Investment Report, of the top 100 multinationals (measured by foreign assets), including national oil companies like Petroleos Venezuela, the U.S. accounted for 27, almost onethird of the total. In 2004, U.S.-based multinationals invested $229 billion abroad. The next biggest investor, Britain, invested only a little over $60 billion (UNCTAD, 2005). Multinationals from the U.S., Canada, Europe, and Japan tend to stew over the same issues, and ally with each other in the WTO. They form a bloc. By contrast, most countries in the South can’t attract capital from the North except for extracting raw materials. Only a few developing countries have been magnets for multinational investment in manufacturing, especially manufacturing requiring advanced skills, which further divides the South into richer and poorer, with a split voice in the WTO. In this respect, multinationals are divisive, more so than exporters or importers. Accessing foreign markets through investment rather than trade also tends to politicize leadership more than otherwise. A large share of global trade occurs within multinational firms; these nonmarket transactions, such as transfer pricing, are mostly hidden from view. The multinationals also want to “source” their inputs from their other subsidiaries, not from local suppliers. These suppliers may be as good as any, but they don’t generate profits within a multinational’s group. To influence tariffs, taxes and rules of origin, the multinational seeks to influence trade policy in dozens of interconnected markets, and thus curries political favor in dozens of capitols throughout the world. The consumer products division of the French petrochemical giant Elf Aquitaine, for example, acquired Yves Saint Laurent, the snobbiest of fashion houses, thereby leveraging its power in petrochemicals to open high-end retail stores to foreign investors. Louis Vuitton-Moet Hennessy (LVMH) is partly owned by Christian Dior and has a joint venture with the South African giant, de Beers diamonds. It can easily cooperate in the WTO with, for example, GAP, an American retail giant, but not with the small retail outlets that are sprinkled throughout

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the developing world. As the multinationals weighed in, the vaunted level playing field of the WTO became a minefield, even if the genteel boutique appeared on the surface. David Ricardo’s brilliant theorem of comparative advantage depends on the assumption of immobile production factors, such as labor, capital and institutions like the multinational firm. Without this assumption, Ricardo’s theorem is no longer necessarily valid. A big company can produce just about anything anywhere. But as leader of the WTO, the US has never investigated the economic and social consequences for trade or economic development of the nullification of Ricardo’s assumption, or the outlandish assumption of modern trade theory that also no longer holds, namely, that brand names are immaterial, and that all countries have free access to the same technology and know-how (perfect knowledge). If they had such access, every country would be developed. The multilateral trade organization no longer has theoretical wisdom to guide it, but it pretends that the trade over which it presides is guided by classical theories. These theories need to be amended in practice given their dysfunctional assumptions, but the multilateral trade leader sees only their political worth – to “push” our trade partners to open their markets. The orthodoxy of open markets and the litany of a level playing field have become political slogans with little economic content. The WTO has thus become dogmatic. In sum, the larger the leader of a multilateral trade organization, and the smaller its share of trade in GDP: 1. The more likely the leader will use world trade for political rather than economic aims; 2. The more ignorant the leader will be of trading conditions; 3. The less subject to internal domestic lobbying the leader will be, and the less politics will characterize the multilateral trade leader (an assumption that doesn’t appear to hold for the U.S.); and 4. The more the trade leader will push for open markets for its growing service sectors, including financial services and direct investments by multinational firms. All of this presents an interesting puzzle. Leadership (or equivalently, entrepreneurship) is the key to the success or failure of any top-down multilateral trade organization. And country leadership was the same under the GATT and the WTO. Washington held the reins of power in both cases! Yet these bodies performed so differently in terms of reducing tariffs, raising imports and exports, and revving up economic development in the South! If nothing else, growth rates of Gross National Product (GNP) were spectacularly different in the developing world in the two periods. GATT coincided with a Golden Age. The WTO coincided with

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Table 3.1

GDP growth rates and GDP per capita growth rates

GDP growth rates (%) Region

GDP per capita growth rates (%)

1950–80

1980–2000

1950–80

1980–2000

Western Europe

4.20

2.20

3.24

2.06

USA

3.47

3.45

1.79

1.93

Japan

7.10

2.65

5.50

2.12

Developed countries average

4.12

2.46

3.06

1.97

Eastern Europe and USSR

5.46

0.41

4.31

–0.85

Latin America

4.75

2.32

2.15

0.55

Asia East Asia

6.90

5.83

4.11

3.43

South Asia

3.98

5.05

1.21

2.49

Middle East

8.04

2.03

3.01

0.47

North Africa

5.32

3.56

2.30

1.25

Africa, south of Sahara

3.70

2.61

1.20

−0.12

5.06

3.02

2.04

0.75

Africa

Developing countries average

Note: For notes, see Amsden (2010). Source: World Tables, Johns Hopkins University, 1980, 1994. World Development Indicators, World Bank, 2002, World Bank online data (www.worldbank.org).

a Dark Age (see Table 3.1). The US heroically led one organization and seriously misled the other, so what have we learned about leadership? What refinements to the above hypotheses can be explored to understand why a Chinese banquet like the multilateral trade organization is sweet or sour?

3.3

Sweet or sour

Both the “First” and “Second” American Empires (governing GATT and the WTO respectively) used their power over trade for extracurricular political activities. The first hypothesis presented above holds water throughout the postwar period. But trade’s politicization was different in each case – the First Empire was defending capitalism against

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communism. It was operating on the heels of the Great Depression and the New Deal, both of which disparaged free markets. As long as it wasn’t communist, the U.S. looked the other way if trade policy fell anywhere along the capitalist spectrum. The U.S. at the time had a highly favorable trade balance; even the great European trading nations were suffering from a Dollar shortage. The U.S. exhorted Americans to Buy Foreign! GATT consistently pushed down the average level of world tariffs; the WTO’s follow-up tariff reductions were marginal. But GATT gave every country the freedom to choose the trade model that best suited it, whether export-led growth or import substitution. The U.S. generously bestowed the gift of “nonreciprocity” – developing countries could keep their markets closed while accessing America’s open markets, although many agricultural markets were closed (there were huge surpluses on American farms anyway) and tariffs on manufactures were cascading – higher at a higher manufacturing stage. The Second Empire, by contrast, was defending orthodox capitalism against heterodox capitalism, that of Japan, where government intervention vaulted export-intensive Japanese industries to the world technological frontier. When political power is used to defend orthodoxy against its brother, heterodoxy, it gives other traders much less freedom of choice than when it fights against an alien enemy with an exotic trading system. The space between alien and nonalien is vast, whereas the space between fraternal protagonists (the U.S. and Japan) becomes a single point that every country, like the angels, has to dance upon. The WTO was the inspiration behind trading on a “level playing field.” This was analogous to what Anatole France described as the majesty of French law, which equally punished a rich man and a poor man for sleeping under a bridge. The level playing field was at once the WTO’s strength and fatal weakness, because it encouraged escape and desertion. Initially Japan and South Korea were second-tier powers in the WTO, somewhere near the 80th floor of the Empire State Building, below the United States on the 102nd floor. They might have been the warriors that defended heterodox policies against the orthodoxy of a level field. But pushed to the ledge, neither country fought valiantly for the developmental model that had made them great. Japan was a wimp because it was prohibited from rearming after World War II and was reliant on the U.S. for its national defense. South Korea, dependent on U.S. support against North Korea, saw its future in trimming tariffs to the bone and deregulating financial markets to join the prestigious Organization for Economic Cooperation and Development (based in Paris) (OECD) – a factor behind its collapse in the 1997 East Asian financial fiasco. Japan and South Korea were among the few countries to join Washington’s “Coalition of the Willing” to fight in Iraq. Until a loose alignment arose between China, India, Brazil, South

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Africa, and much later Russia (with Iran in the wings), the Third World had no-one in the WTO to speak for it. The only countries that didn’t crash in the East Asian financial crisis, China, India, and Taiwan, weren’t operating on the level playing field and kept their capital markets closed. They joined the WTO later. The level playing field – “universalism” – was the beginning of rebellion in the ranks, first in Seattle and finally in Doha, where the WTO was mothballed. Tragically, after ten years of stalling, the poorest countries never got entry to Northern agricultural markets, their reason for becoming free traders and joining the WTO. Understandably, they didn’t defend the WTO in Doha the way they stood up for the United Nations, which is also based on “One Country, One Vote.” African Trade Ministers, at a conference in 2006, expressed their serious concern that some WTO leaders were making use of the process of reform of the United Nations to target UNCTAD for the dustbin of history. Richard Nixon summed up US trade policy toward the developing world in the GATT decades “no one gave a damn.” Roughly 100 years earlier, with the invasion of Japan by Admiral Perry, there was also a lack of interest toward domination on the part of Washington. Being left alone by a trade leader, not having it peer and poke into every trade decision – otherwise called “free-trade imperialism” – was a big plus for Japan’s development, and for development a century later under GATT. By comparison with the WTO, GATT was fondly remembered as the General Agreement to Talk and Talk.

3.4 Digging up the dirt The import substitution policies of the developing world were tolerated during the Uruguay Round, predecessor to the WTO, but they were satanized. Still, history has absolved import substitution, and with it, GATT. The facts about the atrocities of import substitution are well known – according to one opinion, India’s trade policies in the 1970s (exports grew at an average annual rate of 17 percent in nominal US dollars) were as idiotic as China’s Cultural Revolution. But less sensational facts about import substitution have been gathering dust in the Empire State Building’s basement. Digging them up shows the virtues of the brand of laissez-faire accepted by the GATT leadership – “let them do it their way,” rather than the brand of laissez-faire of the WTO leadership, “do it our way.” The facts show that import substitution was the mother of all but the most labor-intensive exports whereas a level playing field has been the mother of mostly labor-intensive and natural resource exports; exports embodying high skills have been relatively rare outside Asia, which has typically circumvented WTO rules, discussed below.1 Even in Japan, “unit costs were reduced by increased domestic demand and mass production before the export-production ratio in growing industries

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began to be boosted.”2 Similarly in Brazil, in the period 1960–80 “exports resulted not only from further processing of natural resources, ... which ... enjoyed a comparative advantage, but also from manufactures that firms learned to produce during the import-substitution phase.” In fact, “export performance after the 1960s would not have been possible without the industrialization effort which preceded it as export growth was largely based on sectors established through ISI in the 1950s.” Later, “import substitution policies created the capacity to export; the dominant export sectors of the 1980s and 1990s were the auto industry and those intermediate and heavy industries targeted for import substitution in the wake of the 1973 oil shock.” In Mexico, the chemical, automobile and metalworking industries were targeted for import substitution in the 1970s and began exporting 10–15 percent of their output in the 1980s. “Much of the rise in non-oil exports during 1983–88 came from some of the most protected industries.” Regarding the Chilean economy and its ability to adjust to an abrupt change in policy in 1973, “a portion of this response capacity, especially in the export sector, was based on the industrial development which had been achieved earlier through import-substitution policies.” In South Korea, “the shift to an export-oriented policy in the mid-1960s did not mean the discarding of import-substitution. Indeed, the latter went on along with the export-led strategy. Export expansion and import substitution were not contradictory activities but complemented each other.” In electronics, “the initial import substitution (IS) phase of the 1960s was critical to the development of the manufacturing skills that enabled (the chaebol [Chaebols are Korean conglomerates]) to become the efficient consumer electronics and components assemblers of the 1970s. Indeed, IS in consumer electronics parts and components continued in the 1970s after domestic demand from export production justified it.” By 1984, heavy industry had become South Korea’s new leading export sector, exceeding light industry in value, and virtually all of the country’s heavy industries had come out of import substitution, just as textiles had done in the 1950s and 1960s. In Taiwan “in the first half of the 1960s, most of the exports came from the import substitution industries. Protection from foreign competition was NOT lifted. Getting subsidies to export was extra.” In Taiwan’s electronics industry, “there is no clear-cut distinction between an import substitution phase and an export promotion phase. Even though the export of electronics products speeded up since the early 1970s, the domestic market for electronics products was still heavily protected through high import tariffs. Whether protection was necessary for the development of local electronics firms is controversial. However, we do observe that the protection of consumer electronics products forced Japanese electronics firms to set up joint ventures with local entrepreneurs and to transfer technologies to local people which helped to expand their exporting capabilities.” In Thailand, approximately 50 percent of exports (excluding processed foods) in 1985

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emerged out of import substitution. In the case of Turkey in the 1980s, “it is important to recognize that the growth in manufactured exports did not stem from the establishment of new export industries, but from existing capacity in industries that before had been producing mostly for the domestic market (that is, industries which had originally been established from import substitution).” Decades later, China’s leading firms were also first building their capabilities through import substitution, and only then venturing into export markets. TCL Company, for example, was formed in 1981 with a $5,000 loan from a local government in Guangdong province, and became a leading Chinese brand name in TVs, personal computers, air-conditioners, and cell phones (the balance of payments busters if production hadn’t been local). TCL “aims to become a global household name, but first it has to succeed at home,” where it faces local competitors battling for turf on the basis of low wages and multinationals leveraging their reputations and know-how. “What TCL lacks, as with most Chinese consumer electronics companies, is proprietary technology, something it aims to rectify with the establishment of five research and development centres, including one in Guangdong with 700 researchers.” Some exports did not come out of the import substitution process directly, but were produced by firms that emerged out of it. The managerial and technological expertise of import-substituting firms in Asia gained them a business reputation and contracts with American firms searching for a lower wage locale than Japan to produce their parts and components. This sequence was also true of most of the Third World’s diversified business groups, which formed the model of big business after World War II in Asia, Latin America, and the Middle East, given their lack of proprietary technology. These groups typically first began serving the domestic market and then diversified into exporting. Thus, import substitution segued into exporting when countries were allowed to design their own trade policies, as they were under GATT. Even the poorest countries were able to achieve a powdering of industries related to the provision of food, clothing, and shelter for the local market. This quickened the stirrings of an African middle class, a key ingredient for the emergence of political democracy. The WTO’s policies were mindful of the danger presented to American and European industry by import substitution in Japan and its neighbors. Washington became determined to prevent any other country from following in Japan’s footsteps, and challenged the “fairness” and corruptness of Japan’s form of government promotion. Opposition to Japan’s trade policies reached as deep as “structural impediments.” Impediments like mom and pop stores were held responsible for barring the entry of American giants like Babies“R”Us. The real knowledge about import substitution, why it worked in some developing countries and not in others, was squandered. Little wonder U.S. and Third World performance under the GATT outshone that under the WTO.

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83

Knowledge

When a great multilateral trade organization is born, the world is typically in a transition. Uncertainty is great and knowledge is at a premium, which influences how a trade leader behaves. The U.S. knew little of the details of trade when both GATT and the WTO were founded, but ignorance was bliss in only one case. GATT was founded in 1947, the same year India gained political independence. This was the beginning of a massive process of decolonization out of which emerged more than 100 politically independent countries. The U.S. knew very little about any of them outside Latin America, subject as it had been since 1823 to the Monroe Doctrine. Lazy laissez-faire (“let them do as they wish”) made sense for the U.S. because the independence leaders of most of these countries, even the poorest, knew both worlds, the one in which they were born and the Western one in which they worked or were educated. Idi Amin, Uganda’s brutal leader, has become a symbol of Third World brutality (he was inducted into the British Army in Kenya at an early age and fought against the Mau Mau – a vivid lesson from Britain in brutality!). But he was an exception. Most Third World leaders were educated – lawyers (Lee Kuan Yew of Singapore, trained in Cambridge, England, or Saddam Hussein of Iraq, trained in Cairo), doctors (Hastings Banda of Malawi, trained in the U.S.), or students (Chou En Lai, Communist China’s Foreign Minister at missionary schools and then Paris; Senegal’s President Leopold Senghor at the Sorbonne; and Kenya’s president Jomo Kenyatta at the London School of Economics). The U.S. in the GATT era was humble enough to know how much it didn’t know. It let developing countries choose their own trade policies within capitalist bounds and falling tariffs, first in the U.S. and Europe. In the WTO, by contrast, the U.S. solved the problem of ignorance with homogeneity – it threw the same blanket of open markets over every country. Knowledge was willfully sabotaged in the unorthodox case of East Asia, whose impressive growth was made to look like a fluke, something free markets could have accomplished better (World Bank, 1993: 1068). In fact, free markets may have made matters much worse! Most of the evidence on the East Asian financial crash of 1997 points to deficiencies in regulation and overproduction, a conclusion even of the CIA, whereas Washington attributed it to political corruption, that great punching bag of the WTO era. In short, in GATT’s lifetime, the U.S. overcame its ignorance with flexible policies and a respect for the knowledge of others. After the WTO was born, it overcame its ignorance with one universal policy and a tendency to bury dissent under the rug. This is how globalism became associated with free trade when it could have been associated with different national trading systems, all accepting certain principles in common (as in fact is the case!). Exchanging the WTO’s “free-trade imperialism” for diversity would have

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made for a lot more lively global political economy and less ideology, which came to mean knowledge as the WTO grew.

3.6

National or foreign enterprise?

A big trade leader with a small trade share in its national income accesses foreign markets through means other than just exports and imports. Multinational direct investment in manufacturing is a prime alternative. Singer Sewing Machines and Ford Motor Company are examples of American investors in Europe a century ago. But the multinational began to flex its muscles mostly after World War II. Even in the GATT era, its biceps had not yet begun to bulge. The most popular venue in the 1950s for US manufacturing multinationals was Canada, followed by Europe. Much of the developing world at first dreaded the multinational as a Trojan horse filled with imperialists, but they had little to fear as far as manufacturing was concerned. The great Caribbean economist and Nobel Prize winner, W. Arthur Lewis, was responsible for drafting Ghana’s first five-year development plan for its Independence in 1957. A public debate erupted over foreign investment, pro and con. Finally, Ghana welcomed foreign investors. Giant aluminum multinationals had been exploiting Ghana’s bauxite since colonialism, but despite a hearty welcome, no manufacturing multinationals came! In Europe, the arrival of American multinationals also raised an outcry. European consciousness in favor of strengthening its own multinationals soared with the publication in 1968 of Servan Schreiber’s blockbuster, Le defi americain (The American Challenge), which warned against all forms of “Americanization.” As multinational firms in the US and Europe invested in each other and shared common interests, and as the American type of business school crossed the Atlantic Ocean, the richest countries bonded even tighter than under the Marshall Plan. At the same time, instead of unity, the multinational firm began to divide the South into countries that got foreign investment in mid-tech manufacturing and countries that did not. In the penthouse of the Empire State Building, there was consensus. Toward the bottom, each floor was different. The developing countries that got the lion’s share of multinational investment – Brazil, Mexico, Singapore, China, Indonesia and so on – were divided even between themselves. Latin American countries, which got their political independence in the early nineteenth century, were hosts to foreign investors from early on. The first multinational firm in Argentina, Pirelli, arrived in 1916. And most of Latin America’s foreign investors never left! They were fixtures even after World War II, often “crowding out” aspiring nationally owned firms, as in the automobile assembly industry. Latin American countries in the 1990s were some of the staunchest supporters of the WTO’s level field. In Asia, by contrast, political independence came only with decolonization after World War II. With decolonization, foreign

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governments and foreign investors were thrown out, opening the door to national enterprise. China expropriated foreign-owned companies, many from Japan. India out-competed British investors or British investors fled from fear of Indian takeovers. South Korea and Taiwan inherited a modern banking system as Japan’s army disintegrated. When Indonesia finally kicked out the Dutch, it inherited more than 400 companies. Africa had plenty of foreign firms in the field of natural resources, but lacked the power to control them. The Middle East finally made some progress in getting better terms from the “Seven Sisters,” the world’s largest oil companies, with the formation of the Organization of Petroleum Exporting Countries (OPEC), which was conceived initially by Saudi Arabia and Venezuela and dedicated to accumulating the knowledge necessary for its members to increase their royalties, tax revenues, and ownership rights. National ownership was everything in globalization. Only countries with their own national enterprises could conceivably “multinationalize,” and only with multinational firms of their own could they attract back the best of their brain drain. To all these issues, however, the WTO was blind. Leadership in the WTO is now being challenged by a new generation – developing countries that are building their own big businesses, especially China, India, South Korea, Taiwan, and, to a lesser extent, Brazil Mexico, and Iran (a nonmember). The share of trade in GDP varies in the new generation, from small (India) to large (China), which may have a balancing effect on trade policy. Without this new generation of leaders, the world economy will remain divided between the U.S., European Union, and Japan. The WTO’s Chinese banquet will tip more and more towards sour dishes.

3.7

Conclusion: Open the windows!

The identity of the WTO has been shaped by the world’s superpower, the U.S., whose huge internal market has gone hand in hand with a small share of trade in GDP. We have argued that a trade leader with a small share of trade in GDP is more interested in the global political returns from trade than in the economic returns. The leader politicizes the multilateral trade organization over which it presides. Politicization in the WTO has taken the form of an “imperialism of free trade” that every member must follow. Such a leader is also likely to be relatively uninformed about the actual costs and benefits of different trading policies than a country with trade in its blood. It accesses foreign markets less through exports than through multinational firms. These ally with kindred multinationals of other advanced countries, creating a powerful bloc that can lobby hundreds of politicians in scores of countries, tipping a supposedly level playing field into a slide. Instead of sweet and sour, the history of trade multilateralism since World War II has been an era of sweet under GATT and an era of sour under the WTO.

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The US politicized GATT as well as the WTO, so it is a mystery why GATT Members, especially developing countries, enjoyed a Golden Age of prosperity, whereas WTO Members – in Africa, Latin America, and the Middle East – suffered a Dark Age. We suggested that these eras were identical in leadership but different in performance because competition was different. The U.S. during the GATT years was locked in mortal combat with the Soviet Union, an alien power, and Washington allowed other countries to design their own trade policies so long as they fell within the capitalist fold. Developing countries were “free to choose,” in the words of Milton Friedman. Import substitution was the trade model that most countries selected for growth. This model was satanized by the Royalists, but in developing countries where prewar manufacturing experience existed, especially in Asia, import substitution became the mother of a broad spectrum of new industries and midtech exports. Import substitution reared the next generation of trade leaders. Basic industries even in some African countries nurtured a small middle class. Fresh from the New Deal, Washington wisely rethought laissez-faire to mean, “Let them do it their way,” rather than the Enlightenment ideal, “Let markets be free,” or the WTO dogma, “Do it our way.” Later, the U.S. was locked in economic combat with Japan. Both countries operated with trade models that were relatively close on the capitalist scale, heterodoxy vs. orthodoxy. After Japan’s financial bubble burst, orthodoxy prevailed worldwide. Everybody had to jam into the same elevator to get to the top of the Empire State Building; even the windows were closed to fresh air! It follows that the greater the freedom of countries to design their own trade policies, the greater their economic growth is likely to be. This ideal needs to be qualified and freedom needs to be bounded. GATT, however, is evidence that flexibility goes a long way towards furthering trade and development. Even more persuasive than GATT that flexibility furthers growth are the loopholes perforating the WTO. The WTO’s rigidity has given rise to rampant evasion of its rules on the part of its members. A “black market” has arisen that is arguably more dangerous than flexible laws. The more controlled trade rules are at the top, the more wiggling out of such rules is likely at the bottom. WTO Members have wiggled the most by not adjudicating (ruling legal or illegal) the existence of FTAs, which also have loopholes, subsidies for science and technology, aid for regional development, and support for improving the environment. These are large loopholes that permit governments to intervene to influence the competitiveness of their exports and imports, as well as their new and declining industries. The WTO’s leader, the American government, has long supported industry beginning with extension services for agriculture in the nineteenth century. At one time the U.S. Congress wanted trade rules to restrict subsidies to R&D. Then someone whispered in the corridors of Congress that the American pharmaceutical industry would suffer a stroke were it not for the basic research of the National Institute of Health, and that industries from aerospace to computers would have attacks

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of angina were it not for support from the Department of Defense. At the subterranean level of American states, Texas competes with Tennessee, for example, by seducing business with subsidized loans, infrastructure, and university collaborations. There is political infighting to get the military to invest locally, as is evident in the Huntsville, Alabama research and development corridor, Houston’s Johnson Space Center, and the Dallas/Fort Worth aerospace industry. The pervasive government intervention that occurred under import substitution in countries ranging from China to India, and Taiwan to Argentina, is still alive and well under the name of promoting science and technology. Taiwan’s biggest national companies assemble U.S.-designed computers and import active parts from Japan. They then begin to import substitute selected parts (“picking winners”) with the support of government science parks and laboratories. Thailand is building its automobile industry in a remote part of the country by using regional policies to attract assemblers. Government involvement in environmental protection and cleanup is now a staple in all members of the OECD, which improves the bottom line in industries ranging from chemicals to solar energy. But the trouble with relying on loopholes is that it is mostly the savvy and rich who can slip through. Centrifugal forces, away from the scorching sun at the center of the WTO, may be expected to strengthen. Regionalism is gaining hurricane force, especially in Asia. Asia’s integration became tighter after the death of Mao in 1976 and the rise of Deng Xiaoping. China realized that it had fallen behind other Asian countries economically. The story is that Deng was on a train to Beijing and a Chinese-American teenager walked down the aisle wearing a digital watch around her neck. Deng and his associates examined it and alarm bells went off. China set out to learn from Asia, not the U.S., about how to modernize. A manager of China’s First Automobile Works could be seen measuring the width of aisles on the assembly lines in South Korea’s Hyundai Motors. Chinese people had long migrated to other parts of Asia and formed a network with which China could communicate and do business. “China is driving intra-Asian economic integration through the Association of Southeast Asian Nations (ASEAN), which excludes the United States and Japan. By 2010 the region’s trade with China is likely to outstrip its trade with the United States” (Perlez, 2006). To reduce dependence on the US market, the South Korean government subsidized exporters to diversify their customer base toward Asia! South Korea’s exports to Asia (excluding Japan) went from 7 percent of the total in 1970 to around 35 percent in 2000. A Japanese elder statesman, Kiyoshi Kojima, stated that the US had overstepped the bounds in pushing Asia for fast trade liberalization that benefited only American business. Most Asian countries “insisted that regional integration focus primarily on the promotion of economic development, and that trade liberalization should

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be promoted gradually” (Kojima, 2002). In March 2006, the Indian Prime Minister remarked in a speech to the Asia Society in Mumbai: The process of engagement in the Asian region has truly taken off. I am confident it will be self-sustaining ... We are linking India into a web of partnerships with the countries of the region through free trade and economic cooperation agreements. We have concluded FTAs with SAARC (South Asian Association for Regional Cooperation), Singapore, Thailand and ASEAN. We are working on similar arrangements with Japan, China and Korea. This web of engagements may herald an eventual free trade area in Asia covering all major Asian economies and possibly extending to Australia and New Zealand. This Pan Asian FTA could be the future of Asia. (Asia Society Conference, March 18, 2006, Mumbai) As India strengthened its “Look East” Policy, the East was strengthened. Where is the WTO in all of this? Most of the 150-plus members of the mightiest trade organization in history probably agree that a global trade body to adjudicate disputes is necessary. But the WTO will be nowhere unless it welcomes diversity and divests itself of a dogma that not all WTO Members freely embrace.

Notes 1. The sources of the quotations in this section may be found in Amsden (2001). 2. This section is from (Amsden, 2007).

References Amsden, A.H. 2001. The Rise of “the Rest”: Challenges to the West from Late-Industrializing Economies. New York: Oxford University Press. Amsden, Alice. 2007. Escape from Empire: The Developing World’s Journey Through Heaven and Hell. Cambridge, Mass.: MIT Press. Amsden, Alice. (2010). A Farewell to Ideology: Developing from Role Models. Cambridge, Mass.: MIT Press (forthcoming). Barshewsky, Charlene. 1998. Annual Report. Washington, DC: US Trade Representative. Jawara, Fatoumata and Aileen Kwa. 2003. Behind the Scenes at the WTO: The Real World of International Trade Negotiations. London: Zed. Kojima, K. 2002. “Asian Economic Integration for the 21st Century.” East Asian Economic Perspectives (Mar.) 13: 1–38. Lanjouw, Jean O. and Iain Cockburn. 2000. Do Patents Matter? Empirical Evidence After GATT. Cambridge, Mass.: National Bureau of Economic Research. Report Number 7495 Perlez, J. 2006. “China’s Role Emerges as Major Role for Southeast Asia.” New York Times: A3. Singh, M. 2006. Mumbai: Asia Society Conference, March 18, 2006. World Bank 1993. East Asian Miracle: Economic Growth and Public Policy. Washington, DC: World Bank.

Part II WTO Membership and Economic Cooperation (Accession and Impact on Policies)

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4 Effects of WTO Accession on Policymaking in Sovereign States: Lessons from Transition Countries Zdenek Drabek and Marc Bacchetta

4.1

Introduction

One of the most remarkable successes of the World Trade Organization (WTO) in recent years has been the expansion of its membership and the continued stream of applications by countries to accede to it. Of the 43 countries that have applied to accede the WTO under Article XII since January 1, 1995, approximately one half are countries in the process of transition from a planned to a market economy. Ten of the 14 countries that have already completed their accession process and between nine and 13 countries – depending on whether East Asian countries are included or not – of the 28 countries negotiating their accession are transition countries. Clearly, the WTO represents a powerful attraction for countries in transition (CITs), which treat WTO Membership as a “stamp of approval” of their policies and their admission into the international community – a feat quite important for CITs that have been isolated from world markets for more than 50 years. The strong interest of CITs in WTO Membership raises the obvious question about the benefits to these countries from their accession to the WTO. It is clearly not enough to say that the main benefits are their rights to participate in the proceedings of the WTO working committees, working parties or the Council. What matters at the end of the day are the tangible benefits from membership. Only if they can point at such benefits will the governments of these countries be able to convince their critics that the decision to join the WTO is right. Only then will they be able to demonstrate to their populations that government policies are also on the right path. The purpose of this chapter is to discuss one particular aspect of WTO accession – the effects of WTO accession on policymaking and institutional reforms in transition countries. We shall do so by looking at the experience of those transition countries that are already WTO Members. We believe that this will offer a useful picture of the forces that ultimately shape the 91

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economic performance of these countries and in particular that it will show how economic performance has been affected by WTO accession. Annex Table 4.1 shows the dates of application and membership of all CITs. Six of them – the Czech Republic, Hungary, Poland, Romania, Slovakia, and Slovenia – had signed General Agreement on Tariffs and Trade (GATT) by 1994 under Article XI. Like all other GATT contracting parties, they became WTO Members upon signing the new WTO Agreements. More recently these countries have been joined in the WTO by ten other CITs. These ten new members, which are in the process of transition, are, by order of accession, Bulgaria, Mongolia, the Kyrgyz Republic, Latvia, Estonia, Georgia, Albania, Croatia, Lithuania, and Moldova.1 The advantages of our approach are threefold. First, by drawing on the experience of these countries we hope to shed more light on highly debated issues such as the advantages of multilateral as opposed to autonomous trade liberalization. Second, given that accession often raises high hopes while in reality it also represents heavy commitments and costly adjustments to new legal and institutional requirements, it is our aim to make an objective assessment of the costs and benefits of accession. Economic transition of the kind undertaken by the former centrally planned economies is not an easy process and like all other transition countries, the new members face specific problems related to transition. Third, what makes the case of transition countries particularly interesting is that these are countries that are moving to establish market-based institutions and policies after a long period of central planning. In order to evaluate the effect of WTO accession on the CITs, we shall adopt the following approach. We shall first ask how much of the trade policy reforms can be attributed to the accession negotiations and how much they reflect autonomous policy initiatives. We shall, therefore, review policy reforms in the countries under study and identify both the autonomous trade measures and those that were not covered by the reform. The actual effects of accession on policymaking will then be examined in the following areas: (1) market access; (2) governance; (3) government budget; (4) structural reforms; (5) trade and investment with regional partners; and (6) macroeconomic management. These are the areas that we believe are most affected by WTO accession. The CITs have acceded under Article XII of GATT, and we shall consider whether this article or other rules have constrained domestic policymaking and, if so, how. The idea is to identify factors that partly offset the positive effect of accession.2 The terms of accession are of a major concern to every acceding country. Moreover, there is a perception among some observers that accession conditions may vary between countries and that these conditions may be in excess of measures that incumbent members would be willing to take in their own countries.3 Even though we shall make general comments on accession conditions, we do not intend to discuss this issue in detail. This is quite a major omission. The effects of accession must clearly be dependent,

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inter alia, on the outcome of the negotiations, that is on the conditions that each country is able to negotiate with WTO Members. We have felt that the issue of accession conditions is so important and, at the same time, complex that it will need to be addressed in a separate chapter.4 The rest of this chapter is divided into two parts. Section 4.2, which is subdivided into three sections, reviews the role of the WTO and its accession process and looks at the main features of the process. Section 4.2.1 describes briefly the new members’ accession packages while Section 4.2.2 provides an assessment of the scope of autonomous trade policy reforms. The main benefits of joining the WTO are discussed in Section 4.2.3. Section 4.3 then looks at various aspects of economic policymaking that we have been able to identify and that are affected by WTO accession. The areas have been delineated above and they constitute the subject of the seven sections of Section 4.3. We shall look at the impact of accession on market access, governance, customs revenues, adjustment costs, regional policies, and stabilization policies. The chapter is concluded with a summary of the main findings and some policy conclusions.

4.2

The WTO accession process

4.2.1 The content of accession packages Only few WTO rules regulate the process of accession.5 Accession is governed by Article XII of the Marrakesh Agreement establishing the WTO, which defines in highly general terms the rules for accession. The specific terms of accession must be negotiated between the WTO Members and the applicant country. Because each accession is a negotiation between the WTO Members and a particular country with typically different economic conditions, each accession is unique. As Lanoszka (2001) put it: “Article XII does not stipulate any membership criteria, and this signals perhaps the most problematic legal aspect of the accession process.... No guidance is given on the ‘terms to be agreed’, these being left to the negotiations between the WTO Members and the Candidate. Furthermore, Article XII does not identify any concrete steps nor does it provide any advice when it comes to the procedures to be used for negotiating the terms of accession.”6 To streamline the examination of accession requests, though, WTO Members have designed administrative procedures, some of which are based on unwritten “rules.” In fact, the best that can be said about the process is that the process is largely governed by unwritten rules derived from precedents and previous rulings.7 The main outcome of the accession negotiations is the terms of accession set out in the protocol of accession. The protocol of accession includes all the commitments made by the acceding country on trade and trade-related policies. Those commitments take the form of a general commitment to abide by WTO rules, of a series of specific commitments referred to in the working party report – for instance on transparency in the privatization

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process or on price regulations, and of tariff concessions and other commitments as listed in the country’s schedules. The lessons that can be drawn from the examination of the negotiated terms of accession and of the length of the negotiation process mainly concern the accession process itself. Ideally, acceding countries should accede on terms that are broadly comparable both for all acceding countries and in comparison with incumbents. In practice, however, the situation may evolve somewhat differently. In several areas acceding countries have made commitments in excess of incumbent members.8 Acceding countries, for instance, are required to bind all tariffs while many developing countries still have relatively high shares of their nonagricultural tariff lines unbound. Similarly, there is pressure on new members to sign all multilateral agreements. The question of whether this practice serves the interests of acceding countries or not is hotly debated. As already mentioned, we will not enter this discussion here except for noting the reason why differences such as these arise. The reason is that Article XII, which governs the WTO accession process, is limited in scope and lacks precision in terms of setting the specific operational procedures, as we have already noted above. As a result, countries accede to the WTO on “the terms to be agreed by negotiations.”9 Another unwritten rule concerns the status of acceding countries. A member’s status determines whether it is entitled to use the Special and Differential (S&D) treatment provisions of the WTO Agreements. In general, there are no WTO definitions for “developed” and “developing” countries. The general principle is the selection based on the principle of what can be called “self-appointment.” A country can present itself to the WTO as a “developing nation.” Other members, however, may challenge the “request,” as frequently happens in specific subject areas of the WTO Agreements, in particular in the area of intellectual property. For countries joining the WTO through the accession process, their status largely depends, once again, on the terms agreed in each specific area of the accessions negotiations. If there is no explicit mention of its status in the protocol of accession, a new member can designate itself as a developing country, even though there is very little formal importance to this act since no formal recognition of developing country status is given to countries on accession. They may only benefit from being granted transition periods. The actual commitments may also restrict the scope for S&D treatment provisions. For instance, if an acceding country makes an explicit commitment to restrict its domestic agricultural support to a level that is lower than is allowed for developing countries, the commitment would be binding even if the country self-appoints itself to developing country status or if it wanted to increase its agricultural support to the level allowed for “developing countries” at a later stage.10 In contrast, the rule is quite clear with respect to “least developed” countries (LDCs). The WTO recognizes as LDCs those countries that have been designated as such by the United Nations.

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There are currently 49 LDCs on the UN list, of which 30 were members of the WTO as of end 2001 and nine are in the process of accession to the WTO.11 Needless to say, the rule is recognized for incumbent LDCs but a necessity for acceding LDCs. The status issue is related to another issue – the right to transition periods for implementing the WTO Agreements. Article XIV.2 of the WTO Agreement states that a member who accepts the Marrakesh Agreement after its entry into force shall implement those concessions and obligations in the Multilateral Trade Agreements that are to be implemented over a period of time starting with the entry into force of the Agreement as if it had accepted the Agreement on the date of its entry into force. Transition periods are thus by no means made automatically available to acceding countries. Article XII, on the other hand, offers members a margin to maneuver. In practice, members have made it clear that transition periods will be granted only if the applicant is successful in making a strong enough case to prove that such a period is necessary. Another important, but this time formal, rule concerns the scope of acceding countries’ commitments. According to Article XII/1, “[T]he accession shall apply to this Agreement and the Multilateral Trade Agreements annexed thereto.” In other words, acceding countries are expected to accept all the rules and conditions as specified in each of the WTO Agreements. This rule is known as the principle of single undertaking. It should also be noted that acceding countries join the WTO under what may be called a status quo for the incumbent countries. The acceding countries cannot negotiate any change in the incumbent countries’ commitments to market access nor can they negotiate any change in the rules of the WTO Agreements. The acceding country is joining the WTO under the existing commitments of the members. As any new member of a “club” has to abide by the rules of the club he/she wants to join, countries acceding into the WTO must accept the terms and conditions of the WTO as they stand. This is an unwritten but fully respected “rule” of accession. 4.2.2 Autonomous or multilateral trade liberalization? In order to dispel any misunderstanding about the subject of this section, it is important to specify the framework of our discussion from the outset. The purpose of the section is not to discuss the merits or pitfalls of one method of trade liberalization as opposed to the other.12 The aim is to discuss the role of WTO accession in the reform process of transition countries. Based on the idea that trade agreements can play the role of external anchors and thereby facilitate trade policy reforms, it may seem that WTO accession has played different roles in different countries. For example, in transition countries that were already WTO Members before the start of their transition, regional integration obviously played the leading role in facilitating the reform process. In other transition countries, WTO accession and

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regional integration both played a role while in a third group of countries, WTO accession most likely played the most important role.13 Nevertheless, the WTO disciplines are critical even for countries that may be more reliant on regional agreements since these must typically be WTO consistent. In this section we briefly discuss the relevant experience of four Central European countries – the Czech Republic, Slovakia, Hungary, and Poland. In the four Central European countries – all of them GATT contracting parties – trade policy reform measures were taken largely autonomously in the first half of the 1990s, that is, prior to the conclusion of the Uruguay Round Agreements. Following the collapse of central planning, the countries eliminated foreign trade monopolies and introduced competition into virtually all foreign trade activities. They unified exchange rates and devalued their currencies. Licensing requirements have been retained only for a few foreign trade transactions such as trade in arms, drugs, goods of historical or artistic value, and other transactions normally permitted in international practices. Price controls have been eliminated on all but a few nontradeables and industrial export and other trade-related subsidies have been abolished. All quotas – the pillar of trade policy under central planning – were also eliminated. Thus, these countries were left with tariffs as the only instrument to control the flow of imports. Their tariff schedules were all inherited from the previous trade policy regime with a fairly low tariff incidence. For example, the former Czechoslovakia inherited a tariff schedule with about 5 percent average tariff incidence – clearly one of the lowest in the world. Hungary and Poland had a tariff incidence somewhat higher but even these two countries demonstrated a fairly open foreign trade regime.14 Most of their tariffs were bound. The trend toward trade liberalization was boosted by Regional Trade Agreement (RTA) negotiations with the European Union (EU). In the early 1990s, these countries began their negotiations of the Association Agreements, later relabelled as the Europe Agreements (Drabek 2000). These were extremely important steps and they affected the course of trade policy in each of these countries. The agreements provided for the establishment of a free trade area (FTA) between the EU and each of these four countries but the agreements extend far beyond a simple free trade arrangement.15 The agreements led to a radical opening of markets for foreign investment – direct and portfolio – and they covered various other activities such as economic cooperation, customs administration, labor issues, etc. They include provisions covering not only manufactures but also agriculture and services. In addition to the Europe Agreements, these countries have also signed other preferential trade agreements. For example, the Czech Republic has a customs union agreement with Slovakia; it has signed the Central European Free Trade Agreement (CEFTA) with Hungary, Poland, and Slovakia, and later with Romania, Slovenia, and Bulgaria; it has an agreement with the

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European Free Trade Area (EFTA) countries; and it has put in place its own generalized system of preferences. The Czech government has also signed dozens of bilateral agreements on investment protection. While the speed of liberalization provided under the umbrella of the Europe Agreements was quite impressive, as was their scope, the agreements have not gone as far the Uruguay Round Agreements in several areas. For example, as regards services the Europe Agreements provided only a reference to the ongoing Uruguay Round Agreements binding both the EU and the countries concerned to incorporate into the Europe Agreements the commitments of both parties made in the Uruguay Round. Similarly, the Uruguay Round has gone further than the Europe Agreements in specifying in detail the technical standards as well as sanitary and phytosanitary standards. Provisions concerning protection of intellectual property as well as trade-related investment measures such as those covered under the TradeRelated Intellectual Property (TRIPs) and Trade-Related Investment Measures (TRIMs) Agreements, respectively, in the Uruguay Round. Safeguards and antidumping measures also applied the WTO standards. In brief, the Europe Agreements were the second important stimulus to trade liberalization – in addition to the governments’ own commitments. However, the Agreements have not covered everything – several topics were negotiated under the umbrella of the Uruguay Round. In sum, the actual Uruguay Round negotiations have brought relatively little in terms of further market opening and trade liberalization in these transition countries. Most of the liberalization measures have been taken autonomously and/or as part of various RTAs. The prospect of accession into the EU played a particularly powerful role. As a feature of trade policymaking, the experience of transition countries is not unique; it is a part of a general trend towards “new liberalism” of the 1980s and 1990s.16 The Uruguay Round Agreements have supplemented the existing reforms in some areas – especially in services, TRIMS, and TRIPS, as noted, and they have brought disciplines into these countries’ trade regimes by adopting multilateral rules on safeguards, antidumping, and others. 4.2.3

Reasons for joining the WTO

Economists have identified different reasons why countries might be interested in joining an international trade agreement. These can be conveniently fitted into two categories – theoretical arguments and practical considerations. In the first (theoretical) category is the argument stating that governments may be in the position to pursue what are known as “beggar thy neighbor” policies and that they will agree to sign international trade agreements as a way of mitigating the incentives to do so. Countries can pursue “beggar thy neighbor” policies by imposing externalities on their trade partners in the absence of an agreement, and the main mechanism through which a country can do so is through changes in the terms of trade. These

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changes are, of course, only possible as a result of a country’s large size or its monopolistic position in the market. To put it differently, governments can act in their own interest if they are in the position to impose optimal tariffs in order to maximize the country’s welfare. However, other (large) countries can do the same, which could lead to trade wars and an erosion of national welfare in each country. By joining a trade agreement, large countries can reach a higher level of national welfare by making their commitments to lower tariffs subject to an international agreement backed by sanctions.17 A related theoretical argument concerns strategic interaction between governments and the private sector. As shown in the pioneering work of Kydland and Prescott (1977), the necessary condition for economic policy to be time consistent is that governments pursue the first-best policies. This is virtually never the case in the presence of trade interventions. The failure to pursue the best policies will lead to a search for better alternatives and pressures for policy changes. As a result, the credibility of government commitments to the policies will be adversely affected. Once again, an international agreement that locks in the original commitments will boost the government credibility. On practical level, the attractiveness of the WTO has several dimensions. The first attraction of the WTO is that governments are able to obtain an improved access to markets for their exports. The accession itself will not affect the most-favored nation (MFN) rates of trade partners of the acceding countries. However, the latter will be able to benefit from all the commitments made by signatories of the WTO Agreements in future trade negotiations.18 By staying outside the WTO, the countries’ trade partners would be in the position to apply discriminatory tariffs against nonmembers. In addition, nonmember countries would have to negotiate border measures with their partners bilaterally or regionally and might be exposed to undue negotiating strength of their partners. The multilateral trading system is, therefore, particularly important for small countries that have a limited power to exploit their (small) size to improve their terms of trade. Their impact on terms of trade maybe enhanced if terms of trade (and, therefore, world prices) are negotiated at a multilateral level. The second practical reason why countries may be interested in joining the WTO – one that has been already noted above in the theoretical context – is the beneficial effect of the WTO on the credibility of government policies. Governments often face a “credibility gap” in trying to convince foreign and domestic investors and the rest of the business community about their commitments to particular policies. By framing the countries’ concessions into legal commitments, WTO Membership provides powerful guarantees of governments’ policy directions. Unlike in the case of unilateral policy reforms, policy reforms supported by multilateral commitments are more credible, in particular, because of the strategic interaction between the government and the private sector that makes the agreement attractive.

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In this setting, governments use international trade agreements to enhance the credibility of their policy choices with respect to the private sector. The “credibility gap” is particularly important and present in the case of many if not most transition countries as a result of their history of central planning and political instability. The third reason is the beneficial effect of the membership on domestic policies and institutions involved in the conduct of international trade. Acceding countries are required to put in place a set of norms and institutions that support the liberalization of markets, increase transparency and promote the rule of law, and tighten enforcement and the evolution of an independent judicial system. In principle, nothing would prevent governments from putting in place these norms and regulations on a unilateral basis. The role of the WTO in this process is to facilitate the introduction of effective reforms not only by reinforcing the credibility of the government’s trade policies but also help to introduce the policies that are based on best practices and must be harmonized. The fourth reason why the WTO is considered to play an important and positive role is its contribution to the predictability, security and transparency of market access. For example, one of the major motivations for the Chinese government to accede to the WTO was the uncertainty to Chinese businesses and the government arising from the temporary nature of tariff provisions applied against Chinese exports in the United States. These provisions have been subject to annual reviews by the U.S. Congress. China’s accession to the WTO abolishes this practice, removes the uncertainty, and reduces both the transaction costs of doing business and distortions pertaining into investment decisions. Moreover, exports from countries that are considered by their partners as nonmarket economies are often a main target of antidumping measures. Many transition countries could fall into the category of nonmarket economies. Accession would typically remove the stigma of “non-market economy status.”19 In addition, not only are these measures used frequently but they are usually more restrictive when applied against nonmarket economies. In sum, the issues of importance are the extension of permanent and unconditional MFN status and the termination of the designation of transition countries as “nonmarket economies” by major trading partners such as the U.S. and EU. The fifth reason is tied to the WTO’s dispute settlement mechanism. The possibility of resolving disputes through the dispute settlement mechanism may appear, in particular to smaller and “weaker countries,” as one of the most tangible benefits from WTO accession. There are very few effective vehicles to resolve international trading disputes outside commercial arbitration, and those that exist can disfavor small trading nations against big ones. The WTO dispute settlement mechanism provides a uniquely fair, accessible, and effective opportunity to each WTO Member – irrespective of its size and level of income.

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Finally, the sixth reason is the opportunity for acceding countries to shape the future rules and disciplines of the WTO. Acceding countries will undoubtedly be interested in participating actively in subsequent multilateral trade negotiations, since only through direct negotiations rather than through an oversight from sidelines may they hope to protect their interests. WTO Membership offers them the most direct access to the forum where multilateral trade rules and disciplines are negotiated.

4.3 The WTO and policymaking in sovereign states: Stylistic evidence from transition countries Accession to the WTO has an important impact on the acceding country. In the rest of this chapter, we shall consider how accession affects policymaking and domestic institutions. Accession implies the adoption of WTO disciplines, and this poses a number of challenges for the country concerned. First, accession will affect the access of foreigners into the country’s domestic markets, and it is likely to facilitate the country’s access to foreign markets. The challenge for the acceding country is to ensure that its industries (i.e., firms producing tradeables) are sufficiently competitive in the face of foreign competition. Second, accession will not only impose certain disciplines and rules but it will also require the establishment of those institutions and policies that are critical for the enforcement of these disciplines. One area of particular importance is governance of public and private institutions that will be affected by WTO accession. Third, accession will also affect government budgets since border measures constitute an element of government policies towards budgetary revenues. Fourth, accession will also lead to various adjustment costs, and these can be divided into two groups – the government (public) financial costs of implementing the WTO disciplines and the private costs of market adjustments resulting from changes in relative prices. Finally, accession will affect the conduct of macroeconomic policy. All of these issues will now be discussed in turn. 4.3.1 Market access: Limitations of WTO commitments Arguably the most important and, undoubtedly, the most visible effect of the WTO on policymaking concerns border measures and their effect on the flow of exports and imports. These measures are typically “visible” because they affect the market access of acceding countries for their exports and the access of foreign firms to the markets of acceding countries. Thus, the first type of question that one can ask about the influence of the WTO on policymaking is the following: “How does the WTO affect the extent to which markets of acceding countries have to be opened? Are the acceding countries ‘forced’ to make unreasonable commitments?” The second type of question concerns trade policies of other countries and their effect on market access of acceding countries. In particular: “Are the trade policies

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of incumbent WTO Members affected by the accession of new members? Is the market access of acceding countries improved by accession?” All of these questions are, of course, important for acceding countries because they affect their exposure to foreign competition and the opening of markets for their exports. An answer to the first type of question can be provided with the help of data presented in Table 4.1. The table shows for a selected number of countries their bound and applied tariff rates on imports of manufactured and agricultural goods. The distinction between bound and applied tariffs is important because it demonstrates the degree of acceding countries’ commitments agreed in the WTO (bound rates) as opposed to the rates actually applied in practice. The bound rate is the critical commitment in the WTO. A bound rate higher than applied rate implies that the country in question is actually pursuing more liberal policies towards imports than it was willing to concede under the terms of accession or that it has liberalized faster than its WTO commitments. Sometimes, of course, countries may not bind their tariff rates in the WTO and agree with members a certain level of tariff without binding. This, by definition, gives them a greater flexibility to change tariffs. What the data in Table 4.1 suggest is that acceding transition countries have not been exposed in the WTO to unreasonable pressures to open up their markets. Many acceding countries have liberalized their trade regimes unilaterally and have been able to negotiate the terms of their WTO accession within the scope of measures already taken. As a result, their WTO commitments are less “liberal” than the measures actually applied. As can be seen from the table, almost all countries in our sample actually applied lower tariffs than those bound in the WTO. The only exceptions were the Czech Republic, Hungary, Poland, and Slovakia, which essentially bound the rates at their actual levels. However, the actual levels were already relatively low, especially in the case of the Czech Republic and Slovakia. Their bindings constituted, therefore, the latter countries’ main concessions on market access. Moreover, some countries were “allowed” to bind their industrial and agricultural tariffs at fairly high levels, as the figures for Bulgaria and Romania indicate. Their bound rates are not only high in absolute terms or relative to other countries but they are also high relative to their corresponding actual rates. Agricultural tariffs – both bound and actual – are higher than those on industrial goods for each country. The data reveal two interesting features. First, the bound tariffs are higher than the corresponding actual tariffs in only three countries in the sample – Bulgaria, Estonia, and Latvia. The other countries have actual tariffs that are about the same on average as their corresponding bindings. It is quite interesting to note that bound rates were significantly lower than the corresponding actual tariff in Hungary and most likely in the Czech Republic and Slovakia, too. The best explanation

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Table 4.1 Bound and applied import tariffs in selected transition countries Simple average bound tariff

Simple average applied tariff

Agricultural products

Industrial products

Agricultural products

Albania

9.4

6.6

10.1 (01)

7.2 (01)

Bulgaria

35.5*

23.0

Croatia Czech Republic

9.4* 10

5.5 4.2

Estonia

17.5

7.3

Hungary

26.9

6.9

Latvia

34.6*

9.4

26.5 (97) 28.1 (98) 24.6 (99) 24.0 (00) 22.8 (01) 13.5 (01) 16.6 (96) 15.6 (97) 15 (98) 13 (00) 13.2 (02) 0.1 (96) 0.1 (97) 0.0 (98) 11.7 (99) 19.0 (00) 18.9 (01) 41.3 (96) 38.9 (97) 36.4 (98) 33.5 (99) 31.1 (00) 31.2 (01) 16.7 (98) 24.8 (99)

Poland Romania Slovak Republic

98.4 10

10.4 31.6 4.2

Slovenia

23.3*

24.4

15.5 (97) 15.3 (98) 12.7 (99) 11.1 (00) 10.1 (01) 5.2 (01) 5.4 (01) 5.1 (96) 4.8 (97) 4.4 (98) 4.3 (00) 0.0 (96) 0.0 (97) 0.0 (98) 3.7 (99) 3.7 (00) 3.7 (01) 9.0 (96) 8.6 (97) 8.2 (98) 7.7 (99) 7.6 (00) 7.4 (01) 3.0 (98) 6.7 (99) 10.5 (00) 16.3 (99) 4.9 (98) 4.5 (99) 4.5 (00) 4.4 (01) 16.4 (01)

134.1 (99) 15.0 (98) 14.0 (99) 13.0 (00) 13.1 (01) 20 (01)

Industrial products

Notes: Bound and applied tariff averages are not strictly comparable for two main reasons. First, the methodology used to calculate applied and bound averages is different. Second, in the calculation of applied averages, non-ad valorem tariffs are substituted with their ad valorem equivalents. * The share of items with a non-ad valorem binding (not taken into account) is nonnegligible. Sources: WTO Secretariat, based on Protocols of Accession.

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of the latter is that the countries have used the bindings as targets for tariff reduction. The second interesting feature of the data is the significant increase in actual tariffs by Estonia. This reflects adjustments made by the Estonian government in anticipation of the country’s accession to the EU and its obligation to adopt the restrictive Common Agricultural Policy. The reply to the second type of question, of how incumbent countries respond to accession of other transition countries, which was brought up in the beginning of this section, is relatively simple and straightforward. As we have noted above, accession to the WTO does not require any change in the existing policies of the incumbent WTO Members. The “rule” also applies to market access conditions for all incumbents including, of course, transition countries. When countries negotiate their WTO accession, incumbent members make no new concessions on access to their markets. The only changes in their policies may be their commitment to maintain the actual market access conditions on a permanent and thus more predictable basis. Pari passu, we have no evidence at present to suggest that any of the incumbent transition countries would have changed their trade or any other policies as a result of accession of another country. However, an issue that needs to be stated at this point is that the commitments of incumbents are not necessarily granted to the acceding countries automatically. An example of this problem is the recent experience of some transition countries with the provisions of the Jackson-Vanik amendment in the U.S. Congress. WTO Membership should in principle automatically confer new members permanent and unconditional MFN status. In practice, however, this has not always been the case. The MFN treatment extended by the U.S. to the Kyrgyz Republic was still contingent at the time of writing this chapter (2001) on the latter country’s adherence to the provisions of the Jackson-Vanik amendment to the 1974 Trade Act regarding freedom of emigration. The U.S. invoked the nonapplication clause of Article XIII of the Marrakesh Agreement before the accession of the Kyrgyz Republic. Without this move, the U.S. would be in violation of their WTO obligation towards the Kyrgyz Republic because of the latter’s MFN status being subject to the Jackson-Vanik amendment. The authority for the permanent extension of MFN status to the Kyrgyz Republic has been enacted but not yet implemented.20 Some of the newly acceded countries graduated from the Jackson-Vanik provisions before their accession, while others had to wait some extra time after their accession. Permanent MFN status was extended to the Baltic states in November 1991. Bulgaria graduated from Jackson-Vanik in October 1996, three months before its formal accession to the WTO. But permanent MFN status was extended to Mongolia only in July 1999, that is, more than two years after its date of accession.21 Perhaps even a better example of the importance of political factors on “market access” of acceding countries is related to the question of “nonmarket

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status.” In some WTO Member countries, antidumping and, in some cases, safeguards procedures applied to so-called “nonmarket economies” differ from those applied to other countries, as we have noted above. Transition countries acceding to the WTO may have expected that their accession to the WTO would automatically entail their “graduation” from the status of nonmarket to market economy. However, these expectations turned out to be overly optimistic. In 2000, the Kyrgyz Republic and Mongolia were still on the EU’s list of nonmarket economies.22 The U.S. government has also delayed in conferring the status of market economy in several instances. 4.3.2 Governance and corruption Beyond its direct impact on efficiency through import liberalization, the most immediate effect of WTO Membership should be its indirect impact on efficiency through improved governance. Corruption and lack of transparency have large costs for economic development. There is a strong evidence, based on cross-country comparisons, that higher levels of corruption are correlated with slower growth and lower levels of per capita income.23 Corruption is very costly. It undermines well-functioning markets in five ways: it acts as a tax, functions as a barrier to entry, leads to a loss of government revenue, disrupts the operation of markets, and it subverts the legitimacy of the state and its ability to provide institutions that support markets.24 Membership of the WTO should help to reduce incentives for corruption by providing countries with what are perhaps the most powerful institutional checks and balances in the international economic sphere. Accession imposes changes both in institutions and policies. As discussed above, accession to the WTO provides, once fully implemented, a set of norms that should contribute to the opening of the economy, enhance the transparency of policies, and promote the rule of law and the evolution of an independent judicial system. Theory and evidence suggest that openness reduces corruption.25 Binding market access commitments, increased transparency, and market-based institutions should further reduce rent-seeking behavior and corruption. The adherence to internationally acceptable rules governing international trade and foreign direct investment (FDI) imposes stricter disciplines on governments and indirectly on firms. An assessment of the impact of WTO accession on institutional quality in the acceding countries is difficult and can only be estimated or inferred from business surveys. In addition, many other factors affect the quality of governance. Accession to the WTO is only one of many measures with an effect on institutional quality and, most likely, its effect is conditional upon other policies. Moreover, the causality may go in both directions; a high level of institutional quality will facilitate the accession while the accession promotes good institutional quality. Also, it is not, of course, possible to trace the precise time pattern of the effects of accession. It is quite likely, for

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example, that institutional quality may be affected long before the actual accession in view of the preparations that the country in question may want to undertake in the anticipation of the actual conditions required by WTO Membership. Bearing these limitations in mind, it may be interesting to compare the quality of institutions across countries and over time. By comparing institutional quality indices across countries focusing on the differences between WTO Members and nonmmembers, we can make a simple test of the effects of WTO Membership. The information is summarized in Table 4.2, which is reproduced from an IMF study (IMF, 2000). The table provides two indicators of institutional quality.26 The first indicator – a “narrow composite index” of institutional quality – is an aggregate of four component indicators: government effectiveness, regulatory burden, rule of law, and graft. The second indicator – a “broad composite index” of institutional quality – is an aggregate of the same four components plus an indicator for the extent of democracy (“voice and accountability”) and one for political instability and violence. The indices, as well as the component indicators, range from –25 (the lowest) to 25 (the highest). The most striking feature of the data in Table 4.2 is the relatively low value of the institutional index for all transition countries across the board. Clearly, CITs generally face a major challenge in increasing the quality of their governance. Nevertheless, the table also suggests fairly significant differences. Limiting ourselves to the CITs that acceded to the WTO before 2000 (under Article XII), Estonia, Latvia, and Mongolia have been assessed as countries with a relatively high level of institutional quality. The quality of Estonia’s institutions, measured within the narrowly defined index, ranks third among the countries on track to EU accession and Mongolia has a higher quality than all the Commonwealth of Independent States (CIS) countries. The Kyrgyz Republics institutional quality is among the best compared to other members of the CIS. Bulgaria is lagging behind the other countries on the path to the EU accession with an index value that is still above the index value for the CIS countries. Overall, the table provides some evidence that WTO Membership goes hand in hand with higher institutional quality. Bulgaria did not achieve the same level of institutional quality as the Czech and Slovak Republics, Hungary, Poland, or Slovenia, but these countries acceded to the WTO long before Bulgaria. In addition, there also seems a strong correlation between the institutional quality and the “proximity” to EU accession, suggesting that the prospect of full EU Membership helped to produce an institutional improvement. At a more detailed level, the table reveals the second most striking feature – all of the CITs that acceded to the WTO before 2000, except Estonia, have corruption as the origin of the low values of the composite indices of institutional quality. Corruption turned out to be the main problem in Bulgaria, Latvia, and Mongolia as well as in the Kyrgyz Republic. In

Table 4.2 Indices of institutional quality, 1997–98 Government Regulatory Rule effectiveness burden of law Graft

Institutional quality Voice and (narrow) accountability

Political Institutional instability quality and violence (broad)

EU accession countries (excluding the Baltic countries) −8.1

5.2

−1.5

−5.6

−2.5

6

4.3

0.1

Czech Republic

Bulgaria

5.9

5.7

5.4

3.8

5.2

12

8.1

6.8

Hungary

6.1

8.5

7.1

6.1

7.0

12

12.5

8.7

Poland

6.7

5.6

5.4

4.9

5.7

10.7

8.4

7

Romania

−5.7

2

−0.9

−4.6

−2.3

4.1

0.2

−0.8

Slovak Republic

−0.3

1.7

1.3

0.3

0.8

7.4

6.5

2.8

5.7

5.3

8.3

10.2

7.4

10.7

10.9

8.5

Slovenia Baltic countries Estonia

2.6

7.4

5.1

5.9

5.3

7.9

7.9

6.1

Latvia

0.7

5.1

1.5

−2.6

1.2

6.2

4.6

2.6

Lithuania

1.3

0.9

1.8

0.3

1.1

7.7

3.5

2.6

Other southeastern European countries Albania Bosnia and Herzegovina Croatia Former Yugoslav Republic of Macedonia

−6.5

–7

−9.2

−9.9

−8.2

−0.1

−10

−7.1

−11.1

−12.6

−11.1

−3.5

−9.6

−9.7

−11.6

−9.9

1.5

2.4

1.5

−4.6

0.2

−3.2

−5.8

−3.1

−2.6

−5.2

−4.2

0.9

4.1 −4

0.3 −3.3

Commonwealth of Independent States Armenia

−6.5

−5.7

−1.5

−8

−5.4

−10

Azerbaijan

−8.3

−10

−5.6

Belarus

−6.6

−14.7

−8.8

Georgia

−5.1

−8.5

Kazakhstan

−8.2

−4

0.2

−8.5

−9.2

−3.6

−7.8

−9.2

−5.2

−3.7

−7.6

−4.9

−7.4

−6.5

−2.9

−7.6

−6.1

−5.9

−8.7

−6.7

−7.1

2.2

−5.3

3.2

−4.2

Kyrgyz Republic

−5.8

−7.6

−4.7

−7.6

−6.4

−2.5

−4.6

−2.8

−0.2

−3.9

−2.9

1.6

Russia

0.2

1.7

−1.5

0.2

8.4

3.7

2.2

−6.2

−5.6

−3.1

−6.9

−5.4

−13.2

−14.0

−15.6

−18.6

−12.9

−13.6

−14.5

0

Tajikistan

−14.2

−15.2

−13.3

Turkmenistan

−12.5

−19.3

−9.7

−8.9 −13

−7.2 −14

−2

0.4

−3

Uzbekistan

−2

−7.2

−5.9

Ukraine

−4.4

−6.5

Moldova Mongolia

−4.5

−15 −11.5

−7.1

−8.9

−8.0

−0.1

−2.4

−5.8

−8.7

−9.6

−11.3

−13.4

−3.3

−10.4

−2.3

na

−9.1

na

−3.9

−0.4

−2.9

East Asia Cambodia China

na 0.2

−0.7

na

−18.2

Lao People’s Democratic Republic Vietnam Source: Based on IMF (2000).

−0.4

−3

−4.6

−12 −4.4

−1.0

na −3.3

−13

4.8

−10.5 −3.8

−14.2

−2 −13.6

6.5

−3.8

108 Zdenek Drabek and Marc Bacchetta

the Kyrgyz Republic, however, the index of regulatory burden is as low as the graft index. Since assessments of corruption used by different agencies may be affected by methodology, we have compared two different methodologies, which are also reported in Table 4.2. The ranking of countries using different methodologies comes out remarkably similarly.27 This fits into the broader picture that corruption is generally the main problem of governance in all CITs, and that their ranking is not likely to be subject to large random errors. The positive change emerging from the studies of corruption over time is that the level of corruption may be changing, and that WTO Membership might also have played some role in this. Three of the five CITs that acceded to the WTO between 1995 and 2000, saw their corruption indices improve over time even though for two of these countries, the perceived level of corruption remained a matter of serious concern. As can be seen from Table 4.3, Estonia with its very low tariffs has an impressively low corruption index, and Latvia is not lagging far behind. Mongolia has achieved a lower level of graft than all of the CIS countries. The “outliers” are Bulgaria and the Kyrgyz Republic. The relatively high corruption level in Bulgaria may be a result of the fact that trade liberalization accompanied a prolonged recession that led to a dramatic reduction in real incomes and hence stronger incentives to enter informal and illegal activities. The case of the Kyrgyz Republic is interesting. According to Broadman and Recanatini (2000), the implementation of clear and effective regulations and policies must be paired with effective steps to reduce corruption. This conclusion is confirmed by various other studies. The Kyrgyz Republic, for example, is fairly open and its customs tariff is transparent. However, the implementation of the customs tariff has been slowed down by the lack of a functioning administration. As a result, widespread corruption developed among customs officials. Supporting evidence is provided by measures of administrative corruption based on the 1999 Business Environment and Enterprise Performance Survey (BEEPS) taken from Hellman et al. (2000).28 These authors have unbundled the concept of corruption and distinguished between “administrative corruption,” “state capture,” and “influence.” Administrative corruption is defined as the extent to which firms make illicit and nontransparent private payments to public officials in order to alter the prescribed implementation of administrative regulations placed by the state on the firms’ activities. The figures in Table 4.4 show that the level of administrative corruption in the Kyrgyz Republic is the second highest in the sample of more than 22 CITs. It is much higher than the overall unweighted average and significantly higher than the CIS average. In general, the message coming from these business surveys is very clear and strong – trade liberalization and WTO Membership are not sufficient to eradicate corruption – a capacity to implement trade policy measures effectively also plays a critical role.

Effects of WTO Accession on Policymaking 109 Table 4.3 Indices of corruption, 1999 Corruption perception indexa (1999)

Graftb (1999)c

EU accession countries (excluding the Baltic countries) Bulgaria Czech Republic Hungary Poland Romania Slovak Republic Slovenia Baltic countries

3.3 4.6 5.2 4.2 3.3 3.7 6

−5.6 3.8 6.1 4.9 −4.6 0.3 10.2

Estonia Latvia Lithuania Other southeastern European countries

5.7 3.4 3.8

5.9 −2.6 0.3

Albania Bosnia and Herzegovina Croatia Macedonia Commonwealth of Independent States

2.3 na 2.7 3.3

−9.9 −3.5 −4.6 −5.2

Armenia Azerbaijan Belarus Georgia Kazakhstan Kyrgyz Republic Moldova Mongolia Russia Tajikistan Turkmenistan Ukraine

2.5 1.7 3.4 2.3 2.3 2.2 2.6 na 2.4 na na 2.6

−8.0 −10 −6.5 −7.4 −8.7 −7.6 −3.9 −1.5 −6.2 −13.2 −12.9 −8.9

Uzbekistan

1.8

−9.6

a

The index ranges from 0 (highly corrupt) to 10. The index ranges from –25 to 25, with higher values corresponding to lower corruption. c 1998 for Mongolia. Sources: a Transparency International (1999); b Kaufmann et al. (1999a and 1999b). b

110 Zdenek Drabek and Marc Bacchetta Table 4.4 Measures of administrative corruption Country

Administrative corruption

Standard error

Albania

4.0

(0.4)

Bulgaria Croatia Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovak Republic Slovenia

2.1 1.1 2.5 1.6 1.7 1.4 2.8 1.6 3.2 2.5 1.4

(0.4) (0.2) (0.4) (0.2) (0.3) (0.3) (0.5) (0.2) (0.4) (0.4) (0.3)

Average for Central and Eastern Europe

2.2

Armenia Azerbaijan Belarus Georgia Kazakhstan Kyrgyz Republic Moldova Russia Ukraine Uzbekistan Average CIS Overall (unweighted average)

4.6 5.7 1.3 4.3 3.1 5.3 4.0 2.8 4.4 4.4 3.7 3.0

(0.7) (0.7) (0.4) (0.6) (0.5) (0.6) (0.6) (0.2) (0.4) (0.6)

Note: Firms were asked, on average, what percentage of revenues do firms like theirs typically pay per annum in unofficial payments to public officials and identify the percentage in the following ranges: 0%–<1%; 1%–1.99%; 2%–9.99%; 10%–12%; 13%−25%; or >25%. The categories were imputed at M 1 %; 6%; 11 %; l9%; and 25% and the mean calculated. The question was posed in terms of firms’ revenues rather that profits since estimates of revenues are more reliable. In addition the question was posed indirectly in terms of “firms like yours” to reassure respondents that their responses would not be attributable directly to their firm. The authors then take total payments as a proxy for administrative corruption since the available evidence suggests that the majority of bribe payments were for this purpose. This measure of administrative corruption differs from the “bribe tax” presented in EBRD (2000), although both were based on the same source. The measure used in Helman’s paper includes the responses of all firms, whereas the measure presented in EBRD (1999) presents the average bribes as a share of revenues among firms that reported paying bribes. Source: Hellman et al. (2000).

Effects of WTO Accession on Policymaking

111

Good governance is also extremely important as an incentive to attract foreign investment. This is especially critical for CITs and for all other countries dependent on foreign investment inflows. WTO Membership is seen as an important element of policies aimed at attracting foreign investors by committing members to apply open, transparent, and stable policies and regulations. As already noted above, WTO accession is only one of many factors that may influence the level of FDI inflows. However, there is now evidence emerging from the literature that transparency and good governance – supported by WTO Membership – can be instrumental in attracting new FDI. Evidence provided by the European Bank for Reconstruction and Development (EBRD) and others shows that progress in the transition process – which includes effective establishment of marketoriented policies and institutions, together with effective implementation of privatization – trade linkages, political stability, perceived risk, and the predominant type of investment play a key role.29 A similar message is obtained from a cursory examination of the shares of FDI in GDP in 1995 and 1999 in transition countries presented in Table 4.5. The fast reformers – which are also the more open countries – have been relatively more successful in attracting FDI than the slow reformers. Among the Baltic countries, Estonia and Latvia have a higher share than Lithuania and when compared to the nonoil-exporting countries in the region, inflows into the Kyrgyz Republic are relatively important. The same conclusion has been reached in more rigorous studies in which the effects of governance and transparency on FDI inflows has been tested in a formal model. Controlling for other economic factors, Drabek and Payne (2002) find a significantly positive statistical relationship between governance and FDI inflows. 4.3.3 Customs revenues WTO accession may affect customs revenues, which are often of an important source of government revenues in countries with relatively low levels of per capita income. This concern is linked to the importance of tariffs as a source of government revenue in many developing countries. But the effect of WTO accession may differ from country to country and the final outcome is indeterminate a priori. To the extent that accession leads to a reduction of tariffs rates in the acceding countries, this will tend to reduce tariff revenues. At the same time, however, WTO accession may broaden the tax base. Accession should lead in principle to the elimination of quotas, which are on the WTO list of prohibited trade policy instruments. Quotas are typically replaced by tariffs in the acceding countries and this switch should add to the governments’ capacity to generate revenue. The WTO Agreement on Customs Valuation should also broaden the tax base and thus contribute positively to tariff revenue as customs authorities are able to register import transactions and collect tariffs more effectively. Last but not least, lower tariffs will in the long run stimulate economic activity, and thus the volume

112 Zdenek Drabek and Marc Bacchetta Table 4.5 Inward FDI stocks in transition countries, 1995–99 (as a percentage of GDP) 1995

1999

EU accession countries (excluding the Baltic countries) Bulgaria

3.4

19.9

Czech Republic

14.5

33.0

Hungary

22.4

39.9

Poland

6.6

17.2

Romania

3.2

16.1

Slovak Republic

7.3

14.6

Slovenia

9.4

13.0

Baltic countries Estonia

18.6

47.9

Latvia

13.8

26.9

5.8

19.7

Lithuania Other southeastern European countries Albania

8.3

16.0

Croatia

2.6

20.2

Former Yugoslav Republic of Macedonia

1.6

6.1

Commonwealth of Independent States Armenia Azerbaijan Belarus Georgia Kazakhstan

1.2

23.1

14.6

81.4

0.3

8.3

1.1

7.0

14.6

51.9

Kyrgyz Republic

9.7

23.1

Moldova

6.6

28.8

Mongolia

3.9

14.1

Russia

1.6

4.4

Tajikistan

3.9

10.4

Turkmenistan

4.6

31.9

Ukraine

2.5

10.5

Uzbekistan

2.5

6.0

17.0

19.4

East Asia Cambodia China

19.6

30.9

Lao People’s Democratic Republic

11.9

42.8

Vietnam

31.1

55.6

Source: UNCTAD: World Investment Report 2000.

Effects of WTO Accession on Policymaking 113

of imports. This will have a positive impact on tariff revenue as well as on the base of other taxes. Authorities in many CITs have also argued that WTO accession may be detrimental to their ability to mobilize resources since tariff reductions will result in a severe drop in tariff revenue. Before considering the evidence, it may be useful to make two general comments about the impact of WTO Membership on government revenues. The impact of the WTO is likely to be greatly exaggerated for at least two reasons. First, the argument about the adverse impact on government revenues assumes that tariff revenue represents an important source of government revenue. However, most CITs have acceded to the WTO with tariff structures inherited from central planning and these tariffs have been relatively low.30 Second, several CITs have pursued unilateral trade liberalization, with most of their market opening taking place before their accession to the WTO (e.g., Estonia). Moreover, CITs have tended to bind their tariffs on industrial products at a relatively low level.31 For all these reasons, there was relatively low pressure from WTO Members for additional tariff reductions. Empirical evidence on the evolution of collected tariff rates in transition countries is brought together in Table 4.6. Collected tariff rates are calculated as the share of tariff revenue in the respective country’s imports. Figures show that collected rates were relatively high in the first half of the 1990s in only a limited number of countries (e.g., Hungary, Poland, Slovenia, the Former Yugoslav Republic of Macedonia, Croatia, and Russia). Over time, the number of CITs for which tariff revenue is an important source of government budgets has dropped considerably. In Hungary, Poland, and Slovenia, collected rates fell steadily and dramatically during the 1990s. In the Former Yugoslav Republic of Macedonia, Croatia, and Russia, the trend is less clear as more recent figures show a rebound. By the end of the decade, however, only the Southeastern European countries, together with Romania, Azerbaijan, and Russia still collected customs revenues at rates of above 5 percent of imports. Nevertheless, even in these countries the tariff revenue shares are roughly at the level of countries outside the Organization for Economic Cooperation and Development (OECD).32 The data thus confirm that the incidence of tariff protection in general declined in CITs during the 1990s but they also confirm that tariffs do not generally play a major role in transition countries. This raises the question of how much of the decline was brought about by the accession to the WTO? The answer must be – very little, if at all. In Hungary, Poland, and Slovenia, the three countries that experienced the largest reduction of their collected rate, the changes in tariff revenue have primarily reflected autonomous measures and the effects of the Europe Agreements. The latter have tied in the trade relations of the Central and Eastern European (CEE) countries closely with the European Union. The Agreements have established, inter alia, free trade areas with tariffs

Table 4.6

Tariff revenues in transition countries, 1991–99 (in percentage of imports) 1991

1992

1993

1994

1995

1996

1997

1998

1999

7.2

7.6

7.3

4.6

4.8

5.5

2.8

EU accession countries (excluding the Baltic countries) Bulgaria

2.2

4.5

Czech Republic

na

na

3.5

3.5

2.6

2.6

1.7

1.5

1.2

Hungary

9.1

11.8

12.0

12.6

12.9

9.6

4.0

2.6

2.4

12.7

14.6

15.0

12.0

9.6

7.4

5.6

4.0

3.4

6.1

4.9

6.6

6.0

4.9

4.2

4.0

5.9

5.5

Poland Romania Slovak Republic Slovenia

na

2.6

2.3

3.4

3.3

2.9

3.3

2.6

2.7

11.0

6.7

7.3

7.0

7.1

6.2

4.0

2.9

2.6

na

na

0.9

0.9

0.2

0.0

0.0

0.0

0.0

Baltic countries Estonia Latvia

na

na

2.9

3.2

1.8

1.5

1.4

1.1

0.9

Lithuania

na

na

1.1

3.2

1.4

1.2

1.3

1.1

na

Other southeastern European countries Albania Bosnia and Herzegovina

na

na

na

na

na

10.5

8.6

9.2

na

Croatia

5.4

10.9

7.4

10.7

9.5

8.9

8.0

7.6

8.1

Former Yugoslav Republic of Macedonia

8.9

6.0

8.5

10.5

12.6

11.4

6.8

7.3

9.1

Commonwealth of Independent States Armenia

na

0.2

6.1

0.7

1.0

1.9

2.7

2.8

3.0

Azerbaijan

0.0

0.1

1.4

1.1

1.6

1.9

4.3

4.4

5.4

Belarus

na

na

3.7

5.4

3.2

4.3

3.9

3.8

2.4

Georgia

na

na

na

0.3

0.5

2.0

4.4

4.2

1.7

Kazakhstan

0.0

17.2

0.5

5.6

3.9

2.0

1.5

1.9

1.6

Kyrgyz Republic

na

na

na

1.0

2.3

2.0

2.2

2.4

1.4

Moldova

na

0.8

2.1

1.1

1.4

1.9

2.2

2.0

3.4

Mongolia

na

na

na

7.1

5.1

5.6

2.4

0.4

na

Russia

na

3.8

12.0

15.0

11.0

7.8

7.1

7.2

8.9

Tajikistan

na

na

0.9

4.0

1.2

0.6

2.6

6.1

2.1

Turkmenistan

na

na

na

na

0.3

0.3

0.4

0.3

0.5

Ukraine

na

na

na

1.7

1.7

1.2

1.9

2.4

2.3

Uzbekistan

na

1.3

2.4

2.5

2.6

1.6

1.6

1.9

0.7

Source: EBRD (2000).

116 Zdenek Drabek and Marc Bacchetta

eliminated over a period of ten years. The case of Bulgaria, which acceded to the WTO in 1996, is similar. In Bulgaria, the collected rate fell from its peak of 7.6 percent in 1994 to 2.8 percent of total imports in 1999. This reduction is less significant than the reductions in Hungary, Poland, or Slovenia where the rates peaked at respectively 13, 15, and 11 percent before falling to levels of around 2–3 percent, but it reflects the same influences. In the Baltic countries, the peak was around 3 percent, which did not leave much room for WTO-induced reductions. No clear downward trend can be observed in the Southeastern European countries up to 1999 but Croatia acceded only at the end of 2000. The evolution in the CIS countries is not homogeneous either but, except in one or two cases, the collected rate remained low during the 1990s. The only country that experienced a significant reduction of its collected rate – from 7.1 percent in 1992 to 0.4 percent in 1998 – that might be related to its accession to the WTO is Mongolia. However, given that Mongolia’s average bound tariff on industrial products is 18 percent and that its average bound tariff on agricultural products is even above 19 percent, the drop in the collected rate is most likely not the consequence of WTO bindings but of subsequent tariff reductions. Note that in Georgia, the collected rate dropped from 4 percent to 2 percent between 1998 and 1999. Given that Georgia acceded in 2000, it is clearly too early to assess the effect of WTO accession but, as with Mongolia, the role of WTO accession can only be limited as the bound rates on industrial products and agriculture were reduced to 6 and 12 percent respectively.33 While the specific reasons for the drop in the collected tariff rate should be investigated and solutions found, we shall confine ourselves to identifying the countries in which a reduction in the collected tariff revenue could potentially pose a serious budgetary problem. As Table 4.7 shows, in some CITs the share of international trade taxes in total government revenue was not negligible, even if it remained significantly lower than, for example, in African countries where it reaches 30 percent on average. Mongolia is the country for which the fiscal revenue problem associated with a fall in tariff revenue could be most serious. The figures in Table 4.7 confirm that in Mongolia international trade taxes expressed as a share of total revenue dropped from a relatively high level – more than 11.4 percent – in 1996 to a relatively low level – less than 1 percent – in 1998. Similarly, in Georgia, tariffs accounted for about 12 percent of government revenue in 1997 and 1998. Based on the information at hand, only two other acceding CITs had a high share of international trade taxes in total government revenue for extended periods of time during the 1990s: Azerbaijan and Albania. In those two countries the fiscal aspect of liberalization may also be important. Among the main causes of the decline in collected rates in Mongolia, as well as in other countries are poor customs administration and smuggling. According to press reports, for example, the effectiveness of the border control agencies in Bulgaria was well below par especially during the

Effects of WTO Accession on Policymaking

117

Table 4.7 Share of international trade taxes in total government revenues (as a percentage) 1991 1992 1993

1994

1995 1996 1997

1998 1999

EU accession countries (excluding the Baltic countries) Bulgaria

2.0

5.2

8.1

7.1

6.7

6.8

6.8

5.5

2.9

Czech Republic

na

na

3.9

4.1

3.6

3.7

2.7

2.3

na

Hungary

5.0

7.2

7.6

7.6

10.6

9.1

5.0

3.5

na

Poland

na

na

na

8.5

7.7

6.5

4.1

3.1

na

Romania

3.0

3.6

4.7

4.4

5.6

6.1

5.6

na

na

Estonia

na

na

1.9

1.8

0.4

0.0

0.0

0.0

0.0

Latvia

na

na

na

4.5

2.7

2.2

2.0

1.6

na

Lithuania

0.7

na

3.7

7.0

3.3

3.0

2.7

2.1

na

Baltic countries

Other southeastern European countries Albania

na

na

na

na

13.4

17.2

17.8

14.1

na

Croatia

3.4

10.7

8.7

9.5

9.2

8.3

8.8

6.7

6.6

8.2

8.9

8.4

Commonwealth of Independent States Azerbaijan

na

na

na

50.8

33.4

21.0

Belarus

na

4.3

17.0

9.7

5.8

5.4

7.6

7.4

na

Georgia

na

na

na

na

na

na

11.9

12.1

na

Kazakhstan

na

na

na

na

na

na

2.7

3.5

na

Kyrgyz Republic

na

na

na

3.0

5.0

5.0

5.0

6.0

4.0

Mongolia

na

16.7

na

11.9

8.8

11.4

5.1

0.8

na

Russia

na

na

na

14.7

8.7

na

na

na

na

Sources: IMF Government Finance Statistics and Staff Reports.

mid-1990s. Customs revenue collection fell short of targets and smuggling became widespread. The government authorities were painfully aware of the revenue losses resulting from the poor functioning of its customs administration and invited the EU to help its to improve its customs, as part of its preaccession assistance. Bulgaria is also pursuing a budgetary reform with the creation of a Unified Revenue Agency to consolidate the collection of taxes and social contributions under a single agency. In Georgia the government had been collecting “perhaps 20 per cent, may be even less than 20 per cent of the applicable customs duties, excise taxes and VAT.”34 The same observer noted that “[I] will be surprised if there is any single customs officer on the line who understands, let alone applies the (WTO) customs

118 Zdenek Drabek and Marc Bacchetta

valuation regulations.”35 The implementation of the WTO’s Customs Valuation Agreement is designed to contribute to increased transparency and stability in customs collection. Two conclusions stand out. First, in most CITs, tariffs never contributed significantly to government revenue during the 1990s, so tariff reductions would, therefore, not cause major budgetary problems. This is not to say that transition countries would not face budgetary constraints but the origin of these problems would most likely not be trade liberalization. Second, the fall in tariff revenue expressed as a share of imports observed in CITs that joined the WTO may not be entirely attributable to the lowering of tariff rates following accession. The tariff reductions are likely to be the consequence of the signing the Europe Agreements and other similar ones by the CEEs and the EU which has led to the creation of FTAs. In some cases, it may also be the consequence of weak customs administrations, a problem that governments would be well advised to address. Effective implementation of the customs valuation agreement would help countries improve tariff collection and customs administration. 4.3.4 Implementation costs and budgetary policies WTO accession poses another major challenge for acceding countries – they will typically have to carry out fairly significant changes in their policies and institutions to ensure the full compatibility of domestic legislation with WTO requirements and the existence of all the institutions required for the implementation of the countries’ WTO commitments. This raises serious questions for the governments of acceding countries. What are the implementation costs resulting from accession? While recognizing that the costs may differ among countries, can we identify the main elements of these costs? How high are these costs? Can they be fully and easily absorbed by the acceding country? If the implementation costs are high, should the country pursue its accession objective by implementing all, or at least the bulk, of the measures before the negotiations or can the measures be introduced during the negotiations? Would it be better for the country concerned to plan its accession in such a way that the adjustment costs are minimized? These are important questions for policymakers and negotiators. We shall not attempt to answer all of these questions as this would be beyond the scope of this chapter. However, we shall address the first two issues – the main elements of implementation costs and the orders of magnitude of these costs. Implementation costs are a part of the adjustment costs of WTO accession that, in turn, can be divided into two broad categories – public and private costs. The former typically includes different types of costs resulting from the implementation of the WTO Agreements, noted above. The first important group includes costs that arise out of the harmonization of the country’s policy instruments with those of the WTO. For example, under GATT Article XI, quotas must be replaced by tariffs as the sole instrument of trade protection. The economic rationale for this rule is to replace administrative instruments of protection

Effects of WTO Accession on Policymaking 119

by price-based policy tools. This is a particularly important policy change for CITs that had traditionally relied on explicit and implicit quotas representing their governments’ planning instruments. Thus, replacing the forbidden policy instruments and moving from administrative to market-based instruments will be a radical step. These switches of policy regimes can be complicated and disruptive as well as costly, as is documented with the example of Mongolia and its cashmere industry (Box 4.1). The changes must obviously be handled carefully and only after thorough preparation. Box 4.1

Mongolia’s policy in the cashmere sector

From the early 1990s, Mongolia’s cashmere sector has been going through great turmoil. The world supply of cashmere increased considerably through the 1990s. Mongolia, whose share of the world market is approximately one third, has contributed significantly to this increase. The breakup of the Soviet-era system left herders free to expand the size of their herds. The size of the flock increased from 5 million head in 1989 to more than 11 million in 1998. At the same time, demand for raw cashmere fell, partly as a result of recession in Japan. The resulting fall in price has been partly offset by sustained purchases of raw cashmere by the government of China, the world’s largest producer and exporter. The Mongolian government has been trying to promote a domestic processing industry. During the 1990s, Mongolia’s processing capacities increased significantly, from a handful of processing firms to nearly 30. However, because Chinese processors pay higher prices and, unlike domestic buyers, most often pay in hard cash, herders have increasingly been exporting their raw cashmere to China. Of Mongolia’s total yield of 2,700 tons of cashmere in 1998, it is estimated that more than one-third went to China. In order to help domestic processors, faced with a shortage of raw cashmere, in 1994 the government of Mongolia introduced a ban on exports of raw cashmere which was in place until 1996. In October 1996, as part of a series of reforms requested by WTO Members as conditions for Mongolia’s accession, the government substituted the ban with an export duty at the rate of not more than 30 percent ad valorem to be phased out and eliminated within ten years of the date of Mongolia’s accession to the WTO. GATT Article XI severely restricts the use of export quotas, while export taxes are allowed. It is estimated that of some 1,000 tons that were exported to China, all but 16 tons of it smuggled across the border, escaping taxes. The processing industry, which according to specialists is not competitive, complains about the high prices and the shortage of raw cashmere. The herders, whose income had declined by 50 percent as a result of the ban, continued to be heavily penalized by the export tax and seek the higher prices paid by Chinese processors. The export tax did not achieve its objective mainly because of implementation problems. But even if it indeed restricted exports, it would still have involved a dead-weight loss and large transfers from the herders to the processors, without helping the herders. Neither the ban nor the export tax were the panacea to the industry’s problems. The way out of the crisis requires a thorough analysis of the industry’s problems at each stage. One such study revealed, for example, that the main reason for the processors’ low competitiveness compared to that of their Chinese competitors is their difficulty in accessing credits.

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The second important group of adjustment of costs includes the costs of institutional changes. The implementation of the WTO Agreements is not a simple matter of adopting new laws. For developing and transition countries, it typically involves the setting up of new administrative capacities and substantial changes in technologies and new investment. For example, the Agreement on Sanitary and Phytosanitary (SPS) Measures and that on Technical Barriers to Trade (TBT) require the existence of specific testing equipment, legal provisions for SPS and TBT norms, sufficient numbers of staff with adequate and appropriate skills, and so on. The implementation of Article VII of GATT requires the establishment of administrative capacity, the training of customs officers, the learning of commercial practices, and the development of risk analysis and audit systems. The implementation of the TRIPs Agreement is equally investment intensive and also requires the drafting of new legislation, augmentation of the administration to review applications, buildup of computerized information systems, extensive training, and the setting up of enforcement agencies, etc. These costs may be quite high. In their study of World Bank and United Nations Conference on Trade and Development (UNCTAD) projects in support of the implementation of technical, sanitary, and phytosanitary standards and of the TRIPs law, Finger and Schuler (1998) concluded: Implementing (such) reforms are investment decisions in that implementation will require purchase of equipment, training of people, establishment of systems of checks and balances, etc. This will cost money, and the amounts of money are substantial. ... Those figures (of project costs) for just three of the six Uruguay Round Agreements that involve restructuring of domestic regulations, come to $130 million. One hundred thirty million dollars is more than the annual development budget for seven of the twelve least developed countries for which we could find a figure for that part of the budget.36 The experience of transition countries has been similar – the costs of implementing the institutional reforms appear to be quite high. This is documented in Table 4.8, which provides details on costs of the World Bank projects related to the implementation of three agreements – on customs valuation, TBT and SPS.37 Even though the costs can be, and in practice they indeed are, spread over several years, they still force governments to make difficult choices. Moreover, since these projects are not automatically self-financing (like, say, borrowings against the future stream of income in an industrial project) and they are funded by a foreign currency debt instrument (e.g., an International Bank for Reconstruction and Development (IBRD) loan), they increase the external indebtedness of what may already be vulnerable economies.38 Full costs of legal and institutional harmonization with WTO standards and requirements are much higher.39 We shall return to these questions below.

Table 4.8 Costs of World Bank projects related to the implementation of three WTO Agreements Area of implementation

Country

Nature of work

Customs valuation

Ten Eastern European countries

Seven-year institutional reform – customs modernization

Tunisia

Customs reform component of a five-year World Bank export development project

Tanzania

Three-year reform of customs procedures

Lebanon

Customs reform component of a seven-year World Bank fiscal management program

4

Armenia

Four-year project involving drafting new laws, training staff, and computerizing procedures

2

Russia

Three-year SPS implementation – disease control and improvement of food processing facilities

150

Algeria

Two-year locust control project

112

Brazil

Seven-year livestock disease control project

108

Argentina

Five-year general agricultural export reform project

83

Poland

Five-year SPS component of agricultural exports development project

71

Hungary

Six-year Slaughterhouse modernization project

Mexico

Four-year project establishing agency to implement industrial property laws

Indonesia

Six-year project to improve IPR regulatory framework

15

Brazil

Five-year project to train staff administering IPR laws

4

Sanitary and phytosanitary standards (all World Bank projects)

Intellectual property rights (all World Bank projects)

Source: World Bank.

Cost ($m) 108 16 8–10

41 32.1

122 Zdenek Drabek and Marc Bacchetta

The experience of transition economies in the area of TRIMs is also interesting. By the time of writing, only Romania had notified its use of TRIMs and had requested a delay in the implementation of its TRIMs commitments. In order to provide some empirical evidence with regard to TRIPs, we have reviewed all reports concerning transition countries prepared by the WTO under the Trade Policy Review Mechanism (TPRM) provisions and the degree of success in implementing the TRIPs Agreement. The results are summarized in Box 4.2. As can be seen from the case studies under review, compliance with the TRIPs Agreement has also run into implementation problems in the transition countries. Furthermore, according to the International Intellectual Property Alliance (IIPA), a private sector coalition formed to represent the U.S. copyright-based industries, there is a lack of effective intellectual property rights enforcement in Bulgaria, Estonia, and Latvia.40 Antipiracy resources are thin and judicial enforcement is almost nonexistent. Estonia, for instance, is alleged to have ineffective copyright enforcement on almost all levels: criminal, civil, administrative, and border operations. Enforcement is also hampered because the appropriate officials do not know the proper procedures to take on piracy cases.

Box 4.2

Implementation of TRIPs Agreement in selected transition countries

Hungary • Signatory to most multilateral agreements protecting intellectual property • Patent and trademark laws have been harmonized with EU legislation • Hungary’s legislation is now more stringent than the minimum standard laid down by the TRIPs Agreement • A substantial unofficial economy persists, making the sale of pirated and counterfeit goods a continuing (though declining) problem. Poland • Signatory to most international agreements protecting intellectual property and member of WIPO • However, serious effort required to improve protection of intellectual property to match the EU, especially in the sphere of enforcement • Very high piracy rates and a history of lax enforcement led the International Intellectual Property Alliance in 2000 to recommend that Poland be placed on the “priority 301 watch list” by the USTR. Romania • Signatory in recent years to a large number of multilateral conventions on the protection of IPRs. • Insufficient enforcement at the border remains an outstanding gap in the protection of copyright. Sources: WTO TPRM Reports for Hungary, 1998; Poland, 2000; and Romania, 1999.

Effects of WTO Accession on Policymaking 123

The implementation of SPS and TBT Agreements has run into similar problems, the origins of which were typically the same – budgetary constraints. For example, a study of the implementation of WTO measures in Bulgaria related to the implementation of the SPS and TBT measures concluded that the main implementation problems lay in the poor financial situation of this country and in the small scale of production. The study distinguished between two types of regulations: those that require substantial changes in the production process and those that do not. The authors concluded that the main problem with the implementation of those agreements that do not require any changes is the shortage of financial resources. The problem with the implementation of the second group of measures is that they require major changes in fixed assets and technologies, and thus – once again – heavy investment.41 Regulations of the second type are mainly related to the Law on Animal Breeding and regulations issued under the relevant law. In sum, the budgetary implications of the WTO Agreements cannot be overestimated. The financial burden may vary from country to country but the full implementation costs of accession are never negligible. However, the question still has to be asked of how these costs compare with the benefits that WTO accession is likely to generate for acceding and incumbent countries, an issue to which we shall return in Section 4.3.5 when we discuss another element of adjustment costs – those related to changes in relative prices. 4.3.5

Adjustment costs and policy response

The second, and arguably the most controversial cost of accession, is the adjustment costs resulting from changes in relative prices and competitive conditions following accession to the WTO. Liberalization of a country’s trade regime will change the domestic relative prices of goods and services, which, in turn, will lead to increased competitive pressures on industries that had until now been protected by tariffs (or quotas). This, in turn, will create incentives for resources – capital and labor – to move into sectors that are more profitable and efficient. This process of resource reallocation is not without costs as labor is retrenched and must move and be retrained (or the opportunity costs of unemployed labor must be incorporated into the calculations of adjustment costs). Capital is more mobile than labor but investors will also compute their adjustment costs and take into account, inter alia, the sunk costs of capital. These adjustment costs are principally private costs but they are also likely to have profound implications for economic policy. It would be very rare indeed for the private costs of adjustment to be fully financed by private individuals or firms. It is more common for governments to share in financing the costs in order to facilitate the adjustments. The relevant measures include, for example, those toward labor retraining, unemployment

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support, etc., all of which force governments to organize their business differently to before. The experience of transition economies is again illustrative of these adjustment problems. Price liberalization in the early 1990s led to dramatic changes in relative prices due to deeprooted price distortions existing under central planning. Privatization of state assets was typically constrained by severe liquidity shortages. This, together with the lack of managerial skills, questionable banking practices, corruption, poor financial supervision, undercapitalization of banks, and bank balance sheets containing a high share of nonperforming assets, together with other market distortions produced economic results that at best can be judged as highly disruptive. The level of output dropped precipitously to well below the pre-1990 level and remained below that level a decade later in many CITs. Unemployment reached levels unprecedented in these countries, and all of m struggled with dangerous bouts of inflation. It is, therefore, not surprising that many of these countries perceive market disruptions as the major impediment to trade liberalization (See Box 4.3). Given the depth of recession, the size of unutilized resources and the collapse of all traditional foreign trade links, economic theory offers no solution as to the optimal conduct of trade policy under these circumstances. The response of governments to changes in domestic market conditions critically depends on the impact of these changes on production, employment, price levels, and welfare. While in the long run the scope for positive

Box 4.3

Market disruptions in Moldova

The government of Moldova has been deeply concerned about the future of its agricultural sector. The agricultural sector has been going through a radical restructuring process. The formerly collective agricultural enterprises are being transformed into thousands of small private farms with size ranging from 1 to 3 hectares. The operation of these farms are far from optimal, with “new” farmers lacking a proper understanding of the basic concepts such as enterprise management, efficiency, price policy, product policy, development and new equipment implementation, competition, etc. The restructuring process of the agricultural sector is being accompanied by a drastic fall in output. Overall agricultural output dropped to 3.01 billion lei in 1999, which is 55.5% less than in 1993. Due to the loss of subsidies by the former collective agricultural enterprises and the lack of resources of the newly privatised farmers less land is cultivated. The lack of inputs and of investment funds has also forced farmers to switch from high-value to low-value crops, even though in normal market conditions high value crops would be more competitive. The result has been a dramatic and unacceptable fall in rural income. Source: Statement of Moldovan representative to TACIS-sponsored conference on the WTO accession, Moscow 2000.

Effects of WTO Accession on Policymaking 125

gains from trade is well understood, countries may face adjustment costs in the short run. We have not been able to collect full information on policy responses of governments in CITs following or just preceding their WTO accession as this would be beyond the scope of this chapter.42 It is clear, however, that the responses will vary. How governments respond in such situations will be determined by a variety of factors such as the level of disruption, availability of resources, and legal provisions for government intervention (e.g., to provide assistance to ailing industries), etc. A complicating factor for the assessment of government responses is the negative perception on the part of some governments and observers about the value of WTO Agreements. The Agreements have been subject to two kinds of criticism. The first criticism concerns the effects of welfare and the distribution of benefits from the TRIPs and TRIMs among countries. The argument is that these Agreements primarily serve the interests of developed countries and do not bring the corresponding benefits for developing and transition countries. On TRIPs, for example, Panagarya (1999) constructed a theoretical case to suggest that the Agreement is an instrument that reduces welfare in developing countries as well as in the world as a whole.43 Similarly, two World Bank economists Finger and Schuler (1998) argued that – in establishing the content of the obligations imposed by the WTO Agreements on intellectual property rights (and customs valuation and SPS) – developed countries have essentially imposed their standards. In their view, the TRIP Agreement for this reason alone does not protect indigenous technology or encourage innovation.44 Criticism of the TRIMs Agreement is aimed at the perception that TRIMs are useful as the second-best policy instrument to stem restrictive business practices by multinational enterprises or to offset distortions caused by tariffs. This view is rejected by the critics of TRIMs who argue that these measures introduce new distortions that tend to increase the countries’ import costs, worsen their balance of payments positions, and fail to generate export earnings or transfer modern technology to developing countries. In their view, the specific measures of the same type as TRIMs that target any of the above distortions will be welfare reducing for the country imposing them. In brief, the critics dismiss TRIMs on both theoretical – pointing to the inefficiencies of these instruments – and empirical grounds, demonstrating their general failure in countries in which they were used.45 These views are sharply in contrast with the general assessments of gains to countries from their accession to the WTO. For example, in an econometric study based on a nine commodity by 12 regions version of the Global Trade Analysis Program (GTAP) model, Yang (1999) estimated the welfare effects of the WTO accession of China, Chinese Taipei, and the countries of the former Soviet Union on both the acceding countries themselves and other regions of the world. He found that accession is likely to bring substantial welfare benefits for the acceding countries and other Asian countries.

126 Zdenek Drabek and Marc Bacchetta

Welfare gains are found to be much more doubtful for other regions and critically depend on the level of agricultural subsidies in the OECD countries. However, if all dynamic factors of globalization were to be included in the analysis, which could not be captured by the model itself, the overall welfare gains become even more widespread and evident.46 In summary, WTO accession can lead to significant budgetary and other adjustment costs. Even though the benefits of accession most likely far outweigh the costs in the long run, the short-term costs are likely to be high enough to put governments in sensitive situations to which they will be expected to respond in order to ease the burden of implementation of WTO Agreements and the costs of adjustment. 4.3.6 Impact on regional arrangements Accession to the WTO may sometimes complicate the relations of countries with some of their existing trading partners. Problems have indeed arisen as a result of conflicts between obligations imposed by regional agreements on the one hand and the WTO on the other. RTAs may in turn complicate a country’s negotiations for accession to the WTO: Article XXIV of GATT specifies the precise conditions under which preferential trade arrangements are acceptable in the WTO. Several examples of conflicts between the regional and multilateral integration processes involving transition countries have been documented. As noted above, regional integration projects may affect the country’s negotiated terms of accession. The prospect of joining the EU, for instance, provides a strong incentive for a WTO acceding country to adopt a trade policy regime that is less open than that of the EU. The more open a country’s trade policy and WTO commitments are compared to those of the EU, the higher the compensation that the country concerned will have to pay to third countries upon its accession, and the higher the welfare cost of the adoption of the common external tariff to the new EU Member.47 This is presumably one of the main reasons why Estonia set its applied tariffs at zero but its bound rates higher because of its prospective accession to the EU.48 Upon its accession to the EU, Estonia would thus have to replace its free trade regime with the EU’s common foreign trade policy, leading to an increase in tariffs and thus to a welfare loss, although the trade diversion costs would be limited because a large share of Estonia’s trade was already with the EU. Moreover, the level of EU protection on raw materials, the main import from non-EU Members, is relatively low. Estonia would have to implement the EU’s contingent protection measures including its antidumping rules but these are WTO consistent. Another example of the conflicts between regional and multilateral commitments is Hungary’s resignation from the Cairns group of agricultural exporters. One of the main reasons for this decision was the fear that the membership in the group might be incompatible with EU Membership.

Effects of WTO Accession on Policymaking

127

Another observation is that regional or bilateral liberalization may not necessarily spill over to arrangements with nonpreferential trading partners. The signing of Europe Agreements and similar bilateral agreements with other East European countries led to liberalization of trade and investment between parties without simultaneous alignment of MFN rates of the CEE countries. This observation was made by Kaminski (1999) concerning four other Central European countries. He notes that while in view of the countries’ interest in acceding to the EU, the best tariff policy action would have been an alignment of MFN applied duties on industrial products with the EU’s post-Uruguay Round rates, not a single country chose to follow this path at the time. Similarly, the Baltic countries also chose to wait. Latvia, for example, made no attempt to “converge” to the EU trade regime in advance of accession despite the fact that it was openly committed to the full adoption of EU trade policy following its accession to the EU.49 It should be pointed out, however, that all of these transition countries would have to align their MFN rates to the EU as a condition for accession. The case of Estonia is not representative in the sense that Estonia pursued a more liberal trade policy than that of the EU. The case of the Kyrgyz Republic illustrates how multilateral commitments can create tensions with trading partners, in particular if they are not WTO Members. Most Kyrgyz trading partners are still not members of the WTO. This significantly limits the immediate benefits of accession. On the other hand, its own WTO Membership allows Kyrgyzstan to participate in the working parties on the accession of its trading partners. Kyrgyzstan’s WTO commitments were also affected by its regional integration projects. The Kyrgyz Republic had introduced a flat 10 percent tariff on all products before its accession to the WTO but its tariffs were bound at only a slightly higher level partly perhaps as a form of resistance to pressures from the customs union agreement that the country had signed with Belarus, Kazakstan, and Russia in 1996. Following Kyrgyz accession to the WTO, Russia and Kazakstan complained that the Kyrgyz Republic’s WTO commitments violated its commitments to its customs union partners – despite the fact that, at the time, an FTA rather than a customs union seems to be a preferred option – and would cause a trade deflection, given the weak customs controls between Kazakstan and the Kyrgyz Republic. Thus, in 1998 and 1999, first Kazakhstan and then Uzbekistan imposed significant impediments to Kyrgyz exports, including very high tariffs, quotas, and other trade restrictions. In brief, the WTO disciplines do not shield the WTO Members from trade restrictive measures or indirect tax and excise systems, if these are taken by nonmembers. It must be emphasized that regional integration among transition countries does not necessarily conflict with the multilateral trading system. Various studies presented at the OECD’s round table in 2000 on “Ten years of trade liberalization in transition economies” provide interesting

128 Zdenek Drabek and Marc Bacchetta

illustrations of the complementarity of the regional and multilateral trade liberalization approaches. On the one hand, countries on the accession track to the EU often see WTO accession as a useful preparation. Purju (2000), for instance, suggests that perhaps the most important benefit of WTO accession for Estonia was the need to respond to the wide range of questions that were raised in the WTO negotiations, which prepared the government and the private sector for the negotiations with the EU. During the negotiations, Estonia was able to address many issues likely to arise in the negotiations with the EU. On the other hand, the harmonization of rules and policies with the EU helps EU-candidate countries to implement their WTO commitments more effectively. For example, Tsvetkovska (2000) believes that Bulgaria’s implementation of the WTO disciplines was facilitated by the fact that the economy had to harmonize its national legislation with that of the EU. Along the same lines, Muravskaya et al. (2000) point out that the negotiations of the Baltic Free Trade Agreement and of the Europe Agreement provided an opportunity to acquire experience and expertise in international trade policy making. 4.3.7 Balance of payments management In Section 4.3.4 above, we discussed the effects of WTO Membership on countries’ internal policies, policy instruments, and institutions. Among these effects, perhaps the least familiar but equally important is the effect of WTO disciplines on macroeconomic policy in the presence of balance of payments disequilibrium. To repeat, this issue is perhaps the most understated in the whole debate about the WTO and its impact on the member countries. The reason for this understatement is partly historical, given the perception of GATT and the WTO as an exclusive domain of trade policy. However, as we shall argue below, trade policy is intermittently tied with domestic macroeconomic and structural policies. The importance of the broader linkages of trade policy stem from the economic relationship between the current account in balance of payments and domestic aggregate variables for savings and investment. This relationship, which is known under the heading of “fundamental identity,” links domestic investment expenditures (relative to savings) to net imports (or net exports). An excess of domestic spending over national savings can happen only if the excess is “funded” through imports and vice versa. An excess of national savings over domestic investment can only happen if the corresponding amount is withdrawn from the domestic economy in the form of net exports. These linkages were well understood by the original GATT negotiators. GATT Articles XII and XVIII make special provisions for countries with balance of payments difficulties, and allow these countries to impose import restrictions in order to ease domestic adjustment and to facilitate the financing of current account deficits. One of the important provisions of these

Effects of WTO Accession on Policymaking 129

Articles is the temporary nature of the restrictions. The restrictions must not be imposed “permanently,” which means that the long-term financing of current account deficits can be achieved only through domestic adjustment that will in turn call for appropriate changes in macroeconomic and structural policies. Another provision specifies that the restriction can only take the form of a uniform import surcharge. Thus, the restrictions must not be selective and subject to different rates of surcharge. In other words, the restrictions must provide uniform protection from imports.50 The critical effect of these provisions is to help introduce a stronger discipline into domestic policymaking – on both the macroeconomic and structural levels. Another reason is to avoid frictions in international trade relations. For example, members conducting inflationary policies that lead to current account deficits are most likely to run into difficulties with their trading partners if they seek aggressively to depreciate their currencies or restrict imports. While these policies may be seen by the countries that apply them as the first-best policy, this is not the case when one takes into account the likely reactions of trade partners. Quite apart from the fact that tariffs are never the first-best policy to correct balance of payments disequilibria, both measures can be seen as the “beggar thy neighbor” policies. For this reason alone, such policies will be often resisted by the countries that are directly affected by them. The WTO Agreements have nothing to say about the former, but as we have seen above, they are quite explicit about the latter. CITs provide interesting examples of the discipline that has been imposed by the WTO Agreements. During the 1995–2001 period, seven out of 14 CITs invoked exemptions under Article XVIII of GATT: Bulgaria, the Czech Republic, Hungary, Poland, the Slovak Republic, Romania, and Yugoslavia (prior to 1995). In other words, one half of all CITs that were WTO Members at the end of the second half of the 1990s did so. What is particularly important in this respect is the fact that by mid-2001 no transition country was still invoking the exemptions; all of these countries had taken measures to abandon their restrictive trade policies and met their WTO obligations. The example of the Czech Republic is interesting for another reason – the country’s use of a wrong policy instrument. When the Czech government decided to invoke the exemption on the grounds of a rapidly deteriorating balance of payments situation in 1996 it chose to restrict imports by requiring importers to make an advance foreign exchange deposit calculated as a percentage of the import bill. The measure was challenged by several trading partners as being WTO illegal since the WTO requires that the restrictions can only be made in the form of a uniform import surcharge. The Czech government realized its mistake and shortly after the notification withdrew the import deposit requirement. The WTO disciplines help strengthen the balance of payments management of countries that run into balance of payments difficulties. This does not mean, however, that countries eliminate all origins of financial

130 Zdenek Drabek and Marc Bacchetta

instability. Balance of payments difficulties may arise for a variety of reasons including, for example, unstable capital movements, deterioration in terms of trade, loss of creditor confidence, a sharp increase in foreign interest rates, and so on. The temporary import restrictions address none of these factors and do not, therefore, eliminate the true origins of the balance of payments crisis. What they do provide, however, is the time necessary to take domestic measures to adjust to the changed international environment.

4.4

Conclusions

Five main conclusions come out of our examination of the postaccession experience of CITs. First, there is no precise blueprint for the conditions of accession for new acceding countries. Acceding countries are expected to sign all WTO Agreements but the detailed conditions of accession may still vary from country to country as a result of negotiations. Thus, the terms and conditions of accession, critically, depend on the outcome of the negotiations, which, in turn, depend on the negotiating power of the country concerned, its negotiating skills, and its readiness to agree to and implement the whole range of the WTO disciplines. Second, during the 1990s most transition countries made an exceptionally profound effort to liberalize their trade and investment regimes. Accession to the WTO has played an important albeit not exclusive role in this process of liberalization. Accession has been seen as critical for some countries such as China. In other countries, the autonomous measures they have taken have been more important in terms of the degree of liberalization. Third, the costs of the WTO Membership are not negligible. Membership requires fairly large investment into the modernization and harmonization of various institutions directly involved in the conduct of foreign trade and investment. In addition, WTO commitments also imply for some transition countries significant changes in the conduct of foreign investment policies and in the protection of intellectual property rights. The “switchover” from central planning to market-based policy instruments may, therefore, be painful but is also highly valuable as we have tried to document in this chapter. Fourth, WTO Membership brings several important benefits to members but there are limits to how far and how much the Agreements can help. The Agreements can help in terms of both better market access and the recourse to better policy instruments and institutions. The Agreements cannot address problems originating in poor domestic supply response, terms of trade changes or exogenous shocks. Accession itself may not even open up new markets for acceding countries because the incumbents are not expected to provide new concessions to them. In addition, the adjustment costs following WTO accession – the membership “fee” – may also be fairly significant but they should be more than offset by efficiency gains, growth of trade, and inflow of foreign capital.

Annex 4.1 WTO: Dates of accession and membership of transition countries Application

Membership

Application

EU accession countries (excluding the Baltic countries) Bulgaria 09/1996 12/1996 Czech Republic 04/1993 (GATT) Hungary 09/1973 (GATT) Poland 10/1967 (GATT) Romania 11/1971 (GATT) Slovak Republic 04/1993 (GATT) Slovenia 10/1994 (GATT)

Commonwealth of Independent States Armenia 11/1993 Azerbaijan 07/1997 Belarus 09/1993 Georgia 07/1996 Kazakhstan 01/1996 Kyrgyz Republic 01/1996 Moldova 11/1993

Baltic countries

Mongolia

07/1991

Russian Federation Tajikistan Turkmenistan

06/1993 05/2001

Ukraine

11/1993

Uzbekistan East Asia

12/1994

Estonia Latvia Lithuania

03/1994 11/1993 01/1994

11/1999 02/1999 05/2001

Other southeastern European countries Albania Bosnia and Herzegovina Croatia

11/1992 05/1999

09/2000

09/1993

11/2000

Cambodia

12/1994

Former Yugoslav Republic of Mecedonia

12/1994

China

07/1986

Yugoslavia

01/2001

The Lao People’s Democratic Republic Vietnam

07/1997

Source: WTO Secretariat.

01/1995

Membership

06/2000 12/1998 07/2001 01/1997

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Fifth, the WTO experience of CITs must be seen by and large as positive. The Agreements significantly improve the stability of market access and they help to eradicate corruption and improve governance without significant losses to government revenues. Moreover, the WTO has also played a positive role in strengthening domestic policies for better management of balance of payments crises. The difficulties that arise as a result of WTO Membership lead to the logical question of whether CITs should not receive special treatment in their quest for WTO Membership. The answer to this question partially depends on the actual terms of accession, which were not subject of this chapter. As a general comment, however, one could say that there is a case to be made for allowing transition countries to benefit fully from the same treatment as countries with similar levels of per capita income. Many of these countries have per capita income that would put them straight into the category of developing countries, and some would even qualify as LDCs. This recognition would allow such CITs to make the required investments as well as the policy and institutional changes over a longer period of time. The case is arguably more evident than the one that would call for a special and differential treatment based on the specifics of these countries as transition economies.

Notes The views in this chapter are strictly personal and should not be attributed to either WTO Members or the Secretariat. We are grateful to Rolf Langhammer, Costas Michalopoulos, our colleague Peter Milthorp, and an anonymous referee for their very valuable comments, as well as to Indradeep Gosh for his statistical assistance. Any remaining shortcomings are obviously our responsibility. 1. The reader will notice that China is not included in our sample. The complexity and importance of the WTO-China relationship is so great that it deserves separate treatment. 2. Although we are very interested in the relationship between the WTO and the introduction of market reforms in these countries, we shall not be asking about the extent to which the WTO has been instrumental in establishing market-based institutions. We believe that this would have taken us to a different field of examination, one that involves political rather than economic analysis. 3. In reporting on discussions in the General Council, Naray noted that “... a number of developing countries’ delegations recalled that in the accession process unreasonable conditions were required of, and imposed on, applicants because developed country members had requested that acceding countries accept more stringent conditions and a higher level of commitment than was required from members themselves (‘WTO-plus’ requirement). For example, the requirement to adhere to several plurilateral agreements, to guarantee full transparency and objectivity and that markets access commitments should be about the same as those made by countries at similar level of development.” Naray (2001), p. 91. 4. We recognize that the omission of terms of accession makes our discussion incomplete. In addition, by concentrating on specific policy and institutional changes, our approach becomes highly specialized and technical. It should be seen as the first step in the analysis of the subject that we are treating in this chapter.

Effects of WTO Accession on Policymaking 5. 6. 7. 8. 9.

10.

11.

12.

13.

14. 15.

16. 17.

18.

19. 20.

133

For a detailed description of the procedures see, for example, Lanoszka (2001). Ibid., p. 589. Ibid. See Langhammer and Lücke (1999), Michalopoulos (2000), or Naray (2001). For further details see also note 1 above. The choice of the commitments of original members with similar levels of per capita GDP as a benchmark for assessing the terms of accession was based on the idea of fairness, that is, treating “similar” countries in a similar way. However, accession terms could be also evaluated against other benchmarks such as, for example, the “free trade package.” The package is based on the notion that the optimal policy is the one that leads to the elimination of all trade restrictions. Yet another benchmark could be cross-country comparisons in which a country’s “package” of accession conditions is compared to that of another country or other countries). Clearly, the main problem lies in defining the optimal package, but cross-country comparisons remain the most frequently used benchmark in practice. See Michalopoulos (2000) or Langhammer and Lücke (1999). The “de minimis” level for developing country members is 10 percent, while it is 5 percent for developed countries and certain categories of domestic support are exempted from reduced commitments for developing country members. See Article VI of the Agreement on Agriculture. The nine countries include Bhutan, Cambodia, Cape Verde, Lao People’s Democratic Republic, Nepal, Samoa, Sudan, Vanuatu, and Yemen. Furthermore, Ethiopia and Sao Tome and Principe are WTO observers. For reasons why countries may be interested in joining international agreements see, for example, Staiger (1995). The reasons for autonomous trade liberalization have been discussed at length and constitute a major part of economic literature. Accession into the EU has undoubtedly played a powerful, and arguably a dominant, role for many candidate countries, which may suggest a different sequence of liberalizing their policies in comparison to, for example, that of Mexico and the role of North American Free Trade Agreement (NAFTA). We are grateful to R. Langhammer (personal communication) for emphasizing this interesting point. For more details, see Drabek and Smith (1995). In the case of Czechoslovakia, the agreements were originally negotiated with the Federal Republic of Czechoslovakia. After the breakup of the federation at the end of 1992, the agreements were negotiated and signed separately with the Czech Republic and Slovakia. The policy changes are discussed and documented in Drabek and Laird (1998). Following on the original work of Scitowsky (personal communication) and his own recent work, these issues are reviewed by Staiger (1995). For specific references to transition and vulnerable developing economies, see, for example, Langhammer and Lücke (1999) and Michalopoulos (2000). In practice, countries have often benefited from reductions of MFN rates even if they remained outside GATT/the WTO. In such situations the main benefit of joining the WTO would be the certainty and predictability of such benefits, which are by no means guaranteed for outsiders. We discuss this issue further below. In the case of China, the nonmarket status was not removed by the U.S. immediately on the day of accession, but only at a later stage. It should be noted that the U.S. also invoked the nonapplication clause of GATT Article XIII in the case of Mongolia and Georgia. We are grateful to C.

134 Zdenek Drabek and Marc Bacchetta

21.

22.

23. 24.

25. 26.

27. 28.

Michalopoulos for reminding us that the treatment of the Kyrgyz Republic does not constitute an isolated case. The political conditionality may have at least two important implications for acceding countries. First, the absence of guarantees regarding the application of the MFN treatment restricts the benefits of WTO accession to new members. This element of uncertainty undermines the stability of market access conditions that is conferred by WTO Membership. Given the importance that new members attribute to the stability and improvement of market access conditions resulting from WTO Membership, the presence of political conditionality reduces the benefits of WTO Membership. Political liberalization is often linked to the liberalization of economic policy that, in turn, is likely to lead to the adoption of measures making the economy more competitive and open, and less-inward looking. Examples are numerous, including the Russian “Perestroika,” the Vietnamese “Doi Moi,” the Chinese economic reform, the Czech “Velvet Revolution,” and others. “Nonmarket status” has been a major cause of trade frictions between many transitions countries on the one hand and the U.S. and EU on the other. It is true that the WTO Agreements do not formally require candidates for accession to have a market economy, even though the Agreements may be interpreted as implying the condition for firms to operate on strict commercial principles and with prices formed in competitive markets in order to avoid implicit taxation and subsidies. Without full transparency in price policy, the current rules and disciplines of the WTO would be virtually unusable. De facto, therefore, the incumbents tend to impose the “market status” requirement on acceding countries. For this reason alone, transition countries have a powerful incentive to introduce such measures as would get them removed from the list of “nonmarket economies.” Some observers argue that WTO Membership already implies a demonstration of policies that are fundamentally market-driven. These observers have suggested that “nonmarket status” should be terminated upon a country’s accession to the WTO. See, for example, Michalopoulos (2000). See Kaufmann et al. (1999b). As an example, in the second half of the 1990s Bulgaria experienced corruption and problems with border controls. This created severe bottlenecks in international trade, with effects similar to those resulting from protectionist policies. It became evident that a radical customs reform was required in order to improve the border controls. Measures to address corruption have been now incorporated in many projects of the World Bank. For a more general discussion, see World Bank (2001). See Bonaglia et al. (2001), Broadman and Recanatini (2000), and Treisman (2000). All component indicators have been developed by Kaufmann et al. (1999a and 1999b). They are based on 300 separate indicators from two types of sources: ratings produced by commercial risk rating agencies and other organizations, reflecting expert opinions; and surveys of firms and households, compiled by international organizations and other institutions. The aggregates are simple averages. The results are reported in the table. They show that the Spearman Rank Coefficient was 0.89. The 1999 BEEPS, conducted by the World Bank and EBRD, was designed to assess the quality of governance across 20 countries of Central and Eastern Europe and the Former Soviet Union from a firm level perspective.

Effects of WTO Accession on Policymaking

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29. The factor “governance including corruption” is only one of the variables affecting FDI and it is included in the EBRD analyses under the term “progress in transition.” See Lankes and Venables (1996), Holland and Pain (1998), and Resmini (2000). 30. The reason for the low rate of tariffs was their purely administrative character since trade flows were decided by fiats. Examples with relatively low tariffs include the Czech Republic, Slovakia, and to a lesser extent also Hungary and Poland. For more details, see Drabek and Smith (1995). 31. For more details, see, for example, Drabek and Laird (1998) and Kierzkowski (2000). 32. Compare, for example, with Ebrill et al. (2001). 33. We must note that, in general, collected rates are often lower because of the effects of RTAs; preferences granted to, for example, developing countries; and exemptions under particular regimes, not to mention the effects of inefficiency and corruption. 34. Quoted from Allen Shinn, Executive Director of IRIS Caucasus Centre. Report on seminar on Georgia’s and Kyrgystan’s Accession to the WTO, 22 March 2000, Tbilisi, funded under TACIS. 35. Ibid., pp. 28–29. 36. See Finger and Schuler (1998), abstract and page 25. 37. For more details see Report on CIS Workshop on WTO Accession, Moscow, May 17–18, 2000 under the TACIS programme. See also discussion in Section 4.3.5. 38. For more details see the World Bank website. 39. Although not exactly comparable, the costs associated with accession of CITs to the EU provide some indications of the size of problem. The Czech authorities estimated that adoption of the EU environmental legislation alone would cost the government 350 billion KC, or about $10 billion. 40. IIPA 2001 Special 301 Report on Estonia, IIPA 2001 Special 301 Report on Latvia, and IIPA 1999 Special 301 Report on Bulgaria. 41. See Ivanova and Georgieva (2000). 42. Economic liberalization has posed a variety of serious allocative problems in transition countries in the wake and following their accession to WTO. For a fuller and more detailed discussion, see Yang (1999). 43. For a more comprehensive discussion of the issues see Maskus (1998). 44. See, for example, Finger and Schuler (1998, p. 23). The criticism of TRIPs is, however, much wider and it includes such issues as equitable sharing of benefits arising from the utilization of genetic resources, transfer of technology, conservation, and sustainable use of biological diversity. 45. The popularity of TRIMs has been quite widely shared among politicians of developing countries even though they no longer attract much interest among economists. The literature on TRIMs and related instruments is vast, and the debate was mainly conducted during the 1970s and 1980s in the context of the related subject – infant industry protection. See, for example, Rodrik (1987). The literature is briefly reviewed in Bora et al. (2000). Morrisey and Rai (1995) and Balasubramanyan (1991) both take a strongly pro-TRIMs position. 46. The author recognized that his model excluded, for example, a treatment of better access to markets for services, the effects of increased transparency, and better protection of intellectual property rights, etc. See Yang (1999, p. 526). His findings are broadly consistent with those of other researchers whose work is reviewed in his paper. Moreover, we should point out that the fairly low overall

136 Zdenek Drabek and Marc Bacchetta

47.

48.

49. 50.

aggregates are common but they often conceal the short-term adjustments needed to implement the relevant policy changes. In its accession negotiations, Croatia faced conflicting demands from the EU and other WTO Members on the liberalization of audiovisual services. This was also the case for Latvia, Lithuania, Estonia, Moldova, Albania, and Bulgaria. Purju (2000, p. 8). The case of Estonia is somewhat exceptional, and most acceding countries to the EU have applied tariffs that are higher than those of the EU. See Muravskaya et al. (2000). Strictly speaking, the uniform rates of import surcharge do not necessarily provide uniform import protection. In theory, this will only happen if production functions are identical in each industry. Otherwise, the governments would have to apply uniform rates of effective tariffs or some other, more sophisticated, measures of import restriction.

References Balasubramanyam, V.N. 1991. “Putting TRIMs to Good Use.” World Development 19(9): 1215–24. Bonaglia, F., J. Braga de Macedo, and M. Bussolo. 2001. “How Globalization Improves Governance.” London: CEPR Discussion Paper No. 2992. Bora, B., P.J. Lloyd, and M. Pangestu. 2000. Industrial Policy and the WTO. New York and Geneva: United Nations, UNCTAD. (Policy Issues in International Trade and Commodities Series, No. 6.) Broadman, H.G., and F. Recanatini. 2000. “Seeds of Corruption: Do Market Institutions Matter?” World Bank Policy Research Working Paper No. 2368. Washington, DC: The World Bank. Drabek, Z. 2000. “The Transition Countries at the Crossroad of Globalization and Regionalism.” Russian and East European Finance and Trade (Mar./Apr.) 36(2). Drabek, Z., and S. Laird. 1998. “The New Liberalism: Trade Policy Developments in Emerging Markets.” Journal of World Trade (Oct.) 32(5): 244–69. Drabek, Z., and W. Payne. 2002. “The Impact of Transparency on Foreign Direct Investment.” Geneva: WTO: ERAD, Working Paper No. 99–02 and Journal of Economic Integration 17(4): 777–810. Drabek, Z., and A. Smith. 1995. “Trade Performance and Trade Policy in Central and Eastern Europe.” Discussion Paper Series No. 1182, May. London: Centre for Economic Policy Research (CEPR). EBRD. 2000. Transition Report. London: European Bank for Reconstruction and Development. Ebrill, L., J. Skotsky, and Gropp, P. 2001. “Revenue Implications of Trade Liberalization.” Occasional Paper No. 180. Washington, DC: International Monetary Fund. Finger, J.M., and P. Schuler. 1998. Implementation of Uruguay Round Commitments: The Development Challenge. Washington, DC: The World Bank, Research Department, mimeo. Hellman, J.S., G. Jones, and D. Kaufmann. 2000. “Seize the State, Seize the Day: State Capture, Corruption and Influence in Transition.” World Bank Policy Research Working Paper No. 2444. Washington, DC: The World Bank. Holland, D., and N. Pain 1998. The Diffusion of Innovations in Central and Eastern Europe: A Study of the Determinants and Impact of FDI, manuscript. London: National Institute of Economics and Social Research.

Effects of WTO Accession on Policymaking 137 International Monetary Fund (IMF). 2000. World Economic Outlook, Focus on Transition Economies, October. Ivanova, N., and M. Georgieva. 2000. “Non Tariff Trade Measures in Bulgaria and Their Impact on Trade.” Prepared for the “Global Forum on Agriculture”. Geneva: WTO. Kaminski, B. 1999. “The EU Factor in Trade Policies of Central European Countries.” World Bank Policy Research Working Paper No. 2239. Washington, DC: The World Bank. Kaufmann, D., A. Kraay, and P. Zoido-Lobaton. 1999a. “Aggregating Governance Indicators.” World Bank Policy Research Working Paper No. 2195. Washington, DC: The World Bank. Kaufmann, D., A. Kraay, and P. Zoido-Lobaton. 1999b. “Governance Matters.” World Bank Policy Research Working Paper No. 2196. Washington, DC: The World Bank. Kierzkowski, H. 2000. “Challenges of Globalization.” In Drabek (2000). 8–41. Kydland, F.E., and E.C. Prescott. 1977. “Rules Rather Than Discretion; The Inconsistency of Optimal Plans.” Journal of Political Economy 85: 473–91. Langhammer, R.J., and M. Lücke. 1999. “WTO Accession Issues.” World Economy 22(6): 837–73. Lankes, H.-P., and A.J. Venables. 1996. “Foreign Direct Investment in Economic Transition: The Changing Pattern of Investments.” Economics of Transition 4(2): 331–47. Lanoszka, A. 2001. “The World Trade Organization Accession Process, Negotiating Participation in a Globalizing Economy.” Journal of World Trade 35(4): 575–602. Maskus, K. 1998. “The International Regulation of Intellectual Property.” Weltwirtschaftliches Archiv 134(2): 186–208. Michalopoulos, C. 2000. “World Trade Organization Accession for Transition Economies”. In Drabek (2000). 63–86. Morrisey, O., and Y. Rai. 1995. “The GATT Agreement on Trade-Related Investment Measures: Implications for Developing Countries and Their Relationship with Transnational Corporations.” The Journal of Development Studies (June) 31(5): 702–24. Muravskaya, T., E. Sumilo, and A. Vanags 2000. “Latvia’s Experience with Regional Integration.” Paper presented at the Round Table on Ten Years of Trade Liberalization in Transition Economies, OECD, Paris, July. Naray, P. 2001. Russia and the World Trade Organization. Basingstoke: Palgrave. Panagariya, A. 1999. “TRIPs and the WTO: An Uneasy Marriage.” Paper presented at the WTO Seminar, Geneva, July 20. Purju, A. 2000. “Estonia’s Experience with Trade Liberalization.” Paper presented at the Round Table on Ten Years of Trade Liberalization in Transition Economies, OECD, Paris, July. Resmini, L. 2000. “The Determinants of Foreign Direct Investment in the CEECs – New Evidence from Sectoral Patterns.” Economics of Transition 8(3): 665–89. Rodrik, D. 1987. “The Economics of Export Performance Requirements.” Quarterly Journal of Economics 102: 633–50. Staiger, R.W. 1995. “International Rules and Institutions for Trade Policy.” In G. Grossman and K. Rogoff (Eds.). Handbook of International Economics Vol. 3, Amsterdam: Elsevier Science. Treisman, D. 2000. “The Causes of Corruption: a Cross National Study.” Journal of Public Economics 76: 399–457.

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Tsvetkovska, M. 2000. “Bulgaria’s Experience with Trade Liberalization.” Paper presented at the Round Table on Ten Years of Trade Liberalization in Transition Economies, OECD, Paris, July. World Bank. 2001. World Development Report 2001: Building Institutions for Markets. Washington, DC: World Bank. Yang, Y. 1999. “Completing the WTO Accession Negotiations: Issues and Challenges.” World Economy 22(4): 513–34.

5 Policy Anchors: Do Free Trade Agreements and WTO Accessions Serve as Vehicles for Developingcountry Policy Reform? Michael J. Ferrantino

5.1 5.1.1

Introduction Hypothesis

The proliferation of bilateral and plurilateral free trade agreements (FTAs1) in recent years has been widely noted. The World Trade Organization (WTO) received notifications of 167 FTAs which entered into force from the beginning of 1990 through July 1, 2005,2 and there may be others. A wide variety of agreements also provide for some integration between members but do not achieve complete free trade in merchandise. Some of these FTAs pair a large developed-country partner with a developing-country partner. Beginning in 2000, the U.S. has initiated FTA negotiations with 23 different countries in 12 separate agreements, and concluded negotiations with 13 of those countries. Similarly, in 2004 ten countries acceded to the EU, expanding its membership to 25. At the time of writing (November 2005), another eight countries are in the queue for EU Membership,3 and the EU has a wide variety of additional agreements, including FTAs with Chile, Mexico, and South Africa and various sorts of arrangements with its regional neighbors under the umbrellas of the “European Neighbourhood Policy” and “EuroMediterranean Partnership.” These phenomena suggest several questions for investigation: 1. Is there evidence associating FTAs with policy reform, over and above preferential tariff reduction?4 Such FTAs usually contain provisions in a wide variety of areas other than tariff reduction, such as investment policy, intellectual property, health and safety regulation, competition policy, and so on. As a result, a developing country that implements an FTA with a large developed partner is required 139

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to make commitments with respect to the operations of a large part of its government apparatus. Some of these commitments may represent improvements in the quality and transparency of governance. These commitments might not be easy to achieve within the domestic political processes of developing countries acting autonomously, but may become feasible as the result of a commitment to a large outside partner. Deeper integration with a large developed partner may thus serve as an “anchor” or “lock-in mechanism” for domestic reforms (Bilal, 2003; Crawford and Fiorentino, 2005). One incentive for such commitments is the possibility that foreign direct investment (FDI) may be attracted thereby (Schiff and Winters, 2003: chapter 4). Tang and Wei (2006) find evidence that WTO accessions are associated with better growth and investment performance and argue that post-1994 accessions to the WTO involved deeper policy commitments in general, and thus stronger growth effects, than pre-WTO accessions to General Agreement on Tariffs and Trade (GATT). 2. Are there important differences between FTAs and WTO accessions as vehicles for policy reform? This chapter examines some broad stylized facts for recent U.S. FTAs, those from 2000 onward, and, for comparison, recent WTO accessions and accession negotiations from the period since the establishment of the WTO to January 2005. WTO accessions are like FTA negotiations in that they require new members to make commitments in a wide range of policy areas, though not as potentially wide a range as is the case in FTA negotiations. One hypothesis to be examined is the possibility that FTAs with large developed partners provide an environment for developing countries to make deeper and more extensive policy commitments than WTO accessions. If this could be established, it would serve as a significant counterargument to the neoclassical objection to preferential FTAs, namely that they cause welfare-reducing trade diversion.5 3. Is the timing of FTA or accession negotiations important for reform? The focus of this chapter will be on a particular hypothesis, which can be stated as follows: the period during which negotiations take place is the place to look for policy linkages. This will typically be an extended period of time before the agreement enters into force. Such an approach contrasts with analyses that look for effects of an agreement turning on the date of entry into force or analyses that exploit the gradual phase-in of tariff commitments to look for trade effects.6 The reason for adopting this approach is that during the period of negotiation, it is possible for the “anchoring” institution (the U.S., EU, or WTO working party) to delay or withhold the commercial benefits of the agreement in exchange for greater commitments on the part of the partner or acceding country. In order for an agreement to “anchor” commitments, the commitments must be made in some form before the agreement is concluded. The history of negotiations might be expected to yield up a paper trail of such commitments. This hypothesis

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is examined by constructing data on timelines associated with recent U.S. FTAs and WTO accessions, and by looking at changes in the behavior of governance indicators during the period of negotiation. For this analysis, the various subcomponents of the World Bank’s “Governance Matters IV” indicators are used (Kaufmann, Kraay, and Mastruzzi, 2005), as well as the aggregate score and some subcomponents of the Heritage Foundation’s Index of Economic Freedom. (Heritage Foundation, 2006). Evaluation of the above hypotheses is complicated by several factors. One large one is the fact that FTA partners may be chosen with a good deal more selectivity than WTO accession candidates. The WTO aims to be a global organization, and is open to all comers. Those countries which have become members recently, or are not yet members, consist very largely of former communist economies, Middle Eastern countries, and small islands. These may have, as a group, weaker governance than the world in general. A country with relatively few FTAs in effect, such as the U.S., has a great deal more choice in potential partners. It may be easier to do successful deals with partners with relatively good governance. Analysis of both the World Bank and Heritage Foundation indicators bears out this difference. The second, nontrivial factor is that the governance indicators used here may not be as strong as would be desired for such an analysis. The findings presented may thus reveal as much about the way the governance indicators are constructed as about the effects of the negotiations. The preliminary analysis offered here contains no strong and general conclusions about the tendencies of FTAs to lead to policy reform in developing countries. The results from the “Governance Matters” indicators show relatively little evidence of improved policies associated with the period of engagement, while some of the Heritage Foundation indicators are more likely to show improvement. The relationship between FTA negotiations (or WTO accession) and reform is likely to be very country specific. Different partners or acceding countries are likely to differ in their ex ante willingness to reform. The nature and extent of commercial interests, both export-promoting and import-competing (“offensive” and “defensive” in the vocabulary of negotiators) is likely to vary from case to case, which can potentially affect the value that both parties place on “deeper integration” commitments. Also, it turns out that some of the commitments associated with the negotiation process may not be embodied in the text of an FTA agreement but are in the nature of “side” commitments, which makes the process of generating a history of such commitments fairly challenging. These two problems taken together lead to a significant analytical problem of endogeneity. An ongoing process of engagement between a developing country and an external anchor is likely to be influenced by both domestic drivers for policy change and the expectations of the anchoring partner, so that identifying whether any given reform is “caused” by either

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the FTA negotiations or the domestic reform process is problematic and perhaps not useful. Some useful stylized facts do emerge from the preliminary analysis. These include the following: (1) U.S. FTAs are generally negotiated much more quickly than WTO accessions, which often take many years to complete. Even if the degree of policy commitment achieved with the two mechanisms were approximately equal, this would suggest that making the commitment through FTAs is more efficient. (2) The length of time it takes to negotiate an FTA or accession varies widely. Agreements with larger economies and economies with weaker initial policies appear to take longer. This suggests that both the extent of needed reform and the weight of commercial issues play a role in the length of time. (3) Recent U.S. FTA partners begin negotiations with a stronger policy environment than recent WTO accession candidates, which may be associated with a greater ex ante commitment to reform. This suggests that selection of potential partners may play a role in the extent of the success of any policy commitments achieved during FTA negotiations. WTO accession, by contrast, is in principle open to all comers. (4) While there is anecdotal evidence of countries undertaking reforms as part of an FTA negotiation or accession process, there is no systematic pattern of improved governance associated with the period of negotiation. This is definitely the case for the “Governance Matters” indicators. For the Heritage Foundation indicators, indicators of trade policy improve as well as (for WTO accessions) the aggregate indicator of “economic freedom,” but some subindicators (such as FDI, regulation, and property rights) deteriorate more often than they improve. Data such as those assembled here can be used in more formal quantitative analyses of the effects of either FTAs or WTO accession on economic quantities. One natural extension of this work is to look for their effects on FDI. Market decisions about which countries to invest in should be expected to be sensitive to a broad range of information about the policy environment in the host country, both explicit and tacit. Moreover, because investment decisions are by their nature both forward looking and responsive to new information, they may be expected to coincide with periods of negotiation leading to successful policy commitments. The experience of Mexico’s NAFTA negotiation and, possibly, China’s accession to the WTO suggest such a pattern. A full-blown analysis of the link between negotiations and FDI has not been performed yet, since it requires resolution of a number of issues resolving data and specification. The scope of this chapter is also limited in that it only considers the case of FTAs for which the U.S. is the large-country partner. The experience of engagement with the EU with developing economies or economies in transition could also be studied fruitfully in this regard. Describing the stylized facts for countries that engage with the EU is significantly more complicated than for countries that engage with the United States, because of both the

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multiple and successive forms such engagement has taken historically and the potential depth of full accession with the EU, which implies substantial variation in the depth of integration at any given point in time prior to or outside of accession. 5.1.2

FTAs vs. WTO accessions

Among the a priori reasons that may be offered in support of the argument that FTA negotiations offer the prospect of deeper integration and firmer “policy anchoring” than WTO accessions are the following: 1. FTA negotiations take place more rapidly than WTO accessions, and are almost always completed more quickly. The median time for completing an FTA negotiation with the U.S., from the beginning of the negotiation to the final entry into force, is 3.0 years. The median time for completing the task of a WTO working party, which represents only part of the accession process (albeit the most intensive phase), is 6.9 years, with a substantially larger variance. The likelihood of changes in government (or of mid-level players in the negotiations), changes in policies that alter the benchmark from which negotiations begin, or changes in economic conditions are much higher in a WTO accession than in an FTA negotiation. 2. The process of FTA negotiations is simpler. In the case of negotiations with the U.S., they are either one-on-one negotiations with countries, or many-on-one negotiations (i.e., with the Dominican Republic-Central American FTA (CAFTA-DR), the Southern African Customs Union (SACU), or the Andean FTA) still having the United States as partner.7 By contrast, there may be two dozen or more members in a WTO accession party, each presenting the candidate with separate agendas that may need to be handled bilaterally or plurilaterally. The process of negotiating with the EU may represent an intermediate case, with a single actor as the “anchor” but with intra-EU politics potentially to be taken into account. 3. Accession to the WTO is in principle limited to matching the commitments of the current members. Other than country-specific market access schedules, these consist of the Uruguay Round commitments negotiated in 1994 and represent a static target. FTAs can and do deal with more and deeper issues. For example, they may have provisions relating to labor, the environment, and competition policy, which to date have been nonnegotiable in the consensus environment of the WTO and may be deeper in such areas as customs and trade facilitation, harmonization of standards, investment, and intellectual property. The timetables in Table 5.1 for recent U.S. FTAs were reconstructed from a variety of sources, including fact sheets and press releases at the web pages of the United States Trade Representative (USTR) on bilateral trade agreements (http://www.ustr.gov/Trade_Agreements/Bilateral/Section_Index.html) and

Table 5.1

Timeline for U.S. FTAs Beginning of negotiationsa

Completion of agreement

Signing

Ratification

Entry into force

Duration Duration (months)b (years)b

Israel

Jan. 84

Apr. 85

Aug. 85

19

1.6

Canada

Jun. 86

Jan. 88

Jan. 89

31

2.5

NAFTAc

Jun. 91

Jordan

Jun. 00

Singapore

Nov. 00

Aug. 92

Aug. 92

Nov. 93

Oct. 00 Jan. 03

May 03

Jul. 03

Jan. 94

31

2.6

Dec. 01

18

1.5

Jan. 04

38

3.1

Chile

Dec. 00

Dec. 02

May 03

Jul. 03

Jan. 04

37

3.1

Morocco

Jan. 03

Mar. 04

Jun. 04

Jul. 04

Jan. 06d

36

3.0

Australia

Mar. 03

Feb. 04

Jul. 04

Jan. 05

22

1.8

Bahrain

Jan. 04

May 04

Sep. 04

Dec. 05

Aug. 06

24

2.0

CAFTA-DR

Jan. 03e

Dec. 03

May 04

Jul. 05

To be determinedf

48

4.0

g

SACU

Jun. 03

43

3.6

Panama

Apr. 04

32

2.7

31

2.6

31

2.6

Colombiah Ecuador

h

May. 04 May. 04

Feb. 06

Peruh

May. 04

Dec. 05

Apr. 06

31

2.6

Thailand

Jun. 04

30

2.5

UAE

Mar. 05

22

1.8

Oman

Mar. 05

22

1.8

Korea

Feb. 06

11

0.9

Malaysia

Mar. 06

10

0.8

a

Oct. 05

Jan. 06

Jul. 06

To be determined

This date may indicate either the USTR’s announcement of intent to negotiate or the actual beginning of negotiations. Through November 30, 2005, for agreements not entered into force. c NAFTA includes Canada and Mexico. d Pending approval of intellectual-property legislation by the Moroccan parliament. e With Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. USTR notified Congress of intent to begin negotiations with the Dominican Republic in August 2003. f CAFTA-DR has been implemented on a country-by-country basis as each member has met the conditions of the agreement. The agreement with El Salvador entered into force on March 1, 2006. The agreement with Honduras and Nicaragua entered into force on April, 1 2006. The agreement with Guatemala entered into force on July 7, 2006. g SACU includes Botswana, Lesotho, Namibia, South Africa, and Swaziland. h USTR’s original declaration of intention to Congress to negotiate the Andean Trade Promotion Agreement, in November 2003, included Bolivia, Colombia, Ecuador, and Peru. These negotiations were later pursued on an individual basis. Negotiations with Ecuador were suspended on May 17, 2006. b

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various United States International Trade Commission (USITC) reports. The trade agreements fall into two broad groups. The first group (with Israel, Canada, and the North American FTA (NAFTA)) were ratified under the “fast-track” trade negotiating authority of the Trade Act of 1974, under which Congress voted trade agreements “up-or-down” without amendment. The Jordanian FTA was conducted during the period 1995–2002, under which such authority had lapsed, while the agreements with Singapore and Chile onward were negotiated under the Trade Promotion Authority granted by Congress in the Trade Act of 2002. For the agreements which have been successfully concluded, the time from the beginning of negotiations to the final entry into force has ranged from 18 to 42 months (1.5 to 3.5 years), with Jordan being the quickest and Guatemala taking the longest. Arguably the process may take longer, as a period of “talks about talks” may precede the start of formal negotiations and include a formal statement of intent to enter into negotiations. Dates for “intent to negotiate,” when available, generally precede the start of formal negotiations by three to six months. At the time of writing, none of the agreements still under negotiation have not normally taken longer than 38 months, though the agreement with SACU is beginning to approach that length of time. Table 5.2 lists the countries that successfully acceded to the WTO between its establishment in January 1995 and December 2005. There is a standard sequence of events in WTO accession: ● ●

●

●

The candidate applies for membership. A working party is established, consisting of those current WTO Members taking an interest in the membership application. Following this, the candidate produces a memorandum describing all aspects of its trade and economic policies that have a bearing on potential WTO Membership. The working party convenes and meets several times. The candidate member makes market access and other commitments, and discusses these both with the working party and bilaterally with individual members. A draft working party report is drawn up, and eventually finalized, with the market access offer being set down in a “protocol of accession.” The WTO’s General Council or Ministerial Conference accepts the protocol of accession on a two-thirds vote of the members, completing the accession process.

Time may be expended at each stage of the membership process. There may be delays in establishing the working party, or in convening it to meet once it is established. Time consumed in the applicant’s preparation of the initial policy memorandum may lead to substantial delays in convening an established working party. The resulting information may be considered to be incomplete, members of the working party may have further

FTAs and the WTO as Policy Anchors

147

questions, or the information itself may change as the result of domestic policy changes. Table 5.2 presents several metrics for measuring the length of the accession process. Three time metrics, in ascending length of time, are (1) the time from the first meeting of the working party to its final report; (2) the time from the establishment of the first working party to its final report (the addition being largely the time it takes the applicant to prepare the initial description of its policies; and (3) the time from application to membership (not measurable in all cases because of missing information on the date of applications under the pre-WTO GATT system that were transformed into WTO applications). A second metric, which captures both time and the complexity of the negotiations, is the number of times the working party met for each applicant. Between the establishment of the WTO and December 2005, there were 22 completed accessions. For these the distribution of time and complexity are given in Table 5.3. There is very little overlap between the short times observed to complete U.S. FTA negotiations and the longer times observed for WTO accessions. It may be thought that the very long time for China’s WTO accession pulls up the average time substantially, but the medians are not much lower than the means: 3.7 years for working party meetings and 6.9 years from the establishment of the Working Party to the Final Report. (The mean of 2.9 years that it takes for an established Working Party to meet for the first time, associated with the applicant’s preparation of its initial memorandum, is longer than the average time for an entire U.S. FTA, and is actually made lower by the inclusion of China). Finally, Table 5.4 describes the 31 WTO accessions that were ongoing as of August 2006.8 Most of these have been going on for a very long time. The list includes ten cases that have gone on for ten or more years. It is in fact Algeria, rather than China, which holds the record for the longest-running working party, dating back to 1987. Several of these ongoing accessions look like fair prospects to exceed China’s mark for time consumed, if not for the number of working parties. (Russia’s incomplete accession is second to China’s for the largest number of working party meetings, at 29 at that time.) Taking into account ongoing accessions and ongoing FTAs makes the contrast between the length of time taken by the two processes even more sharp. If in fact negotiating an FTA with the U.S. involves a level of commitment anywhere near that of a WTO accession, it appears at the outset that such a negotiation could not be successfully completed by many of the countries currently engaged in the WTO accession process, let alone in three years or less. 5.1.3 5.1.3.1

Some anecdotal evidence Mexico and NAFTA

With historical hindsight, it is now clear that Mexico’s negotiation of NAFTA served as a means to “anchor” policy commitments that had been

Table 5.2

Completed WTO accessions as of December 2005 Years from first Years from working establishment party to of working Years from Working final work- party to final application party ing party working party to estabreport report membership Application lished

First working party

Number of working party meetings

Final working party report

Membership

Albania

4.3

7.6

7.8

Nov. 92

Dec. 92

Apr. 96

9

Jul. 00

Sep. 00

Armenia

6.8

8.9

na

?

Dec. 93

Jan. 96

5

Nov. 02

Feb. 03

Bulgaria

4.8

9.8

na

?

Nov. 86

Nov. 91

9

Sep. 96

Dec. 96

Cambodia

2.3

8.7

10.0

Oct. 94

Dec. 94

May. 01

5

Aug. 03

Oct. 04

China

13.7

14.6

15.3

Jul. 86

Mar. 87

Feb. 88

41

Oct. 01

Nov. 01

Croatia

4.2

6.7

7.2

Sep. 93

Oct. 93

Apr. 96

6

Jun. 00

Nov. 00

Ecuador

2.0

2.8

3.3

Sep. 92

Oct. 92

Jul. 93

9

Jul. 95

Jan. 96

Estonia

4.4

5.1

5.7

Mar. 94

Mar. 94

Nov. 94

8

Apr. 99

Nov. 99

Former Yugoslave Republic of Macedonia

2.2

7.8

8.3

Dec. 94

Dec. 94

Jul. 00

5

Sep. 02

Apr. 03

Georgia

1.4

3.1

4.0

Jun. 96

Jul. 96

Mar. 98

3

Aug. 99

Jun. 00

Jordan

3.2

5.9

6.3

Jan. 94

Jan. 94

Oct. 96

5

Dec. 99

Apr. 00

Kyrgyz Republic

1.3

2.3

2.8

Feb. 96

Apr. 96

Mar. 97

6

Jul. 98

Dec. 98

Lithuania

5.1

6.8

7.3

Jan. 94

Feb. 94

Oct. 95

5

Nov. 00

May 01

Latvia

3.5

4.8

5.3

Nov. 93

Dec. 93

Mar. 95

6

Sep. 98

Feb. 99

Moldova

3.8

7.1

7.7

Nov. 93

Dec. 93

Mar. 97

5

Jan. 01

Jul. 01

Mongolia

3.3

4.7

na

?

Oct. 91

Mar. 93

5

Jun. 96

Jan. 97

Nepal

3.3

14.2

na

?

Jun. 89

May 00

3

Aug. 03

Apr. 04

Oman

3.4

4.3

1.4

Apr. 96

Jun. 96

Apr. 97

6

Sep. 00

Nov. 00

Panama

2.4

5.7

na

?

Jan. 91

Apr. 94

5

Sep. 96

Jul. 97

Saudi Arabia

9.7

12.3

12.5

Jun. 93

Jul. 93

Mar. 96

13

Nov. 05

Dec. 05

Tongaa

4.6

10.0

10.5

Jun. 95

Nov. 95

Apr. 01

1

Nov. 05

Dec. 05

Chinese Taipei

8.9

9.0

na

?

Oct. 92

Nov. 92

11

Oct. 01

Jan. 02

Note: The WTO was established in January 1995. Some countries in this table began the process to accede to GATT 1947 before WTO accession processes were available. This table is based on “Protocols of Accessions for New Members Since 1995, Including Commitments In Goods and Services,” found at http://www.wto.org/english/thewto_e/acc_e/completeacc_e.htm, and author’s calculations. a On December 15, 2005, the WTO Ministerial Conference approved Tonga’s accession package. Tonga’s WTO Membership awaited the domestic ratification of the Kingdom of Tonga at the time of compiling the table. Source: http://www.wto.org/english/thewto_e/acc_e/a1_tonga_e.htm.

150 Michael J. Ferrantino Table 5.3

Distribution of time and complexity of accessions Mean

Standard deviation

Years during which working party met

4.5

Years from organization of working party to final working party report Number of meetings of working party

Minimum

Maximum

3.0

1.3 (Kyrgyz Republic)

13.7 (China)

7.4

3.4

2.3 (Kyrgyz Republic)

14.6 (China)

7.8

7.9

1 (Tonga)

41 (China)

made previously, particularly in the area of FDI policy. Embodying these commitments in the form of an agreement with the U.S., which accounted for over 80 percent of Mexico’s foreign trade at the time of the agreement, insured that they would be more difficult to undo later. It is equally clear that Mexico’s path to opening was both driven by domestic initiatives and shaped by other external anchors prior to NAFTA, including Mexico’s agreements with the International Monetary Fund (IMF) in the early 1980s and its accession to GATT in 1986. Changes in FDI rules in 1989 and 1993 were formalized and extended in its NAFTA commitments. Mexico’s restructuring of its debts in the 1989 Brady Plan, its wave of privatizations during 1989–92, and the 1992 constitutional amendment transforming agriculture created an environment in which a lowering of barriers to trade with the U.S. and Canada could potentially provide significant efficiency gains through reallocation of resources. In June 1990, Presidents Bush and Salinas endorsed the concept of a comprehensive FTA, which was formally negotiated from June 1991–August 1992 and ratified in the U.S. in November 1993. Figure 5.1, plotted on a logarithmic scale, shows a progressive scaling up of FDI into Mexico: approximately $1–$2 billion a year preceding the negotiations, $4–$5 billion a year during the negotiations and ratification, and upwards of $10 billion a year subsequently. This pattern lends credence to the idea that NAFTA was seen as more than simply a reformulation of existing Mexican FDI policy. The Mexican policy process itself responded proactively to the outcome of the NAFTA negotiations in a number of areas, demonstrating endogeneity between domestic policy and international negotiations. (USITC, 1993; 1997). 5.1.3.2

China’s WTO accession

The primary external anchor for China’s reforms has been its WTO accession. China’s lengthy and elaborate WTO accession process, extending from 1986 through 2001, encompasses a very substantial portion of the history

FTAs and the WTO as Policy Anchors

151

of China’s economic reforms beginning in 1979. China’s case illustrates the point that substantial domestic policy change can take place without an external anchor. Substantial expansion of special economic zones and foreign trading companies took place in the years prior to China’s WTO application, as well as alterations to the exchange rate system to accommodate the increased flow of foreign transactions. Nonetheless, one can make a reasonable case that the trajectory of China’s reforms, in specific areas such as services and intellectual property as well as the massive unilateral tariff reduction undergone by China during the early 1990s (made even greater by special policies relating to FDI and economic zones), was conditioned by the external anchoring effect of repeated engagement with the WTO working party, including bilateral engagement with large members such as the U.S., EU, and Japan. Indeed, WTO commitments have even been portrayed as a tool Beijing could use to obtain consistency and uniformity from increasingly independent provincial and local governments (USITC, 1999). 5.1.3.3

Recent U.S. FTAs

It is often reported that negotiations of FTAs with the U.S. are associated with specific reforms, both those that are explicitly enumerated in the agreement and those not necessarily enumerated but understood by the participants in some sense to be linked. Customs reforms in the Central American countries (World Bank, 2005) and Morocco have been attributed to FTAs. These initiatives naturally flow from the need to implement direct provisions of the FTA such as the enforcement of rules of origin, but may provide spillover benefits in terms of quicker clearance times for goods, which may be valuable to business. (World Bank, 2005). In Morocco, new labor legislation providing for shortening of the statutory workweek, increasing the age definition of child labor, and increasing the minimum wage, was passed weeks before final conclusion of the U.S.-Morocco FTA and was noted by the USTR (USTR, 2005). In Ecuador, links have been suggested between the U.S.-Andean FTA to proposed new incentives for FDI, strengthening of the financial system to prevent money laundering, strengthening of sanitary and phytosanitary (SPS) regulations, and possible resolution of disputes between the Ecuadorian government and a long list of U.S. companies. (Wong, 2005). Because negotiating an FTA with a large partner interacts with a wide variety of domestic political and economic forces, the number and extent of policy changes in a small country that negotiates an FTA with a large partner are not readily subject to definitive enumeration.

5.2

Linkages among agreements, policy, and performance

There is a large number of direct and indirect channels through which negotiating either an FTA or a WTO accession could impinge either directly or indirectly on a small developing-country partner through either

Table 5.4

Ongoing WTO accessions as of August 2006

Working party established (as of Aug. 2006) (yrs) Afghanistan

6.8

17.7

Application/ draft report (yrs)

Working First party working Application established party

No. of working party meetings

Nov. 04

Dec. 04

Jun. 87

Jun. 87

Apr. 98

8

8.1

Jul. 99

Oct. 97

Oct. 99

1

8.3

Jun. 97

Jul. 97

Jun. 02

3

4.3

May 01

Jul. 01

12.1

Sep. 93

Oct. 93

Jun. 97

7

18.4

Andorra Azerbaijan

Belarus

Working party established/ draft report (yrs)

0.8

Algeria

Bahamas

First working party/ draft report (yrs)

17.7

First draft report

Feb. 05

Bhutan

6.1

Sep. 99

Oct. 99

Nov. 04

2

Bosnia and Herzegovina

6.3

May 99

Jul. 99

Nov. 04

2

Cape Verde

5.3

Nov. 99

Jul. 00

Mar. 04

3

Oct. 04

Sep. 04

0.6

4.3

4.9

Ethiopia

2.8

Jan. 03

Feb. 03

Iran

0.5

Jul. 96

May 05

Sep. 04

Dec. 04

Jan. 96

Feb. 96

Mar. 97

8

Jul. 97

Feb. 98

Oct. 04

1

Iraq

0.9

Kazakhstan

9.8

Lao People’s Democratic Republic

7.8

7.5

8.6

8.7

Lebanese Republic

6.6

Libyan Arab Jamahiriya

1.3

Montenegro Russian Federation

1.8

5.3

5.5

0.6 12.4

9.3

11.3

11.3

Jan. 99

Apr. 99

Oct. 02

4

Jun. 04

Jul. 04

Dec. 04

Apr. 05

Oct. 05

1

Jun. 93

Jun. 93

Jul. 95

29

Oct. 04

Mar. 02

1

Jun. 03

Samoa

7.3

Apr. 98

Jul. 98

Sao Tome and Principe

0.5

Jan. 05

May 05

Dec. 01

Feb. 05

Oct. 05

1

May 95

Jul. 95

Feb. 97

1

Serbiaa

0.8

Seychelles

10.3

Sudan

11.1

Oct. 94

Oct. 94

Jul. 03

2

4.3

May 01

Jul. 01

Mar. 04

2

Nov. 93

Dec. 93

Feb. 95

14

Dec. 94

Dec. 94

Jul. 02

3

Tajikistan Ukraine

11.9

Uzbekistan

10.9

0.3

10.1

1.9

11.3

2.1

11.3

Jul. 04

Jun. 97

Mar. 05

Vanuatu

10.3

5.3

6.3

6.3

Jun. 95

Jul. 95

Jul. 96

3

Oct. 01

Vietnam

10.8

6.3

9.8

9.8

Jan. 95

Jan. 95

Jul. 98

10

Nov. 04

Apr. 00

Jul. 00

Nov. 04

2

Yemen

5.3

Note: a The application originally lodged by the Federal Republic of Yugoslavia in December, 2001 contained Serbia and Montenegro. Serbia and Montenegro filed applications with the WTO as separate customs territories on December 10, 2004. Source: http://www.wto.org/english/thewto_e/acc_e/a1_serbia_e.htm.

154

Michael J. Ferrantino 1.00E+11

NAFTA under negotiation

Pre-NAFTA

NAFTA in force

1.00E+10

1980

Figure 5.1

1985

1990

1995

2000

1.00E+09 2005

Mexico: FDI, net inflows, billion nominal dollars (Logarithmic Scale)

direct or indirect processes.9 There is a diverse array of actors in any domestic political process. These are not limited to export interests and importcompeting interests, whose stakes in the market access provisions of an FTA are well understood by economists. They may, in addition, include regime elites whose primary interest is maintaining power, proreform interests in general, civil servants who are interested in maintaining wages and benefits in the government budget, unions interested in protecting or expanding bargaining power, and urban consumers interested in maintaining budgetary subsidies. Economically, an FTA may influence both the external balance (balance of payments) and internal balance (government budget) within a country. Changes in flows of trade and FDI may increase or decrease pressure on the current account, affecting the valuation of the currency and potentially increasing (or reducing) pressure for currency reform. Structural displacement of labor may result from changing internal prices caused by liberalization. Addressing displacement may be a significant social, political, and budgetary issue. Internal balance may be affected by the loss of tariff revenue, changes in the ability to finance officially contracted foreign debt, and aid-type payments associated with the agreement (Both the U.S. Agency for International Development and the EU’s aid programs engage in expenditures that are directly or indirectly associated with to liberalization agreements). Policies with respect to regulation, privatization, and FDI may be directly linked to provisions of an agreement, particularly one involving services

FTAs and the WTO as Policy Anchors

155

commitments. Potential changes in the full range of fiscal, monetary, and regulatory policies may be pushed in one direction by domestic forces, and simultaneously pushed in either the same (or a different) direction by forces associated with negotiation or implementation of an FTA.

5.3

Two cases – Morocco and Ecuador

The timelines presented above, as well as the analysis to follow, suggest that case-specific circumstances are likely to impact on the success of a country’s engagement with a given policy anchor, whether it be an FTA, a WTO accession, or (related but beyond the scope of this chapter) an IMF funding agreement. The presence of multiple “anchors” is not uncommon. The degree to which engagement with an anchor is associated with successful domestic reform may well depend on the ability of developing-country policymakers to make internal commitments, which in turn may depend largely on domestic factors. The cases of Morocco and Ecuador10 have been chosen for brief description here on somewhat arbitrary grounds. Both cases involve more than one “anchor” – for Morocco, both the EU and the U.S.; for Ecuador, a recent WTO accession, on-and-off IMF agreements and the Andean Pact, in addition to the U.S. The cases differ substantially in the ability of domestic political forces to make commitments. Further study of these and similar cases may turn out to be informative. 5.3.1

Morocco

The Moroccan government’s ability to commit to changes in economic policy is conditioned by the central role of the king in the constitutional monarchy. Although Morocco has parliamentary elections, the political leadership of the king is generally not questioned, and calls for a republic are marginalized. Thus, the succession of the late Hassan II by then 36-year-old Mohammed VI in 1999, represented a significant shift in policy. Under Mohammed, the most severe human rights abuses have been moderated, some political opening has taken place, an anticorruption drive has led to some trials of civil servants, and the rights of women in family law have been expanded. The terrorist attacks on Casablanca in 2003 have not fundamentally affected the Moroccan polity. They do not appear to be associated with a sustained strengthening of jihadist forces that may wish to undermine the present regime and have led to several waves of arrests of suspected terrorists. Morocco’s engagement with external anchors in trade policy can be understood to some extent in the above context. The act of balancing between external poles of influence, which in the Cold War environment consisted of maintaining good relations with the U.S. and Soviet Union simultaneously, has become a balancing among trade partners. The

156

Michael J. Ferrantino

Association Agreement between Morocco and its largest partner, the EU, came into effect in March 2000. It confirms the previously existing state of relatively free trade in manufactures and provides for negotiations for agricultural liberalization, as well as for consultations in such areas as migration. As in the case of Mexico, Morocco has undergone a number of privatizations (1999–2000) and a labor code reform, which came into effect in June 2004, making labor markets more flexible while securing bargaining rights.11 However, revenue from privatization has gone largely toward current budgetary needs, and Morocco maintains a chronic fiscal deficit leading to a borrowing requirement of 4–5 percent of Gross Domestic Product (GDP). Morocco’s FTA with the U.S. was negotiated from January 2003 to March 2004 and ratified in July 2004. Congressional ratification of the U.S.-Morocco FTA followed closely on implementation of the new labor law. 5.3.2

Ecuador

The Ecuadorian polity has been characterized by a frequent and unpredictable succession of governance since the restoration of civilian rule under the 1979 constitution. Quadrennial presidential elections inevitably feature a runoff, with the winning candidate usually representing a minority of the electorate and possessing only a minority in Congress. The powers of the Ecuadorian Congress are substantial. Until the constitutional reforms of 1998, Congress could dismiss ministers, and presidents were subject to midterm elections. Even afterwards, the ability of factions in Congress representing ethnic groups, organized labor, or charismatic personalities to block commitments which presidents made internationally has been substantial. In 1997, 2000, and 2005, presidents were ousted mid-term by a combination of Congressional action and mass demonstrations. This has made it difficult to deal with such issues as banking crises and external defaults. Nonetheless, Ecuador has in some instances managed to make external commitments that led to modest liberalization or reform. These include the implementation of Andean Community tariff reforms in 1994 and WTO accession from 1992–95. The period of WTO accession saw both the implementation of the Andean commitments and a privatization and simplification of export and import procedures. The dollarization program of 2000 provided a monetary “anchor” in the wake of a banking and default crisis. An IMF standby arrangement was restored from 2001–04 after having been absent since the 1980s, but proved difficult to maintain. Documents associated with IMF surveillance of Ecuador demonstrate the difficulty of making internal commitments within the rapidly changing Ecuadorian regime. In this environment, the beginning of U.S. negotiations with Ecuador and Peru was formalized two months later than those with Colombia, although they are described as being part of the same FTA.

FTAs and the WTO as Policy Anchors

157

Negotiations on a U.S.-Ecuador FTA were suspended on May 17, 2006, in the wake of Ecuador’s suspension of a contract with California-based Occidental Petroleum which effectively represented a seizure of its assets.12

5.4 5.4.1

Evidence on governance – FTAs vs. WTO accessions The “Governance Matters IV” indicators

In order to get a rough indication of whether the conditions of governance in developing countries broadly improved during the period of negotiations, the “Governance Matters” indicators of the World Bank were employed. (Kaufmann, Kraay, and Mastruzzi, 2005). The indicators are measured for even-numbered years from 1996–2004 for a maximum of 209 countries. As stated by the authors, the indicators capture six dimensions of institutional quality or governance: 1. Voice and Accountability – measuring political, civil, and human rights; 2. Political Instability and Violence – measuring the likelihood of violent threats to, or changes in, government, including terrorism; 3. Government Effectiveness – measuring the competence of the bureaucracy and the quality of public service delivery; 4. Regulatory Burden – measuring the incidence of market-unfriendly policies; 5. Rule of Law – measuring the quality of contract enforcement, the police, and the courts, as well as the likelihood of crime and violence; and 6. Control of Corruption – measuring the exercise of public power for private gain, including both petty and grand corruption and state capture. Of these, one might expect “Regulatory Burden” to most nearly capture the types of promarket reforms that are thought to be associated with the “policy anchors” hypothesis, with “rule of law” and some of the others playing a secondary role. The indicators are based on 352 underlying variables measuring perceptions on governance, drawn from 32 data sources compiled by 30 organizations worldwide. They are normalized and aggregated, so that each indicator in each year is approximately a standard normal variable with mean of zero and with most of the values lying between –2 and +2. Thus, “progress” in the indicators represents “progress” relative to global average governance rather than absolute progress. Because the indicators are aggregates, they come with standard deviations and the number of observations used in each indicator. Thus, difference of means tests can be applied to changes in the values of the indicators over time, and a level of statistical significance can be assigned to measured improvement or deterioration relative to the period-specific worldwide mean levels.

158 Michael J. Ferrantino

The method used to compare “before and after” scores is as follows:13 First, the period of engagement is dated. For U.S. FTAs, this is defined as beginning in the year that intent to negotiate was announced and ending in the year of entry into force or 2004. For WTO accessions, the period of engagement is defined as extending from the year of the first working party meeting to the year of the final working party report or 2004. Countries with WTO working parties still meeting in 2005 are considered to be “ongoing accessions” while those with their final working party in 2004 or more are considered to be completed. Second, the dates for the biennial nature of the “Governance Matters” data are adjusted. Odd-numbered starting dates are attributed to the year before, and odd-numbered ending dates are attributed to the year after. The effect of this procedure is to restrict the sample to only those countries with processes of engagement that have a distinct biennial beginning and ending point between 1996 and 2004; for example, intent to negotiate for the U.S. FTAs must be in 2002 or earlier. The resulting sample includes ten countries with U.S. FTAs, ten countries with complete WTO accessions between 1996 and 2004, and 13 countries with WTO accessions beginning in 1996 and ongoing in 2005. Of the ongoing accessions, data is available for either nine or ten countries, depending on the indicator. Inclusion of the beginning and ending periods has both advantages and disadvantages. The advantages include the possibility of including preparatory activities before the formal beginning date and actions to come into compliance with commitments just after the formal ending date. The obvious disadvantage is that the dating is less precise.14 Figure 5.2 illustrates the initial levels of the “Governance Matters” indicators for the three groups of countries in question. For every one of the six indicators, the quality of governance ex ante is highest for the U.S. FTA partners, lowest for the ongoing WTO accessions, and intermediate for the completed WTO accessions. Moreover, every one of the indicators is aboveaverage on a global basis (above 0) for the U.S. FTA partners, below-average for the completed WTO accessions and further below average for the ongoing WTO accessions. This immediately dramatizes two points. First, since the partners in U.S. FTAs are selected to have higher ex-ante governance, the chances of their being willing to make significant commitments during the process of engagement would be expected to be higher.15 Second, when taken together with data on the length of time for accessions, a long on-going accession process is likely to be a difficult one, and this in turn is associated with weak governance in the country being engaged. It is also interesting to note that the degree of dispersion among the three groups is highest for the “regulatory quality” indicator, the indicator most likely to be associated with the matters at issue in the period of engagement. The average ex ante score for “regulatory quality” is 0.42 for the U.S. FTA partners, –0.13 for the completed WTO accession candidates and –0.61 for the ongoing WTO accession candidates.

FTAs and the WTO as Policy Anchors

159

0.6 0.4 0.2

Recent U.S. FTAs

0.0

WTO accessions completed during 1996–2004

−0.2 −0.4

WTO accessions ongoing in 2005

−0.6

ac V co oi un ce t a Po abi nd lit lit y ic al st ab ilit y G ef ov fe er ct n ive m ne ent ss R eg ul qu ato al ry ity R ul e of la w C co on rru tro pt l of io n

−0.8

Figure 5.2 Initial values, “Governance Matters” indicators

Tables 5.5, 5.6, and 5.7 report the complete set of initial values, changes in values, and significance levels associated with those values for the three samples, respectively. The significance values were calculated with a standard difference of means test. Table 5.8 summarizes those values in Table 5.7 that correspond to a significant one-tailed change of p ≥ 0.9 (i.e., p ≥ 0.9 for improvements, p ≤ 0.1 for deteriorations). The most striking thing about the results in Table 5.8 is that they show little evidence of improved governance by any indicator for any of the three groups. The ongoing WTO accessions, in fact, show more cases of deterioration than improvement in five of the six indicators, showing a balance of improvement only for “government effectiveness.” This is not encouraging, as it suggests only more efficient repression and corruption. It is true that we might not expect such indicators as “political stability” and “control of corruption” to be highly associated with processes of engagement for trade liberalization. It is also modestly encouraging that there are more significant improvements in the “regulatory quality” indicator than for any other (nine all told, three in each category). But this is a fairly weak source of support for the policy-anchors hypothesis, since there are also ten cases of deterioration and 11 cases of no statistically significant change. Some of the results are simply ironic. Seven of ten U.S. FTA partners show statistically significant deterioration in the rule of law, and six out of ten show statistically significant deterioration in political stability in the period in question. One must hasten to add that causation should not be attributed here. Rather, the domestic circumstances in the prospective partners are environmental factors with which the FTA negotiations have had to contend.

Table 5.5

Initial values of “Governance Matters” indicators Voice and accountability

Political stability

Government effectiveness

Regulatory quality

Rule of law

Control of corruption

0.5613

0.8519

1.3379

1.3754

1.3136

1.5560

Country means

Recent U.S. FTAs Chile

1.1660

Costa Rica

1.1628

1.1005

0.4461

0.7806

0.6661

0.9052

0.8436

Dominican Republic.

0.1940

0.2449

−0.4150

−0.1323

−0.4186

−0.4020

−0.1548

El Salvador

0.0635

0.3230

−0.5007

0.0716

−0.4301

−0.4882

−0.1601

160

Guatemala

−0.4842

−0.4312

−0.5776

−0.0833

−0.8381

−0.7062

−0.5201

Honduras

−0.1549

−0.0800

−0.7315

−0.3442

−0.7695

−0.7648

−0.4742

Jordan

−0.1914

0.2136

0.3972

0.6827

0.5516

0.1492

0.3005

Morocco

−0.3044

−0.1843

0.0553

−0.0138

0.0702

−0.0501

−0.0712

Nicaragua

0.0872

0.1135

−0.8469

−0.4079

−0.6693

−0.4569

−0.3634

Singapore

−0.0511

1.5209

2.4393

2.3115

2.0968

2.5066

1.8040

0.0883

0.3673

0.1604

0.4240

0.1573

0.2249

0.2370

Group means

WTO accessions completed during 1996–2004 Albania

−0.3475

0.1989

−0.3096

0.1560

−0.3199

0.0497

−0.0954

Armenia

−0.5670

0.4102

−0.3229

−0.7367

−0.4606

−0.6493

−0.3877

Cambodia

−0.3531

−0.7335

−0.4362

−0.0675

−0.7658

−0.7185

−0.5124

Croatia

−0.5000

0.2437

−0.1736

−0.0753

−0.5299

−0.4835

−0.2531

Georgia

−0.3741

−0.8125

−0.4049

−0.7875

−0.7350

−0.6432

−0.6262

Jordan

−0.1565

0.3964

0.1797

0.0637

0.2002

−0.0962

0.0979

Kyrgyz Republic

−0.4844

0.7647

−0.4261

−0.1561

−0.6919

−0.7885

−0.2970

Macedonia

−0.0269

−0.8239

−0.5200

0.1301

−0.3158

−0.4510

−0.3346

Nepal

−0.1158

−1.1266

−0.6211

−0.3860

−0.3576

−0.5589

−0.5277

Oman

−0.6102

0.7420

0.7875

0.6073

1.1217

0.1228

0.4619

Group means

−0.3535

−0.0741

−0.2247

−0.1252

−0.2855

−0.4217

−0.2474

WTO accessions ongoing in 2005 Algeria

−1.4607

−2.6222

−0.9828

−1.2006

−0.7908

−0.7023

−1.2932

Azerbaijan

−0.8728

−1.1340

−0.8999

−0.8715

−0.8403

−1.0372

−0.9426

Andorra

1.4409

1.4409

161

Belarus

−1.0253

0.0345

−1.2007

−1.0754

−1.0127

−0.9247

−0.8674

Kazakhstan

−0.9973

−0.0475

−0.8285

−0.2722

−0.7332

−0.8480

−0.6211

Lebanon

−0.5394

−0.6316

−0.4014

−0.4859

−0.2818

−0.3677

−0.4513

0.6684

0.8152

0.0763

−0.0572

1.0421

0.2190

0.4606

−1.2228

−0.2738

−0.0948

0.0685

0.7548

−0.3225

−0.1818

−0.5761

−1.1658

−0.4686

−0.1755

−0.3897

−0.5897

−0.3423

−1.0395

−1.4363

−1.2274

−1.0344

−1.2230

Samoa Saudi Arabia Seychelles

0.0971

Tonga

−0.0878

Uzbekistan

−1.5815

−1.0190

−0.5483

Vanuatu

0.4730

−0.2293

−0.0644

Vietnam

−1.6373

0.5919

−0.1747

−0.5834

−0.8067

−0.6011

−0.5352

0.0598

Group means

−0.5189

−0.4763

−0.5683

−0.6100

−0.4286

−0.6208

−0.5371

Table 5.6

Observed changes in “Governance Matters” indicators Voice and accountability

Political stability

Government effectiveness

Regulatory quality

Rule of law

Control of corruption

Country means

−0.1503

−0.1135

0.0796

Recent U.S. FTAs Chile

162

0.5265

0.0372

−0.0674

0.2450

Costa Rica

−0.0525

−0.1170

0.0434

−0.1124

−0.0995

−0.1294

−0.0779

Dominican Republic.

0.0791

−0.2544

−0.0442

−0.1439

−0.1187

−0.0958

−0.0963

El Salvador

0.1963

−0.5569

0.2798

0.4914

0.0919

0.0932

0.0993

Guatemala

0.0906

−0.4140

−0.2920

0.0174

−0.1188

−0.0327

−0.1249

Honduras

0.1365

−0.6145

0.0475

0.0110

0.1605

0.0533

−0.0343

Jordan

−0.2207

−0.5307

−0.0068

−0.5829

−0.2103

−0.1091

−0.2767

Morocco

−0.2479

−0.0477

−0.0810

−0.2440

−0.1157

0.0313

−0.1175

Nicaragua

−0.0281

−0.2596

0.1370

0.2614

0.0225

0.1129

0.0410

Singapore

−0.0809

−0.0409

−0.1931

−0.4411

−0.2802

−0.0648

−0.1835

0.0399

−0.2799

−0.0177

−0.0498

−0.0819

−0.0255

−0.0691

Group means

WTO accessions completed during 1996–2004 Albania

0.3022

−0.8110

−0.4402

−0.2124

−0.4368

−0.6556

−0.3756

Armenia

0.1309

−0.9795

−0.0675

0.8446

−0.0221

−0.0365

−0.0217

−0.5393

0.1333

−0.4305

−0.1778

−0.2117

−0.2478

−0.2456

Croatia

Cambodia

0.8776

0.2426

0.3274

0.3837

0.6683

0.5227

0.5037

Georgia

0.1681

0.0260

−0.3130

0.2302

0.1658

−0.0620

0.0359

Jordan Kyrgyz Republic

−0.0348

−0.1828

0.2175

0.6190

0.3514

0.2454

0.2026

0.0247

−0.0671

0.1488

−0.5645

0.0193

0.0957

−0.0572

Macedonia

−0.2763

−0.1134

0.1513

−0.2228

−0.1323

−0.2751

−0.1448

Nepal

−0.8820

−0.6116

−0.2763

−0.2129

−0.4661

−0.0487

−0.4163

Oman

−0.0724

0.3230

0.2052

0.1814

0.1141

0.6228

0.2290

Group means

−0.0301

−0.2041

−0.0477

0.0868

0.0050

0.0161

−0.0290

1.2005

0.5199

0.2735

0.0589

0.2089

0.4683

WTO accessions ongoing in 2005 Algeria

0.5483

163

Andorra

−0.2122

Azerbaijan

−0.1015

−0.3877

0.0876

0.2999

−0.0146

Belarus

−0.5147

−0.2760

0.2661

−0.7067

Kazakhstan

−0.2168

−0.0597

0.2028

−0.6146

Lebanon

−0.2657

−0.2003

0.0689

0.0244

0.0699

0.0121

Saudi Arabia

−0.4067

−0.3234

Seychelles

−0.1403

Tonga

−0.2656

Uzbekistan

−0.1697

Samoa

.

.

.

.

.

−0.2122

0.0000

−0.0194

−0.2959

0.0190

−0.2514

−0.2444

−0.2521

−0.1975

0.0000

−0.0348

−0.1384

−0.0950

0.4479

−0.4262

−0.1729

−0.0075

−0.5559

0.4741

−0.1976

0.0327

−0.4065

.

0.2629

−0.0400

.

−0.2592

−0.2527

0.2835

−0.0915

−0.1171

−0.0037

−0.6597

−0.0715

−0.1729

−0.2378

−0.3491

.

.

.

0.0275

Vanuatu

0.2062

−0.3745

−0.2683

Vietnam

0.1006

−0.4362

−0.1348

0.0111

0.2195

−0.1373

−0.0628

−0.1087

−0.0847

0.0567

−0.1597

−0.1081

−0.0263

−0.0718

Group means

.

.

−0.1456

Table 5.7

Difference of means tests Voice and accountability

Political stability

Government effectiveness

Regulatory quality

Rule of law

Control of corruption

Country means

1.0000

0.6494

0.1659

0.9986

0.0016

0.0267

0.4737

Recent U.S. FTAs Chile

164

Costa Rica

0.2236

0.1211

0.7147

0.0893

0.0294

0.0233

0.2002

Dominican Republic.

0.8071

0.0192

0.3009

0.0492

0.0220

0.1195

0.2196

El Salvador

0.9925

0.0000

0.9981

1.0000

0.8979

0.8268

0.7859

Guatemala

0.9087

0.0002

0.0003

0.5726

0.0189

0.3221

0.3038

Honduras

0.9563

0.0000

0.7098

0.5462

0.9962

0.7632

0.6619

Jordan

0.0474

0.0002

0.4748

0.0000

0.0024

0.1311

0.1093

Morocco

0.0008

0.3307

0.1312

0.0007

0.0159

0.6677

0.1912

Nicaragua

0.3548

0.0163

0.9445

0.9971

0.6336

0.9058

0.6420

Singapore

0.2166

0.3460

0.0139

0.0000

0.0000

0.1583

0.1225

Group means

0.5508

0.1483

0.4454

0.4254

0.2618

0.3945

0.3710

WTO accessions completed during 1996–2004 Albania

0.9831

0.0029

0.0025

0.0706

0.0010

0.0619

0.1870

Armenia

0.7749

0.0071

0.3448

1.0000

0.4288

0.4608

0.5027

Cambodia

0.0130

0.5962

0.0457

0.2071

0.0322

0.0399

0.1557

Croatia

1.0000

0.8158

0.9916

0.9984

1.0000

0.9974

0.9672

Georgia

0.8778

0.5351

0.0378

0.9129

0.9573

0.2857

0.6011

Jordan

0.4157

0.1670

0.9363

1.0000

0.9999

0.9666

0.7476

Macedonia

0.0029

0.3484

0.8438

0.1812

0.1178

0.0254

0.2532

Kyrgyz Republic

0.5486

0.4406

0.7723

0.0016

0.5487

0.6010

0.4855

Nepal

0.0000

0.1000

0.1090

0.1733

0.0000

0.3521

0.1224

Oman

0.3424

0.9216

0.8041

0.7831

0.8358

0.9998

0.7811

Group means

0.4958

0.3935

0.4888

0.5328

0.4921

0.4791

0.4803

0.9999

1.0000

0.9996

0.9615

0.7348

0.9625

0.9430

Azerbaijan

0.0295

0.0006

0.9253

1.0000

0.3833

0.5003

0.4732

Belarus

0.0010

0.2394

0.9463

0.0000

0.0311

Kazakhstan

0.0237

0.3734

0.9789

0.0000

0.0009

0.0425

0.2366

WTO accessions ongoing in 2005 Algeria Andorra

165

.

0.2436

Lebanon

0.0028

0.0721

0.7679

0.4999

0.2968

0.0617

0.2835

Saudi Arabia

0.0011

0.0202

0.5830

0.0056

0.0000

0.9998

0.2683

Samoa

0.5299

0.5219

0.9518

0.0288

0.2288

0.4522

Seychelles Tonga

0.2499

0.2651

0.7656

0.3782

0.4147

0.0020

0.0051

0.4773

0.0000

0.0833

0.0016

0.0949

Vietnam

0.7646

0.0003

0.1070

0.5366

0.9987

0.0186

0.4043

Group means

0.2616

0.2139

0.6557

0.4220

0.3323

0.3549

0.3734

Uzbekistan Vanuatu

Note: Bold test scores indicate significant improvement at p = 90 percent or greater; bold italic test scores indicate significant deterioration at p = 90 percent or greater; no significance levels are reported for country means and group means.

Table 5.8

Summary of significant changes in governance indicators

Better/Worse/ Unchanged

Voice and accountability

Political stability

Government effectiveness

Regulatory quality

Control of Rule of law corruption

166

Recent U.S. FTAs

4/2/4

0/6/4

2/2/6

3/4/3

1/7/2

1/2/7

WTO accessions completed during 1996–2004

2/3/5

1/3/6

2/3/5

3/2/5

3/3/4

3/2/5

Ongoing WTO accessions

1/6/2

1/5/2

4/0/6

3/4/3

1/5/4

1/4/5

FTAs and the WTO as Policy Anchors

5.4.2

167

The Index of Economic Freedom

Table 5.9 performs a similar exercise for the aggregate Index of Economic Freedom score of the Heritage Foundation and several of its subscores (trade, foreign investment, regulation, and property rights).16 Specific scores for trade and foreign investment are not available in the “Governance Matters” database, which is an advantage since these scores are available on an annual basis from 1995–2005, so they make possible a somewhat more precise accounting of timing,17 as well as inclusion of a few extra cases in the sample. On the other hand, the scores do not provide much discrimination among levels in the subindex (in most cases they take on values of 1–5 with no intermediate values, with lower scores indicating better performance) and do not come with standard deviations. The finding from the “Governance Matters” index of relative ex ante quality is robust to using the Heritage Foundation scores. Completed U.S. FTA candidates start out with stronger governance than countries with completed WTO accessions, which in turn outrank countries with ongoing WTO accessions. However, the data on the change in scores is very different. On three of the indicators one might associate with FTA- or accessionlinked reform (foreign investment, regulation, and intellectual property), there are multiple examples of improved scores, and only one example of a declining score. The result for the “trade” score is very odd. In ten out of the 11 cases of a change in score associated with WTO accession, the score in fact declines. It is possible that this may reveal some anomaly in the methodology by which the score is compiled. Beach and O’Driscoll (2000: 75) describe the trade policy grading scale in such a way that it depends largely on the average tariff (the top score of 1 is given for average tariffs less than or equal to 4 percent, with the levels 2–5 corresponding to tariffs up to 9 percent, 14 percent, 19 percent and above respectively), with some possible modification of the scores based on an impression of nontariff barriers. Countries in the WTO accession process may not have had publicly assessable tariff schedules prior to the accession process. Reporting of information to the WTO might account for the observed pattern.

5.5 Summary and directions for future research The present chapter has identified several reasons for thinking that U.S. FTAs might serve as more effective “anchors” for domestic policy reform than WTO accessions. Engagement with a single partner can go deeper than the Uruguay Round commitments, and it is easier to engage with a single partner than a WTO working party and to make commitments. Thus, the process goes faster. Moreover, at least in the initial period following the Trade Act of 2002, U.S. FTA partners have been selected from countries that on average offered greater prospects for successful engagement. However,

Table 5.9

Heritage Foundation scores

Country

totpre

tradepre

fdipre

regpre

prightpre

diftot

diftrade

diffdi

difreg

difpright

Completed U.S. FTA accessions 1995–2005 Australia Bahrain Chile Costa Rica Dominican Republic El Salvador

1.900 2.080 2.038 2.713 3.288

2 3 2 2 5

2 2 2 2 3

2.350

2

2

Guatemala Honduras Jordan Morocco

3.013 3.188 2.950 2.963

3 3 4 5

3 3 2 2

Nicaragua 3.088 2 2 Peru 2.830 4 2 Singapore 1.588 1 1 Group means 2.614 2.923 2.154 Completed WTO accessions 1995–2005 Albania 3.575 4 2 Armenia 3.688 3 4 Cambodia 3.000 3 3 Croatia 3.525 3 3 Georgia 3.775 3 3 Jordan 3.100 4 2

2 2 2 3 4

1 1 1 3 4

−0.020 0.020 −0.025 0.048 0.253

0 0 0 1 −1

0 0 0 0 0

0 0 1 0 0

0 0 0 0 0

2

3

−0.150

0

0

0

0

4 4 3 3

4 3 2 4

0.168 0.243 −0.100 −0.032

0 0 0 0

1 1 0 0

0 0 0 0

0 1 0 0

4 4 1 2.923

4 4 1 2.692

−0.188 −0.050 0.025 0.015

0 0 0 0.000

1 0 0 0.231

0 0 0 0.077

0 0 0 0.077

3 4 4 4 4 3

3 3 4 3 4 2

0.200 −0.913 −0.325 −0.037 0.025 −0.138

0 −2 −1 0 0 0

0 −2 0 0 0 0

0 0 0 0 0 0

1 0 0 1 0 0

Moldova Mongolia Nepal Oman Saudi Arabia

3.650 3.225 3.788 2.788 2.950

3 3 5 3 4

3 3 4 3 4

3 3 4 2 2

3 3 3 2 1

0.100 −0.200 −0.163 0.138 0.040

Group means 3.369 3.455 3.091 3.273 2.818 −0.116 Ongoing WTO accessions with first working party meeting 1995 or later Algeria Azerbaijan Belarus Bosnia and Herzegovina Cape Verde Laos Lebanon Russia Tajikistan Ukraine Uzbekistan Vietnam Yemen Group means

0 −2 0 −1 0

0 0 0 1 0

1 1 0 1 1

0 0 1 1 2

−0.545

−0.091

0.364

0.545

3.638 3.575 3.950 3.300

5 3 5 3

3 4 4 4

3 4 3 5

3 4 3 5

−0.148 −0.195 0.040 −0.140

0 0 −2 0

0 0 0 0

0 0 2 0

1 0 1 0

2.860 4.450 3.013 3.550 4.150 4.050 4.388 4.325 3.700 3.765

5 5 4 4 3 5 5 5 3 4.231

3 4 3 2 4 3 4 4 3 3.462

2 5 4 2 4 4 5 5 4 3.846

3 5 4 3 4 4 4 5 4 3.923

−0.020 −0.120 0.038 0.010 −0.150 −0.840 −0.288 −0.495 0.000 −0.178

0 −1 −1 −1 0 −2 −2 0 1 −0.615

0 0 1 2 0 1 0 0 0 0.308

0 0 0 2 0 0 0 0 0 0.308

0 0 0 1 0 0 0 0 0 0.231

Note: Totpre, diftot = initial level (change in) total score. Similarly, tradepre, diftrade = trade score, fdipre, diffdi = foreign investment, regpre, difreg = regulation, prightpre, difpright = property rights (prefix “dif” = change in).

170 Michael J. Ferrantino

a fairly crude test based on indicators of governance shows no systematic tendency for governance to improve for either U.S. FTA partners or WTO accessions. Possible extensions of this work include econometric examination of FDI flows during the period in question, consideration of other governance indicators, and case studies.

Appendix 5.1: Timeline of internal and external events in Ecuador 1979: A period of civilian rule begins under a new constitution. 1992: Ecuador joins Andean Community, lowering its peak tariff from 290 percent to 27 percent, excluding vehicles, and unifies the exchange rate. September 1992: Ecuador applies to join the WTO. July 1993: First of nine meetings of Ecuador’s WTO working party. 1994: Andean Pact Common External Tariff is introduced in a range of 5–20 percent, with duty free trade inside the pact. 1995: Export and import procedures are transferred from the Central Bank to private banks, and simplified. July 1995: Ecuador’s final WTO working party completed. January 1996: Ecuador accedes to WTO. 1996: The populist Abdalá Bucaram is elected president. February 1997: Bucaram is ousted by Congress on grounds of “mental incapacity” and is succeeded for the rest of his term by congressional leader Fabian Alarcón. July 1998: Jamil Mahuad, the Harvard-trained former mayor of Quito, is elected president. 1998: Constitutional reform, replacing 1979 constitution. The new constitution moderately strengthens the President vis-à-vis Congress by abolishing midterm elections and the power of Congress to fire ministers. 1998: Congress passes intellectual property rights legislation in conformity with the WTO Trade-Related Intellectual Property Agreement, and imposes a 4 percent import surcharge for fiscal reasons. November 1998: Deposit Guaranty Agency is charged with cleaning up the financial system. The government issues $1.5 billion of special purpose bonds for this purpose. By August 1999, 70 percent of Ecuadorian banking is under state control. 1999: Import surcharge increased to 10 percent. September–October 1999: Ecuador defaults on Brady Bond coupons and Eurobond coupons. January 2000: 10,000 indigenous protesters occupy Parliament and oust President Jamil Mahuad. Gustavo Noboa becomes president after the intervention of the National Security Council. March 2000: Law for Economic Modernization sets up the legal framework for dollarization. 2000: Import surcharges lifted on specific items. August 2000: Ecuador restructures its debt, reducing Brady Bonds and Eurobonds by 40 percent and issuing two new global bonds to its creditors. September 2000: Dollarization is completed. 2001–03: A private foreign consortium builds the OCP pipeline to carry heavy crude from the Amazon region to the coast.

FTAs and the WTO as Policy Anchors

171

March 2001: All import surcharges removed. December 2001: Ecuador completes its first IMF standby arrangement since the 1980s June 2002: Finance minister Carlos Julio Emmanuel resigns amidst a corruption scandal, weakening the Noboa government. 2002: Tariffs on a variety of inputs used by exporters temporarily lifted. 2002: Fiscal Responsibility and Transparency law is passed, with the intent of capturing pipeline revenue and using it to reduce foreign debt and replenish the social security fund, as well as capping real government spending growth to 3.5 percent per year. This is undermined by public-sector pay rises and legislative rejection of key components of the plan. Attempts to privatize electricity and telecoms fail. November 2002: Former army colonel Lucio Gutiérrez wins second round of presidential election. March 2003: IMF approves a new 12-month $205 million standby arrangement. 2003: Gutiérrez administration reimposes input tariffs that were lifted under Noboa. August 2003: Ruling coalition splits. The leftist Pachakútik party, after opposing several government economic policies, is dismissed by Gutiérrez. Legislation stalls. November 2003: USTR declares to Congress its intent to open FTA negotiations with Colombia, Peru, Ecuador, and Bolivia. March 2004: USTR announces that negotiations with Colombia “and possibly other countries” will begin in May. April 2004: IMF arrangement expires with most available funding undisbursed. May 2004: Andean FTA negotiations begin with Colombia, Peru, and Ecuador after “the resolution of certain issues” with the latter two. USTR announces that Peru and Ecuador will be included in a multicountry Overseas Private Investment Corporation microfinancing initiative worth $54 million. June 2004: USTR Zoellick visits Peru and Ecuador. April 2005: Gutiérrez ousts the Supreme Court. Thousands of Pentecostalist Indians march on Quito. Congress ousts Gutiérrez and replaces him with Vice President Alfredo Palacio Gonzales. The United States recognizes the Gonzales government after receiving assurances that all agreements will continue. July 2005: Venezuelan President Hugo Chavez offers to refine Ecuadorian crude in Venezuelan refineries after buying a large quantity of Ecuador’s debt. August 2005: Oilfield workers strike. President Chavez offers to provide Ecuador with up to 88,000 barrels per day (bpd) to meet its export commitments. September 2005: Ecuador’s Minister of Foreign Commerce Jorge Illingworth, announces the intent to extend the negotiating period with the U.S. on a bilateral FTA until November despite a decision by Colombia and Peru to conclude negotiations in October. November 2005: President Palacio announces postponement of constitutional referendum scheduled in December until January 6. After a round of Andean FTA negotiations on November 14–22, Ecuador’s chief negotiator announces an expected signing by December 6. February 2006: Ecuador deploys a squadron of A-37 combat aircraft to its border with Colombia after an incursion by Colombian air forces pursuing rebels. Ecuadorian forces clash with Colombian-based FARC guerillas. Another round of U.S.-Ecuador FTA negotiations takes place. A state of emergency is declared in Napo province after protests close down an oil pipeline, briefly interfering with oil exports. March 2006: A state of emergency is declared in three oil provinces after renewed strikes. Widespread protests against the U.S.-Ecuador FTA, organized by the Confederation of Indigenous Peoples, affect eight provinces, blockading the

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Michael J. Ferrantino

Pan-American Highway and other transportation arteries and leading to shortages of merchandise and price spikes. In a second, more widespread, state of emergency announced on March 21, the right of free assembly is suspended and the police are granted enhanced authority to make arrests. Occidental Petroleum offers Ecuador $1 billion in a dispute over back taxes and additional investments, in light of a petition by state-owned PetroEcuador to suspend Occidental’s operating license. April 2006: Venezuela leaves the Community of Andean Nations, which includes Ecuador, Colombia, Bolivia, and Peru, objecting to other members’ perceived alignment with the U.S. May 2006: Energy Minister Ivan Rodriguez, announces that Occidental’s contract with Ecuador is “expired,” arguing that a transfer of Occidental shares to a Canadian firm, and their resale to a Chinese consortium, was illegal. PetroEcuador immediately takes over Occidental’s operations and soon runs out of money to pay wages. The USTR announces that negotiations on a U.S.-Ecuador FTA are suspended. Ecuador agrees under protest to international arbitration with Occidental, involving the right to compensation under a bilateral investment treaty with the United States. A visit by Venezuela’s Hugo Chavez leads to two Ecuador-Venezuela energy agreements, described by President Palacio as a major change in Ecuador’s energy policy. July 2006: Ecuador and India sign an agreement to enable Indian-backed joint ventures in oil and gas on Ecuadorian territory. Former presidents Gutiérrez and Noboa sign an agreement to jointly contest the upcoming presidential election, which is set for October 15. August 2006: Chile joins the Community of Andean Nations. Two pipelines owned by PetroEcuador and a Chinese consortium are sabotaged. PetroEcuador enters into negotiations with suppliers over unmet payments.

Notes The views expressed in this chapter are solely those of the author and not those of the U.S. International Trade Commission or any of its Commissioners. The valuable assistance of Kris Nordstrom, Edward Wilson, Nannette Christ, and Russell Husen with the policy data and its presentation are gratefully acknowledged, as are comments by Robert Feinberg, Bill Powers, Richard Pomfret, Jose Signoret, and Sara Wong, and audiences at American University and the Association for Comparative Economic Studies in Boston. Nonetheless, the state of the current draft should be attributed solely to the author’s present condition of perplexity, and not to any of the above-named individuals or groups. 1. The term “free trade agreement” (FTA) is here used loosely to refer to a wide variety of agreements, in preference to “regional trade agreement” (RTA), simply because members of RTAs are not always in geographical proximity. The issue of which of the agreements designated as FTAs succeed in covering “substantially all trade” in the sense of GATT Article XXIV is set aside for the purposes of the present discussion. 2. See http://www.wto.org/english/tratop_e/region_e/region_e.htm for several presentations on FTAs (called in WTO nomenclature RTAs) notified to the WTO. 3. Of these, Bulgaria and Romania were scheduled to accede to the EU as of January 2007; Croatia and Turkey are candidates for accession; and Albania, Bosnia/ Herzegovina, Macedonia, and Serbia/Montenegro are potential candidates for

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4. 5.

6.

7.

8. 9.

10.

11.

12.

13.

14.

173

accession under the Stabilization and Association process. The Serbian region of Kosovo is treated separately under this process. For evidence on tariff cuts associated with WTO accessions in the period under discussion, see Martin (2006). For a summary of the analytics of trade diversion following on from the contribution of Viner (1950), see Baldwin and Venables (1995). For a compilation of evidence on the potential costs of trade diversion, see Schiff and Winters (2003, pp. 210–21). For analysis of the competing propositions that preferential agreements might be either “stepping stones” or “stumbling blocks” to multilateral free trade, see Levy (1997), Krishna (1998), and Andriamananjara (2000). See Rose (2004) for the WTO, and the various studies reviewed in USITC (2003, pp. 93–100) for U.S. FTAs. Subramanian and Wei (2005) find evidence of strong trade-promoting effects for recent WTO accessions. In the case of CAFTA-DR, the terms of final entry-into-force were country specific. In the case of the Andean countries, the negotiations quickly devolved into one-on-one negotiations. SACU is a special case because of its status as a customs union. Table 5.4 should include Saudi Arabia, which completed its Working Party in November 2005 and was admitted on 11 December 2005 to the WTO. Some of these are illustrated schematically in a diagram for the slideshow accompanying this chapter, which could not readily be reproduced in the current text. Except where elsewhere noted, the Economist Intelligence Unit “Country Profiles” for Morocco and Ecuador have been drawn on heavily in this section, with selective emphasis on those factors most relevant to the story at hand. A more detailed timeline of events in Ecuador, which draws in addition on USTR press releases and reports from the geopolitical intelligence service Stratfor for the most recent period, appears as an Appendix 5.1 to this chapter. On Moroccan labor law and the U.S.-Morocco FTA, see http://www.ustr.gov/ Document_Library/Fact_Sheets/2004/Morocco_FTA_Leads_to_Progress_on_ Labor_Reform.html. At the time of the first draft of this chapter (January 2006), FTA negotiations between the United States and Ecuador were still underway. Foreshadowing the next part of the chapter, it is interesting to note that the sequence of completion of the Andean negotiations (Peru first, Colombia second, and Ecuador suspended) corresponds to the rank ordering of the countries on both the Governance Matters IV indicators for 2004 (average of six components) and the Heritage Foundation Economic Freedom scores for 2005 (aggregate). In both sets of measures, Peru receives the highest score and Ecuador the lowest. This does not rule out other possible influences on the relative difficulty of the negotiations, such as the role of sensitive products. I have made the somewhat arbitrary decision to exclude Australia from the U.S. FTA sample. As a developed country, its standard of governance would be considered high ex ante by any definition and unlikely to be affected by engagement in FTA negotiations with the U.S. I am attempting to replicate this effort by using the various components of the Heritage Foundation’s Index of Economic Freedom, as reported annually for 1995– 2005 and include components for trade policy, foreign investment policy, and

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regulation that would be expected to be more closely associated with the activities in question. The scores also are considered to represent absolute improvement or deterioration rather than being normalized. They are not, however, reported with standard errors. 15. It should be noted that the sample selection process causes a focus on the countries that became engaged in the U.S. FTA process first. A sample of all U.S. FTA partners, including the SACU and Andean countries, may not show equally high scores on average. 16. The aggregate index assigns equal weight to ten subindicators. The six not analyzed here represent “fiscal burden,” “government intervention,” “monetary policy,” “banking,” “wages and prices,” and the “informal market” (an indicator of the extent to which black markets crowd out formal markets). 17. For Table 5.9, the beginning year is defined as the year negotiations began for U.S. FTA candidates, and the year of the first working party meeting for WTO accessions. The terminal year is defined as the year of U.S. congressional ratification for completed U.S. FTA negotiations, the year of the final working party meeting for completed WTO accessions, and 2005 for then ongoing WTO accessions.

References Andriamananjara, Soamiely. 2000. “Regionalism and Incentives for Multilateralism.” Journal of Economic Integration (Mar.) 15(1): 1–18. Baldwin, Richard E., and Anthony J. Venables. 1995. “Regional Economic Integration.” In Gene M. Grossman and Kenneth Rogoff (Eds.). Handbook of International Economics Vol. 3. Amsterdam: Elsevier. Beach, William W., and Gerald P. O’Driscoll, Jr. 2000. “Methodology: Factors of the Index of Economic Freedom.” In Gerald P. O’Driscoll, Jr., Kim R. Holmes and Melanie Kirkpatrick (Eds.). 2000 Index of Economic Freedom. Washington, DC and New York: Heritage Foundation and the Wall Street Journal. Bilal, Sanoussi. 2003. “North-South Agreements: Integrating Developing Countries into the Global Trading System?” Presentation for a Seminar on Regional Trading Agreements and the WTO, Geneva: World Trade Organization, November 14. Available online at http://www.wto.org/english/tratop_e/region_e/sem_nov03_e/ bilal_e.pdf. Last accessed on November 30, 2005. Crawford, Jo-Ann, and Roberto V Fiorentino. 2005. “The Changing Landscape of Regional Trade Agreements.” WTO Discussion Paper No. 8. Geneva: World Trade Organization. Heritage Foundation. 2006. Index of Economic Freedom. Available online at http:// www.heritage.org/research/features/index/scores.cfm. Last accessed on January 4, 2006. Kaufmann, Daniel, Aart Kraay, and Massimo Mastruzzi. 2005. “Governance Matters IV: Governance Indicators for 1996–2004.” Washington, DC: World Bank. Krishna, Pravin. 1998. “Regionalism and Multilateralism: A Political-Economy Approach.” Quarterly Journal of Economics (Feb.) 113(1): 227–51. Levy, Philip I. 1997. “A Political-Economic Analysis of Free-Trade Agreements.” American Economic Review (Sep.) 87(4): 506–19. Martin, Will. 2006. “Some Development Implications of WTO Accessions.” Presentation for a session of the Association for Comparative Economic Studies, Boston, MA, January and Chapter 1 in this volume.

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Rose, Andrew W. 2004. “Do We Really Know that the WTO Increases Trade?” The American Economic Review (Mar.) 94(1): 98–114. Schiff, Maurice W., and L. Alan Winters. 2003. Regional Integration and Development. Washington, DC: The World Bank and Oxford University Press. Subramanian, Arvind, and Shang-Jin Wei. 2005. “The WTO Promotes Trade, Strongly But Unevenly.” CEPR Discussion Paper No. 5122. London: Centre for Economic Policy Research. Tang, Man-Keung, and Shang-Jin Wei. 2006. “Is Bitter Medicine Good For You? The Economic Consequences of WTO/GATT Accessions.” Paper presented at the Trade Conference hosted by the Research Department, International Monetary Fund, April 13, 2006. U.S. International Trade Commission (USITC). 1993. Potential Impact on the U.S. Economy and Selected Industries of the North American Free Trade Agreement. Publication 2596 (January). Washington, DC: U.S. International Trade Commission. U.S. International Trade Commission (USITC). 1997. The Impact of the North American Free Trade Agreement on the U.S. Economy and Industries: A Three-Year Review. Publication 3045 (January). Washington, DC: U.S. International Trade Commission. U.S. International Trade Commission (USITC). 1999. Assessment of the Economic Effects on the United States of China’s Accession to the WTO. Publication 3229 (September). Washington, DC: U.S. International Trade Commission. U.S. International Trade Commission (USITC). 2003. The Impact of Trade Agreements: Effect of the Tokyo Round, U.S.-Israel FTA, U.S.-Canada FTA, NAFTA, and the Uruguay Round on the U.S. Economy. Publication 3621 (August). Washington, DC: U.S. International Trade Commission. U.S. Trade Representative, Office of (USTR). 2005. “Morocco FTA Leads To Progress on Labor Reform.” Available online at http://www.ustr.gov/Document_Library/ Fact_Sheets/2004/Morocco_FTA_Leads_to_Progress_on_Labor_Reform.html. Last accessed on November 30, 2005. Viner, Jacob. 1950. The Customs Union Issue. New York: Carnegie Endowment for International Peace. Wong, Sara. 2005. “Ecuador: Trade Issues, Key Statistics, and the FTA with the United States.” Seminar at US International Trade Commission (USITC), August 31. World Bank and International Finance Corporation. 2005. Doing Business 2006: Creating Jobs. Washington, DC: World Bank and International Finance Corporation.

6 Regional Trading Arrangements and WTO Membership: Substitutes or Complements? Richard Pomfret

6.1

Introduction

This chapter asks whether regional trading arrangements (RTAs) are substitutes for or complements to World Trade Organization (WTO) Membership. From the start of the current international trade regime there has been a tension between the nondiscrimination mandated in Article I of the General Agreement on Tariffs and Trade (GATT), requiring most favored nation (MFN) treatment, and the predilection of GATT signatories and WTO Members for discriminatory trading arrangements. The initial negotiations leading to GATT were characterized by an Anglo-U.S. conflict over Imperial Preferences, which were grandfathered despite strong U.S. antipathy, and soon after signing the GATT the largest continental European economies established the European Coal and Steel Community, setting off on the path to a customs union.1 Since then, the tension between multilateralism and regionalism has ebbed and flowed, with three major waves of discrimination. First, in the 1960s, many free trade agreements (FTAs) or customs unions were announced in imitation of the successful European Economic Community (EEC), and the EEC itself, in the absence of other foreign policy tools, created a complex pyramid of preferential trading arrangements with most nonmember countries. This wave receded in the 1970s as all of the other free trade areas and customs unions proved disappointing to some or all members and as the EEC started trying to simplify its external trade policies. The second wave began in the 1980s as the U.S. abandoned its principled adherence to unconditional MFN treatment and as the EEC moved to complete its internal market under the 1992 program. This wave ended in the early 1990s, after the U.S. signed the North American Free Trade Agreement (NAFTA) and dampened its enthusiasm for further discriminatory trade arrangements. The third wave began around the turn of the century as several Asian countries, partly 176

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in reaction to the 1997 crisis, began to consider bilateral and plurilateral options to their previously nondiscriminatory trade policies, and after the 2000 elections the U.S. also returned to a policy of using trade agreements to push market opening and to reward political allies. Despite the temptations of preferential trading arrangements, the GATT/ WTO system has resisted the challenges described in the previous paragraph, and indeed gone from strength to strength. The first two waves of regionalism ended amid major successes of the GATT system. The 1964–67 Kennedy Round completed a dramatic reduction in the tariffs of the major trading nations from the very high levels of the immediate post-1945 period to single digit average levels and the 1973–79 Tokyo Round extended this liberalization to nontariff barriers. The second wave of regionalism was countered by completion of the 1986–94 Uruguay Round and the establishment of the WTO in January 1995. At the time of writing, with the Doha Round in stagnation it is unclear how the third wave will end. Nevertheless, the long-term picture is one of GATT/the WTO going from strength to strength, whether measured by number of members (from 24 GATT signatories in 1947 to 150 WTO members in 2006) or by breadth of coverage and degree of enforcement.2 The juxtaposition of multilateralism and regionalism is a simplification insofar as the true distinction is between nondiscriminatory and discriminatory trade polices and many of the latter are not regional. Nevertheless, the terminology of the debate is so well established that it would be pedantic to insist on the non”regional” status of, say, the U.S.–Jordan or South Korea– Chile bilateral trade agreements. There could also be semantic objections to the application of the term free trade area (FTA), which should imply tarifffree trade among members, to arrangements in which internal trade is not free; for example, trade within NAFTA is hedged by intrusive rules of origin, the Association of Southeast Asian Nations (ASEAN) FTA has internal tariffs of 5 percent or less (rather than zero), and the U.S.–Australian FTA does not cover items with high trade barriers (such as sugar). Section 6.2 of this chapter reviews the economics and post-1947 history of RTAs. Section 6.3 addresses the question of whether the apparent recrudescence of RTAs in the 1990s and the early twenty-first century is in fact making regionalism an increasing feature of the world economy. Section 6.4 asks why, given the continuous expansion in the number of WTO Members, there is a sense of disillusionment with the world trading system based on nondiscrimination and multilateralism. Section 6.5 focuses on claims that RTAs provide a superior anchor for economic liberalization. Section 6.6 concludes.

6.2

The economics of regional trading arrangements

The first article of GATT, signed in 1947 and still the basis of international trade law under the WTO, affirms the nondiscrimination principle3; in

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trade relations all WTO Members must treat trade with any other WTO Member on no worse terms than trade with those with MFN status, that is, all must be treated equally. Nevertheless, over the whole GATT/WTO era there has been a tug-of-war between nondiscriminatory multilateralism and discriminatory trade policies, often in the form of RTAs. Such arrangements are permitted under the GATT/WTO rules, notably under Article XXIV on customs unions and free trade areas, but they are contrary to the spirit of GATT and the stringent conditions in Article XXIV have seldom been fully met in practice. The ambiguity in trade law captures the classic insight by Viner (1950) that any discriminatory trade policy, such as a customs union, is by its nature second best. One distortion is removed from the differential treatment between a member’s domestic products and products from other member countries of the customs union but a new distortion is introduced between imports from member and nonmember countries that were previously treated equally. Thus an RTA can create trade, as preferred imports enter a country’s market at a lower price displacing domestic products or meeting new demand, or it can divert trade as the preferred imports displace imports from a third country. The former improves global welfare, and the latter reduces welfare in the world and in the importing country as imports are no longer supplied by the least-cost producer. Because the trade creation and trade diversion effects of customs union accession work in opposite directions, the direction of change in welfare of the country joining a customs union and of the world is theoretically ambiguous. The analysis applies to any discriminatory tariff reduction, whether a customs union, a free trade area, or other preferential arrangement; a discriminatory tariff reduction may be welfare-improving, but the presumption is that removal of trade barriers on a nondiscriminatory basis would be first best because it permits trade creation benefits without trade diversion costs. Since 1947 three waves of regionalism have swept the world trading system. During the 1950s and 1960s the “rush to discrimination” was led by Western Europe, which founded the only substantial new customs union of the second half of the twentieth century and also established a complex network of preferential arrangements with other trade partners.4 The European customs union was taken as a model by groups of developing countries in Africa, the Caribbean, Central America, and South America, but even the most promising of these arrangements, the East African Community and the Central American Common Market, collapsed during the 1970s. The customs unions agreed among developing countries all failed because they were based on a regional form of import substitution that inevitably led to conflict over trade diversion; each member wanted a regional market for its own inefficient industries, but was unwilling to buy the expensive or poor quality import substitutes being developed by their partners.5 The European customs union had similar strains, especially with respect to farm

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products, but the political will for greater economic union allowed to absorb high costs of integration even in countries with large net economic losses from membership such as in the U.K. or the Scandinavian countries.6 The first wave of regionalism was resisted by the U.S., which remained committed to the multilateral system, and was receding in the 1970s as the EU became established as a single actor in the global trading system. Successful conclusion of multilateral trade negotiations in the 1961–64 Kennedy Round, in which the members of the European customs union negotiated with a single voice for the first time, and in the 1973–79 Tokyo Round, which first seriously addressed the issue of nontariff barriers to trade, sent important signals about the leading trading nations’ commitment to multilateralism. A second wave of regionalism was initiated by the departure of the U.S. from the GATT nondiscrimination principle in the first half of the 1980s. This began with the Caribbean Basin Initiative, included an FTA with Israel, and peaked with the Canada–U.S. FTA which expanded to include Mexico in the NAFTA negotiations in the early 1990s. The introduction of discriminatory arrangements between the U.S. and its major trading partners coincided with the EEC’s 1992 project for completing the internal EU market. Although NAFTA was signed and implemented, and Australia and New Zealand deepened their free trade area into the Closer Economic Relations (CER), the major trading nations reaffirmed their commitment to the nondiscrimination principle with the successful conclusion of the 1986–94 Uruguay Round of multilateral trade negotiations and the establishment in 1995 of the WTO as the successor to GATT. Supporters of the deeper EU, NAFTA, or the CER argued that these were new forms of regionalism going into areas where the Vinerian analysis was inapplicable, such as increasing-returns industries, service activities, or policy harmonization, and that the regional agreements were complementary to the operation of the WTO system. As in the first wave, there was a demonstration effect as groups of developing countries worried about the need to establish and strengthen their own regional groupings. The geographical scope was wider as Latin American regional arrangements, such as Mercosur, and African customs union in various overlapping incarnations were joined by Asian regional organizations; among the regional organizations introducing tariff preferences in the 1980s or early 1990s were the Economic Cooperation Organization (ECO), South Asian Association for Regional Co-operation (SAARC) and ASEAN.7 The practical outcomes were, however, minimal for much the same reasons as in the first wave; each partner was unwilling to grant other partners nontrivial preferential access to its own protected markets.8 In the opening years of the twenty-first century, a third wave of regionalism has been gathering force. This is led by Asian countries, which had previously been the strongest bulwarks of nondiscrimination – Japan and

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South Korea within the WTO and China and Taiwan outside the WTO – who were joined, especially under the G.W. Bush administration, by the U.S. The emergence of Asian regionalism can be dated from the aftermath of the 1997 Asian Crisis and was partly in reaction to dissatisfaction with the International Monetary Fund’s (IMF) role in the international monetary system, but the collapse of the 1999 WTO meetings in Seattle and the diminishing significance of Asia-Pacific Economic Cooperation (APEC) (including the half-hearted attempt by the U.S. to kick-start further trade liberalization at the 1999 APEC summit through its P5 initiative with Australia, Chile, New Zealand, and Singapore) led to new approaches to trade liberalization in the Asia-Pacific region. Bilateral negotiations were begun in 1999/2000 by Japan with Singapore, South Korea, Canada, and Mexico; by South Korea with Chile and New Zealand as well as with Japan; and by Singapore with New Zealand (concluded in 2000), Australia, Canada, and other countries.9 As with the second wave, which was characterized by proponents as a “new regionalism,” the third wave has novel features. With respect to tariffs and some nontariff barriers to trade, the post-Uruguay-Round bar is lower, so effective discrimination requires focus on other aspects. The bilateral agreement negotiated between Singapore and Japan in 2000, for example, focused on areas such as financial services, capital flows, and coordination of regulatory systems. Such “WTO-Plus” features are analytically more difficult areas, often with inherently less transparency than the traditional trade barriers of tariffs or quotas. On the positive side, many WTO-Plus features of RTAs are in fact nondiscriminatory, for example, if an RTA reduces trade costs by improving the efficiency of the signatories’ financial or administrative systems then this is likely to reduce trade costs for other trading partners as well. Nevertheless, the thrust of the analysis of the first two waves remains valid; even in the new areas, multilateral nondiscriminatory trade liberalization is usually the best approach, not only from a cosmopolitan global perspective but also often for the economic welfare of the participants in regional arrangements. Whether regional agreements that push forward the liberalization process are stepping-stones or stumbling blocks to multilateral liberalization remains an open question.10

6.3 Are RTAs an increasing feature of the world economy? Many commentators cite the large number of RTAs notified to the WTO as evidence of the growth and significance of regionalism. From this perspective, because the number of RTAs notified to the WTO reached an alltime high in the early 2000s, regionalism was more prevalent than ever.11 Crawford and Fiorentino (2005) in their survey of RTAs state that “Between January 2004 and February 2005 alone, 43 RTAs have been notified to the WTO, making this the most prolific RTA period in recorded history.”

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These counts include notifications under GATT Article XXIV, General Agreement on Trade in Services (GATS), Article V, and the Enabling Clause, as well as accessions to existing RTAs. They undercount the total number of RTAs, because some RTAs under negotiation have not yet been notified to the WTO and others are among non-WTO Members. On the other hand, the cumulative WTO counts overstate the current situation because they do not exclude abrogated RTAs. When ten new countries joined the EU in 2004, 65 RTAs between the EU and the new members and among the new member countries were subsumed into the EU RTA. Thus in Crawford and Fiorentino’s “most prolific RTA period in recorded history” the net RTA formation was −22. The period could equally well be called the biggest withdrawal from RTAs in recorded history! These interpretations assume that all notified RTAs carry equal weight. Table 6.1 lists the RTAs notified to the WTO in 2005. Two features stand out. The numbers are inflated because RTAs that cover both trade in goods and trade in services (Australia–Thailand, Japan–Mexico, Panama–El Salvador, and Mexico–Nicaragua) are double-counted because they require MFN waivers under both GATT and GATS. Second, most of the RTAs are of minor importance to the global economy: 12 are bilaterals involving pairs of eastern European countries (mostly involving component parts of former Yugoslavia, reflecting regional disintegration) and the others are an agreement between Tunisia and the European Free Trade Area (EFTA) (Iceland, Liechtenstein, Norway, and Switzerland); an Israel–Romania agreement; agreements between Turkey and Tunisia and Turkey and the Palestinian Authority; and a services agreement between the EU and Chile. The Economic Community of West African States (ECOWAS) was founded in 1975, although its preferential trading arrangements were not notified to the WTO until 2005. None of these 26 agreements can be expected to have a significant impact on world trade or even on the trade of the signatories. The main problem with using counts of RTAs as measures of the increasing importance of regionalism is that, while some agreements are important, many RTAs are inconsequential. The May 2004 EU enlargement was far more important than a Moldova–Bosnia RTA, but by the counting logic each has equal weight. Even more nonsensical, by the counting criteria the collapse of Comecon ushered in a major increase of regionalism in the 1990s as eastern European countries signed myriad trade agreements with one another (more than 160 of which were notified to the WTO) and the 2004 EU enlargement represented a major retreat from regionalism. A more economically sensible interpretation of this episode is that the proliferation of bilateral and multilateral FTAs among countries of the former Council for Mutual Economic Assistance and among newly independent states of former Yugoslavia, Czechoslovakia and the U.S.S.R. represented imperfect attempts to compensate for the disintegration of previously integrated economic areas.12 The enlargement of the EU to include eight eastern European

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Table 6.1 RTAs notified to the WTO in 2005 Notification date

WTO provisions

Type of agreement

Thailand-Australia Thailand-Australia Moldova-Bulgaria Moldova-Bosnia and Herzegovina Moldova-Serbia and Montenegro Moldova-Croatia Moldova-Former Yugoslav Republic of Macedonia Romania-Bosnia and Herzegovina Romania -Serbia and Montenegro Romania -Former Yugoslav Republic of Macedonia Bulgaria-Bosnia and Herzegovina Bulgaria -Serbia and Montenegro Panama-El Salvador Croatia-Former Yugoslav Republic of Macedonia Panama-El Salvador Japan-Mexico Japan-Mexico Romania-Israel Former Yugoslav Republic of Macedonia-Bosnia and Herzegovina EFTA-Tunisia Turkey-Tunisia Turkey-Palestine ECOWAS

5 January 5 January 28 January 28 January

Article XXIV GATS Article V Article XXIV Article XXIV

Free trade agreement Services agreement Free trade agreement Free trade agreement

28 January

Article XXIV

Free trade agreement

31 January 31 January

Article XXIV Article XXIV

Free trade agreement Free trade agreement

14 February

Article XXIV

Free trade agreement

14 February

Article XXIV

Free trade agreement

14 February

Article XXIV

Free trade agreement

11 March

Article XXIV

Free trade agreement

11 March

Article XXIV

Free trade agreement

18 March 1 April

Article XXIV Article XXIV

Free trade agreement Free trade agreement

5 April 22 April 22 April 25 April 11 May

GATS Article V Article XXIV GATS Article V Article XXIV Article XXIV

Services agreement Free trade agreement Services agreement Free trade agreement Free trade agreement

7 June 15 September 15 September 26 September

Article XXIV Article XXIV Article XXIV Enabling clause

EU-Chile Mexico-Nicaragua

1 November 2 November

GATS Article V Article XXIV

Free trade agreement Free trade agreement Free trade agreement Preferential agreement Services agreement Free trade agreement

Mexico-Nicaragua

2 November

GATS Article V

Services agreement

Agreement

Source: http://www.wto.org – accessed October 3, 2006.

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countries in 2004, with Bulgaria and Romania to follow, substantially reduced the number of separate RTAs but strengthened the regional integration of Eastern Europe. This is not necessarily to question the significance of RTAs in the global economy, but it is intended to challenge facile quoting of numbers of RTAs notified to the WTO. By 2006 all WTO Members except Mongolia had signed RTAs, but many RTAs have limited coverage (especially some of the post-2000 bilateral agreements) and many are never implemented.13 The RTAs that are most obviously operational and have economic effects – such as the EU, the CERs agreement between Australia and New Zealand, and NAFTA – involve countries with low MFN tariffs and the beyondWTO clauses affect trade indirectly rather than directly. It is difficult to assess the added value of such RTAs to the functioning of international trade.14

6.4 Are countries disappointed with WTO Membership? The burgeoning membership of the WTO, with 150 countries already in and most of the remainder in the accession queue, suggests that WTO Membership is desirable and valued. Yet, once inside the club, new members often seem disappointed. Zdenek Drabek and Wing Thye Woo (Chapter 9 in this volume) address this issue by asking the two questions: why are countries keen to join the WTO and why are they often disappointed after WTO accession? Their method is to undertake a benefit-cost analysis of WTO Membership, and the answer to their questions is that applicants often have false expectations of benefits while new members find that they have underestimated the costs of accession. In general, I agree with their arguments, although I have caveats on some points. Drabek and Woo illustrate the issues with a case study of China, which is an important example of WTO accession but somewhat beside the point of their paper because China did gain benefits from joining and is relatively well placed to absorb the costs of membership. The benefits of WTO Membership are real, but the most important ones are indirect and general. One reason for the failure of exercises such as that of Rose (2004) to find WTO effects in the trade flows of members and nonmembers, is that the major global benefit from the GATT/WTO regime of the past 60 years has been improved international governance. GATT is explicitly a statement of acceptable and unacceptable trade practices. Of course, not all obligations were always met by all GATT signatories, but by and large they are observed and the dispute resolution mechanism has been strengthened since 1995. Moreover, for the most part, GATT signatories followed the same practices and procedures in their trade with nonsignatories.15 To a significant degree, the benefits from a rules-based international trading system are, as with other sets of standards, network benefits. The more

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countries that observe a common set of rules, the more useful the rules are likely to be.16 The network benefits of a rules-based trading system increase with the number of countries that sign on to GATT, but, as pointed out in the previous paragraph, they accrue to others rather than to the new member itself. Indeed, if new members were already benefiting from unilateral MFN treatment in the markets of existing WTO Members, then they notice little or no difference, even though the systemic benefits are increased by expanding WTO coverage. The main source of false expectations is an expected immediate improvement in market access. However, for few accession countries is there any change in their market access. The only major recent exception is China, which almost uniquely did gain improved market access, because MFN status in the U.S. became contractual rather than subject to annual debate in Congress. Thus, China saw real benefits and has not been disappointed.17 There are other benefits from WTO accession, although they may not arise immediately. Drabek and Woo underestimate the potential benefits from the WTO dispute resolution mechanism and a seat at the WTO negotiating table because they look at the whole span of GATT/WTO history. A feature of the GATT era (1947–94) was that the system was biased in favor of the major trading nations, both in the coverage of trade liberalization (agriculture and textiles and clothing were largely outside the system) and in effective recourse against countries breaking GATT rules. As Drabek and Woo point out, most complaints from 1948 to 1994 involved rich countries, but one aspiration of the shift to the more formal WTO was that the dispute resolution process should be open to all. Similarly, the GATT rounds of multilateral trade negotiations were dominated by the U.S., EEC/EU, Japan, and Canada, but a feature of the Doha Round has been the much greater involvement of middle- and low-income countries either individually or as the G20. A striking example of the higher profile of developing countries’ interests and potential benefits is cotton, where Brazil’s case against the U.S. is the first case of a developing country successfully challenging an Organization of Economic Cooperation and Development (OECD) country’s farm subsidy program in the WTO and where the challenge raised by four poor West African countries to introduce cotton into the negotiations was central in turning the Doha Round into the Doha Development Agenda (Baffes, 2005). A final benefit, which I will discuss below in the context of Ferrantino’s chapter, is that the WTO can provide an anchor for market-friendly reforms. This may be double-edged if the WTO is “blamed” for difficult reforms. Moreover, if WTO accession provides no immediate and visible benefits but coincides with an economic downturn, then it may be the subject of blame by association.18 The other half of the answer to the two questions asked by Drabek and Woo is that there are real costs to WTO accession, which are often ignored

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by economists. It is, however, important to distinguish between pseudocosts and real costs. Reduced sovereignty in the area of trade policy formation is a minor consideration if WTO rules enforce best practice for a small open economy. The shift from trade taxes as a source of government revenue is desirable under almost all imaginable conditions.19 The real costs are the institutional requirements for negotiating and implementing codes, which for small poor countries are substantial in their demands on scarce human capital, and also that some codes may be inappropriate for developing countries (e.g., Trade-Related Intellectual Property (TRIPs) and health). Again, China is an exception, because China’s bureaucracy is big enough for the negotiating and implementing costs to be minor. The main conclusion is that acceding countries should try to avoid false expectations and assigning too great significance to WTO. The implementation costs require human capital and involve economies of scale, so that the policy implication is that assistance should be provided to small poor countries.20 Finally, the core of GATT/WTO has stood the test of time, although there is a need for evolution – and the WTO has been evolving in ways that address some criticisms.

6.5 Do RTAs provide a better anchor for policy reform? Michael Ferrantino (“Policy Anchors: Do Free Trade Agreements and WTO Accessions serve as Vehicles for Policy Reform?” in this volume) argues that trade agreements can provide an external anchor for policy reform and that FTAs (with the U.S.) are a more effective anchor than WTO accession. Ferrantino carefully lists caveats about endogeneity, multiple anchors, and the diversity of “policy reform” and his quantitative analysis is hampered by the finite number of cases, which makes it difficult to obtain clear-cut conclusions. Nevertheless, he maintains the central arguments, and those are what I want to challenge. Ferrantino’s evidence for the superiority of FTAs over WTO accession as an anchor is twofold. Firstly, FTAs are negotiated and implemented faster, and are more wideranging than the WTO. Secondly, anecdotal evidence from Mexico, China, Morocco, and Ecuador is marshalled in support of his case. This anecdotal evidence is unconvincing. Mexico is a prime case. Policy reform started in the mid-1980s after the Debt Crisis. WTO accession in 1986 provided an anchor, and NAFTA negotiations in 1991–94 reinforced the anchor, but how do we weigh the relative impact of NAFTA? This is not to deny the existence of anecdotal evidence in support of FTAs operating as an anchor for policy reform – and accession of Eastern European countries to the EU may provide clearer evidence of trade agreements with a large country as a policy reform anchor than the U.S. FTAs. My point is simply that there is no clear evidence of RTAs providing a superior anchor

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to WTO Membership – or even of an external anchor being critical to successful reform. 21 There is much counterevidence to Ferrantino’s claim that FTAs are negotiated faster and implemented sooner than WTO Membership. Some bilateral trade agreements are slow to negotiate (e.g., the EU–Turkey association agreement negotiated in 1963 has still not led to EU Membership for Turkey more than 40 years on) and some long-lasting FTAs have had no policy anchor effect (the EEC/EU–Morocco RTA has existed for more than 40 years with little discernible impact on economic reform in Morocco). Taking only the recent U.S. bilaterals is a biased sample, because the FTAs completed since 2000 are inevitably ones negotiated in under five years. Taking the entire history of U.S. preferential trading arrangements since the early 1980s, apart from Mexico, U.S. FTAs have had little policy anchor impact (the FTAs with Israel, Canada, Jordan, Singapore, Chile, and Australia are the only ones to have entered into force). WTO accession is important because it is contractual. WTO accession negotiations are long because of the unchangeable list of minimum commitments (including transparency, market-determined prices, and so forth).22 In some cases (e.g., the 1989 Tiananmen massacre in China or the occupation of the U.S. Embassy in Iran), political interruptions have been obstacles to speedy accession. Nevertheless, even during the negotiations phase, countries such as China, Russia, or Kazakhstan have reformed their economies by passing WTO-consistent legislation during this period. For small countries, WTO negotiations went faster and commitments were an important policy anchor (e.g., Kyrgyz Republic or Mongolia) or a necessary staging-post to a firmer anchor (e.g., for the Baltic countries WTO accession was a necessary step towards EU accession).23 In sum, WTO accession deserves greater credit as a policy anchor.24

6.6 Conclusions This chapter asks whether RTAs are substitutes for or complements to WTO Membership. During the life of the GATT/WTO system there have been successive waves of RTAs, provoking fears of a rush to discrimination and yet in each case ending with a stronger multilateral system. RTAs have generally proved to be poorly suited to promoting trade liberalization and have created rather than resolved trade disputes, as the nonpreferred trading partners have been quick to identify injury. The only exception to this generalization has been in the rare cases when RTAs have led to beyond-trade economic integration (as in the EU, CER or US–Canada FTA). RTAs may provide a policy anchor, but only when the reforming country is committed to reform (as in the Eastern European EU-acceding countries). The WTO can play a similar role because of its contractual nature and because openness is a frequent concomitant of successful reform, but WTO Membership – like RTA

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Membership – is not a sufficient anchor, and many GATT/WTO Members have slid into nonreform.25 In some cases, preferential trade polices may be antithetical to reform in the beneficiary country.26 One problem with evaluating the WTO and RTAs is the publicity surrounding events like the anti-WTO protests in Seattle and elsewhere, the breakdown of negotiations during the Uruguay and Doha Rounds, or the signing or extending of RTAs. The dramatic reports hide the basic role of the WTO in providing an accepted body of world trade law with functioning (albeit imperfectly) enforcement mechanisms. No RTA can substitute for this. Where RTAs may be complementary is in going beyond the scope of the WTO. As border measures such as tariffs and nontariff barriers to trade diminish, the significance of other trade costs becomes more apparent (Anderson and van Wincoop, 2004), and RTAs can be useful complements to the WTO if they can pave the way for reducing behind-the-border trade costs. This is the experience of RTAs such as the EU or CER and is recommended for other regions in Asian Development Bank (2006) and United Nations Development Programme (2005) reports advocating regional cooperation in trade facilitation rather than RTAs.27

Notes This chapter is based on my discussant’s report in a session at the American Economic Association meetings in Boston in January 2006; I am grateful to the session organizer Zdenek Drabek, and other participants in the session for helpful comments. The chapter was written while I was the AGIP Professor of International Economics at the Johns Hopkins University Bologna Center, which provided congenial facilities for research. 1. Imperial Preferences soon lost relevance as the European empires broke up. European integration was much more important in the long run, but from the 1960s onwards the EEC (later the European Union (EU) negotiated with one voice within GATT and the EU increasingly resembles an economic union rather than a collection of independent trading nations. 2. With Vietnam becoming the 150th member in 2006, the only large nonmember economies are Algeria, Belarus, Iran, Iraq, Kazakhstan, Russia, Serbia, Ukraine, and Uzbekistan, all of whom have applied for membership. The other 30 outstanding applications involve fairly small trading nations. 3. This section draws on material in Pomfret (2001) and Pomfret (2006). 4. The phrase “the rush to discrimination” is from Patterson (1966). For more details on the trading arrangements mentioned in this chapter, see Pomfret (2001). The EEC’s bilateral agreements with Mediterranean countries and with former colonies in Africa, the Caribbean, and the Pacific were complicated by the introduction of the Generalized System of Preferences for developing countries in 1971 and by sector-specific bilateral restrictions of trade such as the Multifibre Arrangement, to the extent that many “preferred” trading partners felt themselves disadvantaged relative to a competitor. The consequences of complex overlapping arrangements like the EEC’s pyramid are now usually referred to, in the vivid expression of Jagdish Bhagwati, as spaghetti bowl effects.

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5. The only East Asian attempt at such a strategy, ASEAN’s promotion of Asean Industrial Projects broke down for similar reasons in the early 1980s. 6. The UK, Denmark, and Sweden are, however, notably more skeptical of the enterprise than most of the other EU Members, a position reflected in their remaining outside the euro zone. 7. These organizations had longer histories but it was only in the early 1990s that they moved explicitly towards introducing preferential tariffs. ECO was revived in 1985 and the three original members (Iran, Pakistan, and Turkey) introduced preferential tariffs in 1992, but these were on a very limited range of goods and the seven new members who joined ECO in 1992 (Afghanistan and six former Soviet republics) did not sign up to the preferential trade agreements. SAARC was launched in 1985 and a framework preferential trading agreement was signed in 1993, but trade between the two largest members, India and Pakistan, was on worse than MFN terms. ASEAN was founded in 1967, but the various preferential economic arrangements of the 1970s and 1980s were ineffective, and even the ASEAN Free Trade Area announced in 1993 was implemented in a half-hearted fashion. 8. Although it was outside the ambit of the WTO, the biggest changes in this period were the collapse of a very large regional arrangement, the Soviet-led Council for Mutual Economic Assistance (Comecon) and in December 1991 the dissolution of the Soviet Union itself. Concerns during the 1980s and the early 1990s that the world economy was splitting into three blocs (the western hemisphere, Europe and Africa, and Asia), almost as envisaged in George Orwell’s 1984, proved to be overblown. 9. On the genesis of the new bilateral agreements see Rajan, Sen, and Siregar (2001). Pomfret (2005) analyzes the interaction of trade and monetary integration in East Asia since 1998. 10. Supporters of RTAs argue that negotiation on difficult topics may be easier among like-minded countries than among all WTO Members. RTAs can provide testing grounds in WTO-Plus areas, out of which WTO negotiators can select what works best. On the other hand, competing norms in, say, competition policy may be difficult to reconcile once they have been established at a regional level. Even a single proposal may be compromised in the eyes of other countries if it has been drawn up by a select group (e.g., the ill-fated OECD Multilateral Agreement on Investment). Critics also worry that RTAs distract trade policymakers from what should be their main arena, the WTO. 11. “Regional Trade Agreements (RTAs) are a major and perhaps irreversible feature of the multilateral trading system” is the opening sentence of a Working Paper (Crawford and Fiorentino, 2005), which appears on the same WTO webpage as a dramatic graph showing the increasing number of RTAs reported since the early 1990s. This section draws on Pomfret (2007) which contains more detailed analysis of the difficulty of measuring the extent of regionalism. 12. The number of such RTAs is understated by counting WTO notifications because the Yugoslav and Soviet successor states were not GATT signatories. As each of these new independent countries becomes a WTO Member, there is surge of reported RTAs as preexisting agreements are notified. The underestimation is, however, not severe because most of the trade agreements among Commonwealth of Independent States countries have existed only on paper and been null in practice. 13. Examples of bilateral agreements with little impact are the Japan–Thailand FTA, which is dismissively referred to as the Thai cooks agreement because the main

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14.

15.

16.

17.

18.

19.

20.

21.

terms exchange a small reduction in Thai tariffs on auto components for easier access for Thai cooks to work in Japan, and the US–Australia FTA. When negotiations began, both were promoted as significant trade agreements between nations with large bilateral trade flows, but the negotiated FTA will have trivial economic impact. Plummer (2007) argues that whatever the relative merits of multilateral vs. bilateral or regional trade liberalization, RTAs are being signed and economists and international institutions should focus on identifying best practices in RTAs and criticizing those RTAs which diverge far from best practice. For example, GATT signatories extended MFN treatment to most nonmembers, even though they were not contractually obliged to do so. The main exception before 1989 was US reluctance to grant MFN treatment to communist countries, but for most of the four decades before 1989 most communist countries chose to remain outside the market-based international trading system. Rose’s results have been challenged by Subramanian and Wei (2005), who respecify Rose’s gravity model and find that the WTO has increased trade by about 120 percent, although the impact has mainly been on countries that have participated actively in GATT/WTO trade negotiations and some sectors have not experienced an increase in trade due to the GATT/WTO. Many RTAs have specific rules of origin, and the proliferation of diverse rules increases the complexity of trade. In countries that sign RTAs offering limited benefits in terms of lower tariffs, etc. but involving compliance with rules of origin, many traders continue to trade on MFN terms rather than availing themselves of benefits to which they might be entitled under the RTA, for example, a commonly cited figure for Singapore is that less than 10 percent of trade is conducted under RTAs agreed with major trading partners. Some important benefits may be only loosely related to WTO accession. For example, in 2006 the U.S. granted to Ukraine “market economy” status, which is a significant benefit when it comes to calculating antidumping duties. This decision was in anticipation of a still undefined WTO accession date, but when Vietnam concluded its WTO accession negotiations in 2006 it still did not have “market economy” status in the U.S. An example is Kyrgyz Republic, the first Soviet successor state to accede to the WTO. Too great emphasis an on the value of WTO Membership led to guilt by association when the Kyrgyz economy went into recession after WTO accession in July 1998, even though the recession was driven by exogenous events, in particular the August 1998 Russian Crisis and a domestic banking crisis. The negative interpretation of the Kyrgyz events was used by opponents of WTO Membership in Kazakhstan and Azerbaijan to stall those countries’ accession negotiations. For poor countries with limited administrative capacity and hence limited ability to substitute other revenue sources for trade taxes, the first-best outcome would be for the international community to support capacity building. Such capacity building can be organized by RTAs on behalf of poor members seeking WTO Membership (e.g., Laos, Cambodia, and Vietnam in ASEAN), but it can be equally – and perhaps better if there are learning effects for the capacity builder – be provided by international organizations such as the WTO, OECD, the World Bank or regional development banks, or UN agencies. The external anchor may come from neither the WTO nor an RTA, for example, Thailand’s successful reforms in the early 1980s were successful because of domestic political will with an IMF program used as supporting evidence of commitment.

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22. There has occasionally been backsliding on these minimal commitments, notably when GATT began to accept nonmarket economies in the late 1980s and early 1990s on the basis of import targets rather than market-friendly institutions, but this was recognized as an error, and subsequent negotiations with nonmarket economies, starting with China, were different. In Russia’s ongoing WTO negotiations, the nature of energy markets has become a major obstacle to accession. 23. For Kyrgyz Republic the major RTA option, the Eurasian Economic Community (EAEC), would involve backsliding on reforms because tariff harmonization to Russian levels would involve substantial increases in Kyrgyz tariffs, reduced competition, and welfare loss (Tumbarello, 2005). WTO Membership provides an obstacle to Kyrgyz participation in an EAEC customs union because on many products the tariff bindings agreed when Kyrgyz Republic acceded to the WTO are well below any common external tariff that would be acceptable to Russia. 24. The terminology may be misleading here. A policy “anchor” focuses on the need to constrain a country so that it sticks to its reforming path, whereas the main contribution of the GATT/WTO system may have been to facilitate reforms by providing a framework of a credible guarantee of more or less stable access to the major foreign markets. In the Asia-Pacific region, APEC, while not an RTA, may have reinforced this role in the 1990s by institutionalizing a commitment by the USA, Canada, Japan, Australia, and other important trading nations to open regionalism. 25. Burma (Myanmar) is an example. Membership in ASEAN also proved insufficient to stimulate reform. 26. Based on eligibility for favorable treatment under the Generalized System of Preferences for developing countries, Özden and Reinhardt (2005) provide empirical evidence that preferential access to export markets is associated with less liberal trade policies towards imports. There is also evidence that in the Doha Round of negotiations countries benefiting from preferential market access for important exports are opposed to multilateral trade liberalization by their trading partners, because that will erode their margin of preference. 27. Trade facilitation measures such as improving customs services or reducing behind-the-border trade costs are not inherently discriminatory, and can be clearly distinguished from RTAs that introduce preferential tariffs or other discriminatory border policies. Regional arrangements like APEC have provided a forum for trade facilitation on a regional basis, without necessarily involving discriminatory trading arrangements.

References Anderson, James, and Eric van Wincoop. 2004. “Trade Costs.” Journal of Economic Literature 42(3): 691–751. Asian Development Bank (ADB). 2006. Central Asia: Increasing Gains from Trade through Regional Cooperation in Trade Policy, Transport and Customs Transit. Manila: Asian Development Bank. Baffes, John. 2005. “The ‘Cotton Problem.’ ” The World Bank Research Observer 20(1) (Spring): 109–44. Crawford, Jo-Ann, and Roberto Fiorentino. 2005. “The Changing Landscape of Regional Trade Agreements.” WTO Discussion Paper No. 8. Geneva: World Trade Organization.

Regional Trading Arrangements and WTO Membership 191 Özden, Çaglar, and Eric Reinhardt. 2005. “The Perversity of Preferences: GSP and Developing Country Trade Policies, 1976–2000.” Journal of Development Economics 78: 1–21. Patterson, Gardner. 1966. Discrimination in International Trade: The Policy Issues, 1945– 1965. Princeton: Princeton University Press. Plummer, Michael. 2007. “ ‘Best Practices’ in Regional Trading Agreements: An Application to Asia.” The World Economy 30(12): 1771–96. Pomfret, Richard. 2001. The Economics of Regional Trading Arrangements. Oxford: Oxford University Press. Pomfret, Richard. 2005. “Sequencing Trade and Monetary Integration: Issues and application to Asia.” Journal of Asian Economics 16(1): 105–24. Pomfret, Richard. 2006. “Regional Trade Agreements.” In M. Fratianni (Ed.) Regional Economic Integration. Amsterdam: Elsevier: 39–54. Pomfret, Richard. 2007. “Is Regionalism an Increasing Feature of the World Economy?” The World Economy 30(6): 923–47. Rajan, Ramkishen, Rahul Sen and Reza Siregar. 2001. Singapore and Free Trade Agreements. Singapore: Institute of Southeast Asian Studies. Rose, Andrew. 2004. “Do We Really Know that the WTO Increases Trade?” American Economic Review 94(1): 98–114. Subramanian, Arvind, and Shang-Jin Wei. 2005. “The WTO Promotes Trade, Strongly but Unevenly.” CEPR Discussion Paper No. 5122, (Jul.). London: Centre for Economic Policy Research. Tumbarello, Patrizia. 2005. “Regional Integration and WTO Accession: Which is the Right Sequencing? An Application to the CIS.” IMF Working Paper 05/94, (Feb.). Washington, DC: International Monetary Fund. United Nations Development Programme (UNDP). 2005. “Bringing Down Barriers: Regional Cooperation for Human Development and Human Society.” Central Asia Human Development Report. Bratislava: United Nations Development Programme, Bratislava. Viner, Jacob. 1950. The Customs Union Issue. New York: Carnegie Endowment for International Peace.

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Part III Impact of the WTO on Trade Flows of Goods

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7 The Effect of Membership in the GATT/WTO on Trade: Where Do We Stand? Andrew K. Rose

7.1

Introduction

Around four years ago I began to work on the effects of the World Trade Organization (WTO) and its predecessor the General Agreement on Tariffs and Trade (GATT).1 I was interested in quantifying the effects of membership in these multilateral trade organizations on international trade. I fully expected to find a large positive effect and was primarily interested in comparing this to the effects of other things that enhanced trade (particularly the effects of currency unions). However, I was astonished to find that a naïve look at the data yielded little evidence that membership of GATT/the WTO had an effect on trade that was either economically or statistically substantive. In this chapter, I review the small literature that has developed around this issue.

7.2 What I did My initial (Rose, 2004a) entrée used bilateral data to estimate the effect of membership of GATT/the WTO on trade. Since this chapter generated the most heat, it’s worth explaining my methodology a little. I used a standard “gravity” model of bilateral trade augmented with additional controls: ln(Tijt) = βDlnDij + βYln(YiYj)t + βXXijt + γ1Bothinijt + γ2Oneinijt + εijt

(1)

where: the regressand (T) is (real) trade between countries i and j at year t, D denotes the great-circle distance between the countries, Y denotes real GDP, X denotes a vector of other controls (population, dummies for common language, money, border, geographic characteristics, colonial characteristics, time dummies, and so forth), {β} denotes a set of nuisance coefficients, and ε is a (hopefully well-behaved) residual. The coefficients of interest to me were γ1 (especially) and γ2, which measure the effects on trade of GATT/WTO Membership by both countries and one country respectively, ceteris paribus. 195

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I estimated (γ) in my benchmark regressions with ordinary least squares (OLS) using a large panel of data covering more than 50 years of data and 175 countries. To my surprise, I found that both coefficients were economically small and statistically insignificant (estimates are tabulated below). I also convinced myself that the results seemed to be insensitive to the exact econometric assumptions I made; this will be discussed further below. In passing, I also used multilateral data and event studies to verify the same points; that, too, will be discussed further later. For a while I didn’t understand this negative result or think it plausible; it struck me as odd that membership in as apparently important an institution as the WTO could have a negligible impact on trade. But thanks to a moment of inspiration provided by my son, I realized that if GATT/WTO Membership had little effect on trade policy, it might also have little effect on trade flows.2 Accordingly, I checked out this explanation in Rose (2004b). In that paper, I used almost 70 measures of trade policy and liberalization – all that I could find – to see if membership of GATT/the WTO was actually associated with more liberal trade policy. With one exception – the Heritage Foundation’s index of economic freedom – the answer was a resounding no; members of GATT/the WTO just didn’t seem to have measurably more liberal trade policy than outsiders. This was consistent with my initial results on actual trade flows; it also seems to jive with the notions of many colleagues, as I discovered in subsequent presentations. I also wrote two more narrowly focused follow-ups on the topic. Since some think that a big part of membership in GATT/the WTO lies in the stability and predictability of trade policy, in Rose (2005a), I examined the second moment of trade flows, not their first moment. Again, I found little evidence of any large membership effect. In Rose (2005c), I compared the GATT/WTO with two other significant international institutions that are in the business of liberalizing trade, the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD). I found that membership of the OECD had a consistently large positive effect while accession to (but not membership of) GATT/the WTO was also associated with increased trade. The latter effect stems from inclusion of country or country-pair specific fixed effects; again, this will be discussed further below. In passing, I note that essentially all of the critiques to my work focus on my 2004a paper; no one, to the best of my knowledge, has investigated the follow-up papers. Too bad; to me, their consistency provides a reassuring part of the larger story. 7.2.1 What I didn’t do (and no one can) I don’t want to claim that the existence of GATT/the WTO has been irrelevant to trade or trade policy. No reasonable person could ever claim that, for a somewhat metaphysical reason. GATT/the WTO could have acted as

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an international provider of public goods in the form of providing a global trade policy that is more liberal than it would have been in the absence of the system. One can never test this hypothesis, since we have only experienced (even in California) one history. Since there is no postwar span of time without GATT/the WTO, the counterfactual is not measurable; thus the basic idea cannot be tested or rejected. GATT/the WTO could have acted as a globo-cop, providing more liberal trade to all the world, independent of membership. This does not strike me as a plausible idea; why the fuss over, for example, China’s accession to the WTO? In any case, since this topic is intrinsically untestable, I do not consider it to be interesting. Accordingly, the literature has stuck to a testable notion, namely the effect of membership of GATT/the WTO on trade. Since there’s a lot of variation across both countries and time on this, estimating the effect of membership on trade is completely feasible. 7.2.2 A quick survey of the preceding literature 7.2.2.1 What happened afterwards (Skip the next paragraph if you don’t enjoy shameless self-congratulation.) In the large, I have succeeded in my objective; there is now a small but growing body of scholarly research that investigates the impact of the international trade institutions on trade. Of course, it’s early days, there’s lots of dispute, and more remains to be done: as Evenett (2005: 1) writes: “we know much less about the effects of WTO accession than we probably should ... Generally, little is known about the effects of WTO accession on developing countries ... The scholarly community is not alone in its lack of attention to WTO accession matters ...” But at least we’ve started. And a propos, I want to thank my critics. To have a critique published on your paper is a high honor. Only those who care actually take the pains to work on a dispute. 7.2.2.2 Reasons I might be right In the remainder of the chapter, I will respond to my critics, organizing my thoughts by theme rather than chapter.3 But before I go into defensive mode, let me lay out a few reasons why you might conceivably think I’m right, namely that membership in GATT/the WTO doesn’t deliver more trade. These facts are mostly conventional wisdom that lie beyond the narrow confines of econometric estimates. 1. Developing countries. There’s essentially universal agreement that GATT historically made few demands on most countries in terms of trade liberalization, since most entrants were developing countries eligible for “special and differential treatment” (references are below). GATT/the WTO has always been a relatively toothless institution (by design) and has few levers to encourage liberalization. If accession to GATT/the WTO doesn’t force

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countries to liberalize, why should one expect accession to have a measurable impact on trade? And if accession isn’t the time when GATT/the WTO forces countries to liberalize, is GATT/the WTO really an effective agent of liberalization? For more on the case of Russia, see Lissovolik and Lissovolik (2004). 2. Sectors. GATT/the WTO has made almost no progress in liberalizing areas of great protectionism, such as agriculture and textiles. 3. MFN status. Most Favored Nation (MFN) status might seem like the great prize of GATT/WTO Membership. It turns out that MFN status is often given away freely.4 4. NTBs. Tariffs have been lowered by developed countries under the auspices of the GATT. But most are also well aware of the (deplorable) fact that non-tariff barriers (NTBs) have often been increased as substitute protectionism. 5. Liberalization and accession. In the voluminous and controversial literature on trade and growth, no scholar, to my knowledge, has ever dated trade liberalization with GATT/WTO accession. (Sachs and Warner, for instance, tie liberalizations to the aftermath of macroeconomic crises.) If accession means liberalization and trade growth, why has no one ever tried to figure out if growth follows accession? Simple: liberalization dates have little to do with GATT/WTO accession. 6. Ceteris Non Paribus. There are many other reasons why trade has grown, including declining transportation/communication costs, higher productivity growth in tradeables, and so forth. 7.2.2.3 Phew: Replication I note in passing that a number of others have been able to confirm my benchmark results. A quick tabulation of γ1 coefficients estimated in a manner similar to (1) is presented in Table 7.1. A number of these are negative; none is significantly positive. The primary objective of a number of these projects was not the relevance of GATT/the WTO. For instance, Felbermayr and Kohler (2005) are primarily interested in resolving the “distance puzzle” of an elasticity of bilateral trade with respect to distance that seems to be increasing over time.5 Leeson (2005) is primarily interested in the importance of the New York Convention for trade. I conclude that plain vanilla estimation of the effect of GATT/WTO Membership on bilateral trade does not deliver a large positive effect; one has to look more subtly for that result. 7.2.2.4 Reasons I might be wrong There are three key criticisms of my work: inappropriate data pooling; inappropriate handling of fixed effects; and selection bias. Below, I summarize the arguments and respond. Then I present a few challenges to my opponents.

The Effect of Membership in the GATT/WTO on Trade Table 7.1 trade

199

Replicating the impact of joint GATT/WTO Membership on bilateral

Source

γ1

Notes

Rose (2004a)

−0.04 (0.05)

Table 1, default

Subramanian and Wei (2006)

−0.25 (0.04)

Imports, Table 6 col. 1

Tomz, Goldstein, and Rivers (2005)

−0.17 (0.03)

Table 2, col. 2

Liu (2006)

−0.08 (0.01)

Felbermayr and Kohler (2005)

0.09 (0.08)

Table 2, positive trade Table 2, intensive margin

Leeson (2005)

0.12 (0.06)

Table 2, default

Gowa and Kim (2006)

0.04 (0.03)

Table 1, col. 2.

Note: Standard errors in parentheses.

Piermartini and Teh (2005: 47–49) provide an alternative summary of different criticisms of my work. These include: 1. The fact that GATT did not require significant reductions in trade barriers for developing countries acceding before the creation of the WTO in 1995; 2. The fact that transition periods for tariff reductions are allowed; 3. The fact that many countries already benefited from MFN before accession; 4. The fact that many countries liberalized beforehand in order to facilitate accession; 5. The fact that least developed countries (LDCs) often export fuels and minerals that face little protectionism (although agriculture, in which they have a comparative advantage, does); and 6. That the first five facts imply that the impact of membership should be higher in developed countries. They also summarize the work of others, especially Subramanian and Wei (2006), Tomz et al. (2005), and the work of authors concerned with zerotrade observations. See also Evenett and Gage (2005), and Evenett, Gage, and Kennett (2004). I’ve collected some key estimates of the effect of GATT/ WTO Membership on trade in a table presented in the appendix.

7.3 Criticism No. 1: Excessive pooling A number of my critics have argued that looking at all trade simultaneously masks the effects of GATT/the WTO. The fine work of Subramanian and Wei (2006) is especially forceful on this point. Their argument is that if

200 Andrew K. Rose

you disentangle by country/time/sector etc, you can find significant trade effects of membership for subsets of the data.6 Subramanian and Wei show convincingly that different pieces of the data can certainly deliver significant and plausible effects of membership on trade. This is certainly a serious critique, but I’m not sure it is a wholly legitimate argument. What do we learn when we study the trade patterns of countries and sectors that have liberalized and ignore those that haven’t? Subramanian and Wei claim that GATT/the WTO has been successful, since there has been liberalization by some countries in some sectors over some periods of time. Why can’t one declare just as well failure since most countries have not liberalized most of their trade by now? To put it a different way GATT has worked well, if you ignore the countries, sectors, and times when it hasn’t. We’re all agreed that if you ignore its failures, GATT/the WTO has been successful. But that’s hardly a ringing endorsement of the institution. 7.3.1 Pooling across countries There are two critiques of relevance here, both associated with handling developing countries. The view of many, most notably Subramanian and Wei (2006), is that GATT was essentially a club for developed countries.7 Subramanian and Wei argue that by including developing countries that are GATT Members technically but not in spirit, I’ve rigged the analysis to make GATT look irrelevant. Combining data on developing and developed countries masks the impact of GATT on the latter. Their powerful conclusion is that GATT/the WTO has more than doubled global trade, much more than a statistical nicety. On the other hand, Tomz et al. (2005) argue that some developing countries participated informally in GATT and seemed to trade more than outsiders. Their statistical analysis relies on a carefully constructed data set that includes not only formal members of GATT, but also a number of other categories for countries that participated in other capacities. Their argument is that I ignored these informal GATT participants, and thus underestimated its impact. So while Subramanian and Wei criticize me for including any developing countries at all, Tomz et al. say the opposite, which strikes me as odd, at least prima facie. Their view is that the relevance of GATT can be rescued only by including developing countries, in particular those that aren’t formally members but are in spirit. Both critiques are well-crafted and serious, but it’s hard to see how they can both be right simultaneously.8 I prefer the Subramanian and Wei interpretation, since Tomz et al. seem incongruous with the literature.9 Let me include a couple of typical excerpts that illustrate my discomfort. In Free Trade Agreements, Schott (2004: 9–10) states: Why are developing countries so interested in FTAs? In the past, these countries were able to obtain improved access to industrial markets

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through GATT negotiations that did not require them to reciprocate by opening their own markets to foreign competition. While useful, prior GATT rounds had two major shortcomings: they did not prompt policy changes in developing countries that would induce adequate flows of investment and transfers of technology (apart from extractive industries), and competitive agricultural and manufactured exports of developing countries often were excluded from the reforms. In short, developing countries were free riders on the GATT system until the Uruguay Round, but derived only modest benefits from their own minimal contributions to GATT negotiations. They protected their own markets, but in turn had to accept the maintenance of high foreign trade barriers against their most competitive exports. Alternatively, Krueger writes in the introduction to The WTO as an International Organization (1998: 7): Developing countries’ attitudes and trade policies during the 1950s and 1960s generally resulted in heightened walls of protection as industrialization through “import substitution” was attempted. That generally meant that developing countries were not benefiting as much as they might have from the growth of the world economy, while the “balanceof-payments” provisions of the GATT were liberally interpreted to enable developing countries to maintain quantitative restrictions, often including import prohibitions, on their imports. Moreover, the GATT articles were amended in the early 1960s to provide non-reciprocal preferential treatment of imports from those countries. One consequence was that developing countries (the East Asian newly industrializing countries being a prominent exception) were losing shares of their world markets. It’s worth stressing that developing countries really are key to Tomz et al. The second row of their Table 7.2 indicates that GATT participation has a statistically weak (though positive) effect on trade when you look only at industrial countries. The effect is significant only when you include developing countries. Another uncomfortable feature of the results of Tomz et al. is that informal participation in the GATT consistently matters more for trade than formal membership. This doesn’t seem wholly plausible to me (at least not without some explanation) and is a cause for concern. I simply don’t understand why informal participation could create more trade than actual membership of GATT. This is especially true in light of the recent work by Tang and Wei (2006), who show that more rigorous entry requirements for WTO Membership are associated with better results. So I don’t really buy the argument of Tomz et al that reclassifying certain developing countries as informal GATT participants can rescue the

Table 7.2

Benchmark estimates, effect of GATT/WTO Membership on bilateral trade

Source Rose (2004a)

No fixed effects

Country fixed effects

−0.04 (0.05)

0.15 (0.05)

Subramanian and Wei (2006)

Dyadic fixed effects Other

Notes

0.13 (0.02)

1.08 (0.10)

Industrial country imports

Tomz, Goldstein, and Rivers (2005)

0.17 (.07)

0.54 (0.06)

0.48 (0.06)

Formal members

Tomz, Goldstein, and Rivers (2005)

0.80 (0.14)

0.86 (0.12)

0.88 (0.09)

Nonmember participants

Liu (2006)

−0.08 (0.01)

0.04 (0.01)

Positive imports

Liu (2006)

2.09 (0.02)

1.45 (0.02)

All imports

Felbermayr and Kohler (2005)

0.09 (0.08)

Positive trade

Felbermayr and Kohler (2005)

0.50 (0.09)

All trade

Helpman, Melitz, and Rubinstein (2005)

0.30 (0.04)

Leeson (2005)

0.12 (0.06)

0.13 (0.05)

Gowa and Kim (2006) Notes: Estimates of γ1 from regressions of type: (1) ln(Tijt) = β1lnD ij + β2ln(YiYj)t + βX ijt + γ1Bothinijt + γ2Oneinijt + εijt Standard errors in parentheses. Dyadic fixed effects refer to inclusion of country-pair specific fixed effects.

0.14 (0.04) 0.13 (0.05) 0.04 (0.03)

Other is ML

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203

importance of the institution. That said, it seems inappropriate to ignore developing countries. There seems to be little doubt that GATT made little impact on the trade policy of many developing countries. Personally, I think this cannot be counted as an indicator of the institution’s success, so I guess I really just disagree with the interpretation of Subramanian and Wei (2006). 7.3.2

Time and industries

Just as Subramanian and Wei (2006) argue that I inappropriately bundle together developing and developed countries, they also argue that aggregating across sectors of economy can disguise the true effectiveness of GATT/ the WTO. In particular, they argue that key sectors (critically agriculture, but also textiles, clothing, and footwear) have not been included in the GATT’s liberalization efforts, so that including these industries in the analysis gives a false impression that the institution has been ineffective. Again, my interpretation is different. Agricultural produce is highly tradable, and has historically been the battleground for commercial policy. The beginning of the modern era of commercial policy is commonly considered to be the repeal of the British “Corn Laws” while the failure to liberalize agriculture remains a key reason why the Doha Round has thus far met with limited success. If GATT/the WTO has been such a successful liberalizer, it does not seem kosher simply to ignore its failures in agriculture.10 On aggregation over time, I have little to say. I hope that the WTO (established to succeed GATT in 1995) has been and will be a more effective liberalizer than GATT. Still, I haven’t been able to see it myself in the data myself.11 Is China the new norm (and if it sticks to the spirit of its accession deal) or the exception? I think we need more time and more post-GATT accessions to resolve this issue. The preliminary evidence, as summarized in, for example, Ferrantino (2006) and Drabek and Bacchetta (2004) exists, but seems rather weak. Tang and Wei (2006) have found positive results of recent WTO entry on growth and investment, although they do not look directly at trade.

7.4 Criticism No. 2: Fixed effects and variation across countries and time A number of my critics note that most of my regressions do not include country-specific fixed effects in my gravity equations. When I did include them (in Table 7.2), the point estimate for the effect of joint membership of GATT/the WTO on trade was 0.15 (robust standard error of 0.05), implying that two countries inside GATT/the WTO trade about 16 percent more, ceteris paribus.12 I dismissed this as “small compared to other effects (e.g., regional trade associations[RTAs]), the long-term growth of trade, intuition, and the hype surrounding the GATT/WTO.” That still seems right to me.

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Andrew K. Rose

Many of my critics include fixed effects for either countries or countrypairs, thus using only time-series variation, the “within” estimator. They usually find significantly positive estimates of the effect of membership on trade. Since the within estimator doesn’t use variation across countries, these estimates answer the question “What is the effect of accession to GATT/the WTO on trade ceteris paribus?” Hausman tests can be used to test the equality of the time-series within and cross-sectional “between” estimators. They typically reject equality of the two, so relying exclusively on OLS estimates (which assume equality) is statistically problematic. So while membership of the institution (which is partly a cross-sectional question) may not have a big positive effect on trade, joining it may (the latter is a time-series issue). A couple of questions in passing. Using the within estimator is tricky, since liberalization may not coincide with accession. There are at least two reasons, both well known. First, countries may liberalize beforehand in order to facilitate accession.13 Second, joining members are often granted phaseins so that liberalization may instead follow accession. A different issue altogether is whether the gravity model works well with fixed effects. Many coefficients change a lot when fixed effects are included. For instance, many of the GDP terms seem small.14 The more important question is how to interpret the evidence. I think we learn something from comparing the trade of members and nonmembers in cross-section. That is, even if the within estimate is not equal to the between estimate, the latter should not be discarded. Cross-sectional estimates often indicate a negative insignificant effect of GATT/WTO Membership on trade. For instance, in Rose (2004a, I found the cross-sectional estimator of γ1 to be −0.50 (with a standard error of 0.21), while Tomz et al. (2005) estimated it to be −0.51 (0.24). I have still not heard a good explanation of how such findings are consistent with an important role for the GATT/WTO in stimulating trade.15

7.5 Criticism No. 3: Selection bias In Rose (2004a), I followed the tradition in the field in essentially ignoring observations where there was no trade between a pair of countries. I reported some cursory Tobit estimates, but didn’t really try to model or understand country-pairs with zero trade. That turns out to be a potentially serious issue if countries that belong to GATT/the WTO systematically trade with more countries than they otherwise would. That is, I didn’t explicitly deal with the extensive margin of trade (whether a pair of countries trades at all), instead focusing on the intensive margin (i.e., how nonzero trade varies across pairs of countries). Three papers have emerged since then that focus on this interesting and potentially important problem: Felbermayr and Kohler (2005), Helpman, Melitz, and Rubinstein (2005), and Liu (2006). Each argues that members of GATT/ the WTO have systematically more trading relationships, so that ignoring the effect of membership on the extensive trade margin leads one to underestimate

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205

the impact of GATT/the WTO. This has been a fruitful insight and is a promising area of research. It has led to a number of different econometric techniques for handling the intensive and extensive margins of trade simultaneously. The reason why I basically ignored the zero trade observations wasn’t silly, and is worth stating. My view was that missing regressor data (especially for GDP, which seemed vital for an empirical gravity model) was more important than censoring of the dependent variable.16 Now you can do without country-specific variables (such as GDP) in certain models; that’s one of the nice features of Helpman et al. or any other technique that includes time-varying country-specific fixed effects. But for others working in the area, missing regressor observations seems to be an issue, for example, for Felbermayr and Kohler, and my original work. Whether modeling the extensive margin of trade turns out to be important is unclear. If you add up the number of observations where a pair of countries actually trades and divide the result by the number of potential bilateral trade relationships, you get a small number (e.g., Helpman et al. show that only around half of all potential country-pairs actually trade). But that treats all trade relationships the same. If you weight by GDP or population, the ratios probably look much larger. Helpman et al. (2005: 6) write “... the enlargement of the set of trading countries did not contribute in a major way to the growth of world trade.” Liu (2006) disputes this conclusion, since he finds that much of the trade growth occurred between trading partners that did not trade in 1948.17 Currently, it’s unclear to me just how important this issue is in practice. There is at least a couple of other issues in the area. Some of the gravity effects estimated with the newer models seem like they’ve changed a lot, at least to me. It would also be interesting to see the effects of the informal participation described by Tomz et al. combined with the careful selection bias techniques that have been developed. Still, GATT/the WTO may well have played an important role in fostering the development of trade linkages that might not have existed in its absence. I expect further work on this issue in the future, but consider it to be a serious criticism of my initial analysis.

7.6 Challenge No. 1: Beyond bilateral trade flows Many of my critics argue that GATT/the WTO has liberalized trade flows, if one looks carefully at bilateral data. Are these results apparent in multilateral data? My finding of a noneffect of GATT/WTO Membership on trade seems to be apparent in the data, at least to me. In Rose (2004a) I presented both event studies and regression results that delivered basically the same result as my bilateral work. The question is: does GATT/WTO Membership raise trade when we look at aggregate trade data appropriately? This is an interesting and important question that my critics have thus far not pursued (or at least not presented in print).

Table 7.3

Aggregate openness and GATT/the WTO Member of GATT/WTO

Log real per capita GDP

Log population

Remoteness

R2

Bivariate

−0.11 (0.02)

Default specification

−0.01 (0.01)

0.13 (0.01)

−0.22 (0.004)

−1.86 (0.39)

0.53

With extra controls*

−0.00 (0.01)

0.13 (0.01)

−0.16 (0.006)

−0.51 (0.44)

0.56

Without year effects

−0.01 (0.02)

Without year effects

0.032 (0.014)

0.16 (0.01)

−0.21 (0.003)

−5.92 (0.34)

0.47

Without year effects, extra controls*

0.006 (0.015)

0.15 (0.01)

−0.14 (0.006)

−4.96 (0.39)

0.51

Level of openness

−5.95 (1.12)

Level of openness

−0.21 (0.92)

9.61 (0.52)

−12.63 (0.26)

Level of openness, extra controls*

−0.58 (1.01)

9.65 (0.50)

−4.59 (0.59)

0.00 (0.01)

0.12 (0.01)

−0.22 (0.004)

Remoteness using levels

0.12

0.00

0.08 82.5 (33.2)

0.40

243 (36)

0.48

−1547 (390)

0.53

Notes: Regressand: log of openness (i.e., ratio of exports plus imports to GDP in percent) unless noted. Data from PWT6; 158 countries, 1950–98; 5,499 observations unless noted. OLS with year effects (intercepts not reported). Robust standard errors in parentheses. * “Extra Controls” are: a) currency union dummy; b) dependency dummy; c) log of area; d) island dummy; and e) landlocked dummy. Extra controls reduce observations to 4803.

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207

To make this all a little more concrete, in Table 7.3 I present some multilateral results that have been taken from Rose (2004a). These examine the determinants of a country’s trade with the rest of the world (rather than a country’s trade with an individual trading partner, as in a bilateral gravity model). When I look at the results, I don’t see any big impact of GATT/WTO Membership on trade.18 In Figure 7.1 I also present a set of four event studies, similarly lifted from Rose (2004a). These examine aggregate openness – the ratio of export plus imports to GDP – around the dates of GATT/WTO entry. I show raw openness in the top-left graphic. The other three are analogous, but portray the residuals once openness has been regressed on the natural logarithms of both real GDP and real per capita GDP, and different fixed effects. Again, there is little evidence that GATT/WTO entry has a strong significant effect on the ratio of aggregate trade to GDP in any of the graphics. Here’s the first challenge to my critics: if GATT/the WTO matters, where’s the evidence that it affects multilateral trade? Man does not live by the gravity model alone.

7.7 Challenge No. 2: Beyond trade flows If GATT/the WTO has liberalized trade, one might imagine that this should be visible in measures of trade policy as well as trade. Looking at the success of GATT/the WTO by relying completely on trade outcomes is problematic since 90

20

80

10

70

0

60

−10 −5

t Openness

5

15

−5

t Residual

5

5

10

0

5

−5

0 −5

−10 −5

5 t Residual, year effects

5

−5 t Residual, country effects

Figure 7.1 Effect of GATT/WTO entry on aggregate openness, (X+M)/Y (+/–5 years around entry of 104 countries) Notes: PWT6 data, 1950–98. Mean with +/–2 standard deviations. Regressions include logs of real GDP and real per capita GDP

208 Andrew K. Rose

there are many determinants of trade. It’s difficult to measure trade policy, so one should be careful; but aren’t more noisy indications of GATT/the WTO’s success better than fewer? I analyzed trade policy in Rose (2004b) and found almost no differences in a variety of measures of trade policy between GATT/ WTO Members and nonmembers. Again, I think it is incumbent on my critics to examine trade policy and show why my analysis is wrong or misleading.19 Table 7.4 shows the weak linkages between measures of trade policy and membership of GATT/the WTO. This is simply taken from Rose (2004b); Table 7.4

Trade policy and GATT/WTO Membership: Panel measures Bivariate

Augmented

Instrumental variable

Import duties as % imports

2.1 (1.7)

1.8 (1.8)

−45 (0.9)

NBER trade liberalization phase

0.2 (0.3)

−0.5 (1.0)

−2.7 (0.3)

Overall Index of Economic Freedom

−0.0 (0.2)

0.0 (0.0)

−4.6 (1.7)

Trade policy measure from Index of Economic Freedom

−0.7 (1.1)

−0.1 (0.2)

−18 (1.6)

Index from FX and commercial policy

0.00 (0.0)

0.00 (0.1)

0.26 (0.6)

Index from tariffs and NTBs

0.5 (1.8)

0.4* (2.0)

−4.3 (0.4)

Indirect counteragricultural bias

0.0002 (0.6)

Gravity-Residuals, basic model

−1.8 (1.8)

−1.8 (1.9)

−117 (0.2)

Gravity-Residuals, augmented model

−1.5 (1.7)

−1.6 (1.7)

−122 (0.3)

Movement to international prices

0.01 (0.4)

0.01 (0.5)

0.06 (0.2)

Modified price Distortion Index

−0.01 (0.3)

−0.01 (0.3)

−3.4 (1.5)

Black Market Premium

−0.26 (1.8)

−0.15 (1.5)

−13 (1.9)

0.0001 (.4)

0.010 (1.0)

Notes: Independent variable is membership of GATT/the WTO. Augmenting regressors: log(population); log(real per capita GDP); and remoteness. Instrumental variable: Polity IV score of autocracy/democracy. Absolute t-statistics (computed with standard errors robust to clustering by countries) in parentheses, except for IV estimates which use conventional standard errors. NBER – National Bureau of Economic Research; FX – Exchange rate. ** indicates significance at 1 percent; * at 5 percent. Year and country fixed effects included throughout. Source: The Authors.

90

20

80

15

70

10

.14 .12 .1

60

.08

5 −5

t

.06 −5

5

(Exports+imports)/GDP

5

−5

t

Import duties, % imports

5 t

Index: FX & Comm’l policy

3

0

40

2

−.001

35

−.002 1

30

−.003

0

−.004 −5

5

25 −5

5

t

t

Index: Tariffs & NTBs

Indirect counter−Ag’l bias

t

5

Gravity residuals, basic .8

.1

.1

−5

.6

0

.4

0 −.1

.2 −.1

−.2 −5

5 t

0 −5

Movement to Int’l prices

5 t

Price distortion measure

Figure 7.2 Effect of GATT/WTO entry on trade policy Notes: Five-year event study around (107) GATT/WTO accessions. PWT6, 1950–98; samples vary. Mean, with +/–2 standard deviations; GATT/WTO averages marked

−5

t

Black−market prem.

5

210

Andrew K. Rose

interested readers can refer to that paper for further details. I also present in Figure 7.2 some analogous event studies, taken from the same paper. There is little evidence that GATT/WTO entry has a strong significant effect on trade policy. My second challenge is: where’s the convincing evidence that membership of GATT/the WTO has affected trade policy?

7.8 Challenge No. 3: What does the WTO do? Until recently there has been something of a problem of understanding the basic rationale for GATT/the WTO. After all, the most primitive argument for trade liberalization is unilateral; why does one need a multilateral institution at all?20 In an influential series of articles summarized in a monograph, Bagwell and Staiger (2003) have now provided an answer: negotiation through GATT/the WTO solves a terms of trade externality. Otherwise liberalizing countries might worry that unilateral elimination of protection might hurt their terms of trade. This is a fine theoretical argument, and I admire and applaud the excellent work of Bagwell and Staiger. But is it of obvious empirical relevance? Thus far it has not been subjected to rigorous empirical analysis. Doing so is far beyond the scope of this chapter, but let me provide a little evidence of relevance. In particular, I present in Figure 7.3 a set of plots that look at the World Bank’s “barter terms of trade” (indexed so that they’re all equal to 100 in year 2000) during the three years before and after the completion of the Uruguay Round. I do this on a country-by country basis, for 12 big economies, 12 in the OECD and 4 developing. Now these graphics are rough. They’re aggregate in that they cover the whole economy. Further, they’re raw and a host of other features undoubtedly affected the terms of trade. One also doesn’t know the counterfactual; how would the terms of trade be expected to move without GATT/the WTO? That is, it’s not clear what the Bagwell-Staiger theory leads one to expect for the terms of trade. All that said, the terms of trade do not look particularly stable around the completion of the Uruguay Round. The analogous event study is presented in Figure 7.4. It pools data across all formal and de facto members of GATT/the WTO (using the Tomz et al. membership data) and all four GATT rounds for which there are terms of trade data. The mean terms of trade is presented in between lines that delimit a confidence interval of +/− two standard errors. It shows that there is typically an improvement of the terms of trade that is both economically and statistically significant. There is a striking amount of time-series variation of the terms of trade around the completion of GATT rounds.

104

105

103 100 102 101 1991 U.S.

1997

112 110 108 106 104 1991

1997

95 1991

94

104

92 1997

102 1991

Canada 120

102

115

100

98

110

98

96 1991

105 1997

1997

1991

96 1991

Japan

1997 The Netherlands

110

105 104 103 102 101 1991

1997 France

100

104

108 102

106 104 1997

1997

1991

110 100 1997 India

1997 U.K.

140 135 130 125 120

90 1991

100 1991

Sweden

120

1997

1997

1991

Spain

120 110 100 90 80

Figure 7.3

106

102

South Africa

Brazil

96

Italy

1997

1991

108

Australia

Germany 107 106 105 104 103 1991

98

98 96 94 1997

1991 Korea

Terms of trade at Uruguay round completion (Barter Terms of Trade, WDI, 2000=100)

92 1991

1997 Mexico

212

Andrew K. Rose 130

120

110

100 −3 Figure 7.4

3 Terms of trade during 4 GATT Rounds

Notes: Formal and de facto members: 153 observed.

I want to stress that this is the opposite of definitive empirical work. No other factors are taken into account, and it’s not clear what the hypothesis of interest is. And this isn’t a challenge to my critics; it’s a challenge for anyone interested in understanding GATT/the WTO and the terms of trade. Still: is there evidence that membership in the GATT/WTO stabilizes or otherwise affects the behavior of the terms of trade?

7.9

Final notes

There may be publication bias in this area of research. Publishing negative results is more difficult than positive ones. That’s especially true in this context, since Rose (2004a) simply presented a nonfinding of a large effect of GATT/WTO Membership on trade. People who find similar results may simply junk them; accordingly, researchers may be tempted to stretch their work towards finding positive conclusions. I won’t provide a conclusion. Personally, I still think the evidence of a strong positive effect of GATT/WTO Membership on trade is lacking. I don’t see its effects on aggregate trade or trade policy. That said, my initial pessimism about the impact of the institution has been tempered by the subsequent work. I find the work of especially Subramanian and Wei (2006) but also Tomz et al. (2005) relevant if not completely convincing. A more important gap in my initial work was the fact that I did not take the extensive margin seriously. I’m now persuaded that membership of GATT/the WTO encourages the creation of trading links where none might otherwise exist. How important this is to world trade and welfare is currently unclear to me; I look forward to more work in the area.

Notes 1. My inspiration came from Li and Wu (2004). 2. The story is entertaining and revolves around a trip I took with my family from San Francisco to Singapore. We had to stop for couple of hours in Hong Kong to

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change planes, and my wife and I gave our son Asher (who happened to be turning three that day) the choice of either playing at the airport playground or going to one of the lounges (as a United Premier Executive, he was entitled to the Gold lounge even at age two). He wisely chose the playground and I got to watch him while Miriam went to the lounge. He played, ran, shouted, and let off steam while I tried (and again failed) to figure out why I couldn’t find any effect of GATT/ WTO Membership on trade. After a while, Asher told me that he’d had enough and wanted to go to the lounge. Fine, I explained, but in the lounge you have to be calm, quiet, orderly and so forth. He agreed. We went to the lounge and sure enough, he went wild as soon as we got in, tearing around, yelling, and having fun (as three-year olds do). I reminded him that we’d agreed to a deal, and he was supposed to shape up when we entered the lounge. “Yes,” he said to me, “but now I’m in.” 3. My responses to two significant critiques – Tomz et al. (2005) and Subramanian and Wei (2006) – are available on my website as Rose (2005b) and (2004c) respectively. I borrow from them freely in what follows. 4. For instance, in 2003 only four countries (Cuba, Laos, North Korea, and Serbia) did not have normal trade relations (the equivalent of MFN status) with the U.S., even though many countries were not in the WTO (Russia and Saudi Arabia being perhaps the most prominent nonmembers). Symmetrically, WTO incumbents have not always extended MFN status to acceding countries Drabek and Bacchetta (2004, pp. 1094–95). 5. Gowa and Kim (2006) are concerned to “show that the GATT had a large, positive, and significant impact on trade between only five of its member states: Britain, Canada, France, Germany, and the United States.” They note that “When Japan acceded to the GATT in 1955, more than 40 percent of its members denied it MFN treatment in order to protect their markets against a flood of textiles and other labor-intensive products in which Japan held a comparative advantage ...” and find that policy towards Italy was similar. They also argue that goods were defined so narrowly that most concessions were essentially bilateral, not multilateral. For instance, they state (Gowa and Kim, pp. 11): As in the interwar era, however, the products on which tariffs were cut were defined as narrowly as possible in an effort to restrict their benefits to a single country. In 1948, for example, when the United States reduced its tariff on feldspar china, it simultaneously added “value brackets” to its tariff schedule, making the new rate applicable “only to plates, cups, saucers and other items valued at more than specified amounts.” This precluded their application to the “bulk” of Japanese imports. That very few products appear on the concessions list of more than one pair of countries also attests to efforts to privatize tariff cuts. During the 1955–56 trade round, for example, the United States cut its tariff on a total of 59 imports from Britain, Canada, France, and Germany. With one exception, no concession seems to have applied to a good produced by more than one of these countries. 6. I did cut the data in more than 40 different ways in the original paper, but obviously I may have missed the right way. 7. Tang and Wei (2006, p. 3) state “In the first four decades of the GATT, developing countries were not asked to do much reform if they wanted to join the club. Indeed, many of them retained very high bound tariff rates even after becoming GATT members.” 8. The criticism of Tomz et al. (2005) is not inappropriate pooling, but measurement error in my GATT/WTO Membership variable.

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9. Tomz et al. (2005, p. 6) write “De facto participants were ‘expected to observe the substantive provisions of the General Agreement.’ But they had fewer administrative responsibilities than formal members ... De facto participants received MFN treatment, were invited to participate in multilateral trade negotiations, and could observe the annual GATT sessions.” By way of contrast Tang and Wei (2006, p. 5) state “Up to the end of 1994, a subset of developing countries were eligible to join the GATT under Article XXVI 5(c) by essentially sending a notification to the GATT without having to promise reforms.” 10. There is little doubt that GATT/the WTO has failed in this area. Consider Dam (1970, pp. 257–58) who states “It would be difficult to conclude that the GATT’s record in the sphere of temperate agriculture commodities is other than one of failure ... [Agricultural protectionism, especially NTBs] cannot be justified under the provisions of the General Agreement ... there can be little doubt that few of the nontariff barriers on imports of agricultural commodities can be justified under ... special dispensations.” 11. In my (2004a) paper, I found that γ1 tended to fall in the last part during the WTO era; for example, See Tables 7.3 and 7.4; Tomz et al. (2005) find comparable results in their tables 3 and 5. 12. In passing: in Rose (2004a), I included only one set of bilateral estimates with country-specific fixed effects, but over a dozen with country-pair-specific (“dyadic”) fixed effects. These take into account not multilateral “trade resistance” and other unobservable features of individual countries, but trade resistance (and other unobservable features) of the relationship between each pair of countries. This seems much more general. 13. Ferrantino (2006) analyzes liberalization during the run up to recent WTO accessions and American FTAs. He notes the long lags between a country’s initial application for WTO Membership and its actual accession. 14. Thus for example, the log product real GDP term falls from 0.93 (standard error of 0.01) in column 3 of table 2 of Tomz et al. (2005) to 0.18 (0.05) when country fixed effects are added, and 0.47 (0.05) when dyadic fixed effects are added in columns 4 and 5. 15. In fact the problem may be worse, since countries that are naturally open to international trade may tend disproportionately to join. This biases the crosssectional coefficient upwards, making it especially likely to be positive. But it’s been found to be negative, by both me and my critics. 16. Usually when you’re missing data to model trade between a country A and country B it’s not the trade data that’s missing (or zero), but that for GDP. 17. However, it is unclear whether this growth occurred because of the appearance of new countries, or because countries that exited in 1948 chose not to trade then but did trade afterwards; see also Felbermayr and Kohler (2005). 18. This is consistent with Drabek and Bacchetta (2004, pp. 1092–93), who find that recently countries “have been able to negotiate the terms of their WTO accession within the scope of measures already taken ...” so that “almost all countries in our sample actually applied lower tariffs than those bound in the WTO.” They later conclude (2004, p. 1105) that “very little” of the tariff decline was brought about by accession to the WTO. 19. Ferrantino (2006, p. 21) writes “The ongoing WTO accessions, in fact, show more cases of deterioration than improvement in five of the six indicators [of national governance], showing a balance of improvement only for “government effectiveness.” This is not encouraging, as it suggests only more efficient repression

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and corruption.” Later on (2006, p. 22) he writes “In 10 out of the 11 cases of a change in score associated with WTO accession the [trade] score [of the heritage Foundations Index of Economic Freedom] in fact declines.” 20. Drabek and Bacchetta (2004) provide a number of other reasons for joining the WTO, but these do not seem particularly compelling to me, since they do not seem intrinsically international. For instance, they argue (2004, pp. 1089–91) that WTO Membership enhances the credibility of both domestic and foreign governments’ policy. But domestic institutions are almost always more important and credible than international commitments.

References Bagwell, Kyle, and Robert Staiger. 2003. The Economics of the World Trading System. Cambridge, MA: MIT Press. Dam, Kenneth W. 1970. The GATT: Law and International Economic Organization. Chicago: University of Chicago Press. Drabek, Zdenek, and Marc Bacchetta. 2004. “Tracing the Effects of WTO Accession on Policy-Making in Sovereign States: Preliminary Lessons from the Recent Experience of Transition Countries.” World Economy 27(7): 1083–125. Evenett, Simon J. 2005. “What is Known about the Effects of WTO Accession on Developing Countries?” Unpublished, Brookings. Evenett, Simon J., and Jonathan Gage. 2005. “Evaluating WTO Accessions.” Unpublished, Oxford University, reprinted as Chapter 4 in this volume. Evenett, Simon J., Jonathan Gage, and Maxine Kennett. 2004. “WTO Membership and Market Access.” Unpublished, Brookings. Felbermayr, Gabriel J., and Wilhelm Kohler. 2005. “Exploring the Intensive and Extensive Margins of World Trade.” Unpublished, Tübingen University. Ferrantino, Michael J. 2006. “Policy Anchors: Do Free Trade Agreements Serve as Vehicles for Developing Country Policy Reform?” Unpublished, USITC, reprinted as Chapter 5 in this volume. Gowa, Joanne, and Soo Yeong Kim. 2006. “An Exclusive Country Club: The Effects of the GATT on Trade, 1950–94.” Unpublished, Princeton University. Helpman, Elhanan, Marc Melitz, and Yona Rubinstein. 2005. “Trading Partners and Trading Volumes.” Unpublished, Harvard University. Krueger, Anne. (Ed.) 1998. The WTO as an International Organization. Chicago: University of Chicago Press. Leeson, Peter T. 2005. “How Important is State Enforcement for Trade?” Unpublished, George Mason University. Li, David D., and Changqi Wu. 2004. “GATT/WTO Accession and Productivity.” In Takatoshi Ito and Andrew Rose (Eds.). Growth and Productivity in East Asia. Chicago: University of Chicago Press. Liu, Xuepeng. 2006. “GATT/WTO Promotes Trade Strongly: Solving the Sample Selection Bias.” Unpublished, Syracuse University. Piermartini, Roberta, and Robert Teh. 2005. “Demystifying Modelling Methods for Trade Policy.” WTO Discussion Paper No. 10: Geneva: WTO. Rose, Andrew K. 2004a. “Do We Really Know that the WTO Increases Trade?” American Economic Review (Mar.) 94(1): 98–114. Rose, Andrew K. 2004b. “Do WTO Members have More Liberal Trade Policy?” Journal of International Economics (Jul.) 63(2): 209–35.

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Rose, Andrew K. 2004c. “Response to Subramanian and Wei.” Unpublished, UC Berkeley. Rose, Andrew K. 2005a. “Does the WTO Make Trade More Stable?” Open Economies Review (Jan.) 16(1): 7–22. Rose, Andrew K. 2005b. “Response to Tomz, Goldstein, and Rivers.” Unpublished, UC Berkeley. Rose, Andrew K. 2005c. “Which International Institutions Promote International Trade?” Review of International Economics (Sep.) 13(4): 682–98. Schott, Jeffrey J. (Ed.) 2004. Free Trade Agreements: US Strategies and Priorities. Washington, DC: Institute for International Economics. Subramanian, Arvind, and Shang-Jin Wei. 2006. “The WTO Promotes Trade, Strongly but Unevenly.” Unpublished, International Monetary Fund. Tang, Man-Keung and Shang-Jin Wei. 2006. “Is Bitter Medicine Good for You? The Economic Consequences of WTO/GATT Accessions” Unpublished, International Monetary Fund. Tomz, Michael, Judith Goldstein, and Douglas Rivers. 2005. “Membership has its Privileges: The Impact of GATT on International Trade.” Unpublished, Stanford University.

8 Does WTO Membership Make a Difference at the Extensive Margin of World Trade? Gabriel Felbermayr and Wilhelm Kohler

8.1

Introduction

Becoming a member of the World Trade Organization (WTO) is not just a question of “raising one’s hand.” Accession is subject to a complex negotiation process, which is costly and which involves demands from existing member countries that applicant countries do not necessarily consider to be in their own immediate interest. Perhaps inevitably, bilateral or regional arrangements may often seem more attractive than WTO Membership. Accession commitments relate to market access, as well as policy rules not directly related to trade. Both add up to something like a “price” for WTO Membership.1 Although the price tag is negotiable, the negotiating process is somewhat biased in favor of existing members. Moreover, there is evidence that the price has risen through time; see Evenett and Primo Braga (2005). Yet, countries are willing to pay this “price.” so there must be a benefit. Arguably, the most important and immediate benefit is an expected increase in exports to existing member countries, beyond the levels that would otherwise be reached. In turn, the “price” that incumbents charge for accepting a new member must be worth something to them as well. Again, it is the expected rise in exports to new member countries. This is in line with what Krugman (1991) has dubbed “GATT think,” essentially a two-sided mercantilist obsession with increasing one’s exports. However, it is enlightened mercantilism in that the principle of reciprocating market access concessions gives indirect leverage to consumer interests (in cheap imports) that would otherwise be victimized in the domestic political process by dominating producer interests (in large export markets) in both countries. Adding severe restrictions on the use of export subsidies, a further important cornerstone of “GATT think,” this enlightened mercantilism unleashes forces towards freer trade. 2 Under reasonable conditions, but not inevitably, it also leads to more trade. 217

218 Gabriel Felbermayr and Wilhelm Kohler

According to this logic, one would expect that WTO accession boosts bilateral trade between acceding and existing member countries. In particular, WTO Membership is commonly regarded as a key vehicle to integrate less developed countries into the world trading system and thus to enhance their growth and development perspectives. Did the WTO deliver on this account? This question, of course, has many dimensions and there is no easy answer. But surely, the WTO should at least have had a trade-promoting influence. Despite the general perception of the WTO as key force behind the enormous increase in world trade observed after World War II, identifying a statistically significant effect of WTO Membership on the volume of bilateral trade turns out to be harder than expected. Several approaches have been pursued in the literature, with varying results. 3 Perhaps the most important and widely recognized study is Rose (2004a), in which he searches for a significant effect of WTO Membership on the level of bilateral trade in a conventional econometric analysis of a large panel of data covering 50 years and 175 countries, controlling for other determinants as suggested by the gravity theory of trade. Summarizing an extensive investigation exploring many perturbations of the data, Rose concluded, at the time, that “we currently do not have strong empirical evidence that the GATT/WTO has systematically played a strong role in encouraging trade.” Given the aforementioned logic that underlies General Agreement on Tariffs and Trade (GATT), it is not surprising that Rose’s findings have caught a great deal of attention. They seem to cast doubt on the WTO as a “success story” that exemplifies the virtues of multilateral trade liberalization. At a time when countries increasingly seem to turn their back on the multilateral system for the sake of regional trade arrangements, the results must seem like bad news for those who preach the benefits of multilateralism. However, far-reaching policy conclusions don’t seem warranted. Indeed, it is not even clear whether we have a puzzle. There are several potential explanations for Rose’s results, some of them perhaps more worrying than others. Hence, we need more research. In a companion paper, Rose (2004b) shed further light on the issue by examining whether WTO Member countries have systematically followed more liberal trade policies than nonmembers. And his conclusion, again, is that “there is little evidence that membership in the GATT/WTO has actually liberalized trade policy.” This seems like a consistent explanation of the results in Rose (2004a), but it also seems to make them more worrying. After all, fostering more liberal trade policies was GATT’s, and still is the WTO’s, primary mandate. And the presumption underlying the a-priori expectation that membership should promote trade is that this mandate has indeed largely been fulfilled. But the message is not as devastating as it might appear at first sight. As Rose (2004b) himself aptly points out, it is important to be aware of a subtle distinction. It may be true that, given the existence of the WTO, Member countries do not pursue systematically more liberal trade policies

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than nonmembers. But this does not mean that these policies are less liberal than they would be without the presence of the WTO as an institution. We probably don’t know enough about the counterfactual to reach a firm conclusion on this latter question. In particular, it would certainly be strange to argue, on the basis of Rose (2004b), that the world would be a better place without the WTO. But still, the “policies explanation” of Rose (2004a) that Rose (2004b) apparently offers seems to raise a somewhat worrying specter. However, in this chapter we do not want to explore any of the issues related to the “policies explanation” of Rose (2004a). Instead, we want to go back to the initial results related to trade as such. It must be pointed out that Rose (2004a) has tried out a large number of empirical methodologies on different partitions of his data set in order to reach a robust story. He is careful to point out that the data do tell partial stories where WTO Membership seems to have promoted bilateral trade. But the evidence, in his view, does not add up to a convincing story of a systematic overall positive influence of membership on trade.4 Several authors have since readdressed the issue, and have come to different conclusions. In his summary of “what happened afterwards,” Rose (2006) identifies three dimensions in which his earlier conclusion might need revision. The first relates to “excessive pooling” in the country, time, or industry dimension. In our view, the question here is whether there is enough systematic variation across countries, times, or industries, that would allow us to come up with a helpful and interesting explanation of why WTO Membership fails to exhibit a systematic influence in the full panel. The time dimension has been explored quite extensively already in Rose (2004a), and the sector dimension would seem rather obvious, given the “classical” GATT exemptions for sectors like textiles and agriculture.5 Exploring the country dimension, Subramanian and Wei (2007) conclude that WTO Membership promotes trade mainly, and strongly, for industrial countries, but not for developing countries.6 Interestingly, their explanation runs partly along the aforementioned “policies explanation.” They argue that industrial countries have simply made more out of their WTO Membership in terms of trade liberalization attempts. A related point is that the WTO may have also served as a trade-liberalizing catalyst for countries who are not (yet) formal members; see Tomz et al. (2007) and the reply by Rose (2007). The second potential “revisionist” point relates to whether evidence in the time dimension should deserve more confidence than evidence in the crosscountry dimension. In some sense the point is technical in nature, relying essentially on the presumption of unobserved country (or even dyad) heterogeneity which makes the ordinary least squares (OLS) panel-estimator biased. In terms of substance, an important dimension of unobserved heterogeneity in the usual gravity specification is, of course, trade policy. In the present context, it would seem natural to generalize the trade costs

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in the “multilateral resistance” terms of the Anderson and van Wincoop (2003) gravity equation. These are normally motivated by distance-related costs, and used to argue for country-specific fixed effects. They might obviously be generalized to also represent trade policies of the importer and the exporter countries. However, in one of his specifications Rose (2004a) did in fact include dyad-specific fixed effects (which nest importer and exporter fixed effects), thus looking only at “within variation” in the time dimension. And in these specifications, he did find slightly more protrade evidence of WTO Membership than in others. But the estimated coefficient was very small, hence this point offers very little comfort. The results obtained by Subramanian and Wei (2007), who also stress the importance of countrypair fixed effects, thus seem to be due more to the distinction between developed and developing countries than to the more general country fixed effects. But there is a question of interpretation that arises in this regard. If the WTO’s prime mandate is to foster more liberal trade policy, why should we expect to find any additional trade-promoting influence, once we control for trade policies via fixed effects? To the best of our knowledge, this question has not been addressed so far in the literature. We address it in the model that we propose below. The third line of criticism acknowledged by Rose (2006) relates to a potential selection bias. By ignoring all country pairs where trade is zero, Rose (2004a) has also ignored a potentially important trade-promoting influence of WTO Membership. Members may trade with more countries than nonmembers and a country may experience an increase in the number of trading partners once becoming a member of the WTO. This is the so-called extensive margin of world trade, as opposed to the intensive margin relating to how nonzero trade varies across countries and time. We have argued elsewhere that excluding the extensive margin generates biased estimates if OLS is used, and we have included it via Tobit estimation techniques; see Felbermayr and Kohler (2006). In one of our specifications we have found evidence of a trade-promoting influence of WTO Membership.7 In this chapter, we intend to undertake a more comprehensive search for WTO Membership effects at the extensive margin. Indeed, the concluding words by Rose (2006) in his survey set the stage for our analysis. He writes: “I am now persuaded that membership in the GATT/WTO encourages the creation of trading links where none might otherwise exist. How important this is to world trade and welfare is currently unclear to me; I look forward to more work on this area.” More specifically, the plan of our chapter is as follows. In Section 8.2, we first present a theoretical model that explains why WTO Membership might play an important role at the extensive margin of world trade. The model is close to Helpman et al. (2008), and it gives rise to what we call a corner-solutions approach to the gravity equation. In Section 8.3, we then show the importance of missing and zero trade data in the Direction of

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Trade Statistics (DoTS) of the International Monetary Fund (IMF), which we use in our subsequent econometric estimation. Section 8.4 reports a series of heuristic results on the role of WTO Membership at the extensive margin that we have extracted from our data, without resorting to the gravity equation. In Section 8.5, we turn to an econometric analysis of the gravity equation, based on the corner solutions model of Section 8.2. We first confirm Rose (2004a) in showing that our data (1965–2004) do not reveal a strong and robust effect of WTO Membership on the intensive margin of bilateral trade. Subsequently, we put the pieces together and estimate our cornersolutions gravity model. We find the extensive margin to make a difference in two ways. Excluding zero trade observations does, indeed, give rise to a downward-bias of the relevant WTO-coefficient; and WTO Membership does promote trade at the extensive margin.

8.2

A simple model of the extensive margin

The standard gravity model of bilateral trade is based on Dixit-Stiglitz-type product differentiation (‘love of variety). Within this model, researches typically assume and monopolistic competition iceberg-type (ad-valorem) variable trade cost. These are meant to capture natural barriers to trade, related to distance and transport, as well as policy-induced barriers such as tariffs. The problem with this model is that it does not allow for zero trade between any two countries, hence there is no extensive margin. However, the extensive margin becomes important as soon as there are fixed costs of exporting and if these costs are specific to the market served. Following Baldwin (1988), we refer to such costs as beachhead costs.8 Helpman et al. (2008) show that the combination of beachhead costs and firm level heterogeneity in productivity, combined with cross-country variation in efficiency, implies that any given country need not serve all foreign markets. This is a natural point of departure for modeling the WTO at the extensive margin. In particular, we argue that – other things being equal – joint WTO Membership of the exporter and importer country should lower variable trade costs, as well as the beachhead costs of exporting. For instance, beachhead costs may result from a certain likelihood that a certain destination country disrupts trade, for instance to alleviate perceived temporary pressure from import competition. Ex ante, an exporting firm may thus face a higher likelihood of periodic temporary reductions in profits from exporting to non-WTO countries than to a WTO country, provided the exporter country itself is a member. There are several reasons for this, and we do not go into details here. Suffice it to mention the host of rules-related policy commitments entered upon accession (see Evenett and Primo Braga, 2005), as well as WTO-type tariff-bindings and the reduction of uncertainty afforded by the WTO rules on safeguard protection, antidumping provisions, and traderelated intellectual property rights (or property rights more generally). In

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an intertemporal model, WTO Membership would thus affect the present value of future profits from exporting. Here, we take a short cut and model this as lower beachhead costs in a static monopolistic competition model of exporting. Suppose the world consists of C countries, i = 1, ...,C, which differ only with respect to their aggregate efficiency, which we denote by (ci) –1. For simplicity, assume that labor is the only factor of production and that firms produce different varieties of a single good, whereby all consumers have identical Dixit-Stiglitz-type preferences, with
≡ 1/(1– ρ)>1 describing the constant elasticity of substitution (CES) between any two (symmetric) varieties. Firms have constant, but different, marginal labor input requirements per unit of output, denoted by a. We assume that a is distributed according to some cumulative distribution function G (a), which is identical across countries and has support [aL, aH]. Notice that the variable a relates to the firm’s own distinct variety. We simplify by using a also to index producers and, thus, varieties according to the Dixit-Stiglitz utility function. Since G (a) is identical across countries, we abstain from additionally indexing a by the producer country. For the sake of further simplicity, we abstain from determining entry and exit of firms as such. We assume a given number of Ni firms in country i, all of which are actively selling in their home market. We refer to Melitz (2003) for a mechanism determining the continuous analog to our Ni. In this mechanism, Ni would be influenced by the prospect of exporting through an aggregate zero-profit condition, including profits on exporting. Our partial equilibrium model thus squarely focuses on the extensive margin of exporting.8 In our exposition, we closely follow Helpman et al. (2008). Denoting the c.i.f. price for a good of variety k in country j by pkj , demand s for this variety may be written as xkj A j ª¬ pkj º¼ where Aj ≡ Yj(Pj)σ–1 In this expression, Y j is equal to country j’s expenditure on goods, and P j is the unit-expenditure function (or exact price index), depending on prices of all varieties served to market j.9 Since each producer manufactures a unique variety, it has market power. Following established tradition, we assume that each producer in country i treats P j (i = 1, ...,C) as a given, thus perceiving a price elasticity of demand equal to
. Normalizing the wage to unity, marginal costs of a producer a are equal to ci a, and its profitmaximizing “ex-factory” price is equal to ci a/ρ , where 1/ρ > 1 is the usual markup factor. Firms in country i who consider serving consumers in country j must incur fixed beachhead costs equal to ci f ij depending on the identity of the exporter (i) and the importer (j) country.10 Notice that these costs also depend on the exporter country’s aggregate efficiency parameter c i. Besides the beachhead costs, there are variable trade costs of the usual iceberg type, denoted by τ ij ≥ 1. Domestic sales do not require any of these costs, whence

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τ ij = 1 and f ij = 1. The profit-maximizing c.i.f. price in country j is then equal to ci aτ ij/ρ. It is assumed that all firms are active in their domestic markets where there are no trade costs. Additional profits to be earned by exporting from country i to country j depend on a firm’s efficiency and are given by πij (a) = B j (ciτ ija)1–
– ci f ij,

(1)

where Bj = Aj (1–ρ)ρ
–1. Note that from a single firm’s perspective B j is given, hence profits are linear in (ciτ ija)1–
, whereby B j is a measure of the size of the foreign market j. The marginal firm that just breaks even on exports to foreign market j is determined by the condition πij (a) = 0. This gives rise to a cut-off value 1

a

ij

ª º V 1 j « BV » W ij  « §¨ c i ·¸ f ij » ¬© ¹ ¼

(2)

such that all firms with efficiency a > aij would make losses by exporting from country i to country j. Clearly, this cut-off value is specific to the exporter-importer relationship and is increasing the size of foreign market B j. It also increases in the exporting country i’s overall efficiency 1/ci, while falling with higher beachhead costs f ij, and higher variable trade costs τ ij. All of this is intuitive. A country-i firm with a < aij will have export sales to country j equal to ( c i aW ij U ) u A j ( c i aW ij U )V A j U V 1 ( c i aW ij )1V . We now define a latent variable / ij

A j U V 1 §¨© c iW ij ·¸¹

1 V

aij

N i ³ a1V dG  a  aL

(3)

In this expression, the integral is the “Melitz aggregator” that allows us to describe aggregate exports in the face of firm-level heterogeneity, given Ni , the exogenous number of producing firms in country i. Actual unit-level input requirements are constrained to a ∈ [aL, aH]. In contrast, aij denotes a virtual input requirement that would just trigger positive exports from country i to country j. Thus, the case aij ≤ aL generates a solution of zero bilateral exports. The point now is that aij is unobservable. What we observe, instead, is an array of multiple trade barriers that for some country pairs gives rise zero trade. How can we derive a workable empirical model? One way is to stipulate a latent variable ij as an increasing function of ij a / aL such that for all aij / aL > 1 we may set ij = Xij + 1, and for aij / aL < 1 we have Xij = 0. This is what we have elsewhere called the “corner-solutions” gravity model, and which may be estimated using Tobit techniques; see Felbermayr

224 Gabriel Felbermayr and Wilhelm Kohler

and Kohler (2006). Equation (3) suggests that this function should be multiplicatively separable, such that / ij : X ij ˜ *  aij aL , with X ij : U V 1 A j N i  c W

(4)



i i 1 V

, and *  aij aL suitably specified such that we may

take logs. Note that the “Melitz aggregator” in equation (3), which is behind *  aij aL , is the same for all countries.

ij Suppose that we may write *  a aL in constant elasticity form, with elasticity γ. We then have

ln / ij

ln / ij0  1  V  ln c i  ln W i  ln * 0  J  ln aij  ln aL ,

(5)

ij V 1 j i where ln / 0 : ln  U A N . Invoking equation (2) for the virtual trigger ij value a , we arrive at

ln / ij

V § L0  ln / ij0  ¨ 1  V  J 1V ©

1 · i i ln f ij , (6) ¸ ln c  1  V  J ln W  J 1 V ¹

where L0 : ln * 0  J ln aL . Notice that by assumption we have
> 1. Figure 8.1 illustrates the corner-solutions nature of this extensive margin model. It depicts ln ij as a linear function of ln τ ij, plotting –ln τ ij towards the left. The dashed parts of the lines ln ij indicate the corner solution in line with equation (4). The underlying assumption is that country j is a WTO Member. A “within-variation” at the intensive margin can now be depicted as ' ln / ij 1  V  J §¨© ln W 1ij  ln W 0ij ·¸¹  ª¬J 1  V º¼ §¨© ln f1ij  ln f 0ij ·¸¹ , whereby the variable and beachhead cost values marked 1 (0) indicate a situation where country i has (not yet) become a member of the WTO. A “within-variation” at the extensive margin would be observed for some other country l, starting out from a higher value of real trade costs τ 0lj , where the same beachhead cost reduction from country j joining the WTO alone would suffice to “wake up” a dormant trading relationship. A “between-variation” at the extensive margin would be observed between countries k and l, both having the same level of real trade costs τ kj0 = τ 0lj , but with country k being a member of the WTO while country l is not. It is obvious that any such “between-variation” could also be caused by differences in overall efficiencies c k and c l. We shall use this corner-solutions model of bilateral exports, in order to specify a gravity equation which we then estimate on a panel data set comparable to Rose (2004a). Details on that specification, as well as the estimation strategy, will follow below. What we want to do next is provide some descriptive evidence on the importance of the extensive margin in postwar evolution of world trade, and to investigate by means of simple heuristic

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ln Λgj ij 1

<

ij 0

“within-variation” – intensive margin : ∆ ln Λij =

γ (1− σ ) ln

ij 1

− ln

ij 0

ij 0

ln Λ1ij

+ (1− σ − γ ) lnτ1ij − lnτ ij0 ln Λij0

− lnτ

ln Λ 0kj

gj

− lnτ 0ij

− lnτ1ij

0 ln Λlj0

− lnτ 0lj

“within-variation” – extensive margin: ln Λ1lj − ln Λlj0 “between-variation” – extensive margin: ln Λ 0kj − ln Λ lj0 Figure 8.1 The “corner-solutions” model of bilateral exports

techniques whether WTO Membership appears to play a role at the extensive margin.

8.3

Quantifying the extensive margin of trade

To discuss the empirical importance of the extensive margin of world trade, we rely on the IMF DoTS, which is a commonly used collection of yearly export and import data of manufactured goods for a large number of countries. According to the CIA World Factbook, as a result of decolonialization and the breakup of the Soviet Union and other smaller countries, the number of sovereign countries increased from 67 in 1945 to 192 in 2005. While the entry of new countries into the panel per se is not a problem in the econometric analysis, it potentially blurs the descriptive analysis that we are about to undertake now.11 In the descriptive analysis of this section, we therefore focus on a balanced panel of countries by restricting ourselves to a sample of 104 countries that have consistently been sovereign from 1965 right up to 2004. This sample contains industrialized countries, as well as developing countries and a couple of formerly communist countries (e.g., China or Poland).12 According to the DoTS, roughly 89 percent of the 2004 total value of world trade (approximately U.S.$841 billion) is attributable to country-pairs that existed before 1965, and 11 percent to pairs created after 1965.

226

Gabriel Felbermayr and Wilhelm Kohler

We define a trading relationship either as a directed dyad (exports from i to j) or as undirected dyads (exports in both directions, i.e., from i to j plus j to i). In the following, we also call an undirected dyad a bilateral trading relationship. In the first case we have 104  103 = 10,712 country-pairs per year, while in the second we have half that number, that is, 5,356 Figure 8.2 plots the fraction of directed relationships for which exports where either positive, zero, or missing. Clearly, the number of export relationships increased quite substantially between 1966 and 2004. While in 1966 a mere 37 percent of all potential trading relationships were active, this number had gone up to about 80 percent by 2004. In contrast, during the same period the share of relationships characterized by missing trade had fallen from about 16 percent to 2 percent, with a major improvement in the data coverage occurring around 1981. Over the 40 years from 1965 to 2004, 7.6 percent of all directed dyads feature missing trade, 35.4 percent have zero trade, and the remaining 57 percent have strictly positive trade volumes. Figure 8.3 breaks down bilateral trading relationships. A bilateral trading relationship is considered active if at least one partner has positive exports. More precisely, let Iijt = 1 if Xijt > 0 and zero otherwise, and then define Sijt ≡ Iijt + Ijit. Obviously, Sijt is zero if there is no trade between countries i and j at time t. It takes the value of 1 if either i has positive exports to j or j has positive exports to i. Finally, it becomes 2 if both countries have positive exports to each other. In Figure 8.3 we plot the fraction of 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 0

20

40

60

80

100

Percent Positive trade

Zero trade

Figure 8.2 Potential export relationships 1966–2004

Missing trade

Does WTO Membership Make a Difference?

227

bilateral trading relationships where Iijt = 2 (two-way trade), Iijt = 1 (one-way trade), Iijt = 0 (zero bilateral trade). Missing refers to the case where Xijt and Xjit are both missing. Figure 8.4 gives a rough sense of magnitude regarding the importance of the extensive margin by depicting the cumulative share of trading relationships of different “vintage.” For instance, the figure shows that the 1965 “vintage” of trading relationships (those that already had strictly positive trade in 1965) is responsible for about 85 percent of the 2004 trade volume. In other words, the total contribution of the extensive margin to 2004 trade over the time span 1965 to 2004 is about 15 percent. Clearly, as we move toward more recent “vintages,” the cumulative contribution of the extensive margin becomes smaller and smaller.13 Overall, Figures 8.2 through 8.4 clearly suggest that the extensive margin has played a nonnegligible role for the total growth of world trade from 1966 up to 2004.

8.4 WTO Membership at the extensive margin: Heuristic evidence In this section, we first explore “heuristic evidence” on WTO Membership at the extensive margin of world trade that may be extracted without relying on a fully specified corner-solutions gravity model of trade. We first take

1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 0

20

40

60

80

100

Percent

Positive two-way trade

Positive one-way trade

Zero bilateral trade

Figure 8.3 Potential bilateral relationships 1966–2004

Missing bilateral trade

228 Gabriel Felbermayr and Wilhelm Kohler 1

0.95

0.9

0.85 1965

1970

1975

1980

1985

1990

1995

2000 2004

First year active Figure 8.4 Share of “trading vintages” in 2004 world trade

a cross-sectional perspective, and then turn to the time series dimension. Table 8.1 runs a multinomial Logit model of the variable Sijt (defined above) on the two dummies BOTHIN and ONEIN, alongside commonsense covariates, such as the GDPs of both countries, geographical distance, adjacency, common language, and a comprehensive set of time dummies. We take the zero-trade outcome of Sijt as a benchmark and show coefficients transformed into marginal effects at the respective covariate sample means. The results are in line with expectations. If two countries are in the WTO, the probability for Sijt = 2 is about 15 percentage points higher than the one for Sijt = 0. The other covariates similarly take values according to intuition. All coefficients are different from zero at conventional levels of statistical significance. Do WTO Members systematically have more active trading relationships? Limiting attention to 110 countries that have been in existence as sovereign entities since 1965, we find that the average number of trading partners increased from 42 in 1965 to 86 in 2004. Given the overall number of members at any point in time, the model proposed above would predict that – ceteris paribus – member countries should have more active trading relationships than nonmembers. As a rough first check, we run a simple Poisson regression (explaining the presence or not of a positive trading relationship) with fixed effects, explaining the number of trading partners of a country as a function of its own WTO Membership and various country characteristics. We also include a set of time dummies to capture common time trends. Table 8.2 sets the Poisson results against a linear model, which we estimate with OLS, and a negative binomial model augmented by fixed effects. The results

Does WTO Membership Make a Difference?

229

Table 8.1 Existence of trading relationships: Multinomial logit estimates Zero trade (base outcome) Both in GATT/WTO

One-way trade

Two-way trade

–0.081

0.153

(0.007) One in GATT/WTO

ln GDP1

–0.083

0.192

(0.015)

(0.025)

–0.103

0.191

(0.003) ln GDP2

ln DIST

Contiguity

0.171

(0.003)

(0.004)

0.153

–0.296

(0.007)

(0.009)

–0.115

0.193 (0.033)

–0.064

0.126

(0.010)

(0.014)

Observations

177,186

Pseudo R2

0.3284

Log Pseudo-LL

(0.004)

–0.082

(0.025) Common language

(0.010)

–120,164

Note: Coefficients are marginal effects evaluated at sample means for dummy variables (“BOTHIN” and “ONEIN”), the coefficient relates to the discrete change of the dummy from 0 to 1. Robust standard errors (adjusted for clustering within country pairs) in brackets. Source: Author’s own calculations based on the data described in the text.

support our expectation. The linear model predicts that joining the WTO increases the expected number of trading partners by 4.3. The Poisson model implies that WTO Members have 12 percent more trading partners than nonmembers, while the negative binomial model shows a smaller effect – of about 9 percent.14 Given that the sample mean of the number of trading partners is 57, the nonlinear results imply that WTO Members have between 5.1 and 6.8 more trading partners than nonmembers. Note that these results are robust to omitted variables bias to the extent that those are time invariant. Countries with more trading relationships need not necessarily have a more diversified trade pattern. We have argued above that trade with a fellow WTO Member country involves a lower risk of unexpected policy interference or enforcement problems. We have crudely modeled this through country-pair-specific beachhead costs. However, depending on

230 Gabriel Felbermayr and Wilhelm Kohler

Table 8.2

Number of trading relationships: Poisson regression (panel estimates) Linear (OLS)

WTOi

4.269 (2.152)*

ln GDP i

12.336 (3.404)**

Constant

–243.422

Observations

3,871

(78.039)**

R-squared

Exponential (Poisson)

Negative binomial

0.122 (0.045)** 0.142

0.090 (0.045)* 0.133

(0.067)*

(0.069)

–0.389

–0.317

(1.213) 3,871

(1.247) 3,871

0.56

Note: Robust standard errors in parentheses, * significant at 5 %; ** significant at 1 %. All regressions include country i and time fixed effects (not shown). Source: Author’s own calculations based on the data described in the text.

the underlying correlation structure, firms might also be able to deal with this type of risk through diversifying their export destinations. As a result, WTO Members would feel less pressure to diversify their trade structure and would converge to a less diversified structure of trade, which is more in line with the pattern of comparative advantage. At the same time, if WTO Membership goes hand in hand with decreased trade costs, new trading partners may become attractive destinations, thus leading to a lower degree of concentration. A priori, the effect would seem ambiguous. To obtain a first rough idea on which of the two effects was dominant in the postwar development of trade, we compute the Herfindahl index of export concentration.15 Figure 8.5 suggests that WTO Membership is indeed associated with lower levels of export concentration. We run a simple linear regression model to check whether the pattern depicted in Figure 8.5 survives conditioning on covariates, such as the country’s GDP, its remoteness (measured by average distance of country i from its trading partners), total GDP of the world economy, and the total number of WTO Members. Table 8.3 reveals that WTO Membership is associated with a lower degree of concentration. But, though statistically significant and robust, the effect is rather small. WTO Members have a concentration measure that is between 0.012 and 0.015 points lower than that of nonmembers. Given that the average degree of concentration is 0.20, the conclusion is that WTO Membership does not make a large difference across countries for the destination country concentration of exports. Finally, we turn to the time series dimension, asking whether WTO Membership comes with a higher likelihood for a dormant trading relationship to rise into activity. Figure 8.6 plots average yearly transition probabilities

Does WTO Membership Make a Difference?

231

0.3

0.25

0.2

0.15 1965 1970 1975 1980 1985 1990 1995 2000 2004 Year Nonmembers

Members

Figure 8.5 Concentration of export destinations – Herfindahl index

Table 8.3 Export concentration as a function of WTO Membership and other covariates WTO

ln GDP

ln GDP

ln (avg. DIST)

–0.014

–0.012

–0.015

(0.004)*

(0.004)*

(0.004)*

–0.020

–0.020

–0.023

(0.001)*

(0.001)*

(0.001)*

–

–

–0.045

–

–

(0.012)*

–

–

0.034

–

–

(0.007)*

–

–

0.000

–

–

(0.000)

ln (WTO*size)

Observations Adjusted R-squared

5,080 0.12

5,080 0.13

5,080 0.13

Note: Robust standard errors in parentheses, * significant at 1 %. Specification (2) contains time fixed effects. All specifications contain a constant (not shown). Source: Author’s own calculations based on the data described in the text.

for WTO Members (right-hand panel, labeled 1) and nonmembers (left-hand panel, labeled 0), again looking only at countries that have existed as sovereign entities throughout the entire period from 1965 to 2004. As a general pattern, the probability that a given zero turns into a positive trade flow (marked Pr(≥1), in a lighter shade) has risen through time for both member

232 Gabriel Felbermayr and Wilhelm Kohler Pr (0−>1)

20

Pr (1−>0) 15

10

5

4 00

4

–2 94 19

85

–9

4 19

–8 75 19

00 19

94

–2

85

0

19 65 –7 4

4

4 –9

4 19

–8 75 19

19

65

–7

4

0

1

Figure 8.6 Transition probabilities for active/dormant trading relationships

countries and nonmembers. However, in all periods of time WTO Members have consistently turned zero trade flows into positive ones with slightly higher probabilities. The opposite pattern obtains when looking at the transition from positive trade flows into zeros (marked Pr(≤1), in a darker shade). The associated probabilities are always lower than the probabilities to transit from inactivity to activity, and lower for WTO Members than for nonmembers. However, while the probability has remained fairly stable for the group of members (right-hand panel), it has fallen for the group of nonmembers.

8.5

WTO Membership: An econometric analysis

The heuristic evidence of the preceding section seems to indicate that WTO Membership matters at the extensive margin of trade creation. However, while we did include some covariates here and there, we certainly did not control for other determinants of trade in any systematic way. It is worth remembering that Rose (2004a) was able to estimate a highly significant positive effect of WTO Membership ceteris non paribus, i.e. leaving other factors uncontrolled for in the procedure. The point was that the effect has all but vanished, once standard gravity effects have been allowed to enter the stage. Of course, there are several ways to bring structural determinants of trade into the picture, and any single approach is unlikely to capture them all. But arguably, the gravity approach is the most convincing one in this

Does WTO Membership Make a Difference?

233

context, for at least two reasons. First, unlike the traditional theory of comparative advantage, it is able to explain not only a country’s global trade, but also its bilateral trade. And second, it has been remarkably successful empirically, consistently throughout several decades of applied research. However, although we have alluded to the gravity approach in Section 8.2 above, equation (6) is not yet a gravity equation, ready for estimation. The variables ci, τ ij and f ij will all be replaced by appropriate proxy variables. This is essentially a question of data availability and efficiency of estimation; see below. On a conceptual level, we need to close the model in two different ways. First, for the exporter country i, we must impose a factor market clearing condition that gets rid of Ni for the sake of country i’s GDP and the price and output of its variety. And secondly, we need to solve for P j the overall price index for the destination country, which is a complex function of all c.i.f. prices. This introduces a comprehensive interdependency across all exporter countries’ values for ci, τ ij and f ij (i = 1, ...,C). We refer to Feenstra (2004) for a convenient summary of how an estimable gravity equation might be derived. The specification that we eventually employ may be written as ln / ij

E1BOTHIN ij  E1ONEIN ij  E 3 ln FTA ij  E 4 ln DIST ij  E 5 ln ADJA ij  E6LANGij  Q  Q i  Q j  u ij 

(7)

where ν is a constant, ν i and ν j are exporter and importer fixed effects, and uij is an error term with the conventional properties. The other variables ij ij on the right are self-explanatory dummies, with BOTHIN and ONEIN ij indicating WTO Membership and FTA indicating joint membership in a regional trading block. With the existence of a time dimension, we need to include time-variant fixed effects ν i × ν t and ν j × ν t , as argued by Baltagi et al. (2003) and Baier and Bergstrand (2007). This is common practice in lieu of a more satisfactory treatment of “multilateral resistance” that Anderson and van Wincoop (2003) have shown to be a key determinant of bilateral trade in the gravity equation. Inclusion of time-variant fixed effects takes into account all exporter- or importer-specific determinants of trade, such as, in particular, the two country’s GDPs.16 In this way, all terms appearing in ij0 in equation (6) are eventually covered by fixed effects, while the forces behind ci, τ ij, and f ij are taken up by the usual resistance dummies of the gravity equation (joint FTA Membership, geographical distance, adjacency, and common language), amended by the WTO dummy, which is the prime focus of our analysis. Equation (7) is not ready for estimation, since it involves latent trade as a dependent variable. Adding equation (4) generates a corner-solutions model of bilateral trade. Applying the logic developed in Wooldridge (2002: 524–25), we demonstrate in Felbermayr and Kohler (2006) that any empirical specification where the zero trade observations (and thus corner solutions)

234 Gabriel Felbermayr and Wilhelm Kohler

are ignored implies an omitted variable bias, leading to inconsistent estimates of all variables in the model. In particular, an empirical strategy that draws on non-zero trade data only, as in Rose (2004a), will systematically underestimate the effect of WTO Membership on trade. Importantly, even if the extensive margin as such does not contribute a lot to the growth of world trade, as some of the figures above might suggest, this does not imply that it is irrelevant for estimation: estimates based on non-zero trade flows alone, that is, the intensive margin estimates, will be biased downward nonetheless. In line with the arguments in Felbermayr and Kohler (2006), we estimate our corner-solutions model employing a Tobit estimation approach. This allows us to disentangle the two margins, which seems important also with respect to the influence of WTO Membership on world trade. In particular, ij writing Z t for the entire explanatory variables, the expected value of bilatij eral exports, conditional on Xt can be broken down according to E §¨© Xtij _ Ztij ·¸¹

E  Xtij _ Ztij  Xtij ! 0 u Pr §¨© Xtij ! 0 _ Ztij ·¸¹ 

(8)

Tobit estimation allows us to present separate marginal coefficients for both terms on the right-hand side, the first being the traditional intensive margin, the second being the extensive margin. In the subsequent presentation of results, we report marginal effects on Pr §¨© Xtij ! 0 _ Ztij ·¸¹ from Probit estimation (conditional probability of a positive relationship), and marginal ij ij · § effects on E ¨© Xt _ Zt ¸¹ from Tobit estimation (conditional expected value of exports). Introducing trading arrangements as explanatory variables in equation (7) raises an endogeneity issue, as emphasized by Baier and Bergstrand (2007). They argue that countries might select endogenously into free trade agreements (FTAs). Specifically, if countries select into FTAs because they hope for deeper integration, FTA Membership is negatively correlated with the current level of trade (and hence the error term), as higher current inefficiencies make FTA Membership that much more attractive. In that case conventional estimates of FTA effects are biased downward. However, that logic is not entirely compelling for the case of WTO Membership, because it could go the other way round as well: a country that receives some positive exogenous shock trades more than the natural level indicated by the gravity equation. That additional trade may make it more worthwhile to join the WTO, since transparency and predictability of partners’ trade policy may now be more valuable. Moreover, the recipe proposed by Baier and Bergstrand (2007) in order to counter the omitted variables problem, namely the use of dyadic fixed effects, appears questionable for the WTO context, for the simple reason that the WTO is a multilateral, not a bilateral system. We follow common practice in using time-variant fixed effects to capture multilateral trade resistance; see Anderson and van Wincoop (2003) and Feenstra (2004). This also takes care of the unobserved heterogeneity on the

Does WTO Membership Make a Difference?

235

country level that may affect the decision to join the WTO (such as positive shocks discussed above). A few words on the data, before we proceed to the estimation results. We have clipped the data to the extent necessary in order to obtain a balanced panel. We use the exporter country GDP-deflator to compute real trade flows. Real GDP values are taken from the World Development Indicators. Data on geographical distance, adjacency, and common language are from CEPII, Paris. The FTA dummy was constructed following Baier and Bergstrand (2007). The Appendix 8.1 provides the usual summary statistics for data. Throughout all our specifications, we use bilateral exports as the dependent variable. Note that the inclusion of fixed effects renders GDP variables as covariates redundant. We have pursued the following estimation strategy. The first stage of our strategy involves looking only at “between-evidence” in cross-country estimations for several sample years with ten-year intervals. The second stage then moves on to panel estimates, thus adding the “withinperspective.” In both stages, we first look at simple OLS estimates from country-pairs with positive trade (intensive margin), mainly for the purpose of comparison with existing literature, in particular Rose (2004a). Subsequently, we undertake a Probit estimation for the extensive margin in isolation, and in a final step we complete each of the two stages with a joint treatment of the extensive and intensive margin via Tobit estimation. Table 8.4 presents the cross-section results, while Table 8.5 contains panel estimates. In the following discussion we mainly focus on the effect of WTO Membership. Table 8.4 shows our results from stage one, starting in the top panel with evidence drawn from the intensive margin alone. The estimates of the distance, adjacency, and common language coefficients, as well as their behavior over time, are closely in line with existing literature. Our data, which feature a specific sample of countries (balanced panel) thus yield conventional results, if treated conventionally.17 Turning to WTO Membership, we see that the cross-sectional variation does not yield robust, meaningful estimates. The point estimates for the coefficient on BOTHINij (unity if both countries are WTO Members, and zero otherwise), vary between 0.604 and −3.655. They are mostly negative and statistically insignificant. This mirrors the finding of Rose (2004a). The middle panel reports findings from a Probit model of the extensive margin, using the same covariates as in the upper panel. The same message transpires regarding WTO Membership: the estimates lack robustness and stability over time, with the single exception of year 1995. WTO Membership does not appear to be associated with a higher likelihood that a potential trading relationship is operative. Finally, the bottom panel of Table 8.4 displays results for the cross-section Tobit estimation of our corner-solutions model. We transform the dependij ent variable to ln Xt + 1, which allows us to continue with a log-log gravity model.18 Except for the WTO Membership variables, the corner-solutions model performs as expected: relative to the upper panel, where only nonzero trade observations were used and coefficient estimates are biased towards

236

Gabriel Felbermayr and Wilhelm Kohler

Table 8.4 Cross sectional estimation of the gravity equation 1965

1975

1985

1995

2004

Intensive margin (OLS) BOTHINij

0.604 (0.695)

ONEINij

0.499

Ln DISTij ADJij

R

(0.974)**

(0.672)

(0.705)

(0.421)

–3.570

–0.605

–1.755

–0.655

(0.990)**

(0.679)

(0.725)*

(0.481)

–1.140

–1.394

–1.583

(0.035)**

(0.039)**

(0.040)**

(0.036)**

(0.069)**

0.772 (0.157)** 0.546

0.676 (0.150)** 0.547

0.868 (0.157)** 0.817

(0.036)** 0.872 (0.163)** 0.915

(0.081)**

(0.079)**

(0.072)**

(0.072)**

5126

5910

7306

8404

0.72

0.70

0.70

0.76

0.72

1.20

1.68

1.76

1.78

2.12

0.301

–0.073

3749

RMSE

–0.409

–1.017

0.645

2

–1.194

(0.700)

(0.117)**

N

–0.673

–0.751

0.397

LANGij

–3.655

Extensive margin (Probit) BOTHIN

ONEIN

ij

ij

Ln DIST

ij

ADJij

0.098

0.039

(0.166)

(0.101)

(0.108) –0.128

(0.081)**

0.106

0.072

(0.161)

(0.106)

(0.089)

(0.106)**

–0.350

–0.417

–0.330

–0.284

(0.015)**

(0.016)**

(0.013)**

(0.012)**

0.419 (0.034)**

LANGij

–0.167

0.163

0.258 (0.037)** 0.210

0.206 (0.027)** 0.165

0.282

0.094 (0.030)** 0.151

(0.025)**

(0.020)**

(0.017)**

(0.012)**

N

8300

8040

9381

8650

R2

0.58

0.53

0.54

0.51

–2,389.04

–2,620.71

–2,971.84

–2,765.88

–2.271

4.090

Pseudo LL

(0.037) –0.040 (0.042) –0.159 (0.009)** 0.083 (0.015)** 0.078 (0.009)** 7366 0.44 –2,416.11

Corner solution (Tobit) BOTHIN ONEINij

ij

–

0.173

–

(1.512)

(1.419)

–

2.040

–0.487

(0.994)** 3.459

–1.847 (0.736)* –1.507

Does WTO Membership Make a Difference?

237

Table 8.4 (Continued)

Ln DISTij ADJij

–

(1.540)

(1.444)

(1.042)**

(0.861)

–

–4.034

–3.587

–3.106

–2.355

–

(0.141)**

(0.132)**

(0.103)**

– –

1.659 (0.529)**

2.171 (0.496)**

LANGij

– –

(0.262)**

N

–

9193

10097

Pseudo LL

–

–19,596.58

–22,430.63

3.844

3.459 (0.251)**

1.264 (0.393)** 3.223 (0.192)** 10452

(0.084)** 1.524 (0.324)** 2.304 (0.156)** 10545

–25,489.26 –27,381.33

Notes: Loglinear specification, dependent variable: ln(Xij+1) All estimations include exporterand importer-country fixed effects Standard errors in paranthesis, * significant at 5 %, ** significant at 1 %. The dependent variable is the natural log of nominal exports from country i to country j. Coefficient estimates for country fixed effects and the constant are not reported for brevity. The number of observations used in the Probit model is lower than in the Tobit case (and sometimes even than in the OLS case), because a large number of outcomes is perfectly predicted by the fixed effects, so that the associated observations are dropped. The linear probability model, that does not suffer from this problem, yields results very similar to the Probit case. Source: Author’s own calculations based on the data described in the text.

zero, all coefficients in the Tobit case are larger in absolute terms, thus confirming the attenuation bias from the omitted variable misspecification. As to the WTO Membership effects, we continue to find estimates that are unstable quantitatively and mostly insignificant statistically. The conclusion from the cross-sectional evidence is that there is no evidence for a positive and sizeable WTO effect on bilateral trade. In other words, moving from the nonzero trade flow model of Rose (2004a) to our corner-solutions model does not help. Estimates are somewhat larger, but nonetheless statistically insignificant and economically meaningless. From the previous work briefly surveyed in our introduction, it consistently transpires that drawing on time series variation makes finding robust and meaningful WTO Membership effects somewhat easier.19 To see if this hold in our case as well, we move to stage two of our strategy, exploiting the time series (“within”) dimension of the data, jointly with the cross-sectional (“between”) variation. As regards WTO Membership, we face the difficulty of appropriately timing the start of the “treatment effect.” Countries might undertake steps towards trade liberalization in the run-up to joining the WTO, and they could be allowed considerable transition periods after joining.20 To avoid these complications, instead of using 40 years of data (from 1965 to 2004), we use only five years (1965, 1975, 1985, 1995, and 2004). Table 8.5 reports our findings for stage two of our estimation strategy, that is, panel regressions. As argued above, consistent estimation of the gravity

Table 8.5 Panel estimation of the gravity equation

ij

BOTHIN

(1) E[X|.,X>0]

(2) P[X>0|.]

(3) E[X|.]

(4) E[X|.,X>0]

(5) P[X>0|.]

(6) E[X|.]

(7) E[X|.,X>0]

(8) P[X>0|.]

(9) E[X|.]

OLS

Probit

Tobit

OLS

Probit

Tobit

OLS

Probit

Tobit

0.065 (0.042)

ONEINij

0.054 (0.093)

ln real GDP i

1.165 (0.009)**

ln real GDP j Ln DISTij

ADJ

ij

0.872

0.106 (0.016)** 0.141 (0.002)** 0.112

0.941 (0.098)** 1.671 (0.209)** 2.172 (0.020)** 1.662

–0.062

0.009

0.212

(0.049)

(0.008)

(0.099)*

–0.114 (0.087) 1.542 (0.071)** 0.950

0.008 (0.011) 0.126 (0.009)** 0.104

1.051 (0.176)** 2.434 (0.126)** 1.929

(0.009)**

(0.002)**

(0.019)**

(0.050)**

(0.009)**

(0.112)**

–1.137

–0.203

–2.535

–1.242

–0.193

–2.423

(0.026)**

(0.007)**

(0.068)**

(0.034)**

(0.007)**

(0.084)**

0.789 (0.134)**

LANGij

0.101 (0.008)**

0.543 (0.054)**

0.100 (0.034)** 0.089 (0.010)**

1.120 (0.417)** 1.561 (0.132)**

0.821 (0.151)** 0.771 (0.061)**

0.111 (0.019)** 0.104 (0.007)**

1.501 (0.462)** 2.338 (0.138)**

0.175 (0.064)** 0.131 (0.090)

0.045

0.267

(0.018)*

(0.110)*

0.062 (0.021)**

0.890 (0.219)**

-

-

-

-

-

-

-

-

-

-

-

-

–1.249

–0.320

–2.497

(0.031)**

(0.012)**

(0.082)**

0.717 (0.143)** 0.742 (0.057)**

0.188 (0.043)** 0.168 (0.012)**

1.356 (0.462)** 2.256 (0.135)**

FTA ij

0.169 (0.056)**

Time fixed effects

–

Country fixed effects (time-variant)

–

R

2

–0.440

(0.016)

(0.136)**

Time fixed effects only

Countryfixed effects (time-invariant)

N

–0.028

27,801 0.64

0.189

0.036

(0.056)**

(0.012)**

–0.326

0.38

42,658

(0.059)*

0.107 (0.022)**

Time fixed effects

Time fixed effects

Country fixed effects – timeinvariant

–

– 42,932

0.139

(0.150)*

27,801

0.64

0.71

–0.427 (0.157)**

Country fixed effects – timevariant 42,542 0.45

42,658 0.7

27,801 0.74

35,576 0.51

42,658 0.73

Note: Robust standard errors (adjusted for clustering within groups of country pairs) in parentheses; * significant at 5 %; ** significant at 1 %. All specifications (except Probit) include constants (not shown), and various fixed effects (not shown). Source: Author’s own calculations based on the data described in the text.

240 Gabriel Felbermayr and Wilhelm Kohler

equation requires inclusion of time-variant fixed effects, in addition to a rigorous treatment of the extensive margin.21 We organize our presentation around the inclusion/exclusion of fixed effects. The first three columns exclude all country fixed effects, which corresponds to the baseline method used by Rose (2004a). Columns (4) through (6) include time-invariant fixed effects as in Felbermayr and Kohler (2006), and finally, columns (7) through (9) relate to a model including time-variant country fixed effects.22 This is consistent with the theoretical requirements of the Anderson and van Wincoop (2003) gravity model estimated with time-variant data. Over all specifications, the behavior of estimates other than those for WTO Membership are largely in line with the literature. Column (1) is a variant of Rose’s (2004a) base model, restricted to positive trade flows (intensive margin only) and estimated over five years of data rather than over 50 years. We also use a somewhat shorter list of covariates, and – perhaps most importantly – use directed exports, rather than total bilateral trade as a dependent variable. Rose’s main finding are upheld: there is no effect of WTO Membership on trade. However, looking at the extensive margin with a Probit model, as in column (2), we do find a positive effect, and the same holds for the Tobit model in column (3). The Probit effect is fairly small, implying that WTO Membership increases the likelihood of positive trade by 1.1-fold, a mere 10 percent. However, the Tobit estimate is large: WTO Membership increases exports from one member to the other by 2.5-fold: e0.941 = 2.56, or a 156 percent increase. In line with Felbermayr and Kohler (2006), columns (4) to (6) include time-invariant fixed effects for exporter countries i and importer countries j. Focusing on strictly positive trade flows, we find no evidence for an effect of WTO Membership, and the same holds for the Probit model. But the Tobit model does signal some positive influence of WTO Membership, which is significant: joint membership leads to an increase in bilateral exports of about 24 percent (e0.212 = 1.24). The specification in columns (7) to (9) is fully consistent with theory and yields consistent estimates for membership effects. Interestingly, we now find a positive membership effect also in the conventional, positive-tradeonly regression. The order of magnitude – a 19 percent increase – is similar to that found in frameworks with time-invariant fixed effects in Rose (2004a). The Probit estimate reveals a significant effect also at the extensive margin, albeit very small in magnitude. Finally, the corner-solutions model implies that joint WTO Membership boosts bilateral exports on average by 31 percent (e0.267 = 1.31). It is interesting to look at the ONEIN effects, although there seems to be a less clear cut theoretical prediction for these than for the BOTHIN effects. Yet, there is a relatively clear picture that emerges from Table 8.5. ONEIN coefficients tend to be significant in the same specifications where BOTHIN is significant. Moreover, where significant at all, the ONEIN coefficients are

Does WTO Membership Make a Difference?

241

both larger and have lower standard errors of estimate than the BOTHIN estimates, the sole exception being the OLS-intensive margin with timevariant fixed effects in column (7).

8.6

Conclusion

Having allowed for the extensive margin of world trade to “speak out,” can we be confident that WTO Membership is worth its “price,” more than Rose’s (2004a) initial work seemed to suggest? Can we conclude that “GATT think” has, after all, been working during the mature phases of the WTO’s life? Has it been working in the sense that countries did reveal more trade, on becoming members, and more trade than countries outside the WTO? Or does controlling for gravity determinants of bilateral trade continue to destroy all evidence that would support the commonly held view that membership is trade promoting, even if we allow membership to play a role at the extensive margin of world trade, too? In our view the answer is a “qualified yes.” Yes, because Probit and Tobit estimations did indeed yield more, and more significantly, positive coefficient estimates for our BOTHIN dummies. And the order of magnitude revealed is not negligibly small. But qualified, because the Probit and Tobit estimates are smaller and less significant in the specification with time-variant country fixed effects, which is the preferred specification on theoretical grounds unrelated to WTO Membership. More generally, one would have wished the effects to be more robust across different fixed effects specifications, or to show up more in the preferred specification than vice versa. Qualified also because the ONEIN effect, which seems much less clear theoretically, comes out more significantly than the BOTHIN effect that we have argued in our own theoretical reasoning. And qualified also because the evidence in favor of a WTO Membership effect seems concentrated mainly in the “within-variation.” But although one might have wished the evidence to show up more consistently in both dimensions, here one can argue to be on the safe side, since there are fundamental theoretical reasons, that we have indicated in the introduction for “within-evidence” to be more trustworthy than “between-evidence.” Abstaining from jargon, what is the message that we have for negotiators and policymakers? It would be silly to try to distill a sharp conclusion regarding practical problems in accession negotiations and decisionmaking. But, although we do not feel that we have a powerful and convincing “revisionist story” to tell with respect to the initial findings in Rose (2004a), we do have some noteworthy evidence to present. The logic that drives WTO Membership applications and negotiations does, after all, find some empirical support in a comprehensive statistical analysis of overall world trade, support that goes beyond individual success stories or a cleverly chosen subset of countries. Based on our analysis, countries that are up for membership

242 Gabriel Felbermayr and Wilhelm Kohler

can be expected to trade somewhat more with existing member countries, and with more of them, than would otherwise be the case. The magnitude of the effect may not be deemed all that impressive, but it is certainly not negligible either: our preferred estimate lies in the vicinity of a 30 percent boost of bilateral exports from both countries once they belong to the WTO. Our findings should also be of some relevance for the broader trade policy debate. It cannot be denied that preaching the virtue of WTO-type multilateralism is made somewhat more difficult if we lack clear empirical evidence of membership effects, either on policies or on trade. Thus, even a modest correction of the earlier skepticism should be welcome. And we do feel that a modest correction is warranted from our results. A corner-solutions approach to the gravity equation, which allows for the WTO to have an influence on the amount of bilateral trade as well as on whether a countrypair trades at all, reveals that the low earlier estimates that were based on the amount of trade alone suffer from a downward bias. In addition, the extensive-margin variation does suggest that membership plays a nonnegligible role in creating trading relationships between countries that would otherwise not trade with each other at all. In the end, “GATT think” is not entirely unfounded empirically. We certainly have not had the final word. Future work should focus on methodological refinements, such as, for instance, a more satisfactory treatment of the “log-of-zero-problem” in the log-linear specification of the gravity equation, or a sharper distinction between missing observations and true zeros in the trade data. Related to this, one might also try to run a genuine sample selection story to the effect that the first dollar of trade between any country-pair is explained by factors different from those determining the amount of trade in an ongoing trading relationship. It would also be valuable to incorporate some explicit modeling of negotiations related to WTO accession, trying to find out in general terms what makes accession successful (in terms of “GATT think”). A particularly interesting extension of our analysis would be to explore the interaction between regional trading arrangements and WTO Membership. Do the trade effects of such arrangements depend on whether or not the participant countries are also longstanding members of the WTO? For lack of space, we have not pursued such questions in this chapter, but the technique that we have developed here might be readily extended to do so. In closing, we return to a point that we have argued in our introduction. The ultimate purpose of the WTO is not really to promote trade per se, but to free trade from barriers where these are harmful. In this regard, the verdict cannot be found by looking at trade flows; one needs to look at trade policies. And even though there is some evidence that member countries did not systematically conduct more liberal trade policies, the rationale of the WTO as an institution does not strictly hinge on any such effect either. Bagwell and Staiger (2003) suggest that the WTO serves a useful purpose in avoiding welfare costs from inefficient noncooperative policy equilibria.

Does WTO Membership Make a Difference?

243

Appendix 8.1 Summary statistics for Table 8.5 Mean

Std. dev.

Minimum Maximum

11.13

3.52

–60.31

21.50

0.66

0.47

0.00

1.00

0.96

0.20

0.00

1.00

Model: OLS (N = 27,801) Ln(Exports) BOTHINij ONEIN

ij j

24.50

2.10

18.61

30.01

ln real GDPi

24.34

2.16

18.61

30.01

8.58

0.85

4.45

9.89

0.04

0.19

0.00

1.00

0.20

0.40

0.00

1.00

0.13

0.34

0.00

1.00

Relation is active (dummy)

0.65

0.48

0.00

Ln(Exports+1)

7.26

5.99

0.00

21.50

BOTHINij

0.58

0.49

0.00

1.00

ln real GDP

Ln DIST

ij

Adjacency

ij

Common language

ij

Free trade agreement ij Model: Tobit/Probit (N = 42,658)

ONEIN

ij

1

0.93

0.25

0.00

1.00

ln real GDP j

23.81

2.15

18.61

30.01

ln real GDPi

23.81

2.14

18.61

30.01

8.68

0.79

4.45

9.89

Ln DISTij Adjacency

ij

0.03

0.16

0.00

1.00

Common language ij

0.18

0.38

0.00

1.00

Free trade agreement ij

0.10

0.30

0.00

1.00

Source: Author’s own calculations based on the data described in the text.

Observing that countries that are members of the WTO do not systematically follow freer (and thus, presumably, less costly) trade policies than nonmembers, does not invalidate the Bagwell-Staiger case for the WTO: They might still pursue less costly policies than would be the case, if the WTO had not been available as an institution. The same goes, if we find scant evidence that they have more trade than nonmembers.

Notes This chapter was partly written while Wilhelm Kohler was visiting CESifo, Munich, in November 2006. He gratefully acknowledges CESifo’s generous hospitality. Special thanks are due to Peter Egger for helpful discussions.

244 Gabriel Felbermayr and Wilhelm Kohler 1. In its accession in November 2006, Vietnam’s commitments ran up to almost 700 pages of text related to slashing trade barriers, ending subsidies, and ensuring protection of property rights, etc. 2. More recently, this logic of GATT/the WTO has been formalized by Bagwell and Staiger (2003). Throughout this chapter, we use the term WTO to mean both the WTO and GATT throughout their history. All GATT agreements were absorbed by the WTO which came into existence in 1995, based on the Uruguay Round agreement under GATT. 3. Brief surveys may be found in Evenett and Gage (2005) and Rose (2006). 4. Rose (2005) compares the WTO with the IMF and the OECD. Following essentially the same strategy as in Rose (2004a), he finds that it is even harder to find any such influence of membership on the IMF, whereas OECD Membership does seem to have had a positive effect on bilateral trade. 5. Rose (2006) surveys other attempts at disentangling specific time and sector effects. See also his review in the previous chapter in this volume. 6. Subramanian and Wei (2007) is a shortened version of their National Bureau of Economic Research working paper of 2003. 7. Our prime interest in that paper was not WTO Membership, but the so-called “distance puzzle.” Evidence of a WTO effect on the extensive margin was also found by Helpman et al. (2008) and Liu (2009). 8. Fixed export costs have become important in the recent extension of the monopolistic competition model to heterogeneous firms; see Melitz (2003) and Helpman et al. (2008). There are other ways to model the extensive margin, but the beachhead cost model proves convenient for the present purpose. In Felbermayr and Kohler (2006), we have proposed an argument based on public infrastructure investment, rather than private costs of exporting. 9. It is worth pointing out at this stage that it is beachhead costs, not firm-level heterogeneity, that give rise to the extensive margin of trade on the country level, separating positive-trade from zero-trade partner countries. Firm-level heterogeneity introduces an extensive margin of exporting within each country, where firms engaged in serving a specific foreign market are separated from those who don’t. While not necessary for the extensive country margin, assuming firmlevel heterogeneity adds some realism to our model and facilitates an easier interpretation against the backdrop of existing literature. 10. Due to firm-level heterogeneity, this price index depends on the cumulative density function G(a) and is, therefore, considerably more complex than the standard formulation. 11. Notice that in a multifactor world cross-country variation in c i would also be determined by the interaction of international factor price differences and the factor intensity of the beachhead effort. In this way, ci could vary across countries even with identical technology. The same applies for marginal costs of production ci a, where the factor intensity of beachhead and production activity could be allowed to differ. Variations in ci thus allow for both a Ricardian and Heckscher-Ohlin interpretation. 12. Whenever new countries are formed, measured world trade increases, simply because trade flows that were formerly classified as internal become external trade. Following Felbermayr and Kohler (2006), we refer to growth of world trade due to the increase in the number of countries as to the pseudoextensive margin. 13. A complete list of countries is available upon request. 14. In Figure 8.4, whenever a trading relationship featuring missing trade turns positive, this is recorded as a movement on the extensive margin. This may be

Does WTO Membership Make a Difference?

245

misleading, as missing trade need not imply zero trade. It may also explain the blip in 1978. 15. On the differential interpretation of exponential and negative binomial models, see Wooldridge (2002, pp. 646–53).

¦

2

§ ¨

¦

·2 ¸

Xij ¨ j Xij ¸ . 16. The Herfindahl index for country i is defined as j © ¹ 17. We alternatively use GDP and time-variant country-specific effects in our estimations. 18. For instance, compare our findings to Baier and Bergstrand (2007) table 1. 19. This is, admittedly, inelegant. However, semilog gravity models tend to perform very poorly. In Felbermayr and Kohler (2006) we argue that adding constants other than unity to bilateral trade values does not substantially alter the results. The simple approach of adding one makes the Tobit model comparable to the conventional nonzero gravity model, an advantage that would be lost if nonlinear methods were used. Liu (2009) follows Santos Silva and Tenreyro (2006) and runs a Poisson model to account for the extensive margin in a gravity model. 20. For a more detailed survey, see Rose (2006). 21. It is not uncommon to observe a ten-year time span for accession negotiations; see Evenett and Primo Braga (2005). It seems plausible to assume that some policy changes are enacted beforehand, in order to solve the inherent commitment problem. At the same time, it is well known that new members are sometimes slow in honoring commitments entered during negotiations, China being a prominent example in this regard. 22. In the descriptive analysis, we carefully avoid the pseudointensive margin and focus on a balanced panel of country-pairs that have existed since 1965. In the econometric exercise, for reasons of comparison, we stick to the same sample of countries. The panel is (potentially) unbalanced, because for some pairs trade is missing. Availability of GDP data is not an issue whenever we use time-variant fixed effects. 23. Fixed effects always means a dummy for country i as an exporter and a dummy for country j as an importer, and not dyad-specific dummies.

References Anderson, J.E., and E. van Wincoop. 2003. “Gravity with Gravitas: A Solution to the Border Puzzle”. American Economic Review 93(1): 170–92. Bagwell, K., and R.W. Staiger. 2003. The Economics of the World Trading System. Cambridge, MA: MIT Press. Baier, S.L., and J.H. Bergstrand. 2007. “Do Free Trade Agreements Actually Increase Members’ International Trade?” Journal of International Economics 71: 72–95. Baldwin, R.E. 1988. “Hyteresis in Import Prices: The Beachhead Effect.” American Economic Review 78(4): 773–85. Baldwin, R.E. 2005. “Heterogenous Firms and Trade: Testable and Untestable Properties of the Melitz Model.” National Bureau of Economic Research (NBER) Working Paper No. 11471. Cambridge, Mass. Baltagi, B.H., Egger P., and M. Pfaffermayr. 2003. “A Generalized Design for Bilateral Trade Flow Models.” Economics Letters 80(3): 391–97. Evenett, S.J., and J. Gage. 2005. Evaluating WTO Accessions: The Effect of WTO Accession on National Trade Flows. Mimeo: University of St. Gallen.

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Evenett, S.J., and C.A Primo Braga. 2005. WTO Accession: Lessons from Experience. World Bank Trade Note No. 22. Feenstra, R.C. 2004. Advanced International Trade: Theory and Evidence. Princeton, NJ: Princeton University Press. Felbermayr, G.J., and W Kohler. 2006. “Exploring the Intensive and Extensive Margin of World Trade”. Review of World Economics 142(4): 642–74. Helpman, Elhanan, Marc J. Melitz, and Yona Rubinstein. 2008. “Estimating Trade Flows: Trading Partners and Trading Volumes.” Quarterly Journal of Economics 123(2): 441–87. Krugman, P. 1991. “The Move Toward Free Trade Zones.” Economic Review 76(6): 5–25. Liu, Xuepeng. 2009. “GATT/WTO Promotes Trade Strongly: Sample Selection and Model Specification.” Review of International Economics 17(3): 428–46. Melitz, M.J. 2003. “The Impact of Trade On Intraindustry Reallocation and Aggregate Industry Productivity.” Econometrica 71(6): 1695–725. Rose, A.K. 2004a. “Do We Really Know that the WTO Increases Trade?” American Economic Review 94(1): 98–114. Rose, A.K. 2004b. “Do WTO Members have More Liberal Trade Policy?” Journal of International Economics 63(2): 209–35. Rose, A.K. 2005. “Which International Institutions Promote International Trade?” Review of International Economics 13(4): 682–98. Rose, A.K. 2006. “The Effect of Membership in the GATT/WTO on Trade: Where Do We Stand?” Forthcoming in Zdenek Drabek (Ed.). Is the World Trade Organisation Attractive Enough For Emerging Economies: Essays in Criticism of the Multilateral Trading System. Basingstoke: Palgrave Macmillan. Rose, Andrew K. 2007. “Do We Really Know that the WTO Increases Trade? Reply.” American Economic Review 97(5): 2019–25. Santos Silva, J.M.C., and S Tenreyro. 2006. “The Log of Gravity.” Review of Economics and Statistics 88(4): 641–58. Subramanian, A. and S.-J Wei. 2007. “The WTO Promotes Trade, Strongly But Unevenly.” Journal of International Economics 72: 151–75. Tomz, M., J. Goldstein, and D. Rivers. 2008. “Do We Really Know that the WTO Increases Trade? Comment.” American Economic Review 97(5): 2005–18. Wooldridge, J.M. 2002. Econometric Analysis of Cross Section and Panel Data. Cambridge, MA: MIT Press.

Part IV Broader Costs and Benefits of WTO Membership

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9 Who Should Join the WTO and Why?: A Cost-benefit Analysis of WTO Membership Zdenek Drabek and Wing Thye Woo

9.1

Introduction

The most striking features of the World Trade Organization (WTO) are, arguably, its membership list and the changes in the list over time. Despite widespread concerns about globalization and about the role of the WTO as a global institution, WTO Membership has been growing rapidly. When GATT the predecessor of the WTO – was established in 1947, the total number of countries signing the Agreement was 23. By 2007, the membership had increased to 150. Moreover, there were more than 30 countries negotiating accession to the WTO. Most of the increase in the membership has come from developing countries and from countries in transition since most developed countries had joined GATT years earlier. Developing countries now account for two-thirds of the total membership. What is evident from the rising numbers is that many countries join the WTO with great expectations and expecting something positive to come from their membership. But not all is well with the WTO Membership despite all these statistical miracles. Some members are surely happy but others are less so. One can even find voices from countries who express regrets of joining the organization. Those voices point to concessions that countries have to make as conditions of accession or as part of multilateral negotiations. Others are disappointed because, in their judgment, the gains from their accession or membership have not been as significant as they had expected or been told. Many of these critical voices are heard not only in the negotiation corridors but are also expressed openly in public. The critical voices are receiving some support from academia, in which several renowned economists have delivered fairly strong criticisms of the WTO in their works. Some have criticized the nature of WTO disciplines, which they see as unsuitable for developing countries (e.g., Stiglitz). Others have assessed the actual effects of WTO in empirical studies. They looked at 249

250 Zdenek Drabek and Wing Thye Woo

countries’ trade performance over time and estimated the extent to which this had been affected by their membership of the WTO. One of the best known studies of this kind was by Andrew Rose (2004), who looked at the impact on trade of various types of cooperative arrangements such as the WTO and currency blocs. He found that the WTO variable did not have a statistically significant effect in the changing trade flows and concluded that the presumed positive contribution of the WTO must, therefore, be reassessed.1 These studies have generated a heated debate among economists. For example, Subramanian and Wei (2004) provided a more detailed and disaggregated study, in which they found that Rose’s findings did not apply in general but that the gains may be unevenly distributed. While the debate is still going on, it is clear that critics of the WTO do have a certain amount of ammunition to use against the liberal multilateralists. In this chapter we shall ask two sets of questions. The first set of questions is: Why are countries so keen on joining the WTO? What are/were the driving forces for and against membership? Domestic or foreign? If domestic, do they come from firms or governments or perhaps other groups of the society? What are the motives for joining? For example, if it is the government that is driving toward membership, what are its motives? There is no doubt that countries are in general keen on joining the WTO. However, somewhere later on, disappointments set in, which is why some members become critical. It is as if dreams have been lost in reality. Thus, the second set of questions that we examine is: Why are many of WTO Members so openly critical? Why do “dreams” about the WTO not often become reality? In other words, what are the countries’ concerns? For example, is it lobbying of domestic firms that may be concerned about protection of industry or is the loss of budgetary revenue that leads governments to react? Is it perhaps the costs of compliance with WTO obligations? Are the governments aware in the first place of the costs of compliance with the WTO Agreements or are they worried about the WTO rules and disciplines? We shall approach our task through a formal cost-benefit analysis, trying as much as possible to draw the distinction between expectations and the outcomes. We shall carry out the analysis by considering two types of countries – those members that have been by and large very happy with their WTO experience, such as China, and those that have been far more skeptical and critical about the role of the WTO. The latter views were voiced in a compilation of case studies edited by Callagher et al. (2005). Our main objective is to identify the important elements of the costs and benefits of WTO Membership and compare them with the perceptions of the countries themselves. In other words, our aim is to assess the merits of WTO disciplines and governance rather than their actual impact on members. This will be done by identifying, with the help of case studies, shortcomings and/or specific problems with the implementation of WTO disciplines. In addition, we shall look at one specific case – China. The choice of China was

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251

determined by the country’s relatively positive experience of being in the WTO, and our assessment of the Chinese case should provide a useful comparison with the more negative experiences of some other countries. The structure of this chapter is as follows. Section 9.2 gives a brief introduction to the cost-benefit analysis of WTO Membership. Sections 9.3 and 9.4, respectively, give fuller discussions of the benefits and costs accruing from WTO Membership. The discussion covering the “drivers” of China’s accession into the WTO is in Section 9.5. The conclusions from and policy implications of our analysis are presented in Section 9.6.

9.2

Costs and benefits of WTO Membership

What do countries seek when they apply for membership to the WTO? Do they clearly understand the benefits that the membership is expected to bring, or are the benefits poorly defined? Do they fully assess and understand the costs that may result from membership? In the final analysis, countries that join must believe that their membership will, at the very least, bring some positive net benefits. Nevertheless, the perceived benefits may not always be met in reality, and the budgeted costs may be very different from the actual ones. Misjudgments, misunderstandings, misinformation, or simply a poor analysis of costs and benefits would all lead to disappointing outcomes. In those situations, it is as if the membership issue was surrounded by myths that are different from reality. As we argue below, this is indeed the case for many countries when they join the WTO. The perceptions are often wrong on several counts, and it is only when these misperceptions are fully understood that the true contribution of the WTO can really be fully understood. The discrepancy between the perceived and actual benefits of WTO Membership depends on many factors. First, the “values” of WTO disciplines and countries’ commitments may not be fully understood by member countries. That is the situation when members accede with overoptimistic expectations. Second, the “values” may not be fully acceptable to the acceding country, resulting in a lack of national consensus about the value of WTO Membership. Third, the costs of WTO Membership may turn out to be far higher than expected. Finally, the “values” may be distorted by imperfections in the design of the disciplines and of the system of WTO governance. It is primarily the first three of these factors that we shall be addressing in this chapter. Our main argument is that the WTO contribution to economic development is potentially very strong but often remains limited. The first reason is that the benefits of WTO Membership are often “over-estimated” by the countries’ policymakers. The second is that the implementation of WTO disciplines can be costly and that the costs are often “underestimated” by policymakers. In brief, the problem lies in both false expectations by countries about the likely effects of the WTO and unrealistic assessments of costs.

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Zdenek Drabek and Wing Thye Woo

Overestimated benefits

The benefits of WTO Membership are traditionally divided into several groups and can be listed under the following headings: 1. 2. 3. 4.

Improved market access; Improved domestic governance resulting in an effective “policy anchor”; Potential benefits of the possibility of resolving commercial disputes; and Benefits from participation in the WTO negotiating forum in order to shape the negotiating agenda and international trading rules; 5. Benefits of improved international governance; and 6. Political gains from accession. 9.3.1 Improved market access – the first myth? There is a widespread belief among policymakers that WTO accession will allow a country to obtain a better market access for its exports than would be the case if it stayed outside the WTO or tried to negotiate better market access through bilateral or regional trading arrangements. Unilateral liberalization, another trade policy instrument, will of course have no impact on the country’s market access unless other countries also pursue unilateral liberalization at the same time. In other words, international negotiations about trade barriers are normally critical for obtaining an improvement in market access; unilateral measures can only work if only countries are convinced about the merits of trade liberalization per se and do not condition it by improved market access. The belief in gains from improved market access does, of course, have solid theoretical foundations. Better market access increases incentives for expanding a country’s exports, which will, in turn, provide important conditions for its exporting firms to improve their utilization of existing capacities or expand their production capacity. Either way, domestic efficiencies are increased because losses through inefficiency are reduced through better capacity utilization or because firms gain from economies of scale once their production capacity is expanded. Moreover, improved market access might lead to changes in the relative prices at which exporting firms trade and this might further stimulate reallocation of domestic resources in the exporting country towards sectors in which the country has a comparative advantage, thus generating further efficiency gains. However, the idea that WTO accession leads automatically to improved market access is fundamentally false on several accounts. First, there will be no immediate improvement of market access for any given country as a result of accession. When countries join the WTO they obtain no automatic improvement of access to their markets. The reason is simple – the incumbents negotiate the concessions of the acceding countries and not an opening of their own markets. Any improvement of market access to an acceding

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253

country would automatically extend – under the most favored nation (MFN) principle – to other WTO Members. Such an outcome would not be acceptable to the incumbents since it would open up a Pandora’s Box of new negotiations and preclude gaining concessions from other incumbents.2 The second reason why the presumption of improved market access is false lies in the nature of multilateral negotiations. Market access concessions are only a part of wide-ranging multilateral negotiations, in which both the agenda and the actual concessions on market access and other areas are negotiated by all members. Accession negotiations are not, of course, such an occasion.3 The third reason why acceding countries do not automatically receive improved market access is the way in which incumbents make their own market access concessions in the WTO. These MFN commitments are only “binding” if they are actually bound, to use the WTO terminology. If the commitments are unbound, the actual market access into the incumbent market may sometimes actually be reduced as incumbents are free to raise those tariffs that are not bound. While most industrial tariffs of developed countries are bound in the WTO developing countries still maintain a large portion of their tariff schedules unbound. Thus, as long as WTO commitments are unbound their impact on domestic incentives, resource allocation, and efficiency is likely to remain weak or nonexistent. Moreover, countries may not gain even if their tariffs are bound. The reason is that bound tariffs are often higher than actual tariffs applied by countries. In agriculture, for example, the average bound weighted tariff is estimated to be 27 percent while the corresponding actual tariff is “only” 14 percent.4 The fourth reason for the limited effect of WTO Membership is the existence of preferential trading arrangements. Following the considerable concessions of developed countries in opening up their markets to exports of developing countries, the latter today benefit from a wide-ranging set of preferential agreements with the U.S., the EE and other developed countries.5 The only circumstance – one that is extremely rare in reality – under which an acceding country may actually benefit from improved market access is in a situation when it might have faced a discriminatory tariff against its exports when it was outside the WTO system. In such a case the country would gain by joining the WTO since the discriminatory tariff of the incumbent country would have to be replaced by the MFN tariff agreed in the WTO. Such cases are very rare since, typically, countries are able to negotiate a preferential tariff or the MFN tariff even in situations when they are not members of the WTO. One example of the latter was in the case of China and its access to the U.S. market, which was subject not only to the MFN tariff but also to annual reviews by the U.S. Congress. It was the latter and not the former that constituted the inhibiting factor for Chinese exporters and became a major force in driving Chinese accession to the WTO.6

254 Zdenek Drabek and Wing Thye Woo

9.3.2

Improved domestic governance – the second myth?

The second usual argument in favor of WTO Membership is based on the notion that this will enhance domestic governance. The idea is that countries’ domestic governance improves as a result of membership. A country benefits from improved domestic governance, apart from welfare gains resulting from increased efficiency in resource allocation, in the enhanced confidence of firms in conducting their business. In particular, foreign businesses and investors may like WTO Membership because in their eyes it strengthens the “guarantees” for doing business on the basis of generally acceptable and transparent rules, and lowers commercial and other associated risks of doing business there. The presumptions are of course, that domestic governance has been a problem for the country in question and that WTO Membership will provide an opportunity to introduce “better” policies and/or strengthen the institutions supporting these policies. This further presupposes that domestic governance issues are not effectively addressed through the domestic political process and that governments may push for membership in order to push through particular types of reforms in the face of domestic opposition. In general, there are two distinct aspects of domestic governance: government policies and the country’s institutions that support them. Both form parts of WTO Agreements, even though the extent to which they are covered varies. Before turning to specific experiences of countries with such policies and institutions, it may be useful to identify the main economic policy areas covered by the Agreements and their main features. The features identified here are our interpretations of particular articles of the legal Agreements rather than a clear stipulation in the Agreements on membership criteria7: 1. Given the WTO focus on trade, the most visible element of economic policy is trade policy and its objective of trade liberalization. The key feature of trade regimes negotiated through the WTO is an attempt to reduce trade barriers and provide for more transparency in trade policymaking, that is, trade liberalization negotiated through improvements to market access for countries’ exports. 2. Another feature of the trade policy intervention through WTO Agreements is the emphasis put on market-based instruments rather than on direct government interventions. This is primarily reflected in the prohibition under the GATT rules on quotas and insistence on their replacement by tariffs. 3. While explicitly not prohibiting membership of countries with “nonmarket economy” status, the WTO Agreements (and their GATT forerunners) were quite clearly designed by the architects of the system for market-oriented economies. Thus, Article XVII of GATT states in paragraph 2 that public enterprises are expected to behave in manner that

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reflects “commercial considerations with respect to price, quality, availability, marketability, transportation and other conditions of purchase or sale ....” Paragraph 1 of the same article disciplines the behavior of state enterprises by even demanding that “such an enterprise shall act ... in a manner consistent with the general principles of non-discrimination.” Other objectives such as employment or price fixing would hardly fit that category.8 4. Accession conditions have also included in several cases the requirement to privatize particular companies that operated in the view of trading partners in a nontransparent and noncommercial manner. 5. The WTO Agreements are clearly poorly equipped to handle countries with a centrally planned system of economic management. Even though membership of the WTO by centrally planned economies is not precluded, none of the GATT or WTO articles specifically addresses the discriminatory practices of centrally planned systems, including in particular the practices of price fixing,9 the administrative management of the exchange rate regime and foreign trade monopolies.10 6. The Agreements are not specifically targeting macroeconomic and financial stability as one of their main objectives. However, the idea of macroeconomic stability is quite clearly incorporated into the body of the Agreements. Thus, Article XII of GATT states in paragraph 2 (b) with respects to safeguards for balance of payments purposes that “Contracting parties applying restrictions under sub-paragraph (a) of this article shall progressively relax them as such conditions improve.” Moreover, paragraph 3(a) extends the discipline by stating that “Contracting parties undertake, in carrying out their domestic policies, to pay due regard to the need for maintaining or restoring equilibrium in their balance of payments ....” In sum, the listed policy areas and their objectives are clearly oriented toward market economies and toward liberalization of markets. The list identified here may not be as straightforward as the list typically associated with policies recommendations of the World Bank and the International Monetary Fund (IMF) but it is evident that the “WTO list” of recommended policies is tending in the same direction.11 While the policies promoted by the Agreements are defended by their supporters as “benefits” of WTO Membership, that view is clearly not fully shared by all members themselves. There is clearly a resistance to trade liberalization, even though the degree of resistance varies. This can be seen in the general unwillingness to adopt trade liberalizing measures on a unilateral basis without receiving concessions from trading partners.12 Moreover, the persistence of various trade-restrictive practices in agriculture and other sectors, through such measures as trade remedies and the maintenance of WTO bound commitments well above the actual

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restrictions, bears witness to the reluctance to move to uninhibited opening of markets. The resistance to trade liberalization from its opponents stems partly from their concerns about its costs. Critics of trade liberalization argue that the benefits of “good” trade policies can be assessed only in conjunction with the costs, an issue that has been often neglected by many trade theorists, who believed in costless trade adjustments. The fact that trade adjustment is rarely costless makes the critics’ point particularly relevant, as we shall discuss further below. In contrast, the supporters of trade and financial liberalization emphasize its benefits. There is no doubt that the reformers in China saw WTO Membership as an instrument for enhancing the competitiveness of the Chinese economy, as we shall also argue further below. The same objective has been pursued by reformers in Vietnam (Phan Van Sam and Vo Thanh Thu, 2005). Thus, the critical question on domestic governance and the role of the WTO is whether WTO negotiations and membership help countries to adopt sensible policies that will improve their trade performance. However, the adoption of sensible trade policies is only one element in the chain between domestic governance and WTO. The establishment of strong institutions to implement those policies effectively is another. In particular, institutions will affect trade performance in at least three separate areas: 1. The provision of information. The lack of information about the competitiveness of the acceding country’s firms, availability of markets, or the conduct of government policies can be a serious impediment to trade; 2. The absence of institutions to enforce government policies;13 and 3. The lack of competitiveness resulting from low productivity of factors of production.14 Accession and trade liberalization should address the first two of these issues, and evidence is probably mixed because the experiences might vary from country to country. Nevertheless, WTO negotiations can go a long way toward helping countries to address problems of poor governance. For example, the accession negotiations of Bosnia and Herzegovina revealed that the country did not posses a unified and internationally fully comparable set of trade data. This has complicated the ability of firms and the government to assess the country’s competitiveness and has also made the country’s offers of concessions to their trading partners unreliable (Brkic and Hadziahmetovic, 2005). It is quite likely that institutional shortcomings in the acceding country, such as poor statistical services, might delay negotiations or even lead to wrong policy decisions. Probably the most serious impediments to full compliance with WTO obligations are (1) an inadequate commitment to implement those obligations fully and (2) a poor institutional capacity to do so. Both of these factors have been the origin of complaints by developing countries about the

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WTO, which eventually led to the Doha Declaration concerning “implementation issues” and the Decision on Implementation at the Doha Ministerial Conference. The matter has been discussed by members at length but without much success. There is probably only one argument that is not subject to controversy. This suggests that the cooperative approach of the WTO disciplines is truly beneficial in enhancing the predictability and transparency of trade relations. The system creates conditions for a greater stability in trade relations, for avoiding trade wars, and minimizing trade conflicts. In particular, the system based on trade rules greatly reduces one of the most serious threats to trade stability arising from policy backsliding. The positive effects of cooperative arrangements on the stability of trade flows have been documented in Drabek (2005).15 9.3.3 Resolution of disputes – the third myth? In theory, there is a clear gain for countries in having an access to an international tribunal of commercial disputes. They can benefit from an impartial court system, based on an agreed set of norms that can enforce its judgments through a mechanism that also operates on the basis of instruments and criteria mutually agreed by all participants. These are the main features of the WTO dispute settlement system.16 Unfortunately, the use of the WTO dispute settlement system can be problematic in practice. When one examines the distribution of complaining countries in the WTO the pattern has been surprisingly stable and biased towards a relatively small group of countries. These include the typical “culprits” – the Quad (the U.S., the EU, Japan, and Canada) and a number of other member countries of the Organization for Economic Cooperation and Development (OECD) such as Australia, New Zealand, South Korea, and Mexico. From 1948 through the end of 2000, the U.S. was either a complainant or defendant in 340 GATT/WTO disputes, constituting 52 percent of the total number of 654 disputes, while the European Community (EC) was a party in 238 disputes, or 36 percent of the total.17 The U.S. and EC participation rates are even higher if one adds the cases of disputes in which they took part as third parties but were not complainants or defendants. Only a handful of developing countries have been able or willing to use the system. Moreover, the list includes not only a relatively small number of developing countries but, once again, the countries tend to be the same ones. The core of the list includes India, Pakistan, Malaysia, Indonesia, Thailand, the Philippines, Chile, Brazil, and Argentina. Clearly, what seems to matter are differences in the legal capacities of countries to use the system. What seems to matter less is the “power” of countries.18 The use of the dispute settlement system by other developing countries remains very limited and the existing cases are few and far between. In his story about Costa Rica’s assertion of its rights under the Agreement

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on Textiles and Clothing, Breckenridge (2005) relates the victory of Costa Rica in its dispute with the U.S. about the illegal use by the latter of safeguard actions. Another famous case involving small developing countries is the so-called “banana” case, in which several Latin American countries challenged the EU system of preferential arrangement with the Asian, Caribbean, and Pacific countries (ACP), a case that has been unresolved and subject to legal proceedings for a decade. The story for African countries is even more depressing. As of August 2002, 262 had been complaints filed with the Dispute Settlement Body (DSB), but none of these disputes figured a sub-Saharan country as a complainant. Only five countries – Nigeria, Senegal, Cameroon, Zimbabwe, and Ivory Coast – had been involved as third parties.19 There are several reasons for the high clumping of “beneficiaries” of the WTO dispute settlement mechanism. However, there is no doubt that the negligible recourse to the system by the majority of developing countries is to a large extent the result of specific constraints existing in these countries that do not allow them to benefit from the system. These constraints include, for example, a lack of qualified lawyers, a lack of legal and financial resources to pursue expensive legal proceedings, and limited awareness among government officials and firms of the opportunities offered to them by the dispute settlement system. In addition, many developing countries are reluctant to enter into disputes with developed countries because they receive from the latter aid and other development assistance, and this leads to “the kind of relationship which does not bode well in a litigation climate.”20 Once again, these are questions of costs that need to be considered in assessing the merits of the mechanism. Moreover, as Bhattacharyya (2005) points out, developing countries must consider the potentially damaging effects of prolonged litigation on the strategic interests of the industry involved in the legal dispute. These interests can be seriously damaged by such lengthy proceedings. 9.3.4 WTO agenda, rules, and disciplines – mitigating factors of benefits? The benefits of WTO Membership also depend on the compatibility of countries’ interests with the WTO agenda and the system of rules and disciplines. If countries are primarily agricultural, the benefits of existing system of WTO Agreements will be relatively limited and smaller than for those whose economic structures are more oriented toward industry. This is because the negotiations have so far primarily emphasized trade in manufactured goods. As a result, the WTO Agreement on nonagricultural market access (and the earlier GATT) is an area in which the progress on market access and on disciplining trade distorting policies has been greatest. This is not to argue that agricultural exporters do not benefit from the existing Agreement on Agriculture but benefits must surely be seen as relatively small.21

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Most of the criticism of the WTO system has so far centered on the agenda rather than on the rules and disciplines. At the same time, each member could probably argue that the existing Agreements do not fully cover its interests.22 But it is generally believed that the existing WTO agenda tends to favor the interests of rich countries rather than those of developing countries. The critics have mainly pointed out to the following shortcomings of the Agreements.23 1. Agriculture – as noted above, the general perception is that the Uruguay Round Agreement has hardly made any imprint on the requests of agricultural exporters; 2. The “new” areas introduced in the Uruguay Round – TRIPs and GATS – primarily serve the interests of rich countries, which have by far the more developed service industries and the need for protection of intellectual property rights; 3. The general reduction of trade barriers notwithstanding, the remaining restrictions on imports of so-called sensitive products by rich countries – such as steel, textiles, clothing, fishing products, and shoes – primarily adversely affect the gains of exporters from poor countries (through the so-called tariff peaks and escalation); 4. The Agreements allow members to use “new” trade-restrictive measures such as antidumping remedies and other safeguards that, measured together with requirements for countries to meet certain technical and sanitary and phytosanitary (SPS) standards, constitute elements of a new protectionism that is privileged to only a small number of members; and 5. Finally, and as we have already noted above, critics have also criticized the limitations of the existing dispute settlement system, which they see as primarily benefiting the richer members.24 9.3.5 Improved international governance – a real winner The real “winner” among all arguments about benefits of the WTO Membership is the argument in favor of improved international governance. Membership of the WTO helps to enhance the formation of international trade rules and their enforcement. Effective participation by each country in this system of governance is guaranteed by the consensus principle, which guarantees each country the same voice irrespective of its size and economic power. Expansion of membership also expands the scope of multilateralism, that is, the geographical area covered by the multilateral rules. In brief, within the WTO it is critical for any country to take part in the organization’s rulemaking process. 9.3.6 Political process of accession – another winner? Another powerful argument for WTO Membership comes from the role of international obligations in the country’s political process of reform. When

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Kyrgyz Republic was under pressure from Russia in the mid-1990s to join in a customs union, Kyrgyz officials successfully argued against certain aspects of the union on the grounds of the country’s obligations in the WTO. When Chinese reformers wanted to introduce market reforms in China against the wishes of more conservative opponents, they chose to pursue the route of WTO Membership in order to facilitate their pursuit of the reform. WTO Membership can, therefore, be used effectively in the face of domestic opposition.25 In conclusion, our fundamental point so far has been that WTO Membership entails potentially significant benefits but these benefits have not been fully exploited by many members. Thus, for many countries the benefits remain potential but they are not realized. A part of the problem is that countries do not typically gain in terms of improved market access from their accession. In other words, countries do not necessarily gain from a reduction of trade barriers but they do gain by obtaining more transparent and predictable terms of trade. The latter will hopefully lead to greater trade stability. Another problem is that their commitment for their economic policies to be consistent with the paradigms of the WTO Agreements is typically resisted. This inevitably leads to compromises: trade barriers continue to play a negative role; some countries suffer from macroeconomic instability; many countries are extremely of suspicious of attempts to extend the agenda for negotiations into areas such as domestic regulation and the treatment of public enterprises; and some countries wish to pursue discriminatory regional trading arrangements. Moreover, the use of the WTO settlement system, although greatly enhanced and shared by a number of countries, remains outside the real possibilities for many poor countries.

9.4 Underestimated costs Our point will be that the costs of membership are high and must not be neglected in countries’ assessments of their likely gains. The costs can be divided into separate groups under the following headings: 1. 2. 3. 4.

Costs of accession; Costs of implementation; Costs of lost government revenues; and Reduced scope for countries to conduct independent national policies (the “national sovereignty” issue).

9.4.1 Costs of accession When countries apply for WTO Membership, they typically have to make changes in their policies and institutions in order to ensure consistency with WTO disciplines and to meet the demands of other members. In some cases the changes required by WTO incumbents can be substantial and

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provoke resentment in the acceding countries. Clearly, the issue at stake is sovereignty – who decides which policies governments adopt, how, and when. Nevertheless, in the majority of acceding countries the issue is somewhat different, even though all countries are concerned about the loss of their sovereignty. The principal argument about costs of membership concerns the terms and conditions under which countries join. We have already discussed the procedures under which accessions take place (Drabek and Bacchetta, 2004). The critical question for acceding countries is of whether the terms and conditions are fair and conducive to economic growth and development. This question remains debated by many observers. Here we shall briefly address the question of “fairness” and return to the question of “usefulness of the WTO for development” further below. Much has been already made in the literature of the conditions for WTO accession. In one of the earlier criticisms of the WTO accession process, Michalopoulos (1999) was highly critical of the administrative process, which he considered to be a serious burden on transitional (and developing) countries. A frequent complaint of acceding countries is that they are expected to implement their commitment too fast. An excessive speed of implementation was highlighted, for example, in studies of trade liberalization in the Philippines (Baracol, 2005), Mongolia (Tsogbataatar, 2005), and in virtually all other countries reviewed in the study of Callagher et al. (2005) in their coverage of implementation difficulties. Other critics have gone even further when they argued in favor of easier conditions of accessions for developing countries under the provisions of special and differential treatment (SDT) – for the so-called “WTO-minus”. In reality most acceding countries tend to accede on conditions that exceed the formal requirements of the WTO – the so-called “WTO-Plus.”26 This has already generated a backlash in some countries; for example the terms that Vanuatu’s government agreed in their accession negotiations were rejected by the parliament and the private sector, resulting in both the country’s accession and economic reform stalling. Following the experience of Vanuatu and of other countries, the WTO Members decided to facilitate the accession of least developed countries by reducing the administrative burdens on poor countries (Callagher et al., 2005: 4). Easier administrative requirements will certainly be welcome by acceding developing members but they will not necessarily eliminate the difficulties faced by acceding countries. The reason for this is that the origins of those difficulties are not just external (i.e., the administrative conditions “imposed” by the WTO) but also internal. The latter include, for example, limited resources and skills available for negotiations; the absence of a negotiating strategy; and poor coordination between government agencies, between government and private enterprise, and with civic society. These domestic shortcoming have been quite common in most acceding

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developing countries as shown from the case studies of Cambodia, Mongolia, Nepal, and Vanuatu in Callagher et al. (2005). 9.4.2

Implementation costs/difficulties

Following on from the original work of Finger and Schuler,27 it is now widely argued that the costs of implementing WTO Agreements are high, perhaps even excessively high. In general, the costs can be high both in budgetary terms and in terms of opportunity costs of alternative public expenditures. Clearly, any dollar spent on measures required under the WTO obligations by governments is a dollar not spent on schools, hospitals, roads, etc., which is an issue of particular importance for poor countries. For example, WTO accession typically calls for significant investment in infrastructure and in training government officials to service the Agreements. This investment has to be accounted for as budgetary expenditure, since it has to be funded by the government. Countries are frequently required to change their systems of customs administration. Additional investment will typically be required to enhance the manpower capacities of countries to service the Agreements (establishment of diplomatic missions, strengthening the WTO units in large embassies, and training of negotiators or backup personnel, etc). These costs can be quite high. In their study of the World Bank and the United Nations Conference on Trade and Development (UNCTAD) projects in support of the implementation of technical, SPS standards and of the TRIPs law, Finger and Schuler (1998) concluded: “Implementing (such) reforms are investment decisions in that implementation will require purchase of equipment, training of people, establishment of systems of checks and balances, etc. This will cost money, and the amounts of money are substantial. ... Those figures (of project costs) for just three of the six Uruguay Round Agreements that involve restructuring of domestic regulations, come to $130 million. One hundred thirty million dollars is more than the annual development budget for seven of the twelve least developed countries for which we could find a figure for that part of the budget.”28 More details of their study are summarized in Table 9.1. Particularly “expensive” WTO Agreements are those on technical barriers to trade (TBT) and SPS and their coverage of standards. Both Agreements play an increasingly important role, since these standards have become a centre of considerable attention for members. The latter is a result of the fact that standards play an increasingly important role in determining trade flows as border measures have declined in relative importance.29 The enforcement of both Agreements can be very costly, partly because of poor information flow between governments and industry and partly because domestic standards may be different from international ones. The latter can pose a variety of problems that have been well documented, for example, in the studies of Nepal by Bijendra Shakya (2005) and of Indonesia Oktaviani

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Table 9.1

263

Cost of SPS-related World Bank projects Cost in millions of U.S.$

Country, date of activity

Activity

Argentina, 1991–96

General agricultural export reform project

82.7

Brazil, 1987–94

Livestock disease control project

108

Algeria, 1988–90

Locust control project

112

Vietnam, 1994–97

Pest management – component of agricultural rehabilitation project

3.5

Madagascar, 1980–88

Livestock vaccination – component of rural development project

11.8

Hungary, 1985–91

Slaughterhouse modernization – component of integrated livestock industry project

41.2

Russia, 1992–95

Improvement of food processing facilities and disease control – components of rehabilitation loan

150

Poland, 1990–95

Food processing facilities modernization – component of agroindustries export development project

71

China, 1993–2000

Animal and plant quarantine – component of agricultural support service project

10

Turkey, 1992–99

Modernization of laboratories for residue control – component of agricultural research project

3.3

Source: Finger and Schuler, 2000.

and Erwidodo (2005). In contrast, countries can gain a great deal from a good flow of information between governments and private firms in implementing the provisions of the TBT and SPS Agreements, as shown in the Orosco’s (2005) case study of Chile. Problems arising from labeling requirements in the context of the TBT Agreement are discussed, for example, by Mansor et al. (2005). Further fragmented evidence has been provided in few other studies dealing with the implementation of the Customs Valuation Agreement. For example, Hancock (2006), citing other sources shows that the total costs

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to Armenia of drafting new customs law, training staff, and streamlining administrative procedures were estimated to be $1.6 million. The same author notes that total costs to Cambodia of an electronic single window for customs was $26 million. Clearly the costs will most likely vary a great deal between countries. Additional data can be found in Table 9.2. In addition to the high costs of investment in infrastructure, countries can also face other problems of implementation. A clear example is the TRIPs Agreement, which has led to a heated debate about its value for developing and some transition countries.30 For example, the Agreement has been criticized for providing protection of geographical indications (GI), which restricts competition among producers of similar goods. Moreover, this protection has been accorded to producers of such items as spirits and wines, which means that the same “privilege” has not been given to producers of other goods. The major beneficiaries are few developed countries and the benefits are limited in scope. Other countries have been less successful in registering their own products for protection under geographical rules of origin.31 Moreover, even in situations when countries could succeed, the costs and the legal burden of maintaining their right under the rule of geographical indications could be too heavy. In other words, the costs of enforcing the rules of GI are high (see, e.g., Azad, 2005; Srivastava, 2005) and could be serious impediments to obtaining gains from the protection of their products under GI provisions of the TRIPs Agreement. The implementation problem arising from the restrictive nature of the TRIPs Agreement is even more serious in the case of protections of patents, Table 9.2 Costs of customs reform projects in selected countries Cost in millions of U.S.$

Country, dates of activity

Activity

Armenia, 1993–97

Drafting of new customs law, staff training, and computerization of procedures – components of an institution building project

1.604

Lebanon, 1994–2001

Staff training, introduction of new tariff classification, and computerization procedures – components of a revenue enhancement and fiscal management project

3.82

Tunisia, 1999–2004

Computerization and simplification of procedures

16.21

Tanzania

Buildings, equipment, new processes, and training

10

Source: Finger and Schuler, 2000.

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which may prevent the targeting serious health hazards and crises. This had been the case for malaria, tuberculosis, and AIDS, which led to the well publicized pressures in the WTO for the renegotiation of certain elements of the Agreements in order to allow exemptions from its provisions under certain conditions.32 These conditions still need to be formally agreed through negotiations. Tables 9.3 and 9.4 provide simple evidence from a small sample of countries for which we could find data about the costs of implementing the TRIPs Agreement. The data in these tables are limited in their coverage of expenditures that have to be typically covered by countries in implementing the Agreement. The tables refer only to budgetary outlays on legislative support, modernization of the trademark system, and training. The data probably also involve some double counting since some of the expenditure was not just for TRIPs -related activities but also for customs administration. The figures confirm our conclusion that the implementation of the TRIPs Agreement is relatively expensive, albeit perhaps not on the scale of the findings of Finger and Schuler (1998). The high costs of implementing WTO Agreements are also at least partially responsible for the skewed pattern of recourses to the WTO dispute settlement system.33 As noted above, the system has been disproportionally used by the U.S. and the EC, and developing countries have been particularly poor users of the system. While the limited use of the dispute settlement system can be explained by factors originating in the countries themselves (e.g., lack of legal and financial resources), the high costs of legal disputes in the WTO are clearly another factor. These costs are related to the costs of legal support, the costs of creating effective partnerships between public

Table 9.3 World Bank projects related to Intellectual Property Rights Cost in millions of U.S.$

Country, date of activity

Activity

Brazil, 1997

Training of staff administering IPR laws – component of science and technology reform project

Indonesia, 1997–2003

Improvement of IPR regulatory framework – component of information infrastructure development project

14.7

Mexico, 1992–96

Establishment of agency to implement industrial property laws – component of science and technology infrastructure project

32.1

Source: Finger and Schuler, 2000.

4.0

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Table 9.4

Implementation costs of TRIPs-related activities Cost in millions of U.S.$ (estimated except where noted)

Country

Activity

Bangladesh

Compliance with the TRIPs Agreement (during transition period): drafting of legislation; procuring new equipment; undertaking judicial work and enforcement measures

Chile

Modernization of IPR system: drafting 0.718 (one-time) of administrative procedures; training 0.837 (annual) (judges, industrial property professionals, and copyright officials); upgrading customs enforcement

Egypt

Upgrade of IPR system: expanding patent 1.79 (one-time) personnel; procuring new equipment; strengthening the judiciary framework; expanding scope of customs activities; training (customs officials)

India

Modernization of IPR system: human resource development; computerization; training; infrastructure improvement

5.9 (over three years)

India

Modernization of trademark system

0.353 (over three years) (cost of completed project)

Tanzania

Modernization of IPR system: drafting of legislation; establishing and strengthening administrative offices; expanding enforcement capabilities; training

1–1.5

0.25 (one-time) 1.1 (annual)

Source: United Nations Conference on Trade and Development. 1994. The TRIPs Agreement and Developing Countries. Geneva: United Nations.

and private sector, and the high opportunity costs of litigation against countries providing development assistance to the country concerned etc.34 (See also Box 9.1.) These examples serve as cases of direct costs of litigation. However, there may be also indirect costs of litigation resulting from the system of remedies that is in place in the WTO. As argued convincingly by several observers, the current system of remedies in the WTO dispute settlement system might have an unequal impact on the behavior of members, and many of them have, therefore, suggested alternative approaches to WTO remedies. Some have even argued that the current WTO remedy system contains biases and perverse incentives.35 For example, Shaffer (2003) has suggested that the WTO rules and practices on remedies are biased in favor of large markets

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Box 9.1 Costs of foreign contingency measures for small firms: A case study of the shrimp industry in India While the industry and the SEAI [Seafood Exporters Association of India], as well as the Indian government, are fairly confident of the strength of their case, the biggest problem being faced by the shrimp exporters is the uncertainty caused by the anti-dumping investigations. After the announcement of the preliminary ITC [International Trade Centre] determination, Sandu Joseph [Secretary of the SEAI] commented that “We have been badly affected. There is no shrimp export happening to the US now.” He said that Indian shrimp exporters had not received any export order from the United States since 17 February 2004. By April 2004 there was widespread concern among the exporters, growers and other stakeholders. Shrimp exports to the United States had come almost to a standstill due to the uncertainty regarding the contingent applicability and incidence of the anti-dumping duty. According to Joseph Zavier, general secretary of the Kerala Boat Owners Association, with almost insignificant exports to the United States since February the shrimp catch had been reduced by 40–45%. The price per kilogram of white shrimps, Rs. 280 a few months previously, had crashed to Rs. 100 in April, while the price per kilogram of another variety of prawn had fallen from Rs. 80 to Rs. 40. In Tamil Nadu and Andhra Pradesh, two large southern states, shrimp farming is done in large barren areas converted into farms. Mohammad Nayeem, once a prosperous shrimp farmer in Andhra Pradesh, is now a broken man. He owns 100 acres of shrimp farm and used to sell the products at a price of Rs. 450–600 per kilogram, but after the ITC decision the price had crashed to Rs. 220, while the cost of production was Rs. 250. In Kerala, shrimp farming is mostly done in paddy fields, converted into shrimp farms, on the fringes of backwaters. According to Rajan P. Mambaly who is one of those who has given his land under lease for shrimp farming, the duty, if imposed, will hit him and the farmers hard, as the net price to the growers would come down to the extent of the anti-dumping duty. The preliminary determination came on 28 July 2004. In a media briefing on 29 July 2004 the chairman of the MPEDA [Marine Products Export Development Authority] observed, “We are not happy with the preliminary determination of the duty rates. The final determination would be on 16 December 2004 and we will fight the case further and try to bring it down to zero level.” The investigation has now moved into the final determination stage. As part of the procedure, DOC [US Department of Commerce] officials visited India in August–September 2004 for onsite verification of the information and data submitted by the mandatory respondents during the preliminary phase of the investigations. Source: Callagher et al. (Eds) (2005)

such as the U.S. and the EC, and the reasons are threefold: their importance for developing countries’ exports, the vagueness of panel recommendations on the form of remedies, and the possibility of dragging out a legal case for years.36 See also Box 9.2.

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Box 9.2 Costs of foreign contingency measures for industry: A case study of Pakistan “... it took the government almost an entire year to request the establishment of a panel at the DSB [Dispute Settlement Body]. After the success at the TMB [Textiles Monitoring Body] review such a delay at this critical stage came at a large cost to the exporters and manufacturers of combed cotton yarn. In the international market the demand for combed cotton yarn was picking up, so that the quota restraints were inhibiting Pakistan’s potential exports and foreign exchange earnings even more.” Source: Turab Hussain. 2005. “Victory in Principle: Pakistan’s Dispute Settlement Case on Combed Cotton Yarn Exports to the US.” In Callagher et al. (Eds.) (2005): 266.

To conclude this section, we have tried to put the issue of implementation costs into perspective by looking at the WTO-related implementation costs in terms of government budgets. We have done so by calculating the relevant costs as a percentage of annual government expenditures on public education. The calculations are summarized in Table 9.5. For some countries the figures are fairly high but, surprisingly, not as large as we have feared or as we have been led to believe by the original study of Finger and Schuler. 9.4.3 Impact on government revenues It is one of the more unfortunate facts of life of many poor countries that their government budgets are excessively dependent on revenues from tariffs on imports. Import tariff are an inefficient means of collecting revenue: they distort incentives to trade and encourage corruption. There are more efficient instruments for collecting budget revenues but, for a variety of reasons, governments may not be able or willing to switch to those alternatives.37 Thus, a highly distorted system of taxation is the reality in many poor countries. Unless these distortions are addressed by appropriate changes in the countries’ tax regimes and administration, accession to the WTO and the subsequent membership will lead to increased pressures on government revenues and, consequently, on government budgets and expenditure policies as a result of pressures from the negotiating rounds to reduce trade barriers. These pressures will vary depending on the initial level of tariffs during accession negotiations and the status of countries in WTO negotiating rounds, that is, the extent to which they countries be expected to reciprocate. But in general, all countries are expected to offer some concessions even though the degree of these is likely to vary between rich and poor countries and will depend on the initial conditions of each individual country. In brief, governments may lose some budget revenues as a result of

Table 9.5 Costs of WTO-related projects in selected developing countries (In millions of current US dollars and as percentages of public expenditure on education)a Costs

In millions of current U.S.$ dollarsb

As percentage of annual public education expenditure (year)

Ethiopia, 2004–11 Preparation for accession negotiations

Preparation for negotiations on WTO accession (studies, advisors, training, workshops, and documentary materials) – component of a private sector development capacity building project

0.65c

0.23 (2002)

Samoa, 2002–08 Services liberalization

Amendment of Postal and Telecommunications Act; publication of postal sector policy – components of a telecommunications and postal sector reform project

0.24

2.12 (2002)

Kyrgyz Republic, 2006–11 TBT

Amendment of TBT regulations; capacity building for National Institute of Standards and Metrology; development and deployment of an internationally recognized accreditation scheme; project management

5.00 d

5.86 (2003)

Peru, 2003–06 TBT

Development of institutions and mechanisms for coordination between public and private sector and among public sector authorities; training for private sector; awareness raising for private sector; development of norms and improvement of certification schemes; equipment procurement; pilot certification projects – components of a trade facilitation and productivity improvement technical assistance project

5.00

0.30 (2002)

Pakistan, 2001–06 Trade facilitation

Development of institutions for interaction between public and private sector; improvement of documentary procedures; capacity building for National Trade and Transport Facilitation Committee

3.50

0.26 (2000) Continued

Table 9.5 Costs of WTO-related projects in selected developing countries (In millions of current US dollars and as percentages of public expenditure on education)a—Continued Costs

In millions of current U.S.$ dollarsb 1.60

As percentage of annual public education expenditure (year)

Armenia Customs

Drafting new customs law, training staff and streamlining procedures

Cambodia Customs

“Electronic single window” (for customs)

26.00

26.48 (2004)

Vietnam, 2005–11 Customs

Modernization of customs systems and procedures; restructuring of the General Department of Vietnamese Customs; equipment procurement and infrastructure improvement; project management

77.70

N/A

Russian Federation, 2003–09 Customs

Restructuring of customs control and clearance; trade facilitation (incorporating international standards); improvement of customs accounting and analysis; review and amendment of customs regulations; restructuring of customs authorities; human resource development; anticorruption measures; equipment procurement and infrastructure improvement; project management

Moldova, 2003–07 Customs

Capacity building for customs authorities; modernization of customs information systems; development of a transit control system and improved mechanisms of customs-private sector interaction; information dissemination and training for private sector; pilot customs projects

Albania, 2000–05 Customs

Monitoring and review of customs procedures; training for customs authorities; development of mechanisms for interaction between public and private sector; information dissemination and training for private sector; equipment procurement and infrastructure improvement; pilot customs projects

185.82

9.68e

12.30

2.13 (2002)

1.17 (2003)

9.93 (2003)

9.62 (2002)

Macedonia, 2000–05 Customs

Restructuring of customs authorities; monitoring and review of customs procedures; training and awareness-raising for customs authorities; development of mechanisms for interaction between public and private sector; information dissemination and training for private sector; equipment procurement and infrastructure improvement; pilot customs projects

14.50

9.58 (2002)

Ghana, 1998–07 Customs

Modernization of customs regulations and procedures; training for customs authority; equipment procurement and infrastructure improvement; ISO 9000 certification for Customs and Port Cargo Clearance Processes – component of a trade gateway and investment project

2.25

0.71 (1999)

Ecuador, 1998–03 Customs

Review and amendment of customs regulations; training for customs service and Ministry of Trade, Industry, and Fishing and private sector; equipment procurement and infrastructure improvement; awareness-raising for public – component of an international trade and integration project (World Bank, 2006)

5.60

0.93 (1998)

Notes: a Total public expenditure on education is defined as the current and capital expenditures on education by local, regional, and national governments, including municipalities (household contributions are excluded). It is calculated from the share of total public expenditure on education in GDP; GDP data are derived from World Bank (2006b). b Figures for project costs are based on appraisal estimates. All figures are rounded to two digits after the decimal point. c A fraction ($5.00 million) of the total projected project cost ($26.5 million) will be covered by a grant under the International Development Association. d The full amount of the total projected project cost will be covered by a grant under the International Development Association. e A fraction of the total project costs for Moldova ($1.275 million), Albania ($1.3 million), and Macedonia ($2.1 million) were to be covered by funds from the Government of the U.S. It is not known whether these funds were offered in the form of loans or grants. Sources: The data on project costs unless otherwise noted are from various World bank projects. The corresponding data on project costs for Armenia and Cambodia are from WTO (2006).

272 Zdenek Drabek and Wing Thye Woo

accession negotiations or of new rounds of multilateral negotiations on market access but the final outcome will depend on the initial conditions and on the governments’ ability to replace the loss of tariff revenues by alternative sources. However, the fact that either accession or tariff reductions as a result of multilateral negotiations might not necessarily lead to a reduction of tariff revenues was documented by, for example, Drabek and Bacchetta (2004) and in Chapter 4 above. 9.4.4 Loss of sovereignty There is a widespread perception and general understanding that the WTO Membership leads to a certain loss of national sovereignty. While some loss of national sovereignty is beyond any doubt, the real question is whether the loss matters and if so to what extent. One can presume, for example, that loss of sovereignty over certain issues may be compensated by gains elsewhere. For example, loss of sovereignty in resolving commercial disputes may be more than amply compensated by gains from international trade subject to lower trade barriers negotiated in the WTO. Nevertheless, it is important to be fully aware of the additional costs that be imposed by the loss of national sovereignty. For example, Linda Schmidt tells the story of services in Barbados and notes that creating regulatory institutions to oversee competitive markets in telecommunications, banking, insurance, and other financial sectors can become a constraint on their development. In that respect she echoes the debate in OECD countries about the role of governments in regulating financial services and, in general, about the desirability of regulations.38 She was mainly concerned about the lack of financial and human resources but, as the debate in rich countries demonstrates, the problem is deeper. Others see the loss of sovereignty as an opportunity. For example, Callagher et al. (2005) conclude that “The WTO Agreements constrain government actions in the regulation of trade but none of those constrains appears in (any of these cases) as a hurdle for governments and for businesses. On the contrary, where WTO Members in the stories told [in their book, ZD] directly invoke the rules ... or make use of the framework of rules and obligations the outcome is positive for developing country business. Where the rules act to constrain or direct government choices ... the constraints seem likely to lead to more opportunities for trade and growth.”

9.5 A case study: The politics and economics of China’s pursuit of WTO Membership China was admitted into the WTO on November 10, 2001 during the WTO Ministerial Conference in Doha [WTO (2001)]. The most important barrier to China’s accession to WTO had been overcome in November 1999 when the U.S. and China successfully concluded their bilateral negotiations. The U.S.-China

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bilateral negotiations had started in 1986 when China applied to join GATT, making the WTO application process for China the longest than for any member country to date. Table 9.6 summarizes the main institutional changes that WTO Membership required of China, for example, tariffs on automobiles would fall from 90 percent to 25 percent and state trading would be confined to cereals, tobacco, fuels, and minerals. It is clear that the substantial liberalization of trade in many services and the lowering of the average industrial tariff from 24.6 percent to 9.4 percent by 2004, and the average agricultural tariff from 31.5 percent to 14.5 percent by the same date created considerable Table 9.6 Summary of key commitments by the Chinese government on WTO Membership Sectors

Key commitments

Agriculture

Farm subsidy capped at 8.5% of value of domestic production (then level = 2%) Elimination of export subsidies Average bound tariff down to 15% (1–3% in-quota rate and up to 65% above-quota rate on cereals), further reductions mostly by 2004

Automobiles

Import tariffs on automobiles to 25% by mid-2006 from 80–100% Restrictions on category, type, and model of vehicles produced to be lifted in two years

Banking

Foreign bank involvement in foreign currency business permitted immediately, and local currency business with local corporations within two years after accession, with local residents within five years. Geographic restrictions on foreign banking business to be lifted over five years

Insurance

Foreign ownership: 50% of life insurance and 100% of nonlife insurance (property/casualty) geographic/business restrictions to be gradually phased out

Securities

Minority foreign-owned joint ventures in fund management industry. Foreign ownership up to 49% in five years

Distribution

Foreign companies to be allowed to set up joint ventures within two years of accession with majority ownership and without geographic restrictions, with exceptions for a few products

Telecommunications

Foreign company stakes: 25% in cell phones, up to 35% in one year and 49% after three years; area restriction to be lifted after 5 years

State trading and trading rights

State trading will continue in cereals, tobacco, fuels, and minerals. All enterprises will be free to import or export after three years

Source: Compiled by the Citigroup from WTO documents.

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adjustment costs for China. For example, given China’s low average population density, China is a natural food importer and a natural factory-oriented society, but its agricultural sector still employed 329.7 million people in 2001, which was more than two-thirds of the rural labor force. The bulk of China’s state-owned sector – which employed 31 percent of the urban labor force – had been relying on WTO-contravening policy instruments like subsidies and import barriers39 for survival. Together, the agricultural sector and the state sector employed about 55 percent of the total labor force in 2001. Sachs and Woo (2003) estimated that almost one-fifth of China’s workers might have to change jobs, the economic adjustments necessitated by WTO Membership could have proved politically destabilizing if not handled adeptly or if external shocks were to slow down economic growth. The preceding two paragraphs yield two especially noteworthy observations: 1. China’s persistence in its application reveals a deeply serious desire to be a member of the WTO. China was certainly not under coercion from the rest of the world to join WTO. 2. The final entry terms that China agreed required it to reduce drastically its barriers to imports and inward foreign investments into many sectors with high growth potential, like telecommunications and financial services. Together, these two observations constitute an interesting riddle. Why did China pursue protracted negotiations to formulate a drastic trade-industrial deregulation package when it could have implemented the same measures unilaterally? Why should China deregulate its trade and investment regimes according to a fixed timetable and under the monitoring of other countries when it could have done so at a pace contingent on the state of domestic and international economic conditions? According to the standard textbook Heckscher-Ohlin (H-O) framework, China should definitely have adopted free trade if it were a small country (i.e., a price-taker on traded goods) and standard macroeconomic stabilization theory would advise that the timing of deregulation should have depended on the then state and projected trajectory of domestic employment and inflation. And, if China was a large enough trader to employ the “optimum tariff” to its advantage, the H-O model would advise it against agreeing to the large across-the-board reductions in its tariffs that are in the final WTO accession document. The riddle is why China did reject so decisively the standard advice on macrostabilization and why did it ignore the “optimum tariff” prescription of the canonical H-O model. This riddle is made more interesting when one takes into account the alarming prediction by some China-watchers that the WTO process would

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generate such large political turmoil that there would be economic stagnation in China for an extended period. The most widely discussed mechanism through which WTO could create political meltdown was macroeconomic shock. Macroeconomic shock resulting from WTO Membership could take two forms. First, WTO Membership might promote a flood of imports that would cause widespread unemployment in the urban and rural areas, and thus provoke social unrest that would bring about macroeconomic collapse. Second, the entry of foreign banks could divert deposits from the already bankrupt domestic banks, and a resulting shutdown of the credit system would disrupt production across the economy. In the ominous words of Gordon Chang (2001), WTO accession would “shake China to its foundations.”40 “In 1998, there were 60,000 protests ... [and in 1999], there were 100,000. Anecdotally, we know at least that demonstrations last year grew bigger ... But the most significant aspect of the recent demonstrations is not their increasing size. It is that these days, barehanded peasants and workers are desperate enough to do battle with armed state security forces. That tells us volumes about the state of China today. “... China’s imminent accession to the World Trade Organization can only aggravate the problem of instability, because membership will limit Beijing’s ability to postpone solutions ... [Imports] will flood the country. And that means uncompetitive state-owned enterprises will fail in even greater numbers than they do today ... And in the countryside, expect China’s peasants to be hit even harder than the urban proletariat, as efficient foreign agribusiness penetrates Chinese markets. “... Accession will knock one or two percentage points off increases in GDP ... [and] China is at the point where the loss of even a percentage point of growth would have a disproportionate impact on urban workers and the peasantry ... [The fact is that] many Chinese today are still hungry, angry and, worst of all, desperate. That desperation will escalate as the country settles into the WTO.”41 “The People’s Bank of China, the country’s central bank, says that about 30% of the loans of the four biggest banks are nonperforming, but that assessment is based on accounting with Chinese characteristics. Foreign observers put the figure closer to 50%, and some even say higher. “... But in less than five years, foreign banks, in accordance with China’s World Trade Organization commitments, will be able to accept local- currency deposits from Chinese citizens. If foreign institutions are able to divert just a little liquidity away from the Big Four, there will be a banking crisis of historic proportions. Beijing’s leaders will try to avoid tragedy, but they might not succeed. For one thing, they don’t have enough money.”42

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We do not accept Gordon Chang’s dire prediction that a WTO-induced collapse was inevitable because we think that these are technical issues that China has the ability to handle (see Sachs and Woo, 2003). In our opinion, there were two main classes of reasons – external and internal – that propelled the Chinese leadership toward WTO Membership despite the considerable risks to social stability from the structural adjustments. The two sets of reasons are: 1. External – in order to strengthen the external economic security of China significantly and to give a major boost to the possibility of China becoming the major Asian hub in international production networks; and 2. Internal – in order to take advantage of the opportunity enabled by the favorable change in the political environment toward capitalist practices to implement the systemic restructuring required to put China on a higher path of sustained growth. 9.5.1 Enhancing external economic security and becoming a more important production hub It is inevitable that the H–O model, being a distillation of many case studies, misses a circumstance-specific but fundamental reason for China’s enthusiasm for WTO Membership, which is that WTO Membership will greatly enhance China’s economic security. Until China completed the U.S.-China Bilateral WTO negotiations in 1999 and the passage of the Permanent Normal Trade Relations Act in 2000, China required annual approval from the U.S. Congress for MFN status in order for its exports to compete in the U.S. markets on equal terms against the exports from WTO Member countries. This annual congressional approval process inevitably rendered China’s exports vulnerable to passing passions in the U.S. political arena over accidents like military airplane collisions in the South China Sea, and the Chinese burning of the U.S. consulate in Chengdu following the unintended U.S. bombing of the Chinese embassy in Belgrade. High and growing global demand for China’s exports of the last two decades has been a powerful force in hastening the transformation of China from a subsistence peasant economy to an industrialized economy. If exports were to falter, then a drastic slowdown in growth would be inevitable. Since the U.S. has traditionally been China’s largest export market, the only way for exports to be a sustainable growth engine is for China to secure assured access to the U.S. market. And, only WTO Membership for China could prevent unilateral U.S. action to switch off one of China’s most important growth engines by simply blocking exports from China in any year, because it would then be a violation of international law for the U.S. to do so. Because it is hard to overstate the importance to China of maintaining both high export growth and access for its exports to U.S. markets, it is hard

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to overstate the importance of WTO Membership to its external economic security. Strictly speaking, the termination of the annual review of China’s MFN status and China’s WTO Membership were mutually exclusive events. From the timing of events, we think that the termination of this annual MFN review was an implicit understanding between the principals in the U.S.-China Bilateral WTO negotiations. Shortly after the successful conclusion of the bilateral negotiations on November 15, 1999 in Beijing, the Clinton administration proposed the Permanent Normal Trade Relations (PNTR) Act to end the annual MFN review. PNTR was passed by the U.S. Congress on September 19, 2000, and signed into law on October 10.43 If the Clinton administration had not passed the PNTR at the time of China’s accession, it could still have retained its legal right to an annual MFN review because Article XIII of the WTO Agreement (the Nonapplication provision inherited from GATT) permits an existing member to “opt out” of some of the WTO regulations, that is, continue some existing bilateral practices that are not WTO-compatible, for an acceding member at the time of its accession. In that case, China would still have become a full member at the WTO, but would not have full WTO rights and obligations vis-à-vis the U.S. (e.g., dozens of GATT contracting parties opted out of GATT relations with Japan when it joined the organization in the 1950s.) This right to invoke nonapplication belongs to both the existing members and the acceding country, and it can be invoked only at the time of the country’s accession. The invoking member may revoke the nonapplication at any time, but once revoked, it cannot be reinstated. Analytically, the removal of the MFN threat when China officially became a WTO Member at the end of 2001 is equivalent to a reduction in the risk premium demanded by investors in China’s export-oriented industries. The complete picture of China’s WTO Membership concerns more than simply a reduction in China’s effective tariffs; it also includes a reduction in the risk premium for investment in export-oriented production inside China. The effect of the tariff reduction was to restructure the composition of China’s output from importables to exportables and nontradeables while the effect of the risk premium was to reconfigure the global distribution of foreign direct investment (FDI) in China’s favor. There is indeed evidence of China’s WTO Membership making China a more attractive destination for FDI. The Japan Bank for International Cooperation (JBIC) conducts an annual survey of Japanese transnational corporations (TNCs) to find out which are the top ten locations for manufacturing FDI over the following three years. Table 9.7 contains the results from the surveys undertaken in 1996, 2000, and 2001. In all, 68 percent of Japanese TNCs listed China as one of the top ten locations in 1996, and 65 percent did so in 2000. These responses made China the most frequently

Table 9.7 The ten most promising destinations for manufacturing FDI by Japanese TNCs over the following three years (Frequency, expressed as a percentage of a country’s identification by Japanese firms responding to annual surveys conducted by Japan Bank for International Cooperation, JBIC) Rank 1

1996 surveya China

Ratiob 68

2000 surveya China

Ratiob 65

2001 surveya China

Ratiob 82

2

Thailand

36

U.S.

41

U.S.

32

3

Indonesia

34

Thailand

24

Thailand

25

4

U.S.

32

Indonesia

15

Indonesia

14

5

Vietnam

27

Malaysia

12

India

13

6

Malaysia

20

Chinese Taipei

11

Vietnam

12

7

India

18

India

10

Chinese Taipei

11

8

Philippines

13

Vietnam

9

Republic of Korea

8

9

Singapore

10

Republic of Korea

9

Malaysia

8

Philippines

8

Singapore

6

10

= U.K./Chinese Taipei

7

Notes: a Fiscal year. b The share of firms that consider the country as promising in total respondent firms (multiple responses). Source: United Nations Conference on Trade and Development (2002).

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identified promising location for FDI in both years, that is, China was ranked first in the list of ten locations. The evidence in favor of our hypothesis that post-WTO China was a more attractive destination for FDI is captured in the 2001 survey. It became clear to the international community at the end of 2000 that China’s accession to WTO was imminent. The upshot was that the proportion of Japanese TNCs in 2001 that identified China as one of the ten most promising locations for manufacturing FDI jumped to 82 percent. Most telling of all, the “identification gap” between China and the U.S., which were ranked first and second respectively in 2000 and 2001, widened from 24 percentage points in 2000 to 50 percentage points in 2001. The frequency with which the ASEAN–4 economies (Indonesia, Malaysia, the Philippines, and Thailand) were identified as top ten locations for FDI dropped between 1996 and 2000, and it is probable that the most important reason for this change in TNC’s perception was the Asian financial crisis. The frequency with which Thailand was identified fell from 36 percent to 24 percent, Indonesia from 34 percent to 15 percent, Malaysia from 20 percent to 12 percent, and the Philippines from 13 percent to 8 percent. In terms of ranking within the ten most cited locations, Thailand slipped from second to third, Indonesia from third to fourth, and the Philippines from eighth to tenth, while Malaysia improved from sixth to fifth. As the Asian financial crisis was over by early 2000, the changes in the frequency of identification and ranking of the ASEAN–4 economies on the list of profitable FDI locations between 2000 and 2001 could therefore justifiably be attributed to the WTO-created improvement in China’s perceived reliability as an international supplier. The frequencies with which Thailand and Indonesia were identified as desirable FDI locations are practically identical in 2000 and 2001, but the identification gaps between them and China increased significantly. The China-Thailand gap went up from 41 percentage points to 57 percentage points, and the China-Indonesia gap from 50 percentage points to 68 percentage points. The frequency with which Malaysia was cited declined from 12 percent to 8 percent, and the Philippines dropped out of the top ten list. Malaysia’s rank moved from fifth to ninth, and the China-Malaysian identification gap soared from 53 percentage points to 74 percentage points. These differences in the survey results of 2000 and 2001 are certainly consistent with our hypothesis of WTO-induced diversion of FDI to China. Even more direct evidence of our hypothesis that WTO Membership had increased the profitability of FDI in China are found in a survey undertaken by the Japan External Trade Organization (JETRO) in October 2001. JETRO asked Japanese TNCs whether they might relocate their existing production facilities to China in response to China’s accession to WTO, and 21 percent replied that they were planning to do so. Of those intending to relocate, 67.5 percent of them would relocate from Japan, 9.0 percent from Hong Kong-China, 6.6 percent from Chinese Taipei, and 6.0 percent from

280 Zdenek Drabek and Wing Thye Woo

the ASEAN-4. The complete breakdown of the locations to be abandoned is given in Table 9.8. While it is true that 99 percent of Japanese TNCs with existing investments in ASEAN–4 and Singapore stated in another survey that they would stay put, UNCTAD (2002: 44) insightfully noted that “[this] does not, of course, mean that their production in China will not expand faster than in ASEAN.” The two main findings from the JBIC and JETRO surveys are that: 1. There was a 17 percentage point jump in 2001 in the frequency with which China was identified as a top FDI location and a general decline in the frequencies with which the ASEAN-4 economies were identified as top FDI locations; and 2. Some 21 percent of firms indicated that they would move their existing production to China. It therefore appears reasonable to conclude from these findings that China’s WTO Membership has encouraged producers to choose China over the other Table 9.8 Survey undertaken in October 2001 of the 21 percent of Japanese TNCs that intend to move to China because of China’s accession to the WTO (survey by Japan External Trade Organisation, JETRO) From Japan

Distributive share 67.5

Hong Kong, China

9.0

Chinese Taipei

6.6

ASEAN-4:

6.0

Malaysia

3.0

Indonesia

1.2

Philippines

1.2

Thailand

0.6

U.S.

4.2

Singapore

1.8

Republic of Korea

1.2

Other Asian countries

1.2

Mexico

1.2

U.K.

1.2

Note: Planned relocation of production sites of these Japanese TNCs (percentage of TNCs responding) Source: United Nations Conference on Trade and Development (2002).

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East Asian economies as the site for investment in additional capacity and/ or to move their existing production capacity to China. We realize that the JBIC and JETRO surveys did not cover non-Japanese TNCs, but anecdotal evidence from the authors’ visits to East Asia suggest that the relocation of existing investments to China and location of new production capacity in China also apply to producers from the U.S., Hong Kong-China, South Korea, and Chinese Taipei.44 A news report in Malaysia in 2002 certainly made it clear that the Malaysian government had no doubt that much of the drop in FDI that Malaysia was experiencing was caused by FDI diversion to China: Malaysia attracted approved manufacturing FDI of only RM 2.16 billion ... for the first six months of this year [2002]. This is a sharp drop from the RM 18.82 billion it pulled in for the whole of last year. “... Everybody is feeling the pinch because the amount of FDIs has shrunk and then, a lot of that is going to China,” Dr. Mahatir [Prime Malaysia] told a news conference later.45 Indeed, the consulting firm, A.T. Kearney, released in September 2002 a survey of senior executives of the world’s largest corporations that found that “China has for the first time supplanted the U.S. as the most attractive destination for foreign direct investment.”46 We can now ask the question of whether effects generated by the diversion of FDI from the ASEAN–4 can be fully captured by a decrease in the capital stock of the ASEAN–4 and a corresponding increase in the capital stock of China? The answer, in our opinion, is “no” for at least three reasons. The first reason is that the diversion of FDI does not necessarily produce a new steady-state where there are winners and losers. In a dynamic, optimizing general equilibrium model, the new steady-state could have only winners, distinguished by big winners vs. small winners. Ceteris paribus, an increase in the rate of return on investments in China (i.e., a decrease in the size of the risk premium required for investments in China) could motivate the world to save more and produce a larger global capital stock in the new steady-state. The fact that a higher proportion of the expanded global capital stock is now located in China does not rule out the possibility that the final capital stock in the ASEAN–4 would be larger than the original capital stock. We note that it is almost a mathematical necessity that a zero-sum outcome in economic welfare is very much more likely in a static general equilibrium model (as operationalized in the standard computable general equilibrium model like the standard Global Trade Analysis Project (GTAP) model) because the size of the global stock is fixed, by assumption. In short, we can analyze FDI diversion adequately only if we recognize that the global capital stock is endogenously generated.

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The second reason why FDI diversion should not be thought of as a simple relocation of the capital stock is because FDI could also generate externalities. The East Asian experience suggests that FDI could facilitate technological transfers (i.e., generate technological spillovers) not only to domestic firms in the same industry but also to domestic firms in other industries; for example, see Okabe (2002) for a confirmation of the existence of these technological spillovers. Furthermore, FDI could also help to solve difficulties of access to the international markets in these goods. In short, a country gaining FDI could experience not only a bigger capital stock but also, possibly, an increase (albeit, most likely, temporary in nature) in its total factor productivity (TFP) growth rate; while a country losing FDI could experience a (perhaps temporary) slowdown in TFP growth as well as a (perhaps temporary) lower capital stock. The third reason why the global reconfiguration of FDI flow is more than a reallocation of the global capital stock is because the greater concentration of FDI in China increases its suitability as the East Asian hub of the international production chains with activities sprinkled in production enclaves throughout East Asia. In short, in the first phase of increased FDI inflows into China, FDI would go into manufacturing activities. If agglomeration of manufacturing activities in China increases its utility as the regional coordination center in international production networks, then the second phase of increased FDI into China would go toward increasing into the higher value added activities of research, design, and development and financing, marketing, and distribution. 9.5.2 Enlarging the political space to implement economic restructuring WTO Membership also marks a watershed in China’s public recognition about the primary source of its impressive growth in the last two decades. The WTO is an international economic organization that specifies and enforces broadly similar economic policy regimes on its membership. China’s willingness to join such an institution reflects more than a desire to protect itself from potential blackmail by the U.S., it also reflects China’s realization that the active ingredient in Deng Xiaoping’s recipe for conjuring up growth was the convergence of China’s economic institutions with the norms of the economic institutions of modern capitalist economies, particularly of East Asian capitalist economies, as well as the closer integration of China’s economy with the world economy through trade and finance. At the early stages of China’s reform, when most of the intelligentsia did not know the full extent of the economic achievements of their capitalist neighbors, when many of the top leaders were ideologically committed to Stalinist-style communism, and when the political legitimacy of the Chinese Communist Party would be undermined if it admitted that the economic management of the preceding 30 years had been a mistake, only gradual

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market-oriented reforms – certainly not drastic reforms – could get the political support they needed to be implemented. Even then, it was important for the survival of the reformist faction of the time that the changes to China’s economic institutions were comfortingly gradual, concentrated in provinces conveniently located far from Beijing, and cloaked in the patriotic rhetoric of experimentation to discover new institutional forms optimal for China’s socialist system and particular economic circumstances. The impressive economic growth that was unleashed by the gradual market-oriented reforms in China has been interpreted by many scholars as the fruits of an experimentalist policy regime.47 This experimentalist view holds that partial price deregulation (dual-track pricing) is intrinsically superior to complete price liberalization and that improvement in SOE efficiency requires only enhanced product competition and not diversification of ownership forms. Gradual, piecemeal reform is seen as being superior to fast, comprehensive reform. Gradual reform was viewed as the byproduct of three aspects: 1. The time-consuming processes of undertaking economic experimentation on different degrees of price flexibility, different types of SOE contracts, and different forms of ownership structures in order to discover the particular institutional features that are optimal for China’s specific economic conditions; 2. Verifying the initial results of the same experiments conducted in other locations within China; and 3. Propagating the new institutional innovations nationally. This view – of the experimentalist school (E-school) – has been strongly contested by the convergence school (C-school), which believes that the experimentalists have made economic virtues out of political necessities in China’s uneven and drawn-out reform process.48 The C-school contends that that the reason why China could grow so impressively without significant restructuring is because China in 1978 was still an undeveloped economy dominated by self-subsistence peasant agriculture whereas the urbanized Central European and Russian economies in 1989 had an overabundance of heavy industries. This meant that the introduction of market forces caused economic development in China and economic restructuring in, for example, Poland and Russia, which translated, respectively, into output growth in China and output decline in Poland and Russia.49 In essence, the C-school argues that the institutional infrastructure that China needed in order to move from a low-income country to an uppermiddle income country could be acquired mainly through adopting best international practices in different spheres and then modifying these practices as experience is accumulated (in China and elsewhere in the world). The C-school sees the East Asian experience as the most relevant model for

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China because that is the best case of “catching-up” industrialization that the world offers. The C-school cautions, however, that changes in international markets over time suggest that blind adherence to an earlier formula will not succeed in present and future contexts. Viewed against the background of this debate between the E-school and the C-school, the desirability of WTO Membership for China is not unambiguous. In fact, China’s decision about joining WTO Membership will determine the economic future of China! If China’s economic successes have been the result of its discovery of new institutional forms (e.g., dual-track pricing, SOE contracts, and fiscal contracts) optimal for China’s particular economic circumstances, then WTO Membership is a negative development because it might be a straitjacket of WTO-enforced institutional harmonization that will constrain China’s scope for experimentation. But if China’s impressive achievements have, instead, been the result of the convergence of its economic institutions to those of a typical advanced member of WTO the experimentalist interpretation is wrong, then WTO Membership is a positive development that will lock China on to the path of deepening economic reform. As in most things, the debate between the two schools has been resolved neither by the formulation of cleverer models nor by more sophisticated massaging of data, but by developments on the ground. The Chinese leadership cast its vote for the superiority of arguments of the C-school when it accepted WTO Membership in Doha in 2001. China could finally embrace institutional convergence publicly in 2001 because after 20 years of evolution in economic institutions, rotation in political leadership, and tectonic change in the political fortunes of communist parties in Eastern Europe and the former Soviet Union after 1989, the only organized opposition in 2000 to the continued convergence of China’s economic institutions to international forms comes form a small group of sentimental Stalinists like Deng Liqun.50 The social and political landscape in China had changed so much by the mid-1990s that the political leadership incurred only minimal ideological liability when they introduced more capitalist incentives (e.g., differentiated pay, leveraged buy-out, and stock options for managers) and capitalist tools (e.g., joint-stock companies, bankruptcy law, and unemployment insurance). The leadership was confident that its explicit embrace of capitalist institutions under WTO auspices would be seen by the general Chinese public (and the Chinese elite) as a step forward in the reform process rather than as a surrender of China’s sovereignty in economic experimentation.51 The tradeoff between stability and restructuring that was so starkly brought to the forefront by China’s entry into WTO was not a new tradeoff. China’s WTO Membership really accentuated an existing dilemma, not introduced a new one. The government had always realized that the soft

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budget constraint of the inefficient SOE sector was a constant threat to price stability and that the diversion of resources to keep this sector afloat was a drag on economic growth. But serious restructuring of SOEs meant much more than facing higher urban unemployment, it also meant confronting the politically powerful industrial-military and industrial-bureaucratic complexes. Economic rents now pose a bigger obstacle to restructuring than ideological sentimentality and, unlike the latter, are not something that the mere passing of time will resolve – ideological sentimentality disappears when the old revolutionaries die but economic rents are inherited by each generation of leaders. Because a major reason for the failure of Gorbachev’s reforms was opposition from the entrenched interests within the ruling structure, China’s WTO accession could be seen as an attempt by reformers to lock economic policies on to a market-oriented course that is costly to reverse.

9.6 Conclusions Membership of the WTO clearly holds great attraction to countries and these attractive features are well known: transparency of agreed disciplines; negotiated improvements in market access; enhanced credibility of government policies; and the resolution of commercial disputes are all features emphasized by the supporters of the modern multilateral trading system. These features are particularly attractive for small countries with little bargaining position in bilateral or regional arrangements and for countries that have been isolated from world markets for a long time for one reason or another but now wish to reenter and become fully accepted international partners. Nevertheless, countries’ reactions to the WTO are not uniformly positive. Some countries have been publicly critical of their failure to benefit from the WTO system of agreements and many countries openly express their disappointment about the discrepancy between the expected and the actual benefits from joining the multilateral trading system. We have tried in this chapter to search for the origin of these disappointments. The first issue we have identified are the misperceptions of WTO Membership. Countries often have a wrong understanding about the benefits to be gained from improved market access. WTO outsiders who are ignorant of the WTO accession procedures wrongly believe that accession will automatically improve the acceding country’s market access. This will be true only under specific circumstances and will only take form of greater market stability. As it turned out, the latter played an extremely important role in the case of China. The second issue relates to the actual implementation of domestic policies that were agreed on during the negotiations for WTO accession.

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The fact is that a necessary condition for effective implementation of policies is the country’s “ownership” of those policies. In other words, policies are unlikely to be implemented effectively if they are seen as being imposed from the outside. We have discussed one specific and controversial feature of those policies, namely the emphasis on market liberalization, which is quite clearly not fully shared to the same extent by all WTO Members. Once again, China is an important exception as it has used its WTO Membership in the pursuit of market liberalization and reform. We have identified also another difficult issue in WTO Membership, namely the scope for gains from the WTO system of dispute resolution. While there is no doubt that the system has been highly beneficial to many countries, its use has been equally highly skewed in favor of developed countries and has eluded many poor countries that have not been able to benefit or have chosen to avoid the system altogether. Misperceptions are particularly serious with regard to the costs of WTO Membership. As we have tried to show from a number of cases, countries are often ignorant about the high costs of implementation of WTO rules and disciplines. In some cases, these Agreements are just too costly for governments to implement without additional external support. In addition, countries may also be adversely affected by a loss of government revenues resulting from negotiated changes to tariff regimes at the time of accession or in multilateral rounds of negotiations on market access. There are also extremely sensitive issues and costs related to the loss of national sovereignty by the countries joining the WTO. The original idea of the framers of GATT/the WTO was to create equal conditions for trade among countries by agreeing on a variety of rules and disciplines. However, what seems to come out quite clearly from the de facto examples of WTO Membership is that the conditions for the implementation of those rules and disciplines vary a great deal between countries. As a result, some governments have practical difficulties in fully implementing the Agreements, others may run into opposition in their own countries, and others yet might discover only later that they have joined the WTO with false expectations. Until these misperceptions and other implementation problems are addressed effectively, we shall continue to witness a great of discord among the WTO Members. For China, its entry into the WTO marks a watershed on many fronts for China. On the economic front, China’s admission into the WTO marks an important improvement in its economic security. Trade and foreign investment have constituted an important engine of growth since 1978. As a result of China’s WTO Membership, this engine of growth could no longer be unilaterally shut off by the U.S. without this action being a major violation of its international commitments. This increase in the reliability of China as a supplier makes it an even more attractive destination for FDI,

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thus helping China to become a more important hub in international production networks. On the political front, China’s accession to the WTO confirms the sharp decline in influence of the remaining Stalinist ideologues and represents an attempt to use an international agreement to strengthen the hands of the market-oriented leaders in implementing further economic restructuring. On the academic front, China’s WTO Membership constitutes the official verdict on the debate between the C-school and the E-school. To appreciate the political and academic watersheds fully, WTO Membership must be viewed in the context of the comprehensive transformation of China’s economy and society that began with the Twelfth Party Congress in 1992 (which dropped the word “plan” entirely from its economic platform) and accelerated after the Seventeenth Party Congress in 1997 (which enunciated “The Three Represents” doctrine that allows the admission of capitalists into the party). Most of the small and medium SOEs in the rich coastal provinces have been privatized and the government has been exploring ways of selling state shares in the large SOEs listed on the domestic stock markets. The state constitution has been amended to give equal legal protection to state and private property. The rural landscape has also been changed greatly by the ongoing privatization (since 1993) of the collectively owned township and village enterprises (TVEs). The extension of land leases from 15 years to 30 years will be recognized as a landmark on the road to private land ownership in the countryside. WTO Membership is, the only one of the many policy actions undertaken by the state to promote the convergence of China’s economy to the norms of its East Asian neighbors and its integration with the world’s major economies.

Notes Prepared for presentation at “The World Trade Organization and Transition” session of the Association of Comparative Economic Studies at the Annual Meeting of the Allied Social Science Associations held in Boston, MA, January 6–8, 2006. Statistical assistance from Alex Riechel is gratefully acknowledged. We have received useful comments from the participants of the panel as well as separate comments from Richard Pomfret. Any remaining shortcomings of the chapter are, of course, are our own responsibility. 1. Jeffrey Frankel has written a great deal in support of Andy Rose’s findings. We have been unable to locate the precise reference to his reestimation of Rose model but his comments in another short paper basically capture the same idea. See Frankel (2005). See also Chapter 7 in this volume. 2. For more discussion see Drabek and Bacchetta (2004). Reprinted as Chapter 4 in this volume. 3. Ibid. 4. See Anderson and Martin (2005). The difference between bound and actual tariff is given by what the countries are willing and agree in the negotiations. 5. For more details see Low and Keck (2004) who are drawing on Hoekman and Leidy (1993).

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6. Accession to the WTO facilitates another aspect of market access – its stability, an issue to which we return further below. 7. For more details see Drabek and Bacchetta (2004). For more details and further discussion see also the chapters in this volume by Martin and Amsden. 8. The provision can be interpreted as excluding practices of material balances by centrally planned economies that were based on a discriminatory treatment of imports and exports. 9. The closest discipline covered with regard to price fixing is “regulations” covered by Article VI of GATS, which recognizes the right of countries to provide for domestic regulations. Paragraph 4 of the same Article makes it clear that such regulations must not “constitute unnecessary barriers to trade in services.” 10. See also our comment in note 4 above. 11. We are referring, of course, to what has become known as policy prescription under the “Washington Consensus.” See Woo (2005) for a critical review of the Washington Consensus and its enlargement from “get your prices right [price fundamentalism]” to include “get your institutions right [institution fundamentalism].” 12. For an earlier account of the problem, see, for example, papers in Whaley (1988). 13. Appropriate institutions are critical for the success of policy reforms such as trade liberalization as we have learned from the work of Rodrik and others. For example, trade liberalization leading to a loss of government revenues should be accompanied by a reform of the government system for alternative revenues. Clearly, if the latter is absent, a country should be seen as unprepared for accession. See Rodrik (2000) and Rodrik et al. (2002). For evidence, see, Schmidt (2005). 14. We are assuming here that an “adequate” provision of information to both private agents and governments and the “right” government policies will address all cases of market failure. 15. The study provides an analysis of trade relations under regional integration schemes but clearly documents the importance of deep cooperation as opposed to that of uncooperative arrangements. Ferrantino in his contribution to this volume analyzes the extent to which WTO contributes positively to stability of economic policies but is less optimistic in that respect. 16. We are, of course, aware of shortcoming of the existing dispute settlement system. They have been reviewed and discussed in a variety of studies such as Davey (2003), Butler and Hauser (2004), and Wolff (2002). However, the overall benefits seem to be generally recognized and accepted. We shall refer to the issue of dispute settlement further below. The issue is also discussed in more detail by Davey in a separate chapter of this volume. 17. See Schaffer (2003), citing Busch and Reinhardt (2002), p. 11. ??? 18. These propositions – the importance of legal capacities and power – have been tested and confirmed in a formal model by Horn et al. (1999). See also Gabilondo (2001). 19. See Mosoti (2003, p. 79). 20. Ibid: 80. 21. For outstanding issues in Non-Agricultural Market Access (NAMA) and in agriculture see, for example, Martin and Winters (1995). 22. The lack of debate about “rule making in the WTO” is unfortunate given the serious complications in establishing global rules. See Drabek (2006). 23. See, for example, Srinivasan (1998) or Panagariya (2003b). 24. The critics have included, for example, Hoekman who criticized the Agreements on a number of grounds which he labeled “holes and loopholes” of the

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25. 26.

27. 28. 29.

30.

31.

32.

33. 34. 35.

36. 37.

38. 39. 40. 41. 42. 43.

44.

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Agreements. The issue is further discussed and an additional evidence provided in the next section. We shall return to this issue in more detail in Section 9.5. The conditions of accession vary from country to country but the “excesses” are already well documented. See, for example, Butkeviciene et al.(2001) and for further references see also Drabek and Bacchetta (2004) and Chapter 4 in this volume. We shall refer to their work further below. See Finger and Schuler (1998, abstract and 25). Many observers consider the restrictiveness of TBT and SPS requirements even more serious than that of border measures. See, for example, Callagher et al. (2005, p. 8). The main arguments were well articulated by Panagariya (2003a) who has also identified the shortcomings of the agreement from the point of view of developing countries. See, for example, Srivastava (2005) who describes the efforts of the Indian Tea Board to register the geographical mark of “Darjeeling” tea. Similar problems have been experienced by other countries and reported, for example, in Amir and Pirzada (2005) and Azad (2005). The original Doha Declaration on Public Health foresaw the exemptions to be made in situations dealing with the three diseases noted in the text. Since then, however, demands of countries have targeted other diseases such bird flu. For example, Vietnam has negotiated with the Swiss firm Roche to be allowed to produce a generic medicine to deal with the bird flu pandemic. See Davey in a separate chapter of this volume. See Shaffer (2003, pp. 16–20). For another relevant example see Azad (2005). Several observers have made recommendations for an alternative system of remedies. To name just a few of the most perceptive and concerned experts, these include Steven Charnovitz, Robert Lawrence, Petros Mavroidis, and Joost Pauvelyn. The reader may refer to Shaffer (2003, p. 6, footnote 3) for full references. See Shaffer (2003), pp. 38–9. The literature reviewing dependence of poor countries on tariff revenues is partially reviewed in Drabek and Bacchetta (2004) and Chapter 4 in this volume, which can be also consulted for an appraisal of different policy options open to governments. For more details see, for example, Drabek (2006). This is why China has over 30 automobile-making firms when Japan, possibly the most efficient car manufacturer in the world, has only five. Chang (2001, p. xviii). Gordon G. Chang. “The Shahs of Beijing.” Far Eastern Economic Review. September 13, 2001. Gordon G. Chang. “Don’t Bank on China.” Far Eastern Economic Review. July 18, 2002. See The White House: China Trade Relations Working Group (2002) for a summary of the US-China Bilateral WTO Agreement in 1999; and World Trade Organization (2001a and 2001b) for the conditions under which China entered the WTO in 2001. Qin (2003) gives an excellent analysis of the legal protocol under which China joined the WTO. For discussions and quantification of how China’s WTO accession has affected other countries, see Abe (2003), Chen (2003), McKibbin and Woo (2002) and Yusof (2003).

290 Zdenek Drabek and Wing Thye Woo 45. “Malaysia turns inward for growth,” The Straits Times, September 21, 2002. 46. “China attracts more foreign investors than US,” Financial Times, September 22, 2002. 47. Lin, Cai, and Li (1994), Lau, Qian, and Roland (2000), Naughton (1994), Nolan (1993), and Rawski (1994). 48. Specifically, the C-school suggests that dual-track pricing was the product of political constraints and not of economic optimization, and hence was non-viable beyond the short-run. The C-school also deems the privatization of the bulk of the SOEs to be both inevitable and desirable provided that it be carried out transparently and honestly, to avoid the corruption that characterized Russian privatization undermine the very economic goals that privatization is designed to support. 49. The movement of Chinese labor from low-productivity agriculture to higherproductivity industry, and from the poor inland provinces to the richer coastal provinces produced an average annual growth rate of 10 percent in the 1978–95 period. The Chinese state sector certainly did not wither away in this period; it employed 18.6 percent of the workforce in 1978 and 18.0 percent in 1995, there were 38 million more state workers in 1995 than in 1978. There was reallocation of labor from agriculture to industry but not reallocation of labor from state to non-state enterprises. China in 1978 was thence very different from Russia in 1991, extensive growth was still possible in China whereas it had run its course in Russia; see Sachs and Woo (1994) and Easterley and Fischer (1994). 50. For recent warnings from this faction against perceived suicide by the Communist Party, see “Elder warns on economic change,” South China Morning Post, January 13, 2000, and “Leftists make late bid to slow reforms,” South China Morning Post, February 10, 2000. 51. This de facto public recognition by the government that the deus ex machina of China’s impressive growth since 1978 is the convergence of its economic institutions to those of market economies will unfortunately not end the academic debate on this issue. Many China specialists have waxed eloquently about how China’s experimentation has created economic institutions that are optimally suited for transition economies in general; see Sachs and Woo (2000 and 2003) for a survey of this debate.

References Abe, Shigeyuki. 2003. “Is ‘China Fear’ Warranted? Perspectives from Japan’s Trade and Investment Relationships with China.” Asian Economic Papers (Spring/Summer) 2(2): 106–31. Amir, Muhammed, and Wajid H. Pirzala. 2005. “Pakistan: Consequences of a Change in the EC Rice Regime.” In Callagher et al. (Eds.) 2005, 473–85. Anderson, Kym, and Will Martin. 2005. Introduction and Summary to Agricultural Trade Reform and the Doha Development Agenda. Washington, DC: The World Bank. Azad, Abdul Kalam. 2005. “Rock ‘n Roll in Bangladesh: Protecting Intellectual Property Rights in Music.” In Callagher et al. 2005, 53–62. Bagwell, Kyle, and Robert Staiger. 1998. “The Simple Economics of Labour Standards and the GATT.” NBER Working Paper No. 6604, June. Cambridge, Mass. Bhattacharyya, B. 2005. “The Indian Shrimp Industry Organizes to fight the Threat of Anti-Dumping Action.” Baracol, D.S. 2005. Philippines: Stakeholder Participation in Agricultural Policy Formation; in Calagher et al. (Eds) 2005, 241–52.

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Breckenridge, John. 2005. “Costa Rica’s Challenge to US restrictions on the Import of Underwear.” In Callagher, et al. 2005, 178–88 Brkic, Svetlana, and Azra Hadziahmetovic. 2005. Accession to the WTO; A Case Study of Bosnia and Herzegovina (mimeo). Sarajevo: Faculty of Economics, University of Sarajevo. Busch, Marc, and , Eric Reinhardt. 2002. “Testing International Trade Law: Empirical Studies of GATT/WTO Dispute Settlement.” In Daniel Kennedy and James Southwick (Eds.). The Political Economy of International Trade Law: Essay in Honour of Robert E. Hudec. Cambridge: Cambridge University Press. 2002, 457–81. Butler, Monika, and Keinz Hauser. 2004. “The WTO Dispute Settlement System: A First Assessment from an Economic Perspective.” JLEO, V16 N2 503. Lausanne and St. Gallen: Universities of Lausanne and St. Gallen. Callagher, Peter, Patrick Low, and Andrew Stoller. 2005. Managing the Challenges of WTO Participation: 45 Case Studies. Cambridge: Cambridge University Press. Chang, Gordon. 2001. The Coming Collapse of China. New York: Random House. Chen, Tain-Jy. 2003. “Will Taiwan be Marginalised by China?” Asian Economic Papers (Spring/Summer) 2(2): 78–97. Davey, William. J. 2003. The WTO Dispute Settlement System Mechanism. Illinois Public Law Research Paper 03–08. Drabek, Zdenek. 2005. Can Regional Integration Arrangements Enforce Trade Discipline? London: Palgrave/Macmillan. Drabek, Zdenek. 2006. Limits to Harmonization of Domestic Rules (mimeo). Geneva: World Trade Organization and Journal of International Trade and Diplomacy 2(1): 47–92. Drabek, Zdenek, and Marc Bacchetta. 2004. “Tracing the Effects of the WTO Accession on Policy Making in Sovereign States.” World Economy 27(7), reprinted as Chapter 4 in this volume. Easterley, William, and Fischer Stanley. 1994. “The Soviet Economic Decline: Historical and Republican Data.” Working Paper No. 4735. Cambridge, Mass.: National Bureau of Economic Research, May. Finger, J. M., and P. Schuler. 1998. Implementation of Uruguay Round Commitments: The Development Challenge (mimeo). Washington, DC: The World Bank, Research Department. Finger, J. Michael, and Philip Schuler. 2000. “Implementation of Uruguay Round Commitments: The Development Challenge.” The World Economy (Apr.) 23(4): 511–25. Frankel, Jeffrey. 2005. “Comments on Richard Baldwin’s ‘The Euro Trade Effects.’ ” What Effects is EMU having on the Euro Area and Its Member Countries. Frankfurt:European Central Bank, June 16. Gabilondo, José Luis Pérez. 2001. “Developing Countries in the WTO Dispute Settlement Procedures; Improving Their Participation.” Journal of World Trade 53(4): 483–88. Hancock, John. 2005. Aid for Trade. Geneva: WTO, mimeo. Hoekman, Bernard, and Michael Leidy. 1993. “Holes and Loopholes in Integration Agreements: History and Prospects.” In K. Anderson and R. Blackhurst (Eds.). Regional Integration and the Global Trading System. New York and London: Harvester and Wheatsheaf, 218–45. Horn, Henryk, Petros C. Mavroidis, and Haaken Nordstrom. 1999. “Is the Use of the WTO Dispute System Biased?” Discussion Paper 2340. London: CEPR.

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Hussain, Turab. 2005. “Victory in Principle: Pakistan’s Dispute Settlement Case on Combed Cotton Yarn Exports to the US.” In Callagher et al. (Eds.), 2005, 459–72. Lau, Lawrence J., Yingyi Qian, and Gerard Roland. 2000. “Reform without Losers: An Interpretation of China’s Dual-Track Approach to Transition.” Journal of Political Economy 108(1): 120–43, February. Lin, Justine Yifu, Fang Cai, and Zhou Li. 1994. “China’s Economic Reforms: Pointers for Other Economies in Transition.” Policy Research Working Paper 1310. Washington, DC: World Bank, June. Low, P. and Keck, A. 2004. Special and differential treatment in the WTO : why, when and how? Geneva: WTO, Staff working paper ERSD–2004–03, 36. Mansor, Noma, Noor Haasnia Kasim, and Yong Sook Lu. 2005. “Malaysia: Labelling Regulations on Natural Rubber Condoms and the WTO TBT Agreement.” In Callagher, Low, and Stoller (Eds.). Managing the Challenges of WTO Participation: 45 Case Studies. Cambridge: Cambridge University Press. Martin, Will, and Alan Winters. 1995. The Uruguay Round: The Widening and Deepening of the World Trading System. Washington, DC: The World Bank. McKibbin, Warwick, and Wing Thye Woo. 2002. “The Consequences of China’s WTO Accession for its Neighbors.” Asian Economic Papers (Spring/Summer) 2(2): 1–38. Michalopoulos, Costas. 1999. Trade Policy and Market Access Issues for Developing Countries (mimeo). Geneva: World Trade Organization. Mosoti Victor. 2003. Does Africa need the WTO Dispute Settlement System? in ICTSD (Ed.). Towards a Development-Supportive Dispute Settlement System at the WTO. Geneva: ICTSD, 71–88; 108. Naughton, Barry. 1994. “Chinese Institutional Innovation and Privatization from Below.” American Economic Review (May) 84(2): 266–70. Nolan, Peter. 1993. State and Market in the Chinese Economy: Essays on Controversial Issues. London: MacMillan. Octaviani, Rina, and Erwidodo. 2005. “Indonesia’s Shrimp Exports: Meeting the Challenge of Quality Standards.” In Callagher, Low, and Stoller (Eds.). Managing the Challenges of WTO Participation: 45 Case Studies. Cambridge: Cambridge University Press. Okabe, Misa. 2002. “International R&D Spillovers and Trade Expansion.” ASEAN Economic Bulletin (Aug.) 19(2): 141–54. Orosco, Claudia. 2005. “SPS an Crisis Management: The Chile-EU Avian Influenza Experience.” In Callagher, Low, and Stoller (Eds.). Managing the Challenges of WTO Participation: 45 Case Studies. Cambridge: Cambridge University Press. Osoti, Victor. 2003. “Does Africa Need the WTO Dispute Settlement System?” Towards a Development Supportive Dispute Settlement System in the WTO. Geneva: ICTSD, March. Panagariya, Arvind. 2003a. “TRIPS and the WTO: an Uneasy Marriage.” 030902, Economics Working Papers Archive. Panagariya, Arvind. 2003b. “Developing Countries at Doha: A Political Economy Analysis.” International Trade 0308015, Economics Working Papers Archive. Phan Van Sam and Vo Than Thu. 2005. “Vietnam’s Preparation for WTO Accession in the Banking Sector.” In Callagher, Low, and Stoller (Eds.). 2005, 150–66. Qin, Julia Ya. 2003. “WTO-Plus Obligations and Their Implications for the World Trade Organisation Legal System: An Appraisal of the China Accession Protocol.” Journal of World Trade 37(3): 483–522. Rawski, Thomas. 1994. “Progress without Privatization: The Reform of China’s State Industries.” In Vedat Milor (Ed.). The Political Economy of Privatization and Public

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10 The WTO Dispute Settlement System: How Have Developing Countries Fared? William J. Davey

This chapter analyzes the experience of developing countries in the World Trade Organization’s (WTO) dispute settlement system and evaluates on a country-by-country basis how they have fared in (1) in the specific cases in which they were involved and (2) in advancing their major trade policy concerns. The chapter then briefly considers several possible reforms to the WTO system that would be of particular interest to developing countries. In order to place the chapter’s analysis in context, an introductory section briefly describes the system and overviews its operation during its first ten years – from 1995 to 2004.1

10.1

The WTO dispute settlement system

An effective dispute settlement system is critical to the operation of the WTO.2 It would make little sense to spend years negotiating detailed rules in international trade agreements if those rules could be ignored. In the WTO dispute settlement is governed by the Dispute Settlement Understanding (“DSU”), which is effectively an interpretation and elaboration of Article XXIII of the General Agreement on Tariffs and Trade (GATT). There are essentially four phases in the WTO dispute settlement process: consultations, the panel process, the appellate process, and surveillance of implementation. 10.1.1 Consultations Under the procedures of the WTO dispute settlement system, the first step in the process is consultations. A WTO Member may ask for consultations with another WTO Member if the complaining member believes that the other member has violated a WTO Agreement or otherwise nullified or impaired benefits accruing to it. The goal of the consultation stage is to enable the disputing parties to understand better the factual situation and the legal claims in respect of the dispute and to resolve the matter without further proceedings. The manner in which the consultations are conducted is up to the parties. The DSU has no rules on consultations beyond that they are to 295

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be entered into in good faith and are to be held with 30 days of a request. Typically, they are held in Geneva and involve capital-based officials, as well as the local WTO delegates of the parties. 10.1.2 The panel process If consultations fail to resolve the dispute within 60 days of the request for consultations, the complaining WTO Member may request the Dispute Settlement Body (DSB), the WTO body that oversees the operation of the dispute settlement system, to establish a panel to rule on the dispute. Pursuant to the DSU, if requested, the DSB is required to establish a panel no later than the second meeting at which the request for a panel appears on the agenda, unless there is a consensus in the DSB to the contrary. Thus, unless the member requesting the establishment of a panel consents to delay, a panel will be established within approximately 90 days of the initial request for consultations. Parties are not required to request a panel at any particular point in time and in most cases, a panel is not requested until considerably more than 60 days after the start of consultations. After the panel is established by the DSB, it is necessary to select the three individuals who will serve as panelists. The WTO Secretariat suggests the names of possible panelists to the disputing parties. If the parties cannot agree on the identity of the panelists within 20 days of the panel’s establishment, any party to the dispute may request the WTO Director-General to appoint the panel, which he is required to do within ten days of the request. Over time, it has become common for the Director-General to appoint panels. The vast majority of panelists are current or former government officials. The task of the panel is to examine, in light of the relevant WTO Agreements, the matter referred to the DSB by the complainant and make such findings as will assist the DSB in making the recommendations or in giving the rulings provided for in those Agreements. More generally, DSU Article 11 provides that a panel shall make an objective assessment of the matter before it, including an objective assessment of the facts of the case and the applicability of and conformity with the relevant WTO Agreements. A panel normally meets with the parties shortly after its selection to set its working procedures and time schedule. The standard proposed timetable for panels makes provision for two meetings between the panel and the parties to discuss the substantive issues in the case. Each meeting is preceded by the filing of written submissions. In the case of the first meeting, the complainant files first and the respondent is expected to file two or three weeks later. Rebuttal submissions filed after the first meeting are typically filed simultaneously. Thereafter, the panel issues its “interim report,” which contains the panel’s findings and recommendations. Parties are allowed to comment on the interim report and a panel must respond to those comments when it

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issues its final report. To date, no final report has reached a different overall result than an interim report, although some significant changes in wording have been made from time to time. If a panel finds that a WTO rule has been violated, it typically recommends that the measure found to be in violation of WTO rules be brought into conformity with those rules. Panels are authorized to make suggestions on how that recommendation could be implemented, but they tend not to do so. After its circulation to WTO Members, the final report is referred to the DSB for formal adoption, which is to take place within 60 days unless there is a consensus not to adopt the report or an appeal of the report to the WTO Appellate Body. This so-called negative consensus rule is a fundamental change from the GATT dispute settlement system where a positive consensus was needed to adopt a panel report, thus permitting a dissatisfied losing party to block any action on the report. Now, as long as one member wants the report adopted, it will be adopted. However, while the losing party cannot block adoption of a report, it has a right of appeal. If a panel report is appealed, after completion of the appeal, it is adopted as affirmed, modified, or reversed by the Appellate Body. For panels, the DSU sets as a goal that the final report should be issued to the parties within six months of the panel’s composition and that, at the latest, the report should be circulated to all members within nine months of the panel’s establishment. In fact, most panel reports are not circulated within that nine-month period; around 12 months is the average. Indeed, in recent years, the median period for circulation has increased to close to 15 months. 10.1.3 The appellate process The possibility of an appeal is a new feature of the WTO dispute settlement system. The Appellate Body consists of seven individuals, appointed by the DSB for four-year terms. The Appellate Body hears appeals of panel reports in divisions of three, although its rules provide for the division hearing a case to exchange views with the other four Appellate Body members before the division finalizes its report. The members of the division that hears a particular appeal are selected by a secret procedure that is based on randomness, unpredictability, and the opportunity for all members to serve without regard to national origin. The Appellate Body is required to issue its report within 60 (at most 90) days from the date of the appeal, and its report is to be adopted automatically by the DSB within 30 days, absent consensus to the contrary. The Appellate Body’s review is limited to issues of law and legal interpretation developed by the panel. However, the Appellate Body has taken a broad view of its power to review panel decisions. It has the express power to reverse, modify, or affirm panel decisions, but the DSU does not discuss the possibility of a remand to a panel. Partly as a consequence of this, the

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Appellate Body has adopted the practice, where possible, of completing the analysis of particular issues in order to resolve cases where it has significantly modified a panel’s reasoning. This avoids requiring a party to start the whole proceeding over as a result of those modifications. 10.1.4 Surveillance of implementation The final phase of the WTO dispute settlement process is the surveillance stage. This is designed to ensure that DSB recommendations (based on adopted panel/Appellate Body reports) are implemented. Under the surveillance function, the offending member is required to state its intentions with respect to implementation within 30 days of the adoption of the applicable report(s) by the DSB. If immediate implementation is impractical, a member is to be afforded a reasonable period of time for implementation. Absent agreement, that period of time may be set by arbitration. The DSU provides that, as a guideline for the arbitrator, the period should not exceed 15 months. Overall, the median reasonable period of time has been about ten months. If a party fails to implement the report within the reasonable period of time, the prevailing party may request compensation. If that is not forthcoming, it may request the DSB to authorize it to suspend concessions (i.e., take retaliatory action) owed to the nonimplementing party. DSB authorization is automatic, absent consensus to the contrary, subject to arbitration of the level of suspension if requested by the nonimplementing member. Suspension of concessions is viewed as a last resort and the preference is for the nonimplementing member to bring its measure into conformity with its obligations.

10.2 Overview of the operation of the WTO dispute settlement system3 10.2.1 10.2.1.1

The first five years (1995–99) General trends

The first ten years’ operation of the WTO dispute settlement system can be divided usefully into two parts. The first half of that period – from 1995 through 1999 – was characterized by extensive use of the system by the U.S. initially, and later by the EU. While there was a wide range of disputes, this period was especially noticeable for carryover cases from the days of GATT and a focus on implementation of Uruguay Round results, particularly in respect of the Trade-Related Intellectual Property (TRIPs) Agreement. For example, there were 185 consultation requests made from 1995 through 1999 involving 125 disputes.4 The U.S. initiated 60 consultation requests (involving 43 disputes), or about one-third of the disputes. During the first five years, the EC initiated 47 consultation requests (involving 44 disputes), also about one-third of the disputes.

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Probably the most noteworthy characteristic of WTO dispute settlement in its early years was the large number of very controversial cases involving systemic issues or specific fact situations that were carried over from the GATT system. Examples would include the EC Bananas case, the EC Hormones case, the Japan Film case, the U.S. Shrimp case, the U.S. HelmsBurton case, the Turkey Textiles case, the India Quantitative Restrictions case, the U.S. Section 301 case, and, just after the end of the period, the U.S. Foreign Sales Corporations case. These cases, which are described in Annex 10.1, all involved the U.S. and/or EC and raised very sensitive and/or controversial issues. Except for the Bananas and the Foreign Sales Corporations cases, the disputes did not directly involve great amounts of trade, but were nonetheless considered very important for symbolic reasons. Fortunately for the system, it managed to defuse these cases – the U.S. lost the Film case and the EC lost the Section 301 case and neither appealed, perhaps because in each case the losing party won some useful points; the Helms Burton case was informally settled on the day the first written submission was due to be received by the panel. The Turkey Textiles and India Quantitative Restrictions cases disturbed some members for systemic reasons,5 but the actual results of the cases did not result in serious implementation difficulties for either respondent. In the Shrimp case, the U.S. lost, but while the case was controversial, the Appellate Body report was welcomed by many as making the WTO more environmentally friendly and the U.S. was able to implement the ruling without difficulty (de la Fayette, 2002).The Bananas case presented the most difficult implementation problem because of a U.S.-EC dispute over how to interpret the DSU. Indeed, that dispute came close to destroying the system in its relative infancy, but it was ultimately finessed (Davey, 2005a: 20, n. 15), and an agreement on implementation was reached in 2001.6 Besides Bananas, only Hormones and Foreign Sales Corporations remained unimplemented for substantial periods and both have been subject to the imposition of retaliatory measures. Even as to those two, progress was eventually made on implementation. The U.S. adopted new legislation that came into force on January 1, 2005 designed to implement the Foreign Sales Corporations decision, and following a successful EC challenge to certain transitional aspects of that legislation before a compliance panel, the U.S. modified the legislation in a way that was acceptable to the EC (BNA, 2006).The EC claims that it implemented the Hormones decision by conducting a new risk assessment and adopting a new measure in 2003. The U.S. and Canada do not accept that claim and they have continued to suspend concessions otherwise owed to the EC. As a consequence, the EC challenged the continuation of those sanctions in a panel proceeding that was pending as of October 2006. Overall, the WTO dispute settlement system seemed to survive these controversial cases reasonably well, although it must be conceded that some of the WTO Members directly involved in the specific cases were somewhat embittered at certain results.

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10.2.1.2 The Appellate Body The most noteworthy development in the first five years of WTO dispute settlement was the flowering of the Appellate Body. The role it would play in the WTO system was quickly put to the test as the first 12 panel reports were appealed. From the outset, the Appellate Body established itself as an activist tribunal. It modified ten of the reports, effectively reversing one of them. In its review of panel reports, the Appellate Body did not focus on whether it approved of the result in general terms as some appellate tribunals do, but rather it closely examined the reasoning and wording of the reports, and did not hesitate to modify reasoning or wording with which it disagreed. The first appeal (U.S. Gasoline) was noteworthy in that the Appellate Body stressed the need to focus on the exact words of the relevant treaty text and to apply the rules of the Vienna Convention on the Law of Treaties (VCLT) in order to interpret the WTO Agreements.7 Moreover, in that appeal, which involved a successful challenge by Venezuela and Brazil to a U.S. environmental measure, the Appellate Body first evinced a concern with ensuring that governments have adequate discretion to take what they view as necessary environmental measures, assuming of course that they meet GATT’s nondiscrimination requirements. Thus, while the U.S. failed to convince the Appellate Body that it met those requirements, it did obtain a decision that it considered to be more environmentally friendly (Office of the United States Trade Representative, 1997a; 1997b). The role of the Appellate Body in handling the six controversial cases discussed above that were appealed is quite instructive. The six cases involved commercial issues (Bananas and Foreign Sales Corporations), institutional issues (India Quantitative Restrictions and Turkey Textiles), and environmental/health issues (Hormones and Shrimp). In the cases involving commercial issues, the Appellate Body applied the WTO rules relatively strictly. Indeed, in the Bananas case, the panel had ruled in the EC’s favor on one of the two major issues in the case by interpreting a waiver obtained by the EC that explicitly permitted banana tariff preferences as also covering quota preferences. The Appellate Body – emphasizing the text of the waiver – reversed that part of the panel report. In the two institutional cases, the Appellate Body took a broad view of the jurisdiction of the WTO dispute settlement system – effectively ruling that it was competent to consider the justification of balance-of-payments measures and to decide on whether a free trade area (FTA) or customs union was consistent with GATT Article XXIV. In contrast, in the two environmental/health cases, the Appellate Body reports interpreted the relevant agreements so as to increase governmental discretion. In the Hormones case, the Appellate Body made a number of statements suggesting that the Sanitary and Phytosanitary (SPS) Agreement should be interpreted so as to afford discretion to governments, such as by invoking the in dubio mitius principle and noting that although SPS measures

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are science based, governments were not required to follow mainstream scientific opinion.8 In the Shrimp case, it built upon the Gasoline case in giving breadth to the exception in GATT Article XX(g) for measures related to the conservation of exhaustible natural resources. While it ultimately did not reverse the panels’ findings of violations in the two cases, its criticisms of the strict approach taken by the panels, as well as the general tone and some of the specific language in its reports, were welcomed by those concerned that trade rules should not override environmental measures (de la Fayette, 2002). By the end of 1999, no one doubted that the Appellate Body had played and would continue to play the dominant role in the WTO dispute settlement system and in the interpretation of the WTO Agreements. While its decisions irked a number of WTO Members, particularly those that had lost on appeal, its position and role seemed to be gaining general acceptance in this period.9 However, in 1998 in the Shrimp case, it made a procedural ruling that outraged most WTO Members. That ruling concerned DSU Article 13’s authorization of panels to “seek” information. The Appellate Body ruled that it should be interpreted to mean that panels had the power to accept unsolicited amicus briefs from nonmembers.10 This ruling was heavily criticized and the resultant controversy seemed to cause the Appellate Body to seek a lower profile. The WTO dispute settlement system survived its first five years in good shape. It was used frequently by WTO Members and it had successfully handled a number of very controversial cases. While members had complaints about individuals cases, they all stated their general satisfaction with the system in the course of the 1998–99 DSU review, in which it was agreed that only some fine tuning of the system was needed (Davey, 2004). 10.2.2

The second five years (2000–04)

The second five years of the WTO dispute settlement system was marked by a noticeable decline in consultation requests – a total of 139 requests, involving 104 disputes, as opposed to 185 requests in the first five years, involving 125 disputes.11 More significantly, the U.S. and the EC were no longer the dominant complainants in the system. In the 2000–04 period, the U.S. filed 20 consultation requests involving 20 disputes (19 percent of disputes) and the EC filed 20 consultation requests, involving 18 disputes (17 percent of disputes). There was a noticeable drop in U.S. and EC consultation requests after 2000. This fall-off in activity is particularly noteworthy compared with the first five years. In contrast, use of the system by developing countries increased dramatically. Indeed, it is striking to consider the evolution in the use of the WTO dispute settlement system by developing countries.12 In the first five years of

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the system’s existence, developing countries initiated by themselves roughly one-quarter of the consultation requests. In the five years from 2000 through 2004, developing countries initiated around 60 percent of the consultation requests – more than doubling their relative share of initiations. Brazil has been particularly active, initiating nine consultation requests. Thus, in the last few years developing countries have become more frequent users of WTO dispute settlement, both in absolute and relative terms. Interestingly, the majority of those cases have involved developing country respondents. That is to say, developing countries seem to have found the WTO dispute settlement system to be a useful mechanism for dealing with a wide range of trade disputes – using it not only against developed countries, but also in their trading relations with other developing countries. Of particular note is the way in which Latin American countries made extensive use of the system in their dealings with each other.13 The importance of this development cannot be overemphasized because it has been argued since the beginning of the WTO that the WTO dispute settlement mechanism is too complicated for developing countries to make effective use of it. Yet, in the last few years, they have become the major users of the system and seem to be able to use it effectively – in terms of settling their own trade disputes with each other. As to the type of case brought, the number of trade remedy cases has increased significantly, as compared to the first few years, especially in respect of cases brought against U.S. trade remedy measures and pursued through panel proceedings. Indeed, in terms of controversy, the WTO dispute settlement system has been controversial in recent times mainly because of the very critical reaction in Washington to U.S. losses in these trade remedy cases.14 A second type of controversial case became significant at the end of the first decade. This type of case involved challenges, mainly by developing countries, to certain basic policies of the U.S. and the EC – witness India’s somewhat successful challenge to the EC’s Generalised System of Tariff Preferences (GSP) scheme, a multiparty challenge led by Brazil to the EC sugar program, a Brazilian challenge to U.S. cotton subsidies, and a challenge by the U.S. and others to the EC’s biotech approval regime. These cases, and a few others, seemed aimed in part at influencing the ongoing Doha Development Agenda negotiations. That is to say that some members are trying to improve their negotiating position through victories in dispute settlement – a not unexpected development. It remains to be seen if they will be successful. At the end of its first decade, the WTO dispute settlement system still seemed to be operating well. Indeed, much of the initial controversy surrounding the system had receded,15 except in Washington where it had undoubtedly risen because of concerns about the system’s treatment of challenges to U.S. trade remedies measures.

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303

The record in settling disputes

The aim of the WTO dispute settlement system is the resolution of traderelated disputes between WTO Members. As the DSU makes clear, in cases where a violation is found, removal of the inconsistent measure is the goal. Otherwise, a mutually agreed solution is the preferred result. In any case, prompt settlement is said to be essential. In considering how the system has performed in meeting these goals, I will examine those cases started with a consultation request prior to July 1, 2002. I do not include more recent consultations requests because so many of them involve pending cases. 10.2.3.1

Results of consultations

Of the 181 disputes started with a consultation request prior to July 1, 2002, 107 – roughly 60 percent of them – either did not result in an adopted panel report or are not pending before an active panel at the time of writing.16 It appears that they were resolved as shown in Table 10.1.17 Overall, this suggests that the consultation process has worked rather effectively. Almost all of the cases examined were disposed of. For the most part, these results were achieved promptly (within 18 months).18 These results demonstrate that consultations often produce fairly prompt and positive results, which underscores that they serve a very valuable function by providing a mechanism that resolves most cases much more promptly than the formal panel/Appellate Body process. 10.2.3.2 Implementation of panel/Appellate Body reports Of the 181 disputes started with a consultation request prior to July 1, 2002, there were 74 disputes – roughly 40 percent of the total number of disputes – where panels had issued reports as of October 2006.19 Of those 74 disputes, the complainant lost in ten of them, such that no implementation was required. Of the 64 other disputes, there had been implementation in 55. That leaves nine disputes where there had been no implementation, Table 10.1 Result of disputes with consultation request prior to July 1, 2002 Settled or dropped, after panel established

18

Settled, with notification to DSB

26

Settled, without notification

20

Dropped (for legal, political, or commercial reasons)

24

Dropped (trade remedy measure not imposed/ removed/expired)

15

Pending? Source: Author's Own compilation.

4

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Table 10.2

Unimplemented/contested disputes

EC Hormones (DS26 and 48)a Brazil Aircraft (DS46) Canada Aircraft and Canada Aircraft Credits (DS70, 71, and 222)b U.S. Section 110(5) Copyright Act (DS160) U.S. Section 211 Appropriations Act (DS176) U.S. Hot-Rolled Steel (DS184) Chile Price Band (DS207)c U.S. Countervailing Measures on Certain EC Products (DS212) U.S. Offset Act (Byrd Amendment) (DS217 and 234)d Notes: a The EC claims it has implemented and has commenced cases (DS320 and 321) against the U.S. and Canada alleging that their continued use of sanctions is not permitted under WTO rules. b Sanctions were authorized in the Brazil and Canada cases, but have not been imposed. c A compliance panel found noncompliance in December 2006; an appeal was possible at the time of writing. d The U.S. repealed the measure effective October 2007; several countries currently impose sanctions.

or a disagreement between the parties over implementation. That suggests a successful implementation rate of 86 percent,20 which is fairly successful for state-to-state dispute settlement. The WTO success rate is comparable to the rate achieved by the GATT dispute settlement system through 1989.21 It is probably true, however, that some difficult cases were never brought to the GATT system because of the right of the losing party to “block” any adverse consequences of a decision against it. Moreover, the success rate of the GATT system declined considerably in the 1990s. In this regard, it is interesting to compare the success rate of the International Court of Justice (ICJ), where one recent study found a 68 percent compliance rate, as defined by the authors, for a sample of cases before the ICJ.22 To get a truer picture of the results of WTO dispute settlement system, however, it is necessary to look more closely at the form and timing of implementation – was the problem measure removed or modified, or essentially maintained? How long did it take to achieve the results? When that is done, it appears that while implementation typically occurs, as discussed above, it is often delayed, particularly when the challenged measure is replaced or modified, as opposed to being withdrawn.23 Thus, a considerable period of time may elapse between the commencement of a case by a consultation request and the final implementing action. As of December 2004, roughly

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60 percent of panel reports requiring implementation had been implemented promptly – either within the original reasonable period of time for implementation or shortly afterward. As to the rest, they were implemented with significant delay (or will be implemented with significant delay if they are ever implemented). Nonimplementation is primarily a problem of the United States and delayed implementation is primarily a problem of the Quad (the U.S., the EC, Japan, and Canada) plus Australia (12 of 15 cases). Developing countries have usually implemented within the original reasonable period of time. Only twice by that time had a developing country been the subject of an Article 21.5 proceeding (Mexico Corn Syrup (HFCS) and Brazil Aircraft) and only in one case has nonimplementation by a developing country been a longstanding problem (Brazil Aircraft). Developing countries seem to have fared as well as developed countries in obtaining results in respect of implementation of panel/Appellate Body reports. As noted, they are more responsible in implementing adverse decisions overall. As to having to deal with foot-dragging by respondents that seems to be a matter of principal concern in developed country vs. developed country disputes. The overall record is impressive, even if delays occur in implementation. It appears that 36 percent of disputes analyzed are resolved following the issuance of panel/Appellate Body reports; that 35 percent of them are settled; and that in 21 percent, the matter has been dropped because the challenged measure disappeared or the commercial interest changed. Only a few remain in dispute at the time of writing.

10.3 The experience of developing countries in the WTO dispute settlement system This section examines the experience of developing countries in the WTO dispute settlement system. It focuses on the involvement in the system of the major users of dispute settlement, which are amongst the more active players in the WTO in general. In the case of Asia, I examine the experience of China, India, (South) Korea, and Thailand. In the case of Latin America, I examine the experience of Brazil, Argentina, Chile, and Mexico. (Generally, African countries have not been much involved in the dispute settlement system.) For each of the countries mentioned, I examine the consultation requests they have initiated and the results – whether they were settled, dropped, or went to the panel process. I also consider the cases that have been brought against these countries. Finally, in each case, a tentative analysis is made of how successful their experience has been. 10.3.1 Asia 10.3.1.1

China

Since its accession to the WTO, China has not been active as a complainant or respondent in the WTO. Through October 2006, China had requested

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consultations and participated in panel proceedings in only one case (U.S. Steel Safeguard), in which it was joined by eight other WTO Members. Similarly, China had been a respondent in only two disputes – (1) Integrated Circuits VAT brought by the U.S.,24 which was settled by mutual agreement and (2) Auto Parts brought by Canada, the EC, and the U.S.,25 in respect of which a panel was established in October 2006. China has been a frequent participant in disputes as a third party, and it may be anticipated that it will become a more active principal player in dispute settlement in the years ahead. 10.3.1.2 India India has been an active participant in the WTO dispute settlement system since its inception in 1995. In terms of cases initiated, it has been only slightly less active than Brazil, the most active developing country user of the system. India as complainant At the time of writing, India has been a complainant in 17 cases. It has brought four cases based on GATT 1994 – one against Poland alleging discriminatory treatment of Indian automobile exports, which was settled to India’s apparent satisfaction; one against Turkey in respect of textile quotas, where it won an important panel/Appellate Body decision on the interpretation of GATT Article XXIV dealing with customs unions and free trade areas, which was implemented by Turkey; one against U.S. ban on imports of shrimp from countries not certified by the U.S. as using appropriate devices to protect turtles from entanglement in shrimp fishing nets, where it won in important Appellate Body report on GATT Article XX, although the U.S. made only relatively minor changes to its shrimp importation rules; and one against the additional preferences granted by the EC to certain drugimpacted countries under its GSP program, which India won in part.26 India has brought ten cases against various trade remedies. It challenged two U.S. safeguards under the Agreement on Textiles and Clothing, one on wool coats and the other on wool shirts and blouses (in both cases, the U.S. allowed the challenged measure to terminate, although it did so in the Wool Shirts and Blouses case only after losing before a WTO panel). Under the Antidumping Agreement, India initiated cases against the EC in respect of cotton fabrics (no measure was ultimately imposed by the EC), bed linen (India won in a panel/Appellate Body proceeding; limited use of “zeroing”), and steel products (settled); against South Africa in respect of pharmaceuticals (apparently not pursued); against the U.S. in respect of steel plate (won at the panel stage; U.S. implemented, and lowered the duty, although not as far as India contended was appropriate, but no further proceedings were taken); the Offset Act (Byrd Amendment) (won along with several other complainants in a panel/Appellate Body decision implemented by the U.S.,

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but only prospectively as of October 2007) and certain U.S. antidumping (AD) practices consultations requested in June 2006; and against Brazil in respect of jute bags (apparently not pursued). 27 The other three cases involved a challenge to U.S. textile origin rules in which India’s claims were rejected by a panel and two cases that India does not seem to have pursued involving EC duties on rice28 and allegedly discriminatory rules for import of pharmaceutical products into Argentina. 29 India as respondent India has been a respondent in 17 consultation requests. In three disputes, involving ten requests in total, India was on the losing end of panel/Appellate Body proceedings. Those three disputes involved the requirement to enact a so-called mailbox mechanism under the TRIPs Agreement; the justification of quantitative restrictions taken by India for balance-of-payments reasons; and India’s regime for investment in the automotive sector.30 The U.S. and the EC were complainants in these three matters.31 Of the remaining seven consultation requests, five involve EC challenges – four to various Indian export and import restrictions and one to Indian ADs on certain products.32 These have not been settled, but all appear to have been partially resolved.33 The other two cases concerned (1) a challenge by Bangladesh to Indian antidumping duties on batteries, which was brought in early 2004 and resolved later that year34 and (2) a challenge by Chinese Taipei to several Indian antidumping measures, which was partially settled.35 Overall assessment of India’s experience In evaluating India’s affirmative use of the WTO dispute settlement system, it is useful to consider the cases it has brought from three perspectives: first, the product sectors involved in its use of the system; second, the type of measure that was attacked; and third, the respondent country. In terms of products, it is not surprising that roughly one-half of India’s cases have involved challenges to measures restricting Indian textile and clothing exports, which are India’s major exports.36 Other Indian challenges have involved steel, shrimp, and rice, all of which merit separate treatment in India’s list of major exports.37 In terms of the types of measures that India has challenged, over one-half of them have been trade remedy measures, especially those against textiles (five cases) and steel products (two cases). This is consistent with India’s negotiating position calling for restrictions on use of trade remedies. In terms of respondent countries, India’s main targets have been the U.S. (seven cases) and the EC (five cases), which have in turn been the main complainants against India. In the area of trade remedies applied to textile products, India has had considerable success in the dispute settlement system. Its successful challenge early in the WTO’s existence to U.S. use of safeguards under the

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Agreement on Textiles and Clothing (Wool Shirts and Blouses) seems to have effectively restrained such use. In respect of antidumping rules, India scored a major victory in the EC Bed Linen case, which restricted the use of zeroing in the calculation of antidumping margins. Indeed, with the exception of the U.S. Textiles Origin case, India has generally had considerable success in its affirmative use of WTO dispute settlement.38 In assessing India’s experience as a respondent, it is instructive to consider the same issues: product sectors involved, types of measures attacked, and identity of complainants. As to the latter issue, the EC has been the main complainant against India, followed by the United States. Indeed, except for the four other parties that also requested consultations in the Quantitative Restrictions case, no WTO Members except the U.S. and the EC requested consultations with India until the 2004 requests by Bangladesh and Chinese Taipei. The main target of the EC and the U.S. has been India’s wide range of import and export controls. The U.S. successfully attacked the justification for many of the import controls in the Quantitative Restrictions case and, subsequent to that case, the EC has had at least partial success in consultations targeting various specific Indian restrictions on imports and exports. Implementation of the Quantitative Restrictions case (including the settlements with the five complainants other than the U.S.) did not seem to be all that difficult for India. Although Indian authorities might not want to concede the point, it appears that India in fact no longer needed to apply import restrictions for balance-of-payments reasons, particularly given its strong foreign exchange reserves in the period under review. Indeed, I think that it could be argued that the actions that India was required to take were pretty much consistent with its decadelong policy of increased openness. Similarly, the loss of the Autos case, which had challenged certain performance requirements imposed by India on investors in the automotive sector, did not seem to occasion much difficulty either. The only difficult case for India to implement was the Patents case, which required it to establish a so-called mailbox procedure so that pharmaceutical companies could preserve their patent priority on products that would become patentable in 2005. The procedure itself was not so controversial – the idea that pharmaceuticals would eventually be patentable was. Overall, I think that the record shows that India has been able to make rather effective use of the WTO dispute settlement system to pursue issues that matter to it because they affect important export sectors. At the same time, it has not been all that much constrained by its losses in the system. One further note – India has been a relatively frequent user of the new Advisory Centre on WTO Law, which was established to provide developing countries with cut-rate legal assistance in WTO matters. The significance of the Advisory Centre is discussed below in Section 10.3.3.

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10.3.1.3 Korea Korea has mainly used the WTO dispute settlement system to challenge trade remedies or subsidies, mostly against the U.S. It has brought seven cases against the U.S. (Colour Television Receivers AD, Dynamic Random Access Memory Semiconductors (DRAMS) AD, Stainless Steel AD, Line Pipe Safeguard, Offset Act (Byrd Amendment), Steel Safeguards, DRAMS CD (Counterveiling Duties)).39 It won all of these cases, including the first case, which was settled when the measure was removed. In DRAMS, however, it won only a small point and the U.S. measure remained unchanged.40 Korea has brought two cases against the EC – one involving retaliatory subsidies on commercial vessels, which it won (although the EC claimed that the subsidy program at issue had effectively expired),41 and one concerning CDs on DRAMS, which Korea also won, although it later claimed that EC implementation was not adequate (but it has not pursued a compliance panel).42 Korea has also brought two cases against Japan – one in respect of quotas on dried laver, which was settled in the course of panel proceedings,43 and one concerning CDs on DRAMS, which is now pending before a panel.44 Finally, Korea brought a case against the Philippines concerning ADs on resins, which was settled.45 Korea has been a respondent in six panel actions – Alcoholic Beverage Taxes brought by the EC and the U.S.; Dairy Safeguard, brought by the EC; Beef, brought by the U.S. and Australia; Procurement, brought by the U.S.; Commercial Vessel Subsidies, brought by the EC; and Paper, brought by Indonesia.46 It won the Procurement case, but lost the others. It has settled four other matters involving inspection requirements (brought by the U.S.), shelf-life requirements (U.S.), bottled water requirements (Canada) and telecommunications procurement (EC).47 Korea seems to have made limited, but relatively successful use of the system to challenge specific trade remedy measures against two of its major exports – steel and electronics (WTO, 2004). It has not been often targeted by others, except in the agricultural area. The two major cases that Korea lost were the Beef case, which grew out of inadequate implementation of a GATT case, and the Alcoholic Beverage Taxes case, which was probably inevitable once Japan lost on a similar issue involving a similar beverage. Neither case can be viewed as having significantly constrained Korean policy on important matters. As to the other cases lost at the panel or appellate stage: (1) the safeguard in the Dairy case was in force for around four years and presumably accomplished its purpose; (2) Korea claimed that it was required to take no action to implement the panel report on commercial subsidies and although the EC objected, it has taken no further action;48 and (3) Korea maintained the ADs at issue in the Paper case, such that Indonesia has requested consultations with a view toward requesting a compliance panel.49 Thus, these cases have not much constrained Korea. Nor have the settlements in foodstuffs area.

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Indeed, the U.S has continued to complain about Korean import procedures for agricultural products.50 10.3.1.4 Thailand Thailand has initiated 12 consultation requests – often in conjunction with other countries. It has challenged (1) EC duties on rice, apparently in conjunction with the U.S. and Uruguay (the U.S. reached a settlement with the EC);51 (2) Hungary’s breach of its export subsidy commitments, which was settled;52 (3) Turkish textiles quotas imposed under the EC-Turkey Customs Union, a case that was successfully pursued through the panel/ Appellate Body process by India;53 (4) the U.S. ban on imports of shrimp not taken by turtle-friendly methods, which Thailand successfully pursued through panel/Appellate Body proceedings with India, Malaysia, and Pakistan;54 (5) a Colombian safeguard on textile filaments, which expired soon after Thailand’s panel request was made;55 (6) an Egyptian ban on tuna allegedly packed in oil from GMO soybeans, which was apparently informally settled;56 (7) the U.S. Offset Act (Byrd Amendment), which was successfully challenged in panel/Appellate Body proceedings brought by several countries;57 (8) the EC’s GSP program, which was successfully challenged by India in a panel/Appellate Body proceeding;58 (9) the EC’s sugar export subsidies, which Thailand successfully challenged with Australia and Brazil;59 (10) the EC’s classification of boneless chicken, which it also successfully challenged with Brazil;60 and (11) two requests regarding U.S. ADs on shrimp, in respect of which a panel was established in October 2006.61 Thailand has only once been the object of a consultation request, which was initiated by Poland and ultimately resulted in a successful challenge of Thai ADs on H-beams in a panel/Appellate Body proceeding.62 In fact, the Thai duties remained in force for over seven years.63 Thus, Thailand has not been constrained at all by dispute settlement cases. As noted, Thailand has often joined with others in disputes, but it has not hesitated to participate in a number of controversial cases – such as the Shrimp case and the challenge to the EC sugar program. Generally speaking, its seems quite comfortable in invoking the dispute settlement system to protect its major exports, which include textiles and food products.64 Its use of the system is in contrast with other South East Asian nations, who have generally not been as active in using the system. This may be explained in part by the fact that the Thai government appears to have invested heavily in its WTO Membership – through a large delegation in Geneva and extensive use of training programs, including those aimed at promoting dispute settlement expertise. 10.3.1.5 Other Asian countries Unlike the countries in Latin America discussed in the next section, Asian countries seem to have made less use of the WTO dispute settlement

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system, both in general and in respect of intra-Asian disputes. After India, Japan, Korea, and Thailand, the most active users of the system have been Indonesia, Pakistan, and the Philippines, each of which has initiated only three cases.65 In addition, Bangladesh, China, Chinese Taipei, Hong Kong, Malaysia, Singapore, and Sri Lanka have each initiated one case.66 At the same time, most Asian developing countries (other than India, Korea, and Thailand, as discussed above) have not often been the target of consultation requests.67 In terms of intra-Asian disputes, there have been only three such disputes involving these developing countries.68 10.3.2

Latin America

10.3.2.1 Brazil Among developing countries, Brazil has made the most extensive use of the WTO dispute settlement system. It has brought 19 cases, and has been a respondent in nine. After establishing an office to coordinate its dispute settlement activity, Brazil brought two important systemic challenges in 2003 – the EC Sugar case and the U.S. Cotton Subsidies case, in both of which it prevailed. Brazil as complainant The major targets of Brazil’s complaints have been the U.S. and the EC. In the case of the former, Brazil has successfully pursued four cases through formal dispute settlement proceedings. Those cases involved discriminatory gasoline standards (with Venezuela; first WTO panel/Appellate Body reports), the Offset Act (Byrd Amendment) (with others), steel safeguards (with others), and cotton subsidies.69 It has also brought two trade remedy cases against the U.S. One case, involving ADs on silicon metal, has apparently been informally settled; the other case, concerning CDs on steel, raises issues that appear to have been decided in other cases.70 The other two cases against the U.S. involved a challenge to the U.S. patent code, which was apparently settled when the U.S. challenge to Brazilian patent rules was settled, and a discriminatory Florida tax on orange juice, which was settled after a panel had been established, but prior to its composition.71 In the case of the EC, Brazil has brought cases involving restrictions on poultry imports, preferential treatment of Brazilian coffee (similar to the Indian challenge to EC’s GSP scheme), ADs on tubes and pipe fittings, the classification of boneless chicken (with Thailand), and the EC’s export subsidies on sugar (with Australia and Thailand).72 The coffee case was settled, while the other four cases went to formal dispute settlement proceedings. Brazil prevailed on a few issues in the poultry case and in the antidumping case, and won significant victories in the other two cases. The most contentious dispute to date initiated by Brazil is its dispute with Canada over aircraft subsidies.73 Each side has lost in cases brought by

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the other and failed to implement, but no retaliatory sanctions have been imposed at the time of writing, although they have been authorized. The other cases brought by Brazil have involved trade remedies imposed by Argentina (textile safeguards; poultry ADs); Mexico (ADs on transformers); Peru (CDs on buses); and Turkey (ADs on pipe fittings).74 Except for the last case, these appear to have been settled, although the Argentina poultry case went through a panel process. Brazil as respondent Brazil has been a respondent in nine disputes. It was successful in defending its countervailing duties on coconuts (challenged by Philippines and Sri Lanka), settled complaints about its automotive regime (by Japan, U.S., and EC), and lost in its aircraft dispute with Canada.75 Three disputes involved challenges by the U.S. or EC to various Brazilian import restrictions.76 These disputes seem not to have been completely settled, although Brazil has revised some of the complained-about practices. The other three disputes involve a U.S. challenge to the Brazilian patent law, which was settled; an Indian complaint about ADs on jute bags, which seems not to have been pursued by India; and a complaint by the EC concerning import restrictions on tires, which is pending before a panel at the time of writing.77 Overall assessment Probably the most controversial dispute in which Brazil has been involved is the aircraft dispute with Canada, which has not been resolved, although it seems to have quieted down in recent years. Otherwise, Brazil seems to have used the system to defend its major export interests in the agricultural field and has had notable successes in the Sugar and Cotton cases.78 At the same time, Brazil has not been much constrained by the system, although the system has been used successfully to pressure Brazil into changing its auto regime and revising certain restrictive import practices. 10.3.2.2 Argentina After Brazil, Argentina has been the most active participant in the WTO dispute settlement system from Latin America. It has been a complainant in 12 disputes and a respondent in 12. As a complainant, Argentina was slow to initiate consultation requests. In the first five years of the WTO system’s existence, Argentina requested consultations with only Hungary (along with five other countries) in respect of it exceeding its commitments on export subsidies, and with the U.S. in respect of its administration of its groundnuts tariff rate quota (TRQ).79 The former case was settled; the latter seems to have been dropped. In the succeeding years, Argentina has been much more active. It brought four cases against Chile – a successful challenge to its price-band tariff system and three cases concerning safeguards on agricultural products. In two of the

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safeguard cases, the safeguard was removed soon after the consultation request was made; the third case was initiated only in October 2006.80 The Price Band case is currently before a compliance panel. Argentina has also initiated cases against the EC in respect of technical standards for wine, the EC system for approving biotech products, and the EC tariff quota on garlic.81 Argentina prevailed on a few issues at the panel level in the Biotech case, but it may be appealed so the ultimate result is unknown at the time of writing. The Wine case has been in consultations for four years; the Garlic case was initiated only in September 2006. Argentina has also initiated a case with Peru involving ADs on vegetable oils, which it has reportedly decided not to pursue for political reasons.82 Finally, Argentina has also successfully challenged the U.S. sunset review of ADs on oil country tubular goods.83 With the exception of the U.S. antidumping cases, Argentina’s emphasis in dispute settlement has been to ensure market access for its agricultural products. Argentina has been a fairly frequent target of consultation requests, principally on the part of the U.S. and the EC, but more recently by others as well. The U.S. successfully challenged Argentine duties on textile products and footwear, and a statistical tax, and then the EC successfully challenged a safeguard measure on some of the same products.84 The EC also successfully challenged in panel cases certain Argentine restrictions on hide exports and an antidumping duty on ceramic tiles.85 Two other cases brought by the EC claiming that Argentine trade remedy investigations were taking longer than the permitted limits were abandoned.86 In April 2005, the EC challenged several Argentine CDs on agricultural products, but it appears that it has not pursued the matter.87 Both the U.S. and India have requested consultations in respect of Argentine rules on pharmaceutical products.88 The U.S. case has been mostly settled; India has not pursued its case. Finally, Brazil and Chile have successfully challenged Argentine trade remedy measures on three occasions.89 Overall, Argentina seems to have had the most success in using the WTO system to pursue complaints against Chile in respect of restrictions on agricultural products. On the other hand, it appears that it has frequently had to remove its own trade remedy measures when they have been challenged by the U.S., EC, Brazil, and Chile. Indeed, one could conclude that, of the developing countries we have examined so far, Argentina has been most constrained by the WTO dispute settlement system. A caveat should be noted: the constraint is in the area of trade remedies, which are fairly easily reinstituted. 10.3.2.3

Chile

Chile has been relatively active in the WTO dispute settlement system. In the period under analysis it has initiated consultation requests in ten disputes and been a respondent in six. The first three cases initiated by Chile

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involved the EC (restriction on the use of the term “scallops”) and the U.S. (CD investigation of salmon and the Offset Act (Byrd Amendment)).90 It obtained a favorable settlement in the Scallops case, the U.S. did not impose duties in the Salmon case, and Chile prevailed with others in the Offset Act (Byrd Amendment) case, which the U.S. has implemented on prospective basis. More recently, Chile has used the system to challenge trade actions by other Latin American nations. It has brought cases against Peru in respect of discriminatory cigarette taxes and import taxes generally, Mexico in respect of import restrictions on matches, Argentina in respect of a safeguard on peaches, Uruguay in respect of discriminatory internal taxes, and Ecuador in respect of a safeguard measure on fiberboard.91 The tax cases were all settled, as was the Matches case, and no measure was imposed in the Fibreboard case. Chile prevailed in a panel proceeding in the Preserved Peaches case and the safeguard was removed within the reasonable period of time, but only a few weeks before it was scheduled to expire. Chile’s most recent consultation request was directed at an EC safeguard on salmon, which was terminated two and one-half months after its consultation request.92 Chile has been the respondent in seven disputes. The EC challenged its tax regime for alcoholic beverages and prevailed in a panel proceeding.93 The EC also challenged a Chilean prohibition on landing swordfish in Chile, which the parties eventually settled.94 Argentina successfully challenged the Chilean price band system for assessing duties on certain agricultural products, and after considerable delay a settlement was reached.95 The other four cases involved Chilean safeguard measures on oils, sugar, fructose, and milk.96 The cases appear to have been dropped following termination of the measure or investigation, except for the Milk case, which was initiated only in October 2006. In short, Chile seems to use the system most successfully in its relations with other Latin American nations, where it has successfully challenged discriminatory taxes and trade remedies. At the same time, those nations have constrained its use of trade remedies in the agricultural sector. 10.3.2.4 Mexico Mexico has made use of WTO dispute settlement on a regular basis over the years. It has initiated consultation requests in 11 disputes and has been a respondent in 13. Except for its involvement in the Bananas case97 and a 2005 dispute over the classification of milk products by Panama (which was settled promptly),98 Mexico has used the dispute settlement system to challenge trade remedy measures. It has brought cases against ADs imposed on cement by Guatemala, Ecuador, and the U.S.99 It ultimately prevailed in its case against Guatemala, although it had to restart the case after its first attempt was rejected for procedural defects. Ecuador withdrew the contested measure, and the panel in the U.S. case was requested to suspend the proceedings in 2006 on the expectation that the matter would be settled.

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Mexico’s other cases have involved a Venezuela antidumping investigation of Oil Country Tubular Goods (OCTG) (no measure imposed);100 and several cases involving the U.S.: a U.S. antidumping action on tomatoes (settled by a price undertaking); OCTG (Mexico prevailed and, as of September 2006, did not accept that the U.S. implementation measure was adequate); a U.S. CD action on steel plate (panel established, but not pursued, apparently because the issue involves U.S. privatization methodology, which is being modified because of prior U.S. court and WTO decisions); and a U.S. AD on stainless steel, in respect of which a panel was established in October 2006.101 Mexico was also a complainant in the Offset Act (Byrd Amendment) case, where it prevailed and the U.S. has prospectively implemented.102 Mexico has been a respondent in 13 cases, five of which have been initiated by the U.S. Those cases included a successful U.S. challenge to ADs on high fructose corn syrup; a case involving ADs on live swine, which was settled; a successful challenge to certain restrictions on access to the Mexican market for telecommunications, the results of which were implemented by Mexico; a successful challenge to ADs on rice; and a successful challenge of taxes on soft drinks containing sweeteners other than cane sugar.103 The other eight cases concern discriminatory customs valuation practice brought by the EC, which was settled under the EC-Mexico FTA; a similar charge brought by Guatemala, which is pending; cases involving import restrictions on matches (brought by Chile) and black beans (brought by Guatemala), which were settled; a case brought by Brazil in respect of an antidumping investigation of transformers, where the measure was withdrawn;104 a case brought by the EC challenging countervailing duties on olive oil, which is pending at the time of writing;105 and a case involving ADs on Guatemalan steel pipes, which is also pending.106 Mexico’s experience in WTO dispute settlement has largely concerned actions by and against the U.S.. However, like the other Latin American countries, it has also made use of the system in dealing with trade disputes over various other matters, and, in particular, over the use of trade remedies. 10.3.2.5 Other Latin American countries The four preceding subsections have suggested that the Latin American countries, particularly in recent years, have made extensive use of the WTO dispute settlement system to resolve disputes with each other. For example, Argentina, Brazil, Chile, Colombia, Costa Rica, Honduras, Mexico, and Nicaragua have invoked the system against other Latin American countries, with the major countries – Argentina, Brazil, Chile, and Mexico being the most active.107 This frequent use of the WTO system has occurred even though the countries involved often have trade agreements between them, some of which, such as MERCOSUR, provide for dispute settlement. Moreover, the WTO system seems to lead to a fairly high rate of settlement.

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Although the sample of cases is small, it appears that over three-quarters of the cases brought through 2004 were settled, compared to the overall WTO record of one-half settlement. This suggests to me that the WTO dispute settlement system provides clear value to developing countries – and as importantly – that developing countries, at least in Latin America, recognize that value. Those countries have, of course, made extensive use of the system in their dealings with non-Latin American countries as well, mainly against the EC and the U.S.108 10.3.3 The Advisory Centre on WTO Law One of the most significant developments affecting the position of developing countries in WTO dispute settlement was the creation in 2001 of the Advisory Centre on WTO Law.109 The Advisory Centre is an international organization formed by a group of developed110 and developing111 countries that provides legal assistance on WTO matters to developing countries for below-market fees. The Director of the Advisory Centre is Frieder Roessler, a long-time GATT official, who had very extensive experience with GATT dispute settlement in his role as Director of the GATT Legal Affairs Division. As of July 2004, the Advisory Centre employed seven lawyers, in addition to the Director. The developed country members of the Advisory Centre have contributed the equivalent of at least US$1 million to its endowment. Developing countries are required to make a one-time contribution that varies depending on their share of world trade and per capita income, with no contribution being required of least developed countries. The Advisory Centre has three principal functions: it provides (1) general legal advice, (2) legal assistance in WTO dispute settlement proceedings, and (3) training in WTO dispute settlement. In respect of legal advice, developing country members of the Advisory Centre are entitled to receive annually a specified amount of free legal advice on WTO law, while nonmember developing countries may receive such advice at higher rates and subject to the priority enjoyed by members. In respect of WTO dispute settlement, the Advisory Centre charges fees for the legal services it provides to its developing country members in WTO dispute settlement proceedings. Those fees vary based on world trade shares and per capita income, with least developed countries paying only SF40 per hour. Least developed countries may receive such services without being a member of the Advisory Centre. Other nonmember developing countries in principle may receive such assistance at higher rates, although to date the Advisory Centre has provided such assistance only to members and one least developed country. As of October 2006, the Advisory Centre’s website listed 23 WTO cases in which it had directly provided assistance. The beneficiaries were Bangladesh (India Batteries AD); Colombia, Costa Rica, Ecuador, and

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Guatemala (2005 EC Bananas implementation arbitration); Ecuador (Turkey Fresh Fruit); Guatemala (Mexico Steel Pipes AD); Honduras (Dominican Republic Cigarettes); India (EC Bed Linen AD, EC GSP, U.S. Textile Origin and India Autos); Indonesia (South Korea Paper AD); Nicaragua (Mexico Beans); Pakistan (U.S. Cotton Yarn and Egypt Matches AD); Paraguay (third party, EC GSP); Peru (EC Sardines); Philippines (Australia Fresh Fruit and Australia Pineapple); and Thailand (EC Sugar, EC Boneless Chicken, U.S. Shrimp and as a third party, U.S. Zeroing and U.S. Lumber AD).112 As is obvious from the list, most of the assistance has been to complaining parties, although assistance was provided to respondents in one cases (India Autos) and to a third party in three (Paraguay in EC GSP and Thailand in U.S. Zeroing and U.S. Lumber AD). Seven of the cases involved developing country vs. developing country matters – in each case on behalf of the poorer complaining developing country (Bangladesh vs. India; Ecuador vs. Turkey; Guatemala vs. Mexico; Honduras vs. Dominican Republic; Indonesia vs. South Korea; Nicaragua vs. Mexico; and Pakistan vs. Egypt). The other cases involved challenges to developed country measures, with six cases directed against the EC (involving EC preferences, ADs, and four agricultural products); four against the U.S. (origin rules, a textile safeguard, and two antidumping matters); two against Australia (related challenges to quarantine rules). Those cases that have been completed have all been at least partially successful, except for the challenge to the U.S. textile origin rules. The Advisory Centre has been operational for only about five years at the time of writing, so it is probably too early to draw any conclusions about its long-term impact on the position of developing countries in WTO dispute settlement. However, as the foregoing description of its activities makes clear, so far it seems to have a clear positive impact. It has been involved in a significant number of disputes and has been quite active in providing training in dispute settlement. 10.3.4 Conclusions on the developing country experience in WTO dispute settlement The foregoing discussion demonstrates that most of the major, more advanced developing countries make effective use of the WTO dispute settlement system. But it is also the case that the least developed country members of the WTO make virtually no use at all of the system and that many smaller developing countries do not use the system either. Therefore, in assessing developing country experience in the system, it is necessary to take account of these differences. Those experts who have examined this problem tend to blame this problem on several factors.113 First, there is a lack of expertise in WTO rules. This often means that the developing country government is unable to interact with its industries to determine if there are potential cases that should be brought, and the industries themselves may also be unaware of WTO rules.

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Even if a potential case is brought to the attention of the government, it may have difficulty evaluating it and certainly will have difficulty in navigating its way through the complexities of the dispute settlement procedures and in formulating its substantive arguments if the case goes to a panel. The country-by-country analysis lends support to this proposition. In particular, the decision by Thailand to devote more resources than other ASEAN countries to dispute settlement training, which would address these expertise problems at least in part, seems to be reflected in its more extensive use of the system. Similarly, the creation of a special unit for WTO dispute settlement in Brazil also underlines the importance and impact of government decisions to take concrete steps to address the expertise problem. Thus, while there is no doubt that lack of expertise is an important problem, it does seem that it can be addressed at least in part by government decisions to devote more attention to improving expertise, through, for example, more extensive training programs. The second problem faced by developing countries is a lack of resources, which to some extent prevents action being taken to solve the problems arising from a lack of expertise since the use of expensive private law firms may be out of the question. Except where it is possible to make use of the Advisory Centre on WTO Law, the cost of actually prosecuting a case is likely to be prohibitive, unless it can be defrayed by industry, which, of course, in a developing country may also suffer resources constraints, especially if there are many small producers involved. As noted below, one additional useful way of addressing this problem would be to have a mechanism for awarding litigation costs to successful developing country participants in a dispute settlement proceeding. The third problem that developing countries face is a political one – there may be fear of facing retaliation by a developed country indirectly – for example, by a reduction in aid. Such a fear may well simply arise more from a concern that such retaliation might occur than from any explicit threat made by a developed country official. Of course, this is the sort of problem that will never go away. It simply reflects the political realities in a world where countries vary enormously by size and wealth. It is worth noting, however, that a rules-based dispute settlement system does help to level the playing field and the WTO experience does include many examples of small countries challenging the major powers. In that regard, studies of developing country participation in WTO dispute settlement have found that they had the expected levels of success when cases went before panels and the Appellate Body (see generally Busch and Reinhardt, 2003).It is also worth noting that since the countries absent from the WTO system tend to be small, it may be the case that one would expect far fewer cases involving them than the major countries. After all, for the most part, small developed countries also do not bring many complaints, although they do appear more often as third parties.

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Fourth, since developing countries are generally the beneficiaries of preferences, it may well be that WTO rules are not all that relevant to their trade. That is to say, the rules relevant for them are the EU’s administration of its ACP preferences (Asian, Caribbean, and Pacific countries, who were parties to the EC’s Lome Convention, which was designed to provide preferential treatment to former colonies of EC Members) or national administration of GSP programs and not WTO rules. Finally, the reduced number of cases may in part reflect cultural factors, in that some societies are less litigious and therefore less likely to use a formal dispute settlement system. This may be confirmed by the contrasting experiences of Latin America and East/South East Asia in using the WTO system to resolve intraregional disputes, as it is commonly suggested that Asian countries are less litigious. As noted above, however, where an ASEAN country has devoted resources to improving its dispute settlement expertise, it does use the system more frequently. In summary, the foregoing discussion suggests that there is a particular need for more training and assistance to developing countries to enable them to handle the initial stages of dispute settlement more effectively. More recent experience suggests that at least the major developing countries – and quite a few Latin American countries in general – have become more effective in using dispute settlement overall, including in using it to obtain early settlements. The establishment of the Advisory Centre on WTO Law and the dispute settlement training activities of the WTO Secretariat and others should help to ensure that developing countries continue to made progress on this front.

10.4

DSU reforms of interest to developing countries

Although WTO Members have expressed general satisfaction with the operation of the WTO dispute settlement system, the system has been under almost constant review for possible reforms since 1998 (see generally Davey, 2004).In the 1998–99 period, there was a formal DSU review process that led to no changes, followed by an attempt to make limited changes in the 1999– 2000 period, followed by a decision to negotiate such changes during the Doha negotiations. The DSU negotiations were supposed to be completed early, but they have not made much progress. The deadline was first set as May 2003, then May 2004, and now the negotiations are open-ended. In considering what sort of DSU reforms should be of interest to developing countries, there is a split of opinion between those who seek special and differential treatment for developing countries on all issues (e.g., more time for this or that, or vague provisions requiring consideration of developing country interests)114 and those who argue that developing countries should seek more general DSU reforms that are likely to benefit them, perhaps disproportionately.115 I favor the latter approach.

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To highlight the above-mentioned difference, among the DSU reform proposals that I doubt would have much significance is one in the Chairman’s text which was unsuccessfully circulated as a basis for agreement in May 2003, that would have modified DSU Article 21.2 to provide that “particular attention shall [instead of should] be paid to matters affecting interests of developing country Members with respect to measures which have been subject to dispute settlement.” For me, this provision is a classic example of a special and differential treatment (SDT) provision that has no obvious meaning. It is not clear, for example, if this refers to developed country measures that have been found to violate WTO obligations, or to developing country measures in violation of those obligations, or both. Thus, making it mandatory may have no obvious effect. It is not clear who shall pay attention, although the provision’s placement in the surveillance article suggests that it is the DSB that should. How it is to do so is not clear, especially since virtually all of the actions that the DSB takes in respect of specific disputes are by reverse consensus. Its broad wording, however, means that it may be invoked at any time to justify SDT. Thus, it may be a useful provision, although not one that seems susceptible of enforcement in any specific case. Another example would be the proposal by the Least-Developed Countries (LDC) Group and the African Group to add a requirement that a panel make findings on the “development implications” of the issues in a case and consider any “adverse impact” that its findings may have on the social and economic welfare of a developing country in a case.116 The DSB is to take such findings into account in making its recommendations. Given the controversies over what policies are in the best development interest of developing countries (the views of the International Monetary Fund, the World Bank, the United Nations Development Programme, and the United Nations Conference on Trade and Development, for example, are not in any sense uniform on these issues), it is not clear what such a requirement would add in practice. Moreover, in the end, the heart of the requirement is that the DSB take such findings as are made on these issues into account in making its recommendations. However, given the way in which the DSB makes such decisions, that is, by reverse consensus, it is not clear how it would ever take such findings into account in a meaningful way. Thus, this is another example of an SDT provision that would be very difficult to operationalize in practice. In my view, two more useful provisions would be the Chairman’s text proposal on costs and a reform of DSU remedies. The proposal on costs would add a new DSU Article 28 that would authorize a panel or the Appellate Body to award an amount for litigation costs, taking into account the specific circumstances of the case, the respective conditions of the parties concerned, and SDT for developing countries. While phrased generally, the proposal is essentially one made by developing countries, who

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would presumably be the chief beneficiaries of the amendment. The award of costs is to be based on principles to be determined subsequently by the DSB, thus its impact is difficult to analyze at this stage. While controversial, this change would help to address the most compelling argument made by developing countries about the DSU, that is, that the system is too expensive for them to use. More significantly for developing countries would be a reform of DSU remedies. In that regard, it is important to recall that the existing remedies are prospective – whether in the form of compensation or retaliation. In addition, it is important to consider their two principal aims – to restore the balance of concessions that was upset when one member violated its obligations (a temporary aim since compliance is the preferred result); and to give that member an incentive to comply.117 The current problem with achieving the first aim – rebalancing – is that if retaliation is authorized, rebalancing takes place at a lower level of trade liberalization than had been agreed to. It would be desirable if a remedy could be devised that would not lead to less liberalization overall. One could consider monetary payments or requiring the payment of compensation through a reduction in other tariffs or trade restrictions maintained by the noncomplying member.118 In respect of the second aim – incentive to comply – there are two issues: timing and level of compensation or retaliation. At present, because remedies are prospective, there is an incentive initially to delay the time at which point they might be implemented, such as by seeking a long reasonable period of time for compliance and then forcing the victor to go through an Article 21.5 panel (and Appellate Body) proceeding. Moreover, if the threat of retaliation does not work, it is possible that the actual existence of retaliation will become viewed as the status quo and a long-term solution, even though the WTO rules in theory require compliance. A preferable solution may be to create incentives for early compliance, such as by providing that any retaliation will be calculated from a date prior to the date set for implementation (e.g., date of adoption or date of panel establishment) or by providing for increasing retaliation over time. Moreover, while retaliation seems to work when threatened by a large country against a smaller one, and has worked between two large countries, it may not be an effective remedy for a small country (even if it can target sensitive large country sectors such as copyright holders). One obvious possible change would be to provide for the payment of fines or damages. An obvious problem would be the disparity in fine-paying ability among WTO Members. The system would have to be designed to avoid the possibility that rich members could effectively buy their way out of obligations in a way not available to the poor members. One alternative would be to tie the amount of fines to the size of the member’s economy, or otherwise provide for a sliding scale that would minimize “discrimination” against poor members. To avoid the perception that the payment of fines is simply

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an alternative to compliance, the fines could be assessed annually (or on some other periodic basis) and could be increased over time. Such a system could serve as a method of rebalancing if the fines are paid to the member owed compliance, and could promote prompter compliance if the fines are increased over time. While a system of fines has not been discussed in much detail in the past, the U.S. administration in 2001 explored the possibility of using fines for environmental and labor rules violations (instead of trade sanctions) in FTAs (Office of the United States Trade Representative, 2001). Indeed, such provisions were included in the Chile-U.S. FTA and the Singapore-U.S. FTA, which came into force in 2004.119 More significantly, each agreement also permitted a defaulting party, when faced with suspension of concessions, to choose to pay an agreed amount (or, absent agreement, one-half the amount of nullification or impairment) on an annual basis in lieu of having concessions suspended.120 This suggests that the traditional government unwillingness to submit to the possibility of fines may be changing.

10.5 Conclusion This chapter has overviewed the operation of the WTO’s dispute settlement system in its first 12 years of operation and focused on the experience of developing countries. It found that in the last few years of this period, developing countries have made increasing use of the system and have had considerable success in resolving disputes amongst themselves, as well as against developed countries. The operation of the system could be improved, however, from the perspective of developing countries, by reforms that provided more effective remedies for smaller countries and helped to defray the cost of WTO litigation.

Annex 10.1 Description of major controversial WTO cases in 1995–99 period121 EC Bananas. The Bananas cases (DS27) involved a challenge to the EC-wide regime for banana imports that had replaced Member States’ regimes in 1993. It provided tariff and quota preferences to the ACP countries and quota preferences to certain Latin American countries (the so-called Banana Framework countries – Colombia, Costa Rica, Nicaragua, and Venezuela). It also set up a complex system of allocating import licenses that favored European companies over U.S. and other non-EC companies that had traditionally supplied the EC banana market. There had been two cases in GATT – one successfully challenging the Member States’ regimes (EEC – Member States’ Import Regimes for Bananas, DS32/R, June 3, 1993) and one successfully challenging the EC-wide regime (EEC – Import Regime for Bananas, DS38/R, January 18, 1994) – but neither report had been adopted.

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EC Hormones. The Hormones case (DS26) involved an EC ban on the use of growth-promoting hormones in beef cattle. It had been subject of discussion in the GATT Council and in the GATT Standards Code Committee in the late 1980s (GATT (1988: 80; 1990a: 72–74; 1990b: 123)). Japan Film. The Film case (DS44) symbolized the U.S. government’s long quest to open Japanese markets to U.S. products and was pressed by a U.S. firm – Kodak, which claimed that Japan had implemented a number of measures to nullify or impair the benefits that were expected to result from Japan’s tariff and quota liberalization actions in the 1960s and 1970s. The case was colloquially known as the Kodak-Fuji case. It was largely based on a nonviolation claim – a form of claim permitted by GATT, but one that has long been controversial since no violation of any agreement is alleged. Only one such claim has succeeded since the early 1950s. (Jackson, Davey, and Sykes, 2002). U.S. Shrimp. The Shrimp case (DS56) involved U.S. rules that, for the most part, permitted shrimp imports only from countries that had adopted U.S. rules and practices with respect to protecting turtles in connection with shrimp fishing through the use of so-called turtle excluder devices that allow turtles to escape from the shrimp nets. It involved the same issues of U.S. “environmental unilateralism” under the Marine Mammal Protection Act that had been controversial in the unadopted GATT Tuna-Dolphin panel reports. United States – Restrictions on Imports of Tuna, DS21/R (September 3, 1991) and DS29/R (May 20, 1994). It was the Tuna-Dolphin case, more than any other event or action, that first made the GATT system widely controversial: “While the [1990 proposal for] NAFTA drew attention to the trade and environment issue, a 1991 GATT panel decision on U.S.-Mexican tuna trade turned that interest into fury.” (Esty, 1994: 29). U.S. Helms Burton. The Helms Burton case (DS38) involved a U.S. law that provided for treble damage actions against foreign entities investing in confiscated U.S. (including Cuban-American) assets in Cuba and required the denial of U.S. visas to individuals connected with those entities. The case symbolized the EU’s longstanding complaints about U.S. unilateralism and attempts to apply U.S. law extraterritorially. Turkey Textiles. The Turkey Textiles case (DS34) presented the question of whether the GATT-compatibility of a customs union or an FTA could be considered by a dispute settlement panel, an issue that had been controversial in unadopted GATT panel reports. See, for example, GATT (1985). The Turkey Textiles case involved the EC-Turkey Customs Union and the EC tried unsuccessfully to become a co-respondent in the case. India Quantitative Restrictions. The India Quantitative Restrictions case (DS90) involved the question of whether the dispute settlement system or only the General Council and WTO Committee on Balance of Payments could

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consider the issue of the justification of measures imposed for balanceof-payments reasons under GATT Articles XII and XVIIIB. The issue had been considered, but arguably had not been settled definitively, in Korea (Restrictions on Imports of Beef, BISD 36S/202, 234 and 268, adopted on November 7, 1989). U.S. Section 301. The Section 301 case (DS152) involved a challenge to the basic U.S. statute – Sections 301–10 of the Trade Act of 1974 – under which U.S. authorities have taken action against various foreign laws and regulations that they considered objectionable. One of the goals of a number of countries in the adopting the WTO dispute settlement system was to rein in U.S. use of this law. See DSU, Article 23. U.S. Foreign Sales Corporations. The Foreign Sales Corporation case (DS108) involved a challenge to U.S. tax rules that allegedly provided an export subsidy. The Foreign Sales Corporations rules replaced rules found to be GATTinconsistent in the Domestic International Sales Corporation (DISC) case. U.S. Tax Legislation (DISC), BISD 23S/98, adopted on December 7–8, 1981.

Notes 1. Earlier versions of this chapter were presented to the Indian Society of International Law’s Second International Law Conference in New Delhi, November 14–17, 2004; the conference on “The Role of Law in Economic Development – Implications for China and the World,” at Sun Yat-sen University School of Law, Guangzhou, PRC, December 5–6, 2005; at the Hongfan Institute of Law and Economics, Beijing, PRC, December 9, 2005; and at China University of Politics and Law, Changping Campus, Beijing, PRC, December 10, 2005. 2. For a much more detailed description of the operation of the WTO system, see Davey (2002; 2004). 3. Section 10.2 is taken from (Davey, 2005a), a paper presented at the World Trade Forum in Bern in June 2004. 4. The WTO website provides a useful chronological list of WTO consultation requests, each of which is assigned a number DS1, DS2, etc. http://www.wto.org/ english/tratop_e/dispu_e/dispu_status_e.htm (visited October 31, 2006). I have treated related consultation requests as involving one dispute. For an explanation of the grouping, see Davey (2005a), p. 18, n. 1. 5. These members felt that decisions concerning the justification for invoking the balance-of-payments exception and the compatibility of FTAs and customs unions with GATT Article XXIV should be decided by political bodies rather than in dispute settlement. 6. It is worth noting that the Bananas case may yet rise again to haunt the system. Implementation was due by 2006 and twice in 2005, arbitrators rejected EC implementation plans. See World Trade Organization (2005). A number of Latin American countries have continued to raise objections to the implementation finally put in place by the EC at the beginning of 2006, but they have not initiated new dispute settlement proceedings. See World Trade Organization (2006), p. 8.

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7. The panel in Gasoline had referred to the VCLT and the practice of GATT panels had been to follow the general approach of the VCLT even when not citing it (see, for example, United States – Restrictions on Imports of Sugar, BISD 36S/331, 342–43, adopted on June 22, 1989 at http://www.wto.org/english/tratop_e/ dispu_e/gt47ds_e.htm). Nonetheless, the Appellate Body’s particular focus on individual words and very extensive use of dictionary meanings was new and caused some to joke that The New Oxford Shorter English Dictionary – the Appellate Body’s favorite dictionary – had become a “covered agreement” under the DSU. 8. EC – Hormones, WT/DS26/AB/R, p. 67, n. 154, and 78. 9. There was some criticism that the U.S. and the EC received better treatment on appeals that did other members, in particular in respect of the Gasoline, Hormones and Shrimp cases. Since the U.S. or EC ultimately lost in these cases, the criticism was necessarily limited to a suggestion that the Appellate Body was concerned in those cases to ease their losses. 10. U.S. – Shrimp, WT/DS58/AB/R, paragraphs 99–110. The Appellate Body later ruled that it also had the power to accept such briefs. U.S. – Lead and Bismuth II, WT/ DS138/AB/R, paragraphs 36–42. 11. The decline has continued. There were only 11 consultation requests in 2005 and 16 requests through October 2006. I doubt that this decline evidences member dissatisfaction with the system. See Davey (2007). 12. In compiling the statistics I cite, I have treated transition economies as developing countries, although the number of cases brought by them is sufficiently small that it makes little difference in the numbers. 13. The extensive use of the system by developing countries has continued in 2005 and 2006. Of the 27 consultation requests in this period (see note 11 supra), 12 were brought by developed countries (EC – 5; U.S. – 4; Norway – 2; and Canada – 1), while 15 were brought by developing countries (three each by Argentina and Mexico and one each by Chile, Costa Rica, Ecuador, Guatemala, India, Korea, Pakistan, Panama, and Thailand). Of the developing country requests, six were directed at other developing countries. Latin American countries continued to be particularly active. 14. Senator Max Baucus, the ranking Democrat on the Senate Finance Committee, was quoted in 2002 as saying that WTO dispute settlement decisions “are looking more and more like a kangaroo court against U.S. trade laws.” Inside U.S. Trade, September 27, 2002. 15. That is not to say that the critics have disappeared, but only to suggest that the focus by many groups in recent times has been more on the outcome of the ongoing negotiations than on specific dispute settlement cases. This has been facilitated by the fact that the cases in recent years have probably been less controversial than in the first few years, at least from the standpoint of the general public. Trade remedies cases do not engender the same passions in the general public as do environmental and health cases. 16. The July 1, 2002, cut-off date allows consideration of over 80 percent of the 324 consultation requests made in the first ten years of the operation of the WTO system. Many of the requests after the cut-off involve pending cases. 17. The specific categorization of individual cases can be seen in Davey (2005a), pp. 45–49. 18. This discussion and the specific categorization of these cases is based on Davey (2006). 19. See Davey (2006) for the categorization of the various individual cases. The status of contested cases has been updated to October 2006.

326 William J. Davey 20. To focus on the rate of implementation at any given point in time may give a misleading impression of the operation of the WTO dispute settlement system. Typically, the results of panel/Appellate Body reports are eventually implemented. 21. Hudec (1993), chapter 11. 22. Ginsburg and McAdams (2004). 23. For a more detailed analysis of the cases, see Davey (2005b). 24. DS309. 25. DS339, 340 and 342. 26. Poland Autos (DS19); Turkey Textiles (DS34); U.S. Shrimp (DS58); EC Tariff Preferences (DS246). 27. U.S. Wool Coats (DS32); U.S. Wool Shirts and Blouses (DS33); EC Cotton Fabrics (DS140); EC Bed Linen (DS141); EC Steel Products (DS313); South Africa Pharmaceuticals (DS168); U.S. Steel Plate (DS206); U.S. Offset Act (Byrd Amendment) (DS217); U.S. Customs Bond (DS345); Brazil Jute Bags (DS229). 28. Although the relationship to the WTO case is not clear, the EC and India reached an agreement on rice duties that will result in lower duties on rice of interest to India. Commission Regulation 1439/2004, OJ L 265/6 (August 12, 2004). 29. U.S. Textiles Rules of Origin (DS243); EC Rice Duties (DS134); Argentina Pharmaceutical Products (DS233). 30. Patents (DS50 and 79); Quantitative Restrictions (DS90); Autos (DS146 and 175). 31. In the Quantitative Restrictions case, the EC settled (DS96), as did the four other complainants – Australia (DS91), Canada (DS92), New Zealand (DS93), and Switzerland (DS94). 32. Export Commodities (DS120); Import Restrictions (DS149); Customs Duties (DS150); Import Restrictions (DS279); Antidumping Duties (DS304). 33. See, for example, EU Market Access Database – India (http://mkaccdb.eu.int/ cgi-bin/stb/barrierdesint.pl?bnumber=020092, visited November 2, 2006), reporting in July 2004 that Indian authorities are open to discussing their antidumping practices and improving them; Id. (http://mkaccdb.eu.int/cgi-bin/stb/ barrierdesint.pl?bnumber=980017, visited November 2, 2006), reporting some success in removing import restrictions in DS149 and DS279; EU Trade website (http://trade.ec.europa.eu/wtodispute/show.cfm?id=149&code=1, visited November 2, 2006), reporting certain progress achieved in DS150. 34. Batteries (DS306). The investigation was initiated on January 12, 2001 and definitive duties were imposed on December 7, 2001 (or January 2, 2002 – the notifications are inconsistent). Following the Bangladeshi consultations request of January 28, 2004, a review was initiated on March 18, 2004, which resulted in the termination of the measure on October 26, 2004. G/ADP/N/85, 119 and 126/ IND. The settlement was notified to the WTO in WT/DS306/3. 35. According to a report on the official website of Chinese Taipei for WTO Affairs (ewto.trade.gov.tw), the consultations requested on October 28, 2004 led to a meeting in New Delhi on February 16, 2005. The report indicates that measures on three of the seven products cited had been revoked shortly before the meeting and that a fourth measure was expected to be revoked. The other three measures may be subject of further contacts between the parties. 36. In 2000–01, exports of textiles and clothing accounted for 27 percent of India’s exports. See World Trade Organization (2000), p. 146. 37. Ibid. 38. I do not mean to suggest that India has always won all of its arguments in these cases – it lost its appeal in Wool Shirts and Blouses and lost most of its claims in Bed

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40. 41.

42. 43. 44. 45. 46. 47. 48. 49. 50.

51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65.

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Linen, but in both cases it won key arguments that benefited it directly in future situations. Colour Television Receivers (DS89); DRAMS (DS99); Stainless Steel (DS179); Line Pipe (DS202); Offset Act (Byrd Amendment) (DS217); Steel Safeguards (DS251); DRAMS CD (DS296). WT/DSB/M/206, pp. 7–9. Commercial Vessels (DS301). Korea appears to have divided DS301 into two cases: one which it won (DS301) on the grounds that certain EC measures affecting Korean vessel exports were unilateral measures violating WTO rules and one (DS307) not pursued challenging EC subsidies granted under those measures under the Subsidies Agreement. DRAMS CD (DS299); see WT/DSB/M/210, pp. 10–12. Laver (DS323); see WT/DS323/5. DRAMS CD (DS335). Resins (DS215). Alcoholic Beverages (DS75 and 84); Dairy (98); Beef (DS161 and 169); Procurement (DS163); Commercial Vessels (273); Paper (DS312). Inspection Requirements (DS3 and 41); Shelf-Life Requirements (DS5); Bottled Water (DS20); Telecommunications Procurement (DS40). WT/DSB/M/187, pp. 1–3. WT/DS312/8. Office of the United States Trade Representative. 2004. Foreign Trade Barriers Report, pp. 292–93, notes improvements resulting from WTO consultations between 1995 and 1999, but continues to complain of various practices, and notes that new regulations were implemented in 2003. EC Rice Duties (DS17). Hungary Export Subsidies (DS35). Turkey Textiles (DS47). U.S. Shrimp (DS58). Colombia Polyester Filaments (DS181). Egypt Tuna with Soybean Oil (DS205). U.S. Offset Act (Byrd Amendment) (DS217). EC GSP (DS242). EC Sugar Export Subsidies (DS283). EC Boneless Chicken (DS286). U.S. Shrimp AD (DS324 and 343). Thailand H-Beams (DS122). Davey, supra note 21, p. 52. World Trade Organization (2003), p. 9 (chart of exports in 2001). Indonesia: Argentina Footwear (DS123), which involved the same measure successfully challenged by the EC in DS121; U.S. Offset Act (Byrd Amendment) (DS217), successfully challenged by several WTO Members; Korea Paper (DS312) (implementation in dispute as of October 2006); Pakistan: U.S. Shrimp (DS58) (with others) and U.S. Cotton Yarn (DS192), in both of which it prevailed in panel proceedings; Egypt Matches (DS327), a challenge to antidumping duties which was settled, DS327/3; Philippines: Brazil Desiccated Coconut (DS22), in which it lost its claim; U.S. Shrimp (DS61), in which it did not join in the formal proceedings pursued in DS58 by India, Malaysia, Pakistan, and Thailand; Australia Fruit and Pineapples (DS270 and 271), in which a panel was established in August 2003 in the Fruit case, although the panel has not at the time of writing been composed and it does not appear that attempts to do have been proceeding actively.

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66. Bangladesh: India Batteries (DS306) (settled); China: U.S. Steel Safeguards (DS252), in which it prevailed along with others; Chinese Taipei: U.S. Steel Safeguards (DS274) (Chinese Taipei did not participate in the panel/Appellate Body proceeding brought by others); Hong Kong: Turkey Textiles (DS29) (Hong Kong did not participate in the panel/Appellate Body proceeding brought by India); Malaysia: U.S. Shrimp (DS58), in which it prevailed with others in the initial panel proceeding, but lost in its solo challenge of the U.S. implementation measure; Singapore: Malaysia Polyethylene (DS1) (settled); Sri Lanka: Brazil Desiccated Coconut (DS30) (Sri Lanka did not participate in the unsuccessful panel/Appellate Body proceeding brought by the Philippines). 67. In addition to the intra-Asian disputes mentioned in the next note, the following consultation requests have been directed at these countries: China Integrated Circuits (DS309), by the U.S. (settled); China Auto Parts (DS339, 340, and 342), by the EC, the U.S., and Canada (panel established in October 2006); Pakistan Patents (DS36), by the U.S. (settled); Pakistan Hides (DS36), by the EC (dropped); Philippines Pork (DS74 and 102), by the U.S. (settled); Philippines Autos (DS195), by the U.S. (settled). 68. Indonesia Autos (DS55 and 64) (Japan won in panel proceedings with others); Malaysia Polyethylene (DS1) (Singapore obtained a settlement); Philippines Resins (DS215) (Korea obtained a settlement). 69. Gasoline (DS4); Offset Act (Byrd Amendment) (DS217); Steel Safeguards (DS259); Cotton Subsidies (DS267). 70. Silicon Metal (DS239); Steel (DS218) (involves U.S. privatization methodology). 71. Patents Code (DS224); Orange Juice Tax (DS250). 72. Poultry (DS69); Soluble Coffee (DS154 and 209); Tube or Pipe Fittings (DS219); Boneless Chicken (269); Sugar Export Subsidies (DS266). 73. Aircraft (DS70 and 71); Aircraft Credits and Guarantees (DS222). 74. Textiles Safeguards (DS190); Poultry (DS241); Transformers (DS216); Buses (DS112); Pipe Fittings (DS208). 75. Desiccated Coconut (DS22 and 30); Autos (DS51, 52, 65, and 81); Aircraft (DS46). 76. Payment Terms (DS116); Import Licensing (DS183); Minimum Import Prices (DS197). 77. Patent Protection (DS199); Jute Bags (DS229); Tyres (DS332). 78. For export statistics for Brazil, see World Trade Organization (2000), p. 123. 79. Export Subsidies (DS35); Groundnuts (DS111). 80. Edible Oils (DS226) (one and one-half months); Price Band (DS207); Fructose (DS278) (two months); Milk (DS351). 81. Wine (DS263); Biotech Approvals (DS293); Garlic (DS349). 82. Vegetable Oils (DS272). 83. OCTG Sunset Reviews (DS268). This case is pending before a compliance panel as of October 2006. Argentina initiated another challenge on different grounds to these ADs in June 2006 (DS346). 84. Textiles and Apparel (DS56 and 77); Footwear (DS121, 123, and 164). 85. Hides and Leather (DS155); Ceramic Tiles (DS189). 86. Wheat Gluten (DS145); Drill Bits (DS157). 87. Countervailing Duties (DS330). 88. Pharmaceutical Patents (U.S.) (DS171 and 196); Pharmaceutical Imports (DS233). 89. Cotton Safeguards (Brazil) (DS190); Preserved Peaches Safeguard (Chile) (DS238); Poultry AD (Brazil) (DS241). 90. Scallops (DS14); Salmon (97); Offset Act (Byrd Amendment) (DS217). 91. Peru Cigarette Taxes (DS227); Peru Import Taxes (DS255); Matches (DS232); Preserved Peaches (DS238); Uruguay Taxes (DS261); Fibreboard (DS303).

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92. EC Salmon Safeguard (DS330); WT/DS330/4. 93. Alcoholic Beverages (DS87, 109, and 110) (the U.S. requested consultations, but was not a full party in the panel proceeding). 94. Swordfish (DS193). 95. Price Band (DS207 and 220) (Guatemala also requested consultations, but did not request a panel). The reasonable period of time for implementation expired in December 2003, but a settlement was not reached until October 2005. BNA International Trade Daily, Tuesday, November 1, 2005. Subsequently, the settlement broke down and the matter is before a compliance panel as of October 2006. 96. Edible Oils (DS226); Sugar (DS228 and 230); Fructose (DS278); Milk (DS351). 97. EC Bananas (DS16, 27, and 158). See Annex 10.1. 98. Panama Milk (DS329); WT/DS329/2. 99. Guatemala Cement I and II (DS60 and 156); Ecuador Cement (DS182 and 191); U.S. Cement (DS281). 100. OCTG (DS23). 101. Tomatoes (DS49); OCTG (DS282); Steel Plate (DS280); Stainless Steel (DS344, also DS325). 102. Offset Act (Byrd Amendment) (DS234). 103. Corn Syrup (DS101 and 132); Live Swine (DS203); Telecoms (DS204); Rice (DS295 – the consultation request also concerns ADs on beef); Soft Drink Taxes (DS308). Mexico in a sense replaced the ADs on HFCS with the drinks tax. Implementation in the Rice case was due in August 2006, but as of October 2006, Mexico had not reported taking any action to the DSB; implementation in the Soft Drinks Tax case was not due. 104. Customs Valuation (EC) (DS53); Customs Valuation (Guatemala) (DS298); Matches (DS232); Black Beans (DS284); Transformers (DS216). 105. Olive Oil (DS341). The EC had also requested consultations in request of the preliminary duties. DS314. 106. Steel Pipes (DS331). 107. Such use involving Argentina (five cases as complainant; three as respondent), Brazil (four cases as complainant), Chile (six cases as complainant; five as respondent) and Mexico (three cases as complainant; five as respondent) is detailed in the preceding subsections. In addition, there have been cases brought by Colombia: Nicaragua Import Measures (DS188); Costa Rica: Trinidad and Tobago Pasta (DS185 and 187) and Dominican Republic Foreign Exchange Fees (DS333); Guatemala: Chile Price Band (DS220, similar to Argentina’s case); Honduras: Nicaragua Import Measures (DS201, combined with Colombia’s similar action), Dominican Republic Cigarettes (DS300 and 302); Panama: Colombia Customs Measures (DS348). All told there have been 24 such cases (counting similar cases as one). 108. In addition to the cases brought by Argentina, Brazil, Chile, and Mexico, the following Latin American countries have initiated WTO disputes against nonLatin American countries: Antigua and Barbuda: U.S. Gambling Services (DS285); Colombia: U.S. Brooms (DS78); Costa Rica: U.S. Underwear (DS24); Ecuador: EC Bananas (DS27 and 158), Turkey Fruit (DS237), U.S. Shrimp (DS335); Guatemala: EC Bananas (DS16, 27, and 158); Honduras: EC Bananas (DS16, 27, and 158); Panama: EC Bananas (DS105 and 158); Peru: EC Scallops (DS12), EC Sardines (DS231); Uruguay: EC Rice (DS25); Venezuela: U.S. Gasoline (DS2). Countries other than Argentina, Brazil, Chile, and Mexico have rarely been requested to consult by countries outside Latin America. The two that have been subject to

330

109. 110.

111.

112. 113. 114. 115.

116. 117.

118. 119. 120. 121.

William J. Davey such requests are: Colombia: Filaments (DS181, brought by Thailand); Venezuela: Import Licensing (DS275, brought by U.S.). Detailed information about the operation of the Advisory Centre and its constitutive documents may be found at its website – www.awcl.ch. According to the website (http://www.acwl.ch/e/members/members_e.aspx, visited November 2, 2006), the original developed country members, who contributed funds for the Advisory Centre’s endowment and initial operation, were Canada, Denmark, Finland, Ireland, Italy, Netherlands, Norway, Sweden, and the United Kingdom. Switzerland acceded as of 2004. According to the website (http://www.acwl.ch/e/members/members_e.aspx, visited November 2, 2006), the 20 original developing country members were Colombia, Dominican Republic, Ecuador, Egypt, Guatemala, Honduras, Hong Kong, India, Kenya, Latvia, Nicaragua, Pakistan, Panama, Paraguay, Peru, Philippines, Thailand, Tunisia, Uruguay, and Venezuela. Jordan, Mauritius, Oman, Turkey, Chinese Taipei, El Salvador, and Indonesia have since acceded. Http://www.acwl.ch/e/dispute/wto_e.aspx, visited November 2, 2006. See, for example, Shaffer (2006), p. 177; Abbott (2007). In the DSU negotiations, the least developed countries and the African group have tended to favor these types of proposals, as has India. See, for example, Roessler (2002), which suggests that procedural privileges are not useful and that SDT should focus on providing access to legal expertise necessary to participate in WTO dispute settlement. TN/DS/W/42, 2 (Kenya, on behalf of the African Group); TN/DS/W/37, 1 (Haiti, on behalf of the LDC Group). DSU Article 22.1. European Communities – Regime for the Importation, Sale and Distribution of Bananas – Recourse to Arbitration by the European Communities under Article 22.6, WT/DS27/ARB, paragraph 6.3 (April 9, 1999). See Pauwelyn (2000). Chile-U.S. FTA, Article 22.16; Singapore-U.S. FTA, Article 20.7. Chile-U.S. FTA, Article 22.15(5); Singapore-U.S. FTA, Article 20.6(5). These descriptions are taken from Davey (2005a), pp. 18–19, nn. 4–12.

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Davey, William J. 2005b. “Implementation in WTO Dispute Settlement: An Introduction to the Problems and Possible Solutions.” RIETI Discussion Paper Series 05-E-00X (on RIETI website as of March 2005), also available at Illinois Public Law Research Paper No. 05–16 http://ssrn.com/abstract=862786. Davey, William J. 2006. “The WTO: Looking Forwards.” Journal of International Economic Law 9: 3. Davey, William J. 2007. “Evaluating WTO Dispute Settlement: What Results Have Been Achieved Through Consultations and Implementation of Panel Reports?” In Y. Taniguchi, A. Yanovich and J. Bohanes (Eds.). The WTO in the Twenty-First Century: Dispute Settlement, Negotiations and Regionalism in Asia. Cambridge: Cambridge University Press, 98–140. de la Fayette, Louise. 2002. “United States – Import Prohibition of Certain Shrimp and Shrimp Products – Recourse to Article 21.5 of the DSU by Malaysia.” American Journal of International Law 96: 685–92. Esty, Daniel C. 1994. Greening the GATT: Trade, Environment, and the Future. Washington, DC: Institute for International Economics. General Agreement on Tariffs and Trade (Organization). 1985. EEC – Tariff Treatment of Citrus Products from Certain Mediterranean Countries, L/5776 (February 7, 1985). Geneva: GATT. General Agreement on Tariffs and Trade (Organization). 1988. GATT Activities, 1987. Geneva: GATT. General Agreement on Tariffs and Trade (Organization). 1990a. GATT Activities, 1988. Geneva: GATT. General Agreement on Tariffs and Trade (Organization). 1990b. GATT Activities, 1989. Geneva: GATT. Ginsburg, Tom, and McAdams, Richard H. 2004. “Adjudicating in Anarchy: An Expressive Theory of International Dispute Resolution.” William and Mary Law Review 45(1229): 1308–12. Hudec, Robert E. 1993. Enforcing International Trade Law: The Evolution of the Modern GATT Legal System. Salem, MA: Butterworth. Jackson, John H., Davey, William J., and Sykes, Alan O. 2002. Legal Problems of International Economic Relations. Eagan, MN: West: 287–88. Office of the United States Trade Representative (USTR). 1997a. “1996 Annual Report of the President of the United States on the Trade Agreements Program.” Washington, DC: USTR. Office of the United States Trade Representative. 1997b. “1997 Trade Policy Agenda.” Washington, DC: USTR. Office of the United States Trade Representative. 2001. Concept Paper, “Using Monetary Assessments to Enforce Panel Decisions under Bilateral Free-Trade Agreements,” reproduced in Inside US Trade under the heading Internal USTR Paper on Monetary Fines (April 2001). Washington, DC: USTR. Office of the United States Trade Representative. 2004. “Foreign Trade Barriers Report.” Washington, DC: USTR. Pauwelyn, Joost. 2000. “Enforcement and Countermeasures in the WTO.” American Journal of International Law 94: 335. Roessler, Frieder. 2002. “Special and Differential Treatment for Developing Countries under the WTO Dispute Settlement System.” In Ernst-Ulrich Petersmann (Ed.). Preparing the Doha Development Round: Improvements and Clarifications of the WTO Dispute Settlement Understanding. San Domenico di Fiesole: Robert Schuman Centre for Advanced Studies, European University Institute: 119, 124. Shaffer, Gregory. 2006. “The Challenges of WTO Law: Strategies for Developing Country Adaptation.” The World Trade Review (Jul.): 177.

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World Trade Organization (WTO). 2000. “Trade Policy Review: Brazil, Report of the Secretariat.” WT/TPR/S/75. Geneva: WTO, September 22, 2000. World Trade Organization. 2003. “Trade Policy Review: Thailand, Report of the Secretariat.” WT/TPR/S/123. Geneva: WTO, October 15, 2003. World Trade Organization. 2004. “Trade Policy Review: Korea, Report of the Secretariat.” WT/TPR/S/137. Geneva: WTO, August 18, 2004: 119. World Trade Organization. 2005. “European Communities – The ACP-EC Partnership Agreement – Second Recourse to Arbitration.” WT/L/625. Geneva: WTO, October 27, 2005. World Trade Organization. 2006. “Minutes of DSB Meeting of 19 July 2006.” WT/ DSB/M/217. Geneva: WTO.

11 Costs of Implementation of WTO Agreements Sam Laird

11.1

Introduction

Implementation of the results of the Uruguay Round has been a key issue in charting the course of the World Trade Organization (WTO) system over the years since 1997. There had been a substantial overhaul and expansion of the scope of the multilateral trading system in the round, which was concluded against a background of growing world trade, and several international institutions predicted global welfare gains of up to $500 billion, much of which was to benefit developing countries. However, the Asian, Russian, and Brazilian crises of 1997–98 changed the global economic environment; problems emerged with the implementation of the WTO Agreements; and efforts to build on the success by launching a “Millennium Round of Multilateral Trade Negotiations” foundered in Seattle in 1999. As a result, the WTO began the new millennium with a great deal of soul searching. The failure of Seattle can be attributed to a number of factors – of which the disruption by antiglobalization activists was probably a minor element. The main issues related to the changing nature of the organization, expectations of the newly expanded membership (mostly from developing countries), different visions of the future of the organization, new issues with a sometimes tenuous linkage to trade policy, and an underlying replay of some old-fashioned issues such as protectionism and the thrust of development policy. However, the issues surrounding implementation of the outcome of the Uruguay Round were among the more important elements that have soured the atmosphere in the WTO since the start of the post-Doha negotiations.

11.2

The emergence of the implementation issue

11.2.1 Quantification of the projected gains from the Uruguay Round One of the most significant implementation issues concerned the quantitative benefits that developing countries had expected to obtain from the 333

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Uruguay Round. This refers to estimates at the end of the Uruguay Round that the implementation would yield global welfare gains variously estimated to range between $212 billion and $510 billion, while the estimated gains for developing countries range between $86 billion and $122 billion.1 Some of these estimates used new techniques and assumptions in global modeling, such as imperfect competition and economies of scale, that economists used to boost the estimates under pressure from the senior management of various institutions in order to produce large numbers that could be used to “sell” the benefits of the round (and that were consistent with those of other organizations).2 However, the gains were largely proportional to each country’s own liberalization efforts and, although many developing countries had extended tariff bindings and lowered bound MFN tariffs, their applied rates were mostly lower than the new, bound, levels so little additional tariff liberalization took place in practice in developing countries and the main gains from the new tariff reduction commitments accrued to the liberalizing developed countries. In this sense, developing countries may have been given a false impression of the potential benefits. 11.2.2

Other implementation concerns

Some developing exporters had expected to gain substantially from the liberalization of the textiles as clothing sectors as quotas were cut back and eventually eliminated and they became disillusioned as the liberalization was backloaded, rules of origin were tightened, antidumping actions and special safeguards were invoked, and some tariffs were increased (within bound rates). In the event, the main gains were captured by China and a few other players, while a number of other developing countries saw their market shares eroded as tariff preferences and guaranteed quotas were reduced. In the case of agriculture, many nontariff barriers were converted to very high duties or specific rates with a high percentage equivalent while permitted levels of domestic supports and export subsidies were computed with considerable slack, and no payments were ever made to net food-importing countries to offset higher food prices. In services, commitments largely amounted to the binding of preexisting levels of access. Various clauses in almost all WTO Agreements that required developed countries to give special attention to the situation of developing countries (special and differential treatment (SDT)) were felt to be little more than “best endeavor” clauses that had little legal value and could not be enforced (Kessie, 2000). Yet another question concerns the development impact of the various agreements. As Hoekman (2002) comments, most rules reflect good policy (with the possible exceptions of the Antidumping and Trade-Related Intellectual Property Rights (TRIPs) Agreements. However, “making them work may require wholesale reform and strengthening a variety of institutions” with important implementation costs that Hoekman considers to be asymmetrically distributed since they are often based on existing rules

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Table 11.1 Development dimensions of major WTO rules and disciplines Encourages moves towards good policy

Significant direct implementation costs

Significant corollary investment required (indirect costs)?

Transparency

Yes

No

No

Tariff reductions

Yes

No

No

Tariff binding

Yes

No

No

?

Yes

Yes

Yes

Yes

No

Agreement on:

Customs valuation Classification (Harmonized System, HS) Production subsidies

?

No

No

Export subsidies

?

No

No

Quotas

Yes

No

No

Balance of payments

No

No

No

Antidumping

No

Yes

No

Countervail

No

Yes

No

Emergency protection

?

Yes

No

Yes

No

Yes

?

Yes

Yes

Technical barriers

Yes

Yes

Yes

Sanitary and phytosanitary (SPS) measures

Yes

Yes

Yes

General Agreement on Trade in Services (GATS) TRIPs

Agriculture

Yes

No

No

Import licensing

Yes

No

No

Rules of origin

Yes

Yes

No

State trading

Yes

No

No

Regional integration

Yes

No

No

Textiles and clothing

Yes

Yes

No

Source: Hoekman (2002).

of the Organization for Economic Cooperation and Development (OECD) countries. Table 11.1 gives Hoekman’s assessment of the development merit and costs of the WTO rules and disciples. As may be imagined this evaluation is to some extent subjective. Nevertheless, it is an indication of the kind of concerns that, after some

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reflection and experience of implementation, developing countries have with the intent and costs of the WTO Agreement. The issue of costs is discussed further below. 11.2.3 Costs of compliance Another facet of implementation was the difficulties faced by developing countries in meeting their new WTO obligations. While there were certainly pressures to conclude the WTO Agreement, some developing countries genuinely believed that signing the WTO Agreement would bring them benefits, through greater predictability, credibility, and transparency of their trade regimes. They hoped that this would lead to new inflows of foreign direct investment, bringing jobs, new technologies, increased productivity, and enhanced international competitiveness. However, full implementation of the WTO Agreement was always going to take time and many developing countries needed technical assistance for which the WTO had limited funding.3 Yet, the need for technical assistance was acute in some cases. For example, Finger and Schuler (2000) estimated that implementation of the WTO Agreement on Customs Valuation would cost as much as some countries’ annual development budgets. In addition, while protection of intellectual property is said to encourage the development of new inventions that benefit mankind, some questions have been raised by the World Bank and other about the appropriateness of the TRIPs Agreement for developing countries, apart from the cost of implementation. In the light of the experience of implementing the TRIPs Agreement, the World Bank has recommended that international trade agreements – which have increasingly set rules on how to protect patents, copyrights, and trademarks – must now specifically consider each developing country’s capacity to innovate, technological requirements, and institutional capabilities, as well as the general need to promote poor people’s access to pharmaceutical products (Fink and Maskus, 2005). World Bank economists have also argued that poor people are “shorted” by companies that register patents based on their knowledge and collect revenues that should go to the poorer communities: “The challenge facing developing countries is to unpackage knowledge from indigenous products and repackage it for commercial markets” (Finger and Schuler, 2003), and have suggested that encouraging nongovernmental organizations to challenge patent grants may prove a more effective solution than attempting to provide additional resources and authority to regulatory agencies. 11.2.4

Source of misunderstandings

To some extent, a problem was the lack of experience of developing countries in the multilateral system. In the history of the General Agreement on Tariffs and Trade (GATT), very little had been asked of them, in part because of SDT under Part IV of GATT (Trade and Development), Article

Implementation of WTO Agreements 337

XVIII (Balance of Payments), and Article XXVIII bis (concerning less than full reciprocity by developing countries) and in part because their markets were small and of little interest to the major traders. The effect of this limited participation was that their key exports, for example, in agriculture, textiles, and clothing, etc. had not been subject to deep tariff cuts, leaving them with relatively high rates supplemented with quotas, subsidies, and other nontariff barriers. Thus, in the Uruguay Round a number of developing countries took the view that they had to participate actively and make offers to reduce tariffs in order to obtain concessions on their exports. In addition, some developing markets, such as China, India, and Brazil were becoming more important and the developed countries exerted pressure to obtain improved access, locked in by firm commitments in the round. Thus, developing countries accepted a wide range of new commitments, of which in many cases they did not fully understand the implications4 and without any external funding to facilitate implementation, such as under World Bank/International Monetary Fund (IMF) reform programs. Some specific agreements did provide for longer transitional periods for developing countries than for developed countries and acknowledged the need for technical assistance. However, a number of developing countries kept making the point that the planned transition periods were insufficient and there was a need to provide extra time for full implementation (which was subsequently granted in a number of areas, such as trade-related investment measures (TRIMs), use of export subsidies, TRIPs, etc.). Moreover, technical assistance from the WTO Secretariat amounted mainly to advice on modification of legislation, rather than funding to cope with real adjustments in their economies. This is consistent with the expertise of the WTO Secretariat, while more substantive assistance from the Bretton Woods institutions, which had the financial resources, would have entailed new lending programs and conditionalities. 11.2.5 Experience of liberalization One key issue, which was not well explored in the early 1990s, concerned the effects of liberalization in the developing countries. The main World Bank/IMF reform programs had been being implemented only for five to ten years and not all of the implications were well understood. While some developing countries were expressing concern about these reforms, labeled as the Washington consensus by John Williams of the Institute for International Economics, these complaints were largely swept aside. In fact, in its own review of the trade-related lending, the World Bank’s Independent Evaluation Group admitted in 2006 that mistakes were made (World Bank, 2006). Another set of case studies, also published in 2006, noted that growth rates in the most countries under study fell below preliberalization rates and that inadequate attention was paid to the specifics of each case – a criticism of the “one size fits all” approach that seemed to characterize some of

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the policy prescriptions of the Structural Adjustment Loan (SAL) programs (Laird and Fernández de Córdoba, 2006). Given the sometimes unfortunate results of the unilateral reforms and their concerns about implementation of the results of the Uruguay Round, developing countries were often unwilling to contemplate new negotiations in various areas and this formed part of their opposition to extending negotiations beyond agriculture and services, which had already been envisaged in the WTO Agreement. While some favored the launching of a “Millennium Round,” others opposed even the inclusion of nonagricultural market access negotiations as well as the wide area of WTO rules. There were also divisions about extending the mandate of the WTO into areas such as trade and competition, trade and environment, trade and investment, transparency in government procurement, and trade facilitation – the so-called Singapore issues (since they were mooted at the first WTO Ministerial Conference in Singapore in December 1996 – but the majority of developing countries – and not a few developed countries – felt that time was needed to absorb the results of the Uruguay Round before venturing into new areas. 11.2.6 Ministerial support for evaluation of implementation issues Agitation by developing countries led to a decision at the WTO’s second Ministerial Conference in Geneva in 1998 (held to coincide with the fiftieth anniversary of GATT) that “full and faithful implementation of the WTO Agreement and Ministerial Decisions is imperative for the credibility of the multilateral trading system and indispensable for maintaining the momentum for expanding global trade, fostering job creation and raising standards of living in all parts of the world ... .” (Paragraph 8). Ministers agreed that at the next Ministerial Conference (Seattle) they would pursue their evaluation of the implementation of individual agreements and the realization of their objectives, including any problems encountered in implementation and the consequent impact on the trade and development prospects of members. Ministers also agreed to establish a process “to ensure full and faithful implementation of existing agreements,” to make recommendations on this and other issues for decision at the following Ministerial Conference (Paragraph 9), and to prepare for the Third Session of the Ministerial Conference. In this context, developing countries prepared a list of 150 elements for consideration on the implementation issue and tabled these proposals in the WTO General Council in the run-up to the Seattle Ministerial Conference at the end of 1999.5 These proposals, which covered almost all areas of the WTO Agreement and Uruguay Round Decisions, were broken down into issues to be decided prior to the conference and issues to be agreed within one year of the conference. However, there was no consensus on the proposals and the debate continued in the aftermath of the failed Seattle conference.

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11.2.7 Establishment of a special implementation mechanism Following that failure, WTO Members made a determined effort to address this and other issues in order to rebuild confidence in the system. Specifically, in early 2000, the WTO General Council established a special mechanism to deal with implementation issues. The General Council decided that members would exercise due restraint in respect of the nonimplementation by developing countries of WTO commitments. The key issue was to obtain an extension of the transition period for the implementation of specific agreements, as had already been granted to a number of developing countries in various WTO committees, notably in relation to customs valuation. As a modest outcome of the special mechanism, in December 2000 the WTO General Council adopted a decision on seven implementation measures related mainly to some points of clarification on subsidies (WTO document WT/L/384 of December 15, 2000). India described the decision as “below its lowest expectations” and expressed concern that there had been no decisions on textiles, antidumping, and subsidies.6 The Indian delegate said the only real decisions were a rectification of the failure to include Honduras in Annex VII of the Subsidies Agreement and a decision on clarifying the operation of tariff rate quotas (TRQs) in agriculture. In other discussions during the year, the length of transition periods were an issue in relation to TRIMs and customs valuation, the operation of the Agreement on Net food-importing Countries, SPS/technical barriers to trade (TBT) concerns of developing countries (including their participation in international standard setting bodies), and TRIPs issues (link to the Convention on Biodiversity). Other key areas in the implementation debate concerned the effects on expected improvements in market access of the use or abuse of antidumping measures and problems in the integration of the textiles and clothing sector into GATT 1994. There have been one or two dispute settlement cases in relation to commitments in textiles and clothing but otherwise developing countries’ complaints seemed to relate more to the spirit of the Agreements rather than any breach of legal obligations. 11.3

Doha

There was considerable pressure at Doha Ministerial Conference for ministers to make a decision to launch a new round of negotiations. The pressure was particularly severe since the meeting took place barely two months after the attack on the World Trade Center in New York (“9/11”). Ministers were under pressure to take decisions that were said to be of importance to showing confidence in the global economy, which had been showing signs of weakening that year. Moreover, after the failure at Seattle, there was a sense that the credibility of the WTO system was at stake, especially in tackling development issues where implementation of the WTO Agreement was the core question.

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In the two years leading up to the WTO Ministerial Conference in Doha in November 2001 probably no subject attracted more attention or generated more controversy within the WTO than the issue of implementation. As the WTO said prior to Doha, “... it is certain that the question of implementation will not only be at the center of ministerial activity during the meeting but that any broader work program undertaken by the WTO will be contingent on resolving the issue in a satisfactory manner.”7 The issue of implementation of the Uruguay Round Agreements was the subject of several separate decisions by ministers in Doha. First, paragraph 12 of the main Ministerial Declaration states: We attach the utmost importance to the implementation-related issues and concerns raised by Members and are determined to find appropriate solutions to them. In this connection, and having regard to the General Council Decisions of 3 May and 15 December 2000, we further adopt the Decision on Implementation-Related Issues and Concerns in document WT/MIN(01)/17 to address a number of implementation problems faced by Members. We agree that negotiations on outstanding implementation issues shall be an integral part of the Work Programme we are establishing, and that agreements reached at an early stage in these negotiations shall be treated in accordance with the provisions of paragraph 47 below. In this regard, we shall proceed as follows: (a) where we provide a specific negotiating mandate in this Declaration, the relevant implementation issues shall be addressed under that mandate; (b) the other outstanding implementation issues shall be addressed as a matter of priority by the relevant WTO bodies, which shall report to the Trade Negotiations Committee, established under paragraph 46 below, by the end of 2002 for appropriate action. The Ministerial Decision on Implementation-related Issues and Concerns of 14 November 2001 (WTO document WT/MIN/(01)/17) covered implementation issues under 12 separate headings (regrouped below): ●

●

●

●

●

balance of payments exceptions (GATT Article XVIII, drawing attention to the lesser stringency than under Article XII); market access commitments (allocation of quotas under GATT Article XIII, essentially to look at the “substantial interest of developing countries”); agriculture (no limits to use of Green Box subsidies for rural development and food security, subject to certain conditions); least developed countries (LDCs) and net food-importing countries (effectiveness of the WTO Agreement in these areas); export credits, export guarantees, and insurance programs under the Agriculture Agreement (avoidance of circumvention of the agreement);

Implementation of WTO Agreements 341 ●

●

●

●

●

●

●

●

●

●

TRQs under the Agriculture Agreement (provision of information on quota administration); SPS measures and TBT (longer timeframe for implementation by developing countries, timeframe between notification and implementation of new measures, acceptance of equivalent rather than identical measures by other governments, provision of technical assistance to implement SPS standards); textiles and clothing (effective implementation of early implementation, restraint on antidumping after the termination of the Agreement on Textiles and Clothing (ATC), examination of origin, more favorable treatment of small suppliers and LDCs in quota administration, faster expansion of quotas); TRIMs (positive consideration of requests by LDCs for extension of transition periods); antidumping (special care in instigating second investigations within one year, underscoring that special regard is to be had for developing countries, assessment of how to make time-period for assessing negligible imports more predictable, improvement of reviews of the agreement); customs valuation (note of some extensions of transition periods by Customs Valuation Committee, Goods Council to give positive consideration to requests by LDCs for extension of implementation period, examination of how to improve cooperation among customs authorities to combat fraud); rules of origin (committee urged to complete work on harmonized rules of origin); subsidies (clarification of operation of Annex VII of the Subsidies and Countervailing Measures (SCM) Agreement dealing with countries whose annual per capita GNP is less than $1,000, proposals for Green Box classification for certain subsidies for “legitimate development goals” to be handled under the work program – paragraph 12 of the Doha Ministerial Declaration (above), specification of time period for determination of competitiveness of LDC exports); TRIPs Council to continue discussion on non-compliance complaints,agreement not to file such complaints pending recommendations at next ministerial conference, information to be provided on functioning of incentives by developed countries’ private sectors to promote and encourage technology transfer to LDCs under Article 66.2 of the TRIPs Agreement; Cross-cutting issues (the WTO Committee on Trade and Development was to consider: a) how to make nonbinding commitments on SDT mandatory and more effective; and b) how SDT could be incorporated into new negotiations. WTO Members granting preferences were to ensure they were generalized and not for any selected group); Other issues to be handled under paragraph 12; and

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WTO technical assistance to focus on meeting WTO commitments and to enable developing countries to participate more effectively in future multilateral negotiations.

At Doha, the Declaration on TRIPs and Public Health (WT/MIN(01)/DEC/2 of November 20, 2001) and the Decision on Procedures for Extensions under Article 27.4 [of the SCM Agreement) for Certain Developing Country Members (G/SCM/39 of November 20, 2001) were also about implementation. The TRIPs Declaration concerned the use of compulsory licensing for the production of drugs to cope with AIDS and other serious public health problems, as well as paving the way for the TRIPs Council to find a solution to the problem of countries without their own manufacturing capacity. Here the issue was whether such countries could import generic drugs from other developing countries with such manufacturing capacity. The SCM decision, strictly a decision of the Committee on Subsidies and Countervailing Measures, spelled out in further detail the decisions on subsidies that were part of the Ministerial Declaration itself concerning extension of the transition period and Annex VII countries. In practice, there was very little substantive treatment of issues and the process was effectively transmitted to the Trade Negotiations Committee, established under the Ministerial Declaration, for further consideration of the overarching issues, while special and regular sessions of individual committees or councils of the WTO would handle requests for extension of transition periods and other technical issues on an ad hoc, case-by-case basis. SDT – which is closely related and can also be seen as an overarching issue – was to be handled in Special Sessions of the Committee on Trade and Development. While a number of countries were less than happy with the outcome, the words of the declarations and decision gave everyone something to take home, and the post-Doha program was launched successfully. The texts were indeed replete with references to development and, as such, have been recognized as holding out hope for a positive outcome on development, but, equally, much would depend on how these would be implemented.

11.4

Post-Doha

The Trade Negotiations Committee (TNC) considered the issue of implementation of the WTO Agreements on a number of occasions, on the basis of reports from various special sessions of other committees, but without making much progress. Indeed, in the reports from committees the issue of implementation scarcely received a mention, the reports being dominated by the substantive issues within the responsibility of each body in the negotiations. The Chairman of the TNC (the Director-General, first Dr. Supachai and later Mr. Lamy), in his report to the WTO General Council had to report

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in phrases such as “despite all the hard work ... Members did not seem to have reached agreement on definitive solutions on most of the issues before them” (TN/C/3 of July 28, 2003) or “the situation has not evolved significantly” (TN/C/5 of July 28, 2005). The chairman, however, offered two explanations. First, he said that “as long as the approach to the outstanding issues remains one in which all the issues are linked together, it will not be possible to resolve any of them.” Second, he noted that “progress on any given issue has remained out of reach due largely, but not exclusively, to the difficult political nature of the treatment of one particular issue – extension of geographical indications (GIs).” This concerned the proposal that GIs be extended to products other than wines and spirits, where there was no agreement among members. Just a few months later, concern at the lack of progress was recognized in the Hong Kong Ministerial Declaration of December 2005, and this essentially represents the state of play (as of early 2007). The declaration reaffirmed the so-called “July Package” of 2004 in respect of implementation issues, urging “the TNC, negotiating bodies and other WTO bodies concerned to redouble their efforts to find appropriate solutions as a priority to outstanding implementation-related issues.” Ministers noted the work of the Director-General in his consultative process on all outstanding implementation issues under paragraph 12(b) of the Doha Ministerial Declaration, including on issues related to the extension of the protection of geographical indications provided for in Article 23 of the TRIPs Agreement to products other than wines and spirits and those related to the relationship between the TRIPs Agreement and the Convention on Biological Diversity. The Director-General was to intensify his consultative process on all outstanding implementation issues under paragraph 12(b), if needs be by appointing chairpersons of concerned WTO bodies as his “Friends” and/or by holding dedicated consultations, and to report back to the regular meetings of the TNC and the General Council. On the closely related issue of SDT, Ministers at Hong Kong declared that “provisions for special and differential treatment are an integral part of the WTO Agreements.” They also reaffirmed the Doha commitment that all SDT provisions be reviewed with a view to strengthening them and making them more precise, effective and operational. In Hong Kong, the ministers adopted a number of decisions related to the treatment of LDCs, but were obliged to recognize that substantial work still remained to be done. Among the more important decisions was that allowing tariff-free, quota free access for LDCs by 2008 to developed markets and such developing markets as consider themselves able to offer this was not concretely operational for all members. This was subject to two important constraints, namely that the date of 2008 was qualified as “or by no later than the implementation date” (meaning after the conclusion of the round), and, second, that members facing implementation difficulties could limit this to 97 percent of products

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initially (effectively excluding Bangladesh’s textiles and clothing from such treatment in the U.S.). Ministers also committed themselves to addressing the development interests and concerns of developing countries, especially the LDCs, in multilateral negotiations.

11.5

Conclusions

The issue of implementation of the WTO Agreements that has plagued the WTO process since the conclusion of the Uruguay Round has two sides. First, many developing countries argue they did not get what they thought had been promised in terms of improved market access and welfare gains. While economists were aware that most of these gains derived from a country’s own liberalization, this was likely not well understood by most developing countries’ governments. Moreover, the tariff-binding overhang after unilateral reforms meant that deep cuts in the bound rates did not lead to substantial cuts in applied rates in most developing countries, while on the other hand limited cuts in agricultural protection and backloading of the removal of textiles and clothing quotas did not produce the export gains that had been hoped for. Second, developing countries were either unaware of or underestimated the kind of adjustments they would have to make and how much implementation would cost them, and technical assistance was limited to legislative and regulatory change to ensure conformity with new WTO commitments, rather than to cope with adjustments in the real economy. Moreover, predetermined transition periods for implementation were inadequate in many cases. Overall, there is some evidence of “oversell” of the benefits of the Uruguay Round and, as in the example of Akerloff’s “lemons,” this has made it much harder to do a deal in the Doha negotiations. Apart from the issue of oversell, developing countries’ concerns about the issue of implementation are linked to several other interrelated issues. For example, experience in implementing reforms and World Bank/IMF programs has been rather negative in a number of cases, and this has only recently been acknowledged by the international organizations. There is also an argument that GATT/the WTO is systemically biased against developing countries, as evidence by the bias in protection against developing countries’ exports. Moreover, the high cost of and technical expertise required to utilize the dispute settlement cases makes it harder for developing countries to defend their interests, especially against the larger countries. As another example, it has also been argued the preexistence of subsidies in developed countries allowed them to continue with such measures in agriculture, whereas developing countries – which largely could not afford subsidies – are precluded from their future use by the Agreement on Agriculture. In other words, concerns about implementation were reinforced by resentment about a perceived bias in the WTO system. The lack of transparency in the WTO consultations and the difficulties of small delegations in coping with

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a heavy meeting program add to the sentiment that the WTO is a “rich man’s club.” The handling of the implementation issue in the post-Uruguay Round era seems to have been largely a mechanical process with little substance, although some extension of the transitional periods was arranged, mainly on a case by case basis. Developing countries had sought some form of waiver or generalized agreement to avoid having to make individual justifications, particularly since the WTO has taken a much more negative view of requests for waivers than GATT but, except for a relatively permissive approach to the LDCs, this has not been accepted. Prior to Doha, issues were covered in different committees as well as the Implementation Review Mechanism. After Doha, the issues continued to be handled across a range of WTO bodies, but were brought together in the TNC with reports from the different chairpersons and an overview by its chairman. As noted in this chapter, there has been little progress over the years since 1997, except that transition periods were extended in some cases and that there was some clarification on the operation of various Agreements. Increased funding has been mainly oriented toward the training of government officials in how to meet WTO legal commitments. Special and differential treatment, handled in Special Sessions of the Committee on Trade and Development, was to some extent a parallel overarching issue where progress was made on some issues. However, there is a fundamentally different perception about the nature of SDT between developed and developing members of the WTO. Developed country members tend to regard SDT as a purely transitory set of measures to give developing members extra time to adopt the same, single set of rights and obligations as developed members. Developing countries, however, regard SDT as a right and as a set of permanent measures designed to assist countries that have quite different economic characteristics and problems. They also regard SDT as in some way correcting what they see as past discrimination and the systemic bias against them. Overall, the establishment of the WTO in 1995 was a major success; unifying the dispute settlement system and making recommendations mandatory; bringing agriculture, textiles and clothing within the main framework of rules; extending the coverage to services; and making some important revisions to WTO rules across the full spectrum. The WTO is now also much more transparent than GATT. However, there are obviously some areas where decisions reached under negotiated compromises are less than satisfactory, and work is continuing on these. On the whole, developing countries have welcomed the establishment of the WTO but continue to press for improvements in the rules and the way it does business. Putting development at the center of the WTO was an important achievement at Doha, but the final judgment on the success in this respect will depend on full implementation of the Doha Declaration and more generally of the WTO Agreement.

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Sam Laird

The experience of implementing the WTO Agreement means that members will want to be more careful about the precise meaning of commitments, allowing adequate implementation periods, tolerance for implementation problems, and financial support. While the WTO is not a development agency, development issues need to be addressed within the multilateral trading system because of the significance of the trade and development links. Belatedly, WTO Members have also come to realize that funding has to be available to tackle substantive development issues, including supply-side issues, whereas its own technical assistance is limited in scope. However, such greater efforts are beyond the capacity and expertise of the WTO and require a wider cooperative effort at the international level, involving other agencies as well as more coordinated donor activity. This is the reason for the decision at the Hong Kong Ministerial Conference in December 2005 to ask the WTO Director-General to create a task force to make recommendations on how to operationalize Aid for Trade, intended “to build the supplyside capacity and trade-related infrastructure that they need to assist them to implement and benefit from WTO Agreements and more broadly to expand their trade.” Ministers also invited the Director-General “to consult with members as well as with the IMF and World Bank, relevant international organisations and the regional development banks with a view to reporting to the General Council on appropriate mechanisms to secure additional financial resources for Aid for Trade, where appropriate through grants and concessional loans.” It is not expected that the outcome of this process will do anything to resolve the past problems of implementation of the WTO Agreement, but it may prevent a repeat of the problems that have been evident since the conclusion of the Uruguay Round. There is a danger that no clear agreement on such funding can be reached prior to the conclusion of the Doha negotiations beyond some kind of assurance of the “best endeavors” that have proven to be mostly worthless in the past. If so, the WTO runs the risk of repeating the mistakes of history rather than learning from them.

Notes Professor Samuel Laird is Special Professor of International Economics, University of Nottingham, and Visiting Professor, World Trade Institute, Berne. 1. For a review of these estimates, see Safadi and Laird (1996). 2. The main estimates were produced by OECD, the World Bank, and the GATT Secretariat using global computable general equilibrium (CGE) models. 3. At the conclusion of the Uruguay Round, the WTO technical assistance budget was SFR 10 million, of which 90 percent was made up of voluntary contributions from a limited number of developed countries (notably the Netherlands, Norway, Sweden, Switzerland, and the U.K., among others), and thus lacked some uncertainty from year to year.

Implementation of WTO Agreements 347 4. This judgment is based on interviews by the author when conducting some 30 trade policy reviews for GATT/the WTO. 5. Some 800 proposals were tabled by WTO Members in 1999 for consideration by ministers. These were summarized in a Compilation of Proposals Submitted in Phase 2 of the Preparatory Process as part of the Preparations for the 1999 Ministerial Conference, a document of 217 pages (WTO document JOB(99)/4797/ Rev.3 of November 18, 1999), of which 67 pages were devoted to proposals on implementation. 6. Hong Kong, China considered that the failure to deal with implementation of the Agreement on Textiles and Clothing was an attempt to reopen the Agreement, which the spokesman said was not an option. 7. Briefing Notes by the WTO Secretariat for the Doha Ministerial Conference 2001.

References Finger, J.M., and P Schuler. 2000. “Implementation of Uruguay Round Commitments”. The World Economy 23(4): 511–25. Finger, J.M., and P Schuler. (Eds.) 2003. Poor People’s Knowledge. Washington, DC: Oxford University Press and World Bank. Fink, C., and K Maskus. (Eds.) 2005. Intellectual Property and Economic Development: Lessons from Recent Economic Research. Washington, DC: World Bank. Hoekman, B. 2002. “Strengthening the Global Trade Architecture for Development”. WPS 2757. Washington, DC: World Bank. Kessie, E. 2000. “Enforceability of the Legal Provisions Relating to Special and Differential Treatment under the WTO Agreements”. Journal of World Intellectual Property 3(6): 954–75. Laird, S., and S Fernández de Córdoba. (Eds.) 2006. Coping with Trade Reforms. London: Palgrave MacMillan. Safadi, R. and Laird, S. 1996. “The Uruguay Round Agreements: Impact on Developing Countries”. World Development 24(7): 1223–42. World Bank. 2006. Assessing World Bank Support for Trade 1987–2004: An IEG Evaluation. Washington, DC: World Bank.

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Index acceding countries benefits of WTO for, 97–100 improved market access for, 252–3 policymaking in, 100–30 scope of commitments of, 95 status of, 94–5 accession accession packages, 93–5 adjustment costs, 123–6 balance of payments management and, 128–30 benefits of, 189n17, 217–18 by China, 18–19, 24–5, 27, 150–1 completed, 148–9 contractual nature of, 186 costs of, 184–5, 260–2 customs revenues and, 111–18 development implications of, 13–34 effects on policymaking, 91–132 vs. FTAs, 143–7, 185–6 governance and, 104–11, 157–67 impact on regional arrangements, 126–8 implementation costs, 118–23 market access and, 100–4 negotiation of, 142, 217 ongoing, 152–3 policy reform and, 139–74 political process of, 259–60 process, 13–34, 93–100, 146–7 protocol of, 93–4 rules governing, 93 terms of, 92 time and complexity of, 146–7, 150 timing of, 140–1 trade liberalization and, 95–7, 198 WTO rules on, 14–17 accession commitments, 217 accountability, 157, 164–5 adjustment costs, 123–6 administrative corruption, 108, 110 administrative process, 261 Advisory Centre on WTO Law, 316–17 Africa, dispute resolution and, 258 African customs union, 179

agricultural sector, 198, 203, 274, 341 agricultural subsidies, 86–7, 184 agricultural tariffs, 27–30, 34n4, 34n9, 101, 103 Albania, 30, 270 Amin, Idi, 83 antidumping rules, 104, 221 antipiracy measures, 122 anti-WTO protests, 187 APEC, see Asia-Pacific Economic Cooperation (APEC) Appellate Body, 300–1 appellate process, 297–8, 300–1 applied tariffs, 102 arbitration, 37–8, 52–3, 55–60, 62–3, 66–7, 99, 298 arbitration procedures, commercial law, 57–60 Argentina, 312–13 Armenia, 264 Article XXIV, 178 ASEAN, see Association of Southeast Asian Nations (ASEAN) Asean Industrial Projects, 188n5 Asia dispute resolution and, 305–11 foreign investment in, 84–5 interregional trade in, 87–8 regionalism in, 179–80 see also specific countries Asian financial crisis, 58, 83, 177, 180, 279 Asia-Pacific Economic Cooperation (APEC), 180, 190n24 Association Agreements, 96 Association of Southeast Asian Nations (ASEAN), 87, 177, 179 Australia, 173n13, 179, 183 auto parts industry, 41–2 automobile industry, 40, 41 backward linkages, 41–2 balance of payments, 128–30 Bananas case, 258, 299, 300, 322, 324n6 Bangladesh, 266 349

350

Index

barriers to trade, 26, 221, 262 Barshevsky, Charlene, 72 Bataan Export Processing Zone, 50 Baucus, Max, 325n14 beachhead costs, 221, 244n9 “beggar thy neighbor” policies, 97–8, 129 benefits improved international governance, 259 mitigating factors, 258–9 overestimated, 252–60 political process of accession, 259–60 see also costs and benefits bilateral investment treaties (BTIs), 64, 67 bilateral trade, 205–7 corner-solutions model, 224–5 effects of GATT/WTO membership on, 201, 202 standard gravity model of, 221 WTO membership and, 218–21 bilateral trade agreements, 127, 177, 188n13 bilateral trading relationships, 226–32 bound tariffs, 101, 102, 253 Brazil, 184, 265, 337 dispute resolution and, 311–12 import substitution and, 81 bribery, 60–3, 67 budgetary policies, 118–23 Bulgaria, 101, 103, 105, 108, 116–17, 183 Business Environment and Enterprise Performance Survey (BEEPS), 108 Cambodia, 30, 34n1, 264, 270 Canada, 179 capacity building, 189n20 capital, 123 Caribbean Basin Initiative, 179 ceiling bindings, 19 Central America, 47–8, 151 Central Americans Common Market, 178 Central and Eastern European (CEE) countries, 127 see also specific countries Central European Free Trade Agreement (CEFTA), 96–7 centrally planned economies, 255 Chang, Gordon, 275

child labor standards, 47 Chile, 181, 263, 266, 313–14 China, 15, 21, 85, 337 accession of, 18–19, 24–5, 27, 150–1 bilateral negotiations between U.S. and, 272–3 bureaucracy of, 185 commitments by, 273 under Deng, 87 dispute resolution and, 305–6 economic restructuring in, 282–5 exports, 276–7 external economic security for, 276–82 FDI in, 277–82 import substitution and, 82 labor movements, 290n48 manufacturing in, 41 market-oriented reforms in, 18–19 MFN status for, 276–7 nonmarket status of, 133n19 processing trade exports, 16 regionalism and, 180 tariff reductions in, 30, 34n7 trade liberalization in, 273–4 WTO membership of, 184, 250–1, 272–87 CITs, see countries in transition (CITs) Closer Economic Relations (CER), 179 clothing, 341 colonies, 15, 33 commercial law arbitration procedures, 57–60 commercial risk, 57, 58–60, 67 commitments, by ascending countries, 16–17, 19 comparative advantage, 77 compliance costs, 336 computer industry, 40–1 consultations, 295–6, 303 contract manufacturing, 43 control of corruption, 157, 164–5 Convention on Biological Diversity, 343 convergence school, 283–4, 290n47 Corn Laws, 203 corruption, 60–3, 67, 104–11, 134n24, 157, 164–5 Costa Rica, 42, 48, 51, 257–8 costs accession, 260–2 adjustment, 123–6

Index 351 costs – continued compliance, 336 implementation, 118–23, 184–5, 262–71, 333–47 see also costs and benefits costs and benefits in China (case study), 272–85 improved international governance, 259 misperceptions about, 251 mitigating factors, 258–9 overestimated benefits, 252–60 dispute resolution, 257–8 improved domestic governance, 254–7 improved market access, 252–3 political process of accession, 259–60 underestimated costs, 260–72 accession costs, 260–2 impact on government revenues, 268–72 implementation costs/difficulties, 262–8 loss of sovereignty, 272 of WTO membership, 249–87 see also specific countries cotton, 184 Council for Mutual Economic Assistance (CMEA - Comecon), 181, 188n8 countries in transition (CITs) adjustment costs for, 123–6 bound and applied tariffs in, 101–3 budgetary policies, 118–23 dates of accession and membership of, 131 effects of WTO accession on, 91–132 governance and corruption in, 104–11 interest of, in WTO membership, 91 policymaking in, 100–30 regional agreements of, 126–8 trade liberalization in, 95–7 credibility gap, 98–9 Croatia, 116, 136n47 cross-cutting issues, 341 customs reforms, 151, 264 customs revenues, 111–18 customs unions, 178–9 customs valuation, 121, 341 Customs Valuation Agreement, 263–4

Czech Republic, 42, 92 domestic policymaking, 129 trade liberalization in, 96–7 decolonization, 83, 84, 225 Deng Xiaoping, 87 developing countries accession and, 94, 197–8 concessions to, 1 dispute resolution and, 257–8, 305–22 effects of trade liberalization on, 337–8 GATT and, 200–1 governance, 157–67 implementation costs for, 333–47 increased profile of, 184 misunderstandings with, 336–7 multinational investment in, 84–5 policy reforms in, 139–74 policy space for, 3, 38 rule implementation in, 23–4 status of, 94–5 trade reform and, 16 Direction of Trade Statistics (DoTS), 220–1, 225 dirty tariffication, 34n4 discriminatory trade policy, 178 dispute resolution, 7, 99, 257–8, 288n16, 295–330 1995–1999, 298–301, 322–4 2000–2004, 301–2 Advisory Centre on WTO Law and, 316–17 appellate process, 297–8, 300–1 arbitration, 37–8, 52–3, 55–60, 62–3, 66–7, 99, 298 consultations, 295–6, 303 controversial cases, 322–4 developing countries experience with, 305–19 FDI and, 55–60 overview of system operation, 298–305 panel process, 296–7 record on, 303–5 reforms, 319–22 surveillance of implementation, 298 Dispute Settlement Body (DSB), 258, 296 Dispute Settlement Understanding (DSU), 295

352 Index Doha Declaration on Public Health, 289n31 Doha Development Agenda, 184 Doha Round, 1, 26, 177, 184, 339–42 domestic content requirements, 44 domestic governance, 254–7 domestic market conditions, 124–5 domestic spending, 128 Dominican Republic, labor standards in, 51 duties, 21–2 East African Community, 178 East Asia, 16 Eastern Europe, 42 Economic Community of West Africa (ECOWAS), 181 Economic Cooperation Organization (ECO), 179 economic development accession procedures and, 17–34 WTO membership and, 251 Ecuador, 151, 156–7, 170–2, 173n12, 271 Effective Rate of Protection methodology, 20 Egypt, 74, 266 electronics industry in China, 82 in South East Asia, 41, 43–4 Elf Aquitaine, 76 emerging markets transition economies and, 122, 124, 127–8 empirical tests, 64, 113, 122, 190n26, 219, 233–4, 242 endogeneity, 141 environmental regulations, compensation of foreign investors for, 51–5 Estonia, 101, 105, 111 intellectual property rights in, 122 regional trade agreements of, 128 tariffs of, 126 Ethiopia, 269 Eurasian Economic Community (EAEC), 190n23 Euro-Mediterranean Policy, 139 Europe Agreements, 96, 97, 127 European Bank for Reconstruction and Development (EBRD), 31, 111 European customs union, 178–9

European Economic Community (EEC), 176 European Free Trade Area (EFTA), 97, 181 European Neighborhood Policy, 139 European Union (EU), 126–7, 181, 183, 187 experimentalist school, 283 export costs, 244n8 Export Processing Zones, 50 export relationships, 226–32 export incentives , 20 exports, 16 Chinese, 24–5, 276–7 diversity of, 75 increase in, 217 expropriation, 51–5 extensive margin of world trade, 220, 221 econometric analysis, 232–41 model of, 221–5 quantifying, 225–7 WTO membership at, 227–32 external anchors, 155–6, 185–7, 189n21 external balance, 154 extractive industries, foreign investment in, 55–7 Extractive Industry Transparency Initiative (EITI), 63 farm subsidies, 184 FDI, see foreign direct investment (FDI) Ferrantino, Michael, 185–6 Film case, 299, 323 fines, 321–2 fixed effects, 203–4 fixed export costs, 244n8 flexibility, 21, 22 forced labor standards, 47 Ford Motor Company, 84 foreign direct investment (FDI), 33 arbitration and dispute settlement involving, 55–60 in Asia, 84–5 bilateral investment treaties to attract, 64, 67 in China, 277–82 in infrastructure and extractive industries, 55–7 international regulatory framework for, 37–68 in Latin America, 84–5 locational subsidies and, 64–6

Index 353 foreign direct investment (FDI) – continued in manufacturing and assembly, 39–41 performance requirements on, 38–44 tariff jumping, 40 in transition countries, 111, 112 TRIMs Agreement and, 44 foreign enterprise, 84–5 foreign investors, protection against expropriation for, 51–5 Foreign Sales Corporations case, 299, 300, 324 free trade imperialism of, 83–6 see also trade liberalization free trade agreements (FTAs), 4, 74, 172n1 governance and, 157–67 negotiation of, 142, 143, 146, 151 policy reform and, 139–74 proliferation of, 139 timelines for, 144–5 timing of, 140–1 vs. WTO accessions, 143–7, 185–6 free trade areas (FTAs), 96 free trade package, 133n9 Free Trade Zones, 50 FTAs, see free trade agreements (FTAs) fundamental identity, 128

Ghana, 84, 271 Global Trade Analysis Program (GTAP) model, 125, 281 governance, 134n28 accession and, 100, 141–2 corruption and, 104–11, 132 domestic, 254–7 FTAs vs. WTO accessions, 157–67 improvements, 142, 254–7, 259 indicators, 141, 157–67 international, 259 transparency of, 140 “Governance Matters” indicators, 157–67 government effectiveness, 157, 164–5 government intervention, in industry, 87 government investment, 21 government revenues, accession and, 111–18, 268–72 government(s) credibility of, 98–9 interaction with private sector, 98 response of, to domestic market conditions, 124–5 gravity equation, 235–40 gross domestic product (GDP) growth rates, 78 per capital growth rates, 78 trade share of, 72, 73–4 Guatemala, 146

Gasoline case, 301, 325n7 GATT think, 217, 242 General Agreement on Tariffs and Trade (GATT), 1, 13, 15, 18, 74, 77–8, 85, 86 CITs and, 92 developing countries and, 200–1 informal participation in, 201 membership in, 249 nondiscrimination principle, 179 nondiscrimination requirement in, 176, 177–8 rationale for, 210–12 trade effects of, 195–215 trade policy and, 207–10 General Agreement on Trade in Services (GATS), 181 General Motors (GM), 40 Generalized System of Preferences, 187n4, 190n26, 302 geographical indications (GI), 264

Hausman tests, 204 health regulations, compensation of foreign investors for, 51–5 Helms Burton case, 299, 323 Herfindahl index, 231, 245n16 Heritage Foundation, 141, 167, 168–9, 173n12, 173n14, 196 Hewlett-Packard (HP), 40–1 Hong Kong Ministerial Declaration, 343 Hormones case, 299, 300, 323 Hungary, 40, 92, 96–7 Hyundai, 43 imperialism, of free trade, 83–5 implementation costs, 118–23, 184–5, 262–71, 333–47 implementation issues, 256–7, 262–9, 333–6, 338 import protection, 19–20, 22 import restrictions, 128–9 import substitution, 16, 80–2, 87

354

Index

import tariffs, 268 incumbent countries market access and, 253 response of, to accession countries, 103 Index of Economic Freedom, 141, 167, 168–9, 173n12, 173n14, 196 India, 20, 85, 266, 326n38, 337, 339 dispute resolution and, 306–8 independence for, 83 Look East policy of, 88 shrimp industry in, 267 indirect expropriation, 52 Indonesia, 58, 265, 279, 311 infant industries, 22 infrastructure, foreign investment in, 55–7 institutional changes, costs of, 120 institutional quality, 105, 106–7 intellectual property rights, 121, 122, 125, 221, 264–6, 298, 336 intermediate inputs, 21 internal balance, 154 International Center for the Settlement of Investment Disputes (ICSID), 52 International Confederation of Free Trade Unions (ICFTU), 48 international cooperation, 2 international governance, 259 International Intellectual Property Alliance (IIPA), 122 International Labor Organization (ILO) Declaration on Fundamental Principles and Rights at Work, 45 labor standards and, 45–51 International Monetary Fund (IMF), 180, 196, 221, 255 international regulations, for foreign direct investment, 37–68 international trade organizations, governance of, 72 investment, in manufacturing, 84 investment cooperation, role of, 5–6 Iran, 186 Ireland, locational subsidies by, 65 Israel, 181 Jackson-Vanik amendment, 103 Japan, 79–82, 86, 179–80 Japan Bank for International Cooperation (JBIC), 277

Japan External Trade Organization (JETRO), 279–80 Japan-Thailand FTA, 188n13 Jawa Power, 59 joint ventures, 40–1 Jordan, 74, 146 Kennedy Round, 179 Kenya, 39 knowledge, 83–4 Korea, 309–10 Korean model, 42–4 Kosovo, 74, 83–4 Kyrgyz Republic, 103–5, 108, 111, 260 implementation costs in, 269 recession in, 189n18 regional trade agreements of, 127 RTAs and, 190n23 labor standards, enforcement of, via trade agreements, 45–51, 66 Labor-Management Councils (LMCs), 46 laissez-faire, 80, 83 Latin America dispute resolution and, 258, 302, 311–16 foreign investment in, 84–5 labor standards in, 47–8 regional trade agreements in, 179 see also specific countries Latvia, 101, 105, 111, 127 least developed countries (LDCs) concessions to, 24 recognition of, 94–5 level playing field, 79–80 Lewis, W. Arthur, 84 liberalization, see trade liberalization linkages among agreements, policy, and performance, 151–5 backward, 41–2 between WTO rules and economic development, 8–9 manufacturing, 39–41 policy, 140 trade, 111, 128–9, 205, 208, 333 Lithuania, 111 litigation costs, 265–6 lobbying, 75 locational subsidies, 64–6, 67

Index 355 Louis Vuitton-Moet Hennessy (LVMH), 76 Lucky Goldstar, 43 Macedonia, 271 macroeconomic policy, 128–30 macroeconomic stability, 255 Malaysia, 279, 281 manufacturing and assembly direct investment in, 84 foreign direct investment in, 39–41 market access, 100–4, 217, 252–3 market economy, 18–19 market failure, long-term investments and, 55–7 Marrakesh Agreement, 93, 95 Marshall Plan, 84 means tests, 164–5 Melitz aggregator, 223, 224 mercantilism, 217 merchandise trade, 27, 30 Mercosur, 179 Methanex case, 54, 63 Mexico, 40–1 dispute resolution and, 314–15 import substitution and, 81 intellectual property rights and, 265 NAFTA and, 147, 150, 154, 179 policy reform in, 185–6 MFN tariffs, 27 MidAmerica corporation, 58, 59 Ministerial Conference, 338 Ministerial Decision on Implementation-related Issues and Concerns, 340–2 Mitsumi, 50 Moldova, 124, 270 Mongolia, 103, 104, 105, 108, 116, 119 monopolistic competition, 221 Monroe Doctrine, 83 Morocco, 151, 155–6 most favored nation (MFN) treatment, 25, 66, 98, 103, 176, 189n15, 198, 276–7 Multi-Fiber Arrangement (MFA) quotas, 15, 187n4 Multilateral Agreement on Investment (MAI), 37 multilateral negotiations, difficulties with, 1–2 multilateral regulations, 38

multilateral trade, 5–6 multilateralism, 176, 177, 179 multinational corporations (MNCs) corrupt payments by, 60–3, 67 labor standards and, 45–51 locational subsidies to, 64–6 manufacturing investment by, 84 performance requirements and, 38–44 U.S., 76 NAFTA, see North American Free Trade Agreement (NAFTA) national enterprise, 84–5 National Labor Relations Board (NLRB), 48 national savings, 128 national sovereignty, 272 National Treatment principle, 26 natural resource development projects, 55–7 negative integration measures, 18, 19–21 negotiations accession, 13–15, 18–19, 25–6, 92–4, 126, 130, 140, 186, 241, 265–72 bilateral, 15, 22, 25, 74, 180 free trade, 139–74 GATT, 34, 176 market access, 22 multilateral, 1, 6, 100, 179, 184, 249, 253 WTO, 3, 5, 128, 256–60 see also specific agreements (i.e., NAFTA, Uruguay Round) Nepal, 30, 262–3 new liberalism, 97 new regionalism, 180 New Zealand, 179, 183 Nixon, Richard, 80 nonagricultural tariffs, 27–30 nondiscrimination principle, 47, 176–9 nonmarket economies, 99, 103–4, 134n22, 190n22, 254–5 non-tariff barriers (NTBs), 198 North American Free Trade Agreement (NAFTA), 40, 133n13, 176, 177, 179, 183 Chapter, 11, 52–4 Mexico and, 147, 150, 154

356

Index

obsolescing bargain, 56 OECD, see Organization for Economic Cooperation and Development (OECD) OEM certification, 43 optimal tariffs, 98, 274 Organization for Economic Cooperation and Development (OECD), 60–3, 79, 184, 196, 257, 335 Organization of Petroleum Exporting Countries (OPEC), 85 Original Equipment Manufacture (OEM), 41–2 Orwell, George, 188n8 Pakistan, 268, 269, 311 Palestinian Authority, 181 Panama, 30 panel process, 296–7 patents, 75–6, 264–5, 336 performance requirements, on foreign investors, 38–44 Permanent Normal Trade Relations (PMTR) Act, 277 Peru, 269 petrochemical sector, 39 pharmaceutical industry, 86–7 Philippines, 279, 311 Bataan Export Processing Zone, 50 labor standards in, 51 Poland, 92, 96–7 policy anchors, 185–7, 190n24 policy reform, 4, 139–74 in China, 282–5 regional trade agreements and, 185–6 see also reform policy rules, 217 policy space, 3, 5, 7–8, 37–8, 51–2 policymaking effects of WTO accession on, 4–5, 91–132 of GATT/WTO membership, 207–10 political interests, 74 political issues, 186 political liberalization, 134n21 political risk, 58–60, 67 political risk insurance, 56–7 political stability, 164–5 positive integration measures, 18, 22–4 price liberalization, 124 prisoner’s dilemma, 65–6

private property rights, 52–5 private sector, interaction between government and, 98 Probit effect, 240, 241 product differentiation, 221 protectionist barriers, 19–21, 22, 198 Protocol of Accession, 13, 93–4 publication bias, 212 Quantitative Restrictions case, 299, 300, 323–4 quotas, 19, 111, 254 Reebok, 50 reform(s) budgetary, 117 of commercial law arbitration, 67 components of, 62–3 customs, 262–4 domestic, 254–7 DSU, 319–22 economic, 282–5 institutional, 91, 120 market, 132n2, 184, 260, 286, 344 policy, 98, 99, 139–70, 185–7, 288n13 political process of, 259–60 regulatory, 67 structural, 92, 95–7 trade policy, 92 regional trade agreements (RTAs), 2, 96–7, 172n1, 176–90 economics, 177–80 growth of, 180–3 impact of WTO accession on, 126–8 negotiation of, 96 policy reform and, 185–6 rules of origin, 189n16 regionalism, 87, 176, 177, 178–80 regulations environmental, 51–5 health, 51–5 international, for FDI, 37–68 labor standards, 45–51, 55 multilateral, 38 safety, 51–5 regulatory burden, 157 regulatory quality, 158, 164–5 Report of the Working Party, 13 retaliation, 321 Ricardo, David, 77

Index 357 risk commercial, 57–60, 67 political, 56–60, 67 Romania, 92, 122, 181, 183 Rose, Andrew K., 2, 218–19, 220, 250 RTAs, see regional trade agreements (RTAs) rule of law, 157, 164–5 rules on accession, 14–17 of origin, 341 Russia, 270 safeguard protection, 221 safety regulations, compensation of foreign investors for, 51–5 Samsung, 43 Sanitary and Phytosanitary (SPS) Measures, 120, 121, 151, 262–3 Saudi Arabia, 173n8 Schreiber, Servan, 84 Section, 301 case, 299, 324 sectors, 198, 203 selection bias, 204–5, 220 self-appointment, 94 services trade policies, 31–2 Shrimp case, 299, 300, 301, 323 side commitments, 141 Singapore, 180 Singer Sewing Machine, 84 Slovakia, 92, 96–7 Slovenia, 92 South Asian Association for Regional Co-operation (SAARC), 179 South East Asia, electronics industry in, 41, 43–4 South Korea, 42–4, 74, 79, 85, 179–80 exports of, 87–8 import substitution and, 81 sovereignty, loss of, 272 Soviet Union, 73, 188n8, 225 special and differential treatment (SDT) provision, 24, 94, 320 spillovers, 41–2 structural impediments, 82 subsidies, 184, 341 Taipei, 13 Taiwan, 21, 43–4, 85 import substitution and, 81 regionalism, 180

take-or-pay contracts, 59 Tanzania, 266 tariff bindings, 19, 26 tariff jumping FDI, 40 tariff revenues, 111–18, 268, 272 tariffs, 19, 23, 26, 94 accession and, 96 agricultural, 27–30, 34n4, 34n9, 101, 103 applied, 102 bound, 101, 102, 253 decline in, 16, 17 on exports, 20 MFN, 27 nonagricultural, 27–30 optimal, 98, 274 reductions in, 27, 79 revenues, impact on customs, 111–18 use of, 18 technical assistance, 336 technical barriers to trade (TBT), 120, 262 technological change, 22 technology transfer, 41 terms of trade, 210–12 textile quotas, 15–16, 25 textiles, 198, 341 Textiles case, 299, 300, 323 Thailand, 188n13, 189n21, 279 dispute resolution and, 310 import substitution and, 81–2 Tiananmen massacre, 186 TLC Company, 82 Tobit estimation, 234, 241 Tokyo Round, 177 trade extensive margin of, 217–45 knowledge of, 83–4 merchandise, 27, 30 rules governing, 72 services, 31–2 terms of, 210–12 Trade Act (1974), 146 trade agreements, enforcement of labor standards via, 45–51, 66 trade barriers, 26, 221, 262 trade disputes, 7 trade diversification, 75 trade diversion, 173n5 trade expansion, 21

358

Index

trade flows bilateral, 205–7 impact of WTO membership on, 2, 8, 195–215, 217–45 stability of, 257 trade leaders, 73–8 trade liberalization, 27–32, 34, 87–8, 254 accession and, 198 in Asia-Pacific region, 180 autonomous or multilateral, 95–7 in China, 273–4 experience of, 337–8 resistance to, 256 in transition countries, 95–7 WTO membership and, 218–19 Trade Negotiations Committee (TNC), 342–3 trade policy, 207–10, 219–20 Trade Policy Review Mechanism (TPRM), 122 trade reform, 16, 25–6, 31–2 Trade-Related Aspects of Intellectual Property Rights (TRIPS), 18, 22, 97, 122, 125, 264–6, 298, 334, 336, 341, 343 Trade-Related Investment Measures (TRIMs), 44, 97, 122, 125, 135n45, 341 trading relationships, 226–32 transition countries, see countries in transition (CITs) transition periods, 95 transparency, 1, 99, 104, 257 TRIMs, see Trade-Related Investment Measures (TRIMs) TRIPS, see Trade-Related Aspects of Intellectual Property Rights (TRIPS) Tunisia, 181 Turkey, 82, 181 Uganda, 83 unemployment, 124 United Nations Center for International Trade Law (UNCITRAL), 52 United Nations Conference on Trade and Development (UNCTAD), 120 United States FTA negotiations by, 74, 143–6, 151

FTA partners, 167, 170 regionalism and, 179 trade share of, 73–4 WTO leadership by, 72–80, 85–8 United States International Trade Commission (USITC), 146 universalism, 80 Uruguay Round, 34n4, 80, 177, 333–4, 338 Uruguay Round Agreement on Textiles and Clothing, 15 Uruguay Round Agreements, 97 US Foreign Corrupt Practices Act, 61 U.S. multinationals, 76 US Private Investment Corporation (OPIC), 55 U.S.-Chile Free-Trade Agreement (CAFTA), 54 U.S.-China bilateral negotiations, 272–3 Value Added Taxes (VAT), 19, 21 Vienna Convention on the Law of Treaties (VCLT), 300 Vietnam, 13, 15, 21 voice, 157, 164–5 Washington Consensus, 288n11, 337 Western Europe, 178 Wilkinson, Ian, 73 work councils, 46 Working Party, 13 World Bank, 255 World Bank projects, costs of, 121 World Integrated Trade Solutions (WITS), 27 World Trade Organization (WTO) accession procedures, 13–34 agenda, 258–9 attractions of, 1 criticism of, 2, 249–50, 285 disciplines, 258–9, 335 dispute settlement mechanism, 99, 257–8, 288n16, 295–330 empirical assessments of, 6–7 expansion of, 91 leadership of, 73–8 problems with, 1–2 rationale for, 210–12 reasons for joining, 97–100 rules, 258–9, 335

Index 359 World Trade Organization (WTO) – continued terms and conditions of accession, 4 U.S. leadership of, 72–80, 85–8 WTO accession, see accession WTO Agreements, 258–9 costs of implementing, 262–9, 333–47 criticism of, 5–6, 288n23 effects of, 4–5 as instruments of international cooperation, 6 limitations on, 100–4 WTO membership benefits of, 183–4, 217, 251–60 for China, 184, 250–1, 272–87 cost-benefit analysis of, 249–90 costs of, 260–72, 286 disappointment with, 183–5, 285–6 econometric analysis, 232–41 effects on policymaking, 4–5, 100–30

effects on trade flows, 2, 8, 195–215, 217–45 at extensive margin, 227–32 governance and, 104–11, 254–7 impact on trade flows, 2, 8 increase in, 249 overestimated benefits of, 252–60 regional trade agreements and, 176–90 trade effects of, 195–215, 217–45 trade liberalization and, 218–19 trade policy and, 207–10 underestimated costs of, 260–72 WTO rules on accession, 14–17 implementation requirements of, 2 WTO-Minus commitments, 17 WTO-Plus commitments, 17, 180, 261 Yugoslavia, 103