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Between Theories of Trade and Development: The Future of the World Trading System
The Robert Hudec Public Lecture, The Society for International Economic Law
Bern, Switzerland
July, 2014
Michael Trebilcock†
Professor of Law and Economics
University of Toronto
Faculty of Law
DRAFT: Not for Quotation or Attribution; Comments Welcome
† I am heavily indebted to Avery Au for invaluable research assistance in the preparation of this paper.
Table of Contents
Introduction
Part 1: The Limits of the Multilateral Trading System
a.The Function and Underlying Rationales of the Multilateral Trading System
b.Dealing With Losers: The Political Economy of Policy Transitions
c.The Political Economy Critique of Special and Differential Treatment
d.The Uruguay Round and the Path to Doha
Part 2: Lessons from the History of Development Economics
a.Grand theory: trade pessimism and state-led development
b.Grand theory: harmonization and integration
c.The New Development Economics
Part 3: Looking Forward – New Directions for Policy Development
a.From the Single Undertaking to Plurilateral Agreements
b.The Need for Institutional Diversity
c.Nudging PTAs Towards Non-discrimination
Conclusion
Introduction
This paper explores the theoretical and institutional linkages between trade and development. It compares the underlying rationales of trade agreements with the evolution of development economics to illustrate persistent tensions between the two.
I argue that different understandings of development have resulted in incompatible conceptions of the purpose and scope of the multilateral trading system. Further, I observe that disagreements over appropriate conceptions of development pose a significantobstaclenot only to the protracted Doha Round, but rounds to come.
During the Doha Round, developed nations sought to deepen and expand the non-tariff disciplines of the Uruguay Round within the single-undertaking format adopted during the Uruguay Round. In contrast, developing countries sought to rebalance the widely perceived unfairness of the Uruguay Round’s non-tariff disciplines and position the “development agenda” at the centre of trade negotiations; indeed, Doha was officially declared the “Development Round”(as though trade policy and development policy were coterminous).However, the content of an appropriate and feasibledevelopment agendawithin a trade context was and continues to be the subject of much debate.[1] Within this debate, there are three important lines of inquiry this paper will address. The first asks: to what extent isthe development agenda fundamentally at odds with the institutional constraints of the multilateral trading regime? The second asks: which trade-related measures are effective at fostering development?Given the answers to the prior two, the third asks:what is the proper role of the World Trade Organization vis-à-vis development? Parts One to Three of this paper will address each question in turn.
I do not claim here to be presenting any novel thesis.[2] Rather, my task in this paper is to draw a narrative across the rich literature and accomplishments of many esteemed international trade scholars, including Robert Hudec, for which this keynote address is named. Indeed, many of the arguments I draw upon today were directly addressed or foreshadowed by Hudec in his classic account of the developing nation experience in the GATT.[3] The continued relevance of this work is a testament to his penetrating insights.
It is necessary at the outset to say a few words about the often ambiguous usage of the term “development.”Here I conceive of development as broadly inclusive of measures like life expectancy, literacy and well-being as captured by numerous indicators such as the UNDP Human Development Index. While it is useful and customary to employ GDP or derivative measures as proxies for development status, we must be vigilant against conflating the two. The causal links betweennarrow measures of income and diverse development indicators are hardly straightforward. [4] Similarly, drawing strong causal links between economic growth and particular trade policies is inadvisable. While there are crucial economicadvantages to trade-openness, the relationship of specific trade policies toeconomic growth is, after years of research and debate, not only ambiguous but fundamentally impossible to isolate.[5]
Despite these qualifications, our work as scholars of international economic law is todraw useful connections between development, economic growth and trade policy.While doing so, we should proceed with modesty, wary of strong claims concerning the degree or direction of specific causal linkages.Given the pervasive ambiguity in drawing linkages between these three subjects, we should be wary ofplacing on one institution the burden of fulfilling diverseororthogonal objectives.
I proceed in three parts. Part One of this paper sets out the institutional constraints of the multilateral trading system.Here I emphasize that the GATT’s core purpose is to provide aninstitutional mechanismtoconstrain domestic protectionist interests. The GATT enhances the political feasibility oftrade liberalization by incentivizing the winners from trade to provide political supportfor liberalization while mitigating the transition costs of the losers from trade.
More generally, Kaldor-Hicks efficient policy changesproduce local winners and local losers in the process of creating net global welfare gains. However, often even in cases where Kaldor-Hicks efficiency is both technically clear and ethically compelling, local losers wield sufficient political influence to block policy reform.I explore this theme in my recent book, Dealing With Losers: The Political Economy of Policy Transitions,[6]where I analyzeeight case studiesin which local losers have successfully resisted significant welfare gains. For each case study, I illustrate a rangeof viable policy options and institutionalinnovations to effectively “deal” with losers – via compensation, transition cost mitigation, or by building opposing coalitions. The GATT serves as an exemplary case-studyand the analysis of its time-tested institutional mechanisms serves as one chapter in my book. However, in my book, I did not have the opportunity to deal with the special case of developing nations within the GATT system. Doing so here, I assesshow developing nations have (and have not) employed the GATT system to constrain protectionism at home and achieve market access abroad.
The overarching narrative is in four phases: first at the GATT’s inception, developing country concerns were essentially ignored. Second, over the next fifty years different kinds of Special and Differential Treatment (SDT) were gradually incorporated into the GATT driven by rationales of exceptionalism and preferential treatment.Third, during the Uruguay Round developing nations weakenedtheir commitment to SDT substantially by endorsing reciprocity and agreeing to a “grand bargain” (the single undertaking). Fourth, the current Doha Round has witnessed a revival of developing countries’ commitment to SDT.
Over the last fifty years the trade regime has both underestimated and overestimated its ability to positively contribute to development. On the one hand, SDT has largely proven “a device not for favouring developing countries, but for excluding them” from the benefits of trade liberalization.[7]On the other hand, in the view of many economists, Uruguay’s grand bargain turned out to be both unfair to developing nations and misaligned with core GATT principles. Rather, than an incremental, reciprocal exchange of market accesscommitments,Uruguay disciplines advanced a dogmatic regulatory harmonization agenda that imposed large costs on developing nations,unduly restricting their development policy space, and granting them little market access in return. To discern the elements of a moreappropriate middle-grounddevelopment agenda in the multilateral trade regime, we must turn to the insights of development economics.
Part Two provides a brief history of development economics as a discipline from the 1940s to present day: its principal movements and their policy consequences. The overarching narrative is in three parts. First, I review grand theories of early development economists: big push, import substitution, and modernization. Second, I discuss the rise and fall of the Washington Consensus or neoliberalism – another grand theory. Finally, having swungbetween diametrically opposed accounts, I turn to the emergence of the New Development Economics (NDE)[8] that charts a path between the more egregious excesses of past movements while drawing upon their most important insights.Rejectingreductionistgrand theories and one-size-fits-all policy recommendations, NDEadopts stronger micro-economic foundationswith a focus oninformation economics, institutional analysis, and empirical research. With respect to development policy, it acknowledges the modest state of development knowledge emphasizing the need for experimentation.Generally, it recommends empirical diagnostics followed by highly tailored country-specific solutions, usually in the form of targeted and limitedpolicies that aim toshift incentives, enhance information,andcreate sustained institutionalchange.
Taken together, Parts One and Two show that the one-size-fits-all approach to trade disciplines, especially those extending deeply into domestic regulations,is fundamentally incompatiblewith aneconomically sound development agenda.However, as the history of SDT demonstrates, a policy of exceptionalism with respect to the trade regime will fail developing nations in two ways: it will deny them market accessgains that can be achieved via the reciprocity mechanism as well as the benefit of placing effective constraints on domestic protectionism.
Clearly, there must exista middle-ground where adequate policy space for development andwealth-enhancing trade disciplines can both be achieved. The devil is of course in the details,the crucial “detail” being the trade and development interface. The term “interface” is employed here to recognize that the objectives of the trade regime and those of development policy are distinct and best pursued via different institutional mechanisms, but, nevertheless, the means to both ends are connected in significant ways. The principal interface issue is the need to distinguish betweenharmful protectionism and legitimate development policy diversity.Designing and maintaining an appropriate institutional interface is a complex and multifaceted problem; indeed, it is one of the major challenges for current and future generations of tradeand development scholars.
In Part Three, I advance three proposals which I believe are sound steps in the right direction toward achieving an appropriate interface between trade and development objectives. First, I recommend leaving behind the single-undertaking format and moving to a larger role for plurilateral agreements; second, I recommend institutional diversity in designing and implementing the trade- development interface; and third I assess two ways to place multilateral disciplines on PTA proliferation.
None of my proposals is a quick fix; none is without political risk or without its fair share of ambiguities – such is the nature of our craft. However, these recommendations all draw upon a substantial body of literature analyzing the connections between development and international trade. My goal here is to draw a narrative through the evolution of our field and the great accomplishments of our predecessors, but furtherto sketch a narrative with a clear direction for both future research and policy development.
Part 1: The Limits of the Multilateral Trading System
a.The Function and UnderlyingRationales of the Multilateral Trading System
The theoretical case for unilateral trade liberalization relies on several unrealistic assumptions, four of which are especially important:
1)Every country is a small and unable to influence world prices
2)There is costless re-allocation of the factors of production
3)There is minimal political opposition to the distributive consequences of the gains from trade.
4)Trade liberalization does not significantly interfere with or undermine economic development objectives
As these assumptions are relaxed, the case for liberalization becomes substantially more complex. Indeed, explaining the existence and continuity of the GATT has been a challenge for economic and political theorists alike. There are three major approaches to explaining the structure and function of the GATT:[9]
1)Terms of trade theory: the maximization of national income (including the exercise of market power to do so)
2)Political economy theories of reciprocity and commitment: defeating or resisting domestic protectionist interests
3)Foreign policy objectives such as world peace and facilitating global public goods
These explanatory strategies may be understood as complements rather than substitutes. However, the political economy theory of reciprocity provides the most practical insight into the form and function of trade agreements. That is to say, the core function of the multilateral trade system –what distinguishes it most from other international institutions – is to facilitate the reciprocal exchange of commitments to reduce impediments to trade.
Acknowledging the central function of reciprocity is not, of course, to down-play theimportance of complementary terms of trade and foreign policy rationales in the design of trade agreements. As is well known, the overarching rationale for the formation of the GATT was one of foreign policy: to better secure the conditions for world peace.[10] Still today, there are crucial benefits to multilateral trade negotiations that are not strictly economic: namely, mitigating large bargaining-power differentials via Most Favoured Nation treatment, facilitating regulatory transparency and promoting rule of law in international relations.[11] Likewise, terms of trade theory provides an elegant explanation for how the principles of non-discrimination and reciprocity allow largecountries to break free from an inefficient prisoner’s dilemma.[12]
Nonetheless, the political economy approach provides the fundamental explanation for the function of the GATT in reducing barriers to trade. In economic theory, trade restrictions result in income transfers to a concentrated minority at the expense of a diffuse majority. As such,liberalization is, naturally, resisted by protectionist interests at the expense of the general welfare. Reciprocal trade agreements incentivize domestic export interests, via access to foreign markets, to oppose domestic protectionist interests.While the quid pro quo trading of concessions is based on an inherently flawed mercantilist conception of the gains from trade, it possesses a solid grounding in political economy – often reflecting the positions of politicians and trade negotiators.
Therefore, the GATT may be understood as possessing a coherent and distinct function among international institutions: to enable and sustain a marketplace for exchangingconcessions.[13] Indeed, three central features of the GATT – transparency, accountability, and incrementalism - may be usefully understood as setting out the necessary conditions for the success of a reciprocity-based marketplace.
Transparency of trade policy measuresis required forreciprocal exchange since actors in the marketplace must be able to understand the content of their bargain. By effectively eliminating quotas and greatly narrowing the scope of restrictive trade measures, the GATT enhanced thetransparency of negotiations and achieved great success in facilitating progressive tariff reductions – in the case of industrial products, down from close to fifty percent on average in 1947 to little more than three percent on average today.
Accountability is an essential feature of the reciprocal exchange of concessions since, for a concession to be credible, it must be supported with enforcement. The Dispute Settlement Bodyhas performed this task admirably, justifying its moniker as the “crown-jewel” of the trading system.
Incrementalismgreatly facilitates reciprocal exchange since it effectively limits the size of transactions to small changes that are better understood by parties. Further, small changes entail smaller transition costs, increasing the likelihood of a bargain. Hence incrementalism keeps both the scope and size of the“negotiating set”limited.[14]To further enhance the principle of incrementalism, transition costs aremitigated via the gradual phase-in of tariff reductions and by allowing for the temporary implementation of restrictive measuresto protect against unexpected economic shocks via safeguard mechanisms.
So far I have left unaddressed the cornerstone of the multilateral trading system – the principle of non-discrimination as expressed in the most-favored nation principle:the obligation of similar treatment of all like products from all member nations. Prima facie, the MFN principle undermines the reciprocity mechanism by allowing third party nations to “free-ride” on the quid pro quoconcessions negotiated by twocontracting parties. Looking to the history of trade agreementsas well as the contemporaryexplosion of PTAs, trade agreements animated by the reciprocal exchange of concessions certainly do not require the MFN principle to perform their political economy function. However, MFN is crucial in enabling a particular kind of trading system: themultilateral trading regime. In particular, MFN provides a solution to the prisoner’s dilemma of trade restrictions as between large nations and promotes better international relations byreducing the possibility of destructive disputes over discriminatory practices.Schwartz and Sykes note that:[15]
The possibility of [discriminatory] threats, followed by counter threats, retaliation, and so on, might make for an uncertain and unstable trading regime that would unravel and threaten the political gains from reciprocal trade negotiations. With the MFN obligation in place, by contrast, nations are disabled from making threats to discriminate.
Hence, there are good reasons to believe, as did the founders of GATT, that the multilateral system provides a crucial public good–an ethos of global economic co-operation - that PTAs are fundamentally unable to provide.[16]
There is one further important benefit conferred by MFN. From the standpoint of neoclassical economic theory, as the global market is expanded and trade barriers are reduced, there are more gains to be had via comparative advantage, competition,and returns to scale. The benefits of a larger marketplace to enhance global welfare are significant.
b.Dealing With Losers: The Political Economy of Policy Transitions
In my book, Dealing with Losers I examine a set of case studies where economically and ethically sound policy changes have been successfully blocked by a variety of domestic political interests - that is, the losers from Kaldor-Hicks efficient policy reforms.My book is directed topoliticians and concerned citizens so thatthey may understand the political economy problems underlying these issuesand potential policy solutionsto them. For each case, I provide a range of strategies for dealing with losers falling into three broad categories: compensation (e.g. lump sum, annuities, and subsidies); transition mitigation (e.g. gradual phase-ins, postponed implementation, provision of contingent protections, grandfathering,retraining programs) and the formation of opposing coalitions (e.g. connecting advocacy groups, ideational appeals to the greater good).