Trade Policy: Past, Present, and Future When tariff reduction has occurred, it has been by...

International Economics

Trade Policy: Past, Present, and Future

When tariff reduction has occurred, it has been by negotiation. We will reduce our tariffs if you will reduce yours. From the economist’s point of view, it is rather like my offering to stop hitting myself on the head with a hammer if you agree to stop hitting yourself on the head with a hammer.

(David Friedman)

Chapter 8


The Goals of This Chapter

• Use historical examples to illustrate how economic, social, and political factors determine trade policies.

• Relate historical trends in trade policies to changes in economic, social, and political factors.

• Show that there is no clear historical trend towards free trade; periods of free trade have been followed by periods of restricted trade, and vice versa.

• Provide detailed information on the GATT, the World Trade Organization, and the other institutions that guide the trade policies of individual countries today.

• Encourage students to use the examples of history to help them set their expectations about how trade policy is likely to evolve in the future.


The Ups and Downs of Trade Policy

• The world has meandered through periods of increasing globalization as well as periods of increasing isolation.

• 2,000 years ago during the time of the Roman Empire, trade was free throughout the Mediterranean region.

• After the fall of the Roman Empire, Europe fragmented into separate, isolated nations characterized by feudalism.

• During the Renaissance, Europe began to open again to trade and foreign technology.

• Europe embraced free trade during the 1800s, but was quick to suppress trade during the early 20th century.

• Only in the latter half of the 20th century did Europe again expand trade and seek globalization.



• The Middle East remained open to outside influences after the fall of Roman Empire.

• More than 1,000 years ago, Middle Eastern Muslim states were noted for their trade and technological development.

• China also reached its technological apex during the Sung dynasty around the year 1000.

• Fear of outside ideas grew in the Muslim states, however, and by 1000 trade and technological progress slowed.

• China and Japan eventually closed themselves completely to foreign trade and all other contacts with foreigners.

• Japan opened its borders to trade and technology again in the mid-1800s, but China did not seriously open to trade until very recently, during the 1980s and 1990s.



• The evolving policies by European monarchs to promote and shape international trade after 1500 are now often referred to as mercantilism.

• Mercantilists saw international trade as a beneficial activity provided that it was regulated by government so that it enhanced the immediate interests of domestic merchants, manufacturers, and the Crown.

• Mercantilism was a political strategy as much as it was a trade policy, designed to strengthen central monarchs and their merchant allies in the major European countries.

• The notion that exports are “good” while imports are “bad” dates from the mercantilist era.



• During the Enlightenment, social thinkers increasingly undermined mercantilist trade policies by developing logical arguments for free trade.

• Most notably, Adam Smith reasoned that because specialization and exchange were the true source of economic growth and improved human welfare, the protection sought by the mercantilists must reduce the long-run growth of human welfare.

• Most likely, mercantilist trade policies were abandoned because they imposed high costs on the new industrialists who rose to political prominence during the Industrial Revolution.



• Free trade was strongly supported within Great Britain, the leader of the Industrial Revolution.

• Britain therefore used diplomacy to open borders to trade in Europe, such as the 1860 Cobden-Chevalier Treaty that reduced many tariffs on trade between Britain and France.

• Most bi-lateral trade agreements contained a most favored nation (MFN) clause, which effectively made all agreements multi-lateral.

• The inclusion of MFN clauses in its trade agreements resulted in France having one of the very lowest average tariff rates in the 1860s, just 3.8 percent of the value of imports.



• Unlike Europe, the United States was protectionist in the nineteenth century.

• The northern states, with its new industries, generally favored high tariffs, but the predominantly agricultural South favored free trade.

• After the Civil War, U.S. tariffs remained between 40 and 50 percent until the early 20th century.

• Woodrow Wilson, a Democrat, pushed through sharp reductions in tariffs in 1913, but this trend toward trade liberalization was short lived because World War I broke out in 1914.



• At the end of the 19th century, it was improved transport, not trade liberalization, that caused trade to expand rapidly.

• A natural coalition in France and Germany consisting of new industries and farmers gained enough political clout to reverse Europe’s trade policies in the late 1800s.

• An extended slowdown of economic growth during 1873-79 did not help the cause of free trade, and foreign imports were a convenient target for political leaders seeking ways to satisfy their disgruntled constituencies.

• Only Britain, Holland, and Denmark seemed able to resist the pressures from special interests for protection and maintain open markets.


The Tumultuous Inter-War Period

• The Treaty of Versailles, which formally ended the war in 1919, determined that Germany should compensate the Allies for their war losses.

• To make this reparations scheme work, Germany would have to run a large current account surplus with the allied countries in order to earn the pounds, francs, and lira to pay war reparations.

• The allied countries would have to run current account surpluses with the United States in order to retire their debts with U.S. lenders.

• Neither the European allies nor the U.S. would liberalize trade enough to permit the necessary trade deficits.



• The U.S. enacted the Fordney-McCumber Tariff in 1922, which doubled average tariff rates when Europe was still struggling to recover from World War I.

• When in 1929 the stock market crashed and the Federal Reserve Bank’s perversely contractionary monetary policy pushed the United States economy into a sharp recession, pressure for protection became even stronger.

• The U.S.’s Smoot-Hawley Tariff of 1930 caused a trade war that quickly engulfed much of the world.

• By 1933, world trade volume had fallen by more than 70 percent from its 1929 levels.



• The negative consequences of the Smoot-Hawley tariff of 1930 were so obvious that less than four years later the United States took the lead in proposing negotiations to reduce tariffs.

• The Reciprocal Trade Agreements Act (RTAA) was passed by the United States Congress in 1934.

• This Act recognized the difficulty of having a legislative body oversee trade policy, and it gave the president fast-track authority to negotiate trade agreements.

• The RTAA clearly signaled a change in the direction of U.S. trade policy, although the world would have to wait until after World War II to see the full results of the Act.


Trade Policy After World War II: The GATT

• In 1947, a group of the largest Western economies negotiated the General Agreement on Tariffs and Trade (GATT).

• Set the legal framework within which international trade policy was to be set and trade negotiations were to be conducted.

• The GATT was signed by 23 countries in 1947, and 13 more countries had signed on by 1951; the 36 signatories included all the major market economies.

• The GATT still serves as the framework rules for today’s World Trade Organization.



The GATT specified that, among other things:

• Countries commit to keeping their tariffs below explicit limits.

• Countries negotiate by offering reductions in their limits on tariffs to induce other countries to reduce their tariffs.

• Countries agree to give all other signatories most favored nation (MFN) treatment.

• Countries do not discriminate between foreign and domestic goods and services once they have entered the country and tariffs have been paid.

• Countries use tariffs rather than quotas or other less visible non-tariff barriers if trade must be restricted.



• The GATT was also intended to provided a framework within which countries were encouraged to participate in multilateral trade negotiations.

• However, the early GATT negotiating rounds produced only modest reductions in tariffs and other trade barriers.

• U.S. negotiators were severely restricted by the “no injury clause” in the president’s fast-track authority.

• The U.S. also pushed a textile VER on Japan in the 1950s.

• By 1960 trade negotiations seemed stalled, and the Dillon Round produced few tangible results.



• In 1962 Congress agreed to give President Kennedy authority to offer across-the-board tariff reductions in return for similar across-the-board reductions by other nations without being burdened by the “no injury” rule.

• The 1962 Act provided new ways to deal with injury, including extended unemployment compensation, tax benefits to induce industries to modernize and switch production, and subsidized retraining of workers.

• These alternative measures to help displaced workers made it politically possible for the U.S. Congress to pass fast track authority without a “no injury” clause.

• The Kennedy Round started in the early 1960s turned out to be a much more successful trade round.



• The Trade Adjustment Assistance program, established in 1962 to replace the “no injury” clause, was extended under the U.S.’s fast track authority bill, the Trade Act of 1974.

• The Tokyo Round was also quite successful in reducing tariffs.

• At the end of the 1970s, the average tariff level was little more than 20 percent of the 1930 tariff war level.

• Many difficult issues had been avoided during the many GATT rounds, however.



• The Kennedy and Tokyo Rounds dealt mainly with tariffs on manufactured goods.

• The Multi-Fiber Agreement was not covered in the negotiations and had in fact been sanctioned by the GATT.

• Also ignored were the widespread protection of agricultural products by the developed economies.

• International trade in services was restricted by a wide range of regulations and blatant protectionist measures.

• Countries also devised many new non-tariff barriers to take the place of the tariffs that were reduced or eliminated.

• In the 1980s, the key GATT members, with prodding by the Reagan administration, agreed to a new round of broader negotiations, called the Uruguay Round.



• The opening session of the Uruguay Round was held in the Uruguayan seaside resort of Punta del Este in 1985.

• Nearly 120 countries would eventually participate. • The Uruguay Round was not completed as scheduled in

December of 1990 • The negotiations stalled over trade restrictions on

agricultural products, textiles, and services such as transportation and banking.

• The negotiations were extended, and a formal agreement was finally signed in April of 1994.

• Even then some parts of the negotiations were left to be completed later.



The major accomplishments of the Uruguay round were:

• Tariffs were reduced, on average, by nearly 40 percent.• It was agreed to phase out the Multi-Fiber Agreement by

2005.• Most countries agreed to establish compatible patent and

copyright laws by 2000, 2006 for less developed countries.• The establishment of the World Trade Organization

(WTO), a permanent organization to replace the informal organization and staff that oversaw the previous GATT agreements.



There were also important failures during the Uruguay round:

• Little progress was made to eliminate barriers to trade in services.

• Transportation services also remained protected in most countries.

• There were few reductions in the protection of agricultural products by the more developed economies of Europe, Japan, and elsewhere.

• The MFA will be replaced by equivalent tariffs, which may be preferable to quotas, but trade in clothing and textiles will still be highly taxed after 2005.



• On November 14, 2001 in Doha, Qatar, the delegates for the 142 WTO members agreed to begin a new round of trade negotiations, called the Doha Round.

• There were to be negotiations to further reduce tariffs on industrial goods.

• Agricultural protection was to be a major issue.

• Intellectual property rights were again to be discussed; many developing countries wanted to revisit the issue.

• Controversial “anti-dumping laws” were to be subject to more objective rules.


Table 8.1Tariff Reductions during the GATT Rounds

% Cut in All Tariffs Average Tariff Level as % of 1931 level

Negotiations between 1934 and 1947: 66.8%

1st Round (Geneva, 1947) 21.1% 52.7%

2nd Round (Annecy, 1949) 1.9 51.7

3rd Round (Torquay, 1950-51) 3.0 50.1

4th Round (Geneva, 1955-56) 3.5 48.9

Dillon Round (Geneva, 1961-62) 2.4 47.7

Kennedy Round (Geneva, 1964-67) 36.0 30.5

Tokyo Round (Geneva, 1974-79) 29.6 21.2

Uruguay Round (Geneva, 1987-94) 38.0 13.1

Sources: Real Phillipe Lavergne (1983), The Political Economy of U.S. Tariffs: An Empirical Analysis, Ottawa: North-South Institute, pp. 32-33. Updated for Uruguay Round.


Trade Expansion without “Injury”

• If “injury” means no reduction in domestic output of any specific industry, then the no injury rule effectively limits the gains from trade to the gains from exchange without specialization.

• Illustrated is the gain from exchange while keeping output of food and clothing at the pre-trade point A.

• There are gains, but they are small compared to the full potential gains from trade.

A

Food

CPL1

p

0 100 200 300 400 500 Clothing

200

300

100

400

B

P

I1 I2 I3


Trade Expansion with “Injury”

• Letting the economy specialize by shifting production from A to P raises real income to the level of consumption possibilities frontier CPL2, and permits consumption at point C.

• Point C lies on the higher indifference curve, I3.

• Specialization causes domestic production of food to decline, causing alleged “injury.”

A

Food

CPL1p

0 100 200 300 400 500 Clothing

I1 I2 I3 I4

200

300

100

400

C

B

P

CPL2

D


Table 8.2Tariff Escalation: 1994-2000

Agricultural Products Industrial Products1st Stage Semi-proc. Fully Proc. 1st Stage Semi-proc. Fully Proc.

Less Developed Countries Average:

17.9 23.2 27.7 10.7 11.9 15.5

Industrialized Countries Average:

4.8 8.6 12.0 3.2 3.6 5.1

Source: World Bank Web site, www.worldbank.org, August 2, 2001.

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