RIETI Special Seminar

WTO 2020: 21st Century Trade Governance (Summary)

Speaker Richard E. BALDWIN
Professor of International Economics, The Graduate Institute, Geneva
Commentator ISHIGE Hiroyuki
Consulting Fellow, RIETI / Former Vice-Minister for International Affairs, Ministry of Economy, Trade and Industry (METI)
Commentator MIZUNO Masayoshi
Director, International Economic Affairs Division, International Affairs Department, Minister's Secretariat, Ministry of Agriculture, Forestry and Fisheries (MAFF)
Moderator WAKASUGI Ryuhei
Professor, Kyoto University / Research Counselor, RIETI


Richard Baldwin

Regionalism is an important topic. The nature of regionalism has changed but economists' way of thinking about it has not. With my comments today, I would like to change the way you think about regionalism and what it means for the WTO. This requires me to convince you of three things. First there is something called 21st century trade, second that 21st century trade requires deeper disciplines than 20th century trade, and three that "21st century regionalism" has emerged to fill the governance gap between 21st century trade and 20th century trade governance now provided by the WTO.

To put 21st century regionalism into perspective, let us place it on the broad canvas of globalization. In the pre-industrial revolution era, simple consumption, simple production, and poor transportation meant that consumption and production had to be spatially bundled. Almost everything consumed in the village was made in the village.

The emergence of steam power, railroads and steamships weakened the "transportation glue" that spatially bundled together production and consumption. This sparked what I call globalization's first unbundling—i.e. the spatial separation of production and consumption and the rise of long distance trade. This was the beginning of 20th century trade where international commerce primarily meant goods crossing borders, and trade liberalization primarily meant cutting tariffs based on fairly simple disciplines.

However, the spatial unbundling for production and consumption at the international level was accompanied by a clustering of production at the nation and sub-national level. This first unbundling led to the clustering of production within factories. The reason was that the combination of scale economies and complexity of the production process created a sort of "coordination glue" that resulted in the bundling of such activities inside the same factory. Inside the factory, was a constant flow of goods, people, ideas, training, and services among the various production bays.

But this changed sometime around the 1990. Just as steam power caused globalization's first unbundling, the information and communications technology (ICT) revolution caused globalization's second unbundling. By making it possible to put the production bay of a factory in another country without stopping the two-way flow of goods, people, and ideas, the coordination glue weakened and the factories themselves unbundled. Some of the flows that previously took place within a factory now became part of international commerce. As this sort of exchange was radically more complex than putting goods on boats, international commerce itself became more complex—production still required the continuous two-way flows goods, people, ideas, training, and services among the various production bays, but now the bays were in different nations.

Here, it is important to distinguish between transportation glue and coordination glue, as they have very different effects in their economic outcomes. What we have been seeing over the past 15 years has been a weakening of the coordination glue, without much change in the transportation glue.

I believe that the second unbundling took place between 1985 and 1995, although this needs to be tested empirically. For instance, the log number of Internet hosts surged in 1985 and the number of telephone subscribers had an inflection point around 1995. These are the two events that I'm using to date the second unbundling. ICT was to the second unbundling what steam power was to the first.

As an implication of the second unbundling, outward-processing trade experienced an inflection point around the mid-1980s and again accelerated in 1995. Similarly, the number of Japanese auto and electrical machinery plants in East Asia increased once in 1985 and again in 1995. An international input/output matrix from JETRO shows Japan as a major supplier of parts to other Asian countries in 1985, but becomes much denser by 2000 as an indication of the complex movement of not only goods, but also of people, ideas, and capital.

What all of this means is that 21st century trade is more complex. While 20th century trade was characterized by goods made in one nation being sold in another nation, 21st century trade is characterized by multi-directional and mostly regional flows of people, goods, services, capital, and information. Therefore, the difference between 20th century and 21st century trade is not mostly about trade costs, but rather about coordinating production internationally.

The second point of my argument is that a governance gap emerged as a result of the emergence of 21st century trade. Trade in the 21st century needs deeper disciplines, and policy makers have in fact reacted to the growing complexity of trade as early as in 1986. The European Union launched its single market program to underpin the complex flow of goods, people, capital, and services; the US and Canada launched the US-Canada Free Trade Agreement, which included services and investment for the first time of an FTA outside of Europe; and the Uruguay Round was launched to address the Trade Related Aspects of Intellectual Property Rights (TRIPs), Trade Related Investment Measures (TRIMs), and other 21st century issues. So already in 1986 there was a realization—especially among advanced countries—that deeper disciplines were needed to underpin the growing complexity of world trade.

The ICT revolution, in my view, accelerated North-South unbundling. However, while North-North unbundling was underpinned by good governance structures and domestic business laws, North-South engagement was based on legal structures that were systematically less strong. Therefore, there was a need for new North-South disciplines, but because the WTO was otherwise occupied, a governance gap emerged.

The third point of my argument is about 21st century regionalism. I think of 21st century regionalism in terms of three events: the explosion of bilateral investment treaties in the 1990s, the establishment of North-South deep regional trade agreements (RTAs), and unilateral tariff liberalization by emerging economies.

The explosion of bilateral investment treaties occurred between 1985 and 1995, which is in line with my timing of the second unbundling.

The establishment of North-South deep RTAs began with the signing of NAFTA-like agreements by the US in 1994, followed by the signing of association agreements by EU after 1994, and the signing of economic partnership agreements (EPAs) by Japan after 2007.

Unilateral tariff liberalization by developing countries took place between 1985 and 1992, in response to the change in the nature of trade and the unwinding of the import substitution policy. Unilateral pro-business reforms were also adopted to promote exports and attract offshore facilities.

To summarise, while 20th century regionalism was mostly about tariff preferences, 21st century regionalism is much less so. Tariff preferences certainly still matter a lot for shallow RTAs and a little for deep RTAs. However, through detailed calculations of tariff preferences conducted by Theresa Carpenter and Andy Lendle, two of my former students, using detailed tariff-line import data and detailed tariff data, it was basically found that 50% of world trade takes place over an RTA, but only 16% of this trade is eligible for preferences due to zero MFN, and less than 2% of the imports have preferences over 10%. This clearly shows that RTAs are not only about preferential tariffs.

To reiterate my three points: there is something called 21st century trade. It requires deeper disciplines, but because the WTO was otherwise occupied, a governance gap emerged, and 21st century regionalism has organically emerged to fill that gap.

Next, we need to consider how to think about this new type of regionalism, and what it means for the WTO. Let us examine some conceptual frameworks.

The traditional view is that RTAs are about tariff preferences. In contrast, 21st century regionalism sees RTAs as disciplines necessary to underpin the second unbundling. Is this a distinction without a difference? To answer that, I wish to point out why we care about regionalism. There are three main reasons: because we care about inefficiency resulting from discrimination; because of the injustice and power asymmetries that regionalism can create; and because of its threat to support for the multilateral trading system.

The traditional view sees preferential trade agreements from a tax-economics perspective as represented by the following three elements: Adam Smith's certitude that the country that gets the preference wins; Gottfried Haberler's spillover, which points out that third nations lose; and Jacob Viner's ambiguity that the preference-giver may or may not win. These elements govern economic and political economy analyses and I suspect govern the way most people think about regionalism.

The received wisdom we have now was largely established by Paul Krugman, Jagdish Bhagwati, and to a lesser extent by Larry Summers in the early 1990s. Krugman posed the question "Is bilateralism bad?" and concluded that RTAs are solely about tariff preferences. Bhagwati published a book called Termites in the Trading System: How Preferential Agreements Undermine Free Trade in which he discusses RTAs as though they were equal to tariff preferences. Summers was more broad-minded, and said that all "isms" are good, referring to unilateralism, multilateralism, regionalism, and so on.

However, if we accept the argument that 21st century regionalism is about underpinning complex trade, it is safe to assume that we are talking about regulation economics and not tax economics. This also means that Vinerian economics is moot or insufficient. I would also point out that regulation economics is far more complex than tax economics. Many of the barriers that are liberalized by 21st century regionalism are frictional barriers, or what I call behind-the-border barriers. They have to do with entry restrictions and nothing to do with the border. Regulatory changes made in the context of a bilateral agreement benefit not only the two relevant countries, but everybody else as well, because they do not come with rules of origin. Similarly, a look at the econometric estimates of trade effects of regional trade agreements almost always shows external trade creation. These results make no sense in Vinerian economics, but make perfect sense if RTAs are about deregulating and making economies more pro-business.

Another issue regarding regulation economics is whether it should be in the WTO or not. If RTAs are only about tariffs, there is strong logic for centralization at the global level. If the RTAs are about regulation, then there is mixed logic for centralization. In economics, this is called "fiscal federalism." As policies and issues addressed in RTAs are not necessarily best dealt with in the WTO, we need to think hard about what should be in the WTO.

So, should we think differently about regionalism and multilateralism? I would argue, "Yes, very differently," because firstly, a different political economy drives them. While the basic nature of the bargain in traditional RTAs is the exchange of market access, in 21st century RTAs, it is an exchange between northern factories and southern reform, to put it bluntly. The implication is that only the EU, U.S. and Japan can engage in RTAs at the moment, but since the WTO has no factories on offer and is not in the same business as RTAs, RTAs are not a large threat to the WTO. Secondly, RTA tariff cuts are multilateralizable, whereas behind-the-border disciplines may not be, and thirdly, the unilateral tariff cutting that has come as a result of this has made it much more difficult to finish WTO deals, because all possible cuts have been made, and there is nothing left to negotiate.

In summary, let me reiterate that in the first unbundling, GATTs and RTAs were mainly about tariffs; in the second unbundling, 21st century regionalism is mainly about behind-the-border barriers. The politics is factories for reform, not exchange of market access. Therefore, the key questions we have to answer are: "Are the US, EU, and Japanese disciplines multilateralizable, or are we creating three separate international disciplines on next-generation issues?" and "Can and should some of these disciplines be brought under the WTO?"

I will finish by presenting a couple of speculative future scenarios for the WTO. Plan A is to complete Doha this year, restore WTO centricity, and move on to dealing with next-generation issues in the WTO rather than only in the RTAs. Plan B is to allow WTO centricity to erode and promote RTAs and bilateral investment treaties (BITs) as the underpinnings of 21st century regionalism. The latter, however, could mean a slide back towards a 19th century "Great Powers" world where world trade rules are defined by the U.S., EU, and Japan, but exclude Brazil, India, China, and other new trade giants.


ISHIGE Hiroyuki

I have two main points. The first is about tariffs. Professor Baldwin has mentioned that regionalism is no longer about tariffs, but when we take a look at what is occurring in our immediate reality, I am slightly inclined to think differently. For example, we are currently seeking an FTA or EPA with the EU to lower the high tariffs on TVs and automobiles. Korea is also negotiating with China in regard to China's high tariff on automobiles. A reduction of these tariffs would bring a significant difference even in the second unbundling, so I must say that tariffs are still largely important in today's trade.

My second point is about disciplines in the 21st century. Professor Baldwin seems to be posing the issue of whether disciplines should be set by the WTO or RTAs, but I think the issue rather lies in understanding what disciplines are needed and considering the most effective way of applying them.

A basic consensus exists in regard to disciplines that are needed, but I think there are three possible methods for applying those disciplines. One is to take a plurilateral approach. This means including emerging countries into agreements and treaties that have been initiated by developed countries. The TPP is a type of plurilateral approach, and I see TPP members as essentially aiming to create new disciplines for governance in 21st century trade. If Japan is to survive on trade investment, I do not think it has the option of not participating in the discipline creation process.

The second is to take a sectoral approach. This approach has been taken many times under the WTO, and has produced significant results in negotiations after the Uruguay Round and in establishing the Information Technology Agreement (ITA). Today, some modifications have been made, and a new type of approach called the clustering approach is emerging in the trade sectors amid the services negotiations in the Doha Round.

The third is the multilateralization of deep RTAs, as Professor Baldwin has mentioned. Whether a foundation for multilateral disciplines exists in Japan, I am not sure, and wish to hear his views.

Lastly, I would like to say a word about the Doha Round. Unless the Doha Round is concluded, the WTO cannot begin to create disciplines for 21st century trade. Therefore, the WTO needs to finish Doha, regain public confidence, and move forward. Professor Baldwin has said earlier that he is optimistic about the completion of the Doha Round. I wish to hear more about the reasons for his optimism.

MIZUNO Masayoshi

As a government official in charge of agriculture, I wish to firstly point out that agricultural trade is different from what Professor Baldwin has mainly presented. I do not disagree with him that in the trade area consumption and production have been unbundled, but unlike other trade areas, the unbundling of production and consumption is a particularly large concern in the agricultural area, because consumers tend to prefer locally produced products from the perspectives of food safety, environment, and health. Another point I need to mention is that the role of the WTO is still valid in the agricultural sector, because tariffs on agricultural products are still high.

That said, I would like to present some interesting negotiations and developments in the agricultural sector.

In the area of market access, negotiations are being held to reduce the high tariffs on agricultural products and sensitive products. However, differential treatment is applied to many developing countries. Not only is the level of their tariff cut much more modest, but many products will be exempt from that tariff cut level, and 5% of all agricultural products will be exempt from any reduction at all. This means that even after the end of the Doha Round, many developing countries will still have a significant level of tariff protection.

Another recent phenomenon is the emergence of export restrictions by many countries, particularly since 2008, when biofuels created a shortage in food supplies. This trend is expected to continue and bring another peak in the prices of agricultural products in 2011, but some countries are now addressing this uncertainty of food trade by unilaterally reducing tariffs on foods. We need to pay close attention to this trend in agricultural negotiations, and note that while tariff reduction is important, we also need to establish some form of mechanism where we can share information on future tariff and export measures. In this sense, I agree with Professor Baldwin, that not only tariff reduction, but policy coordination is also important in agricultural trade.


Mr. Ishige raised two major points. One point is that preferences still matter, and I actually said that they matter a lot for small agreements and a little for big agreements. I also believe that the domino effect, or what I call the domino theory, still matters a lot, too. There is no doubt, especially to big markets such as China, the U.S., and EU, that a 5% preference into the EU market is worth gold. Much of the opening is actually general pro-business reforms that are instituted in the context of a bilateral agreement but are actually easier for everybody. So, I fully agree with Mr. Ishige's view.

The second point was about what to put into the WTO. In Geneva, they are called next-generation issues. It is unclear what these issues are, but one that is probably on almost everybody's list is investment. There are more than 2,500 bilateral investment treaties, but since they are not that different from each other, I think there is some opportunity for multilateralizing some of the disciplines that are in BITs and perhaps changing the focal point of adjudication. Infrastructure services might be another thing that could go into the WTO.

TPP and rulemaking, also mentioned by Mr. Ishige, are examples of what I was previously discussing, that if it doesn't happen in the WTO, it will happen somewhere else. Therefore, I agree with him that if the TPP continues to move forward, it would be very difficult and shortsighted for Japan not to be part of it.

Mr. Ishige also made some comments on how we can move forward. My view in this respect is that the WTO has gotten itself into an "impossible triangle" composed of universal rules, consensus decision-making, and hard enforcement, under which it can take as many as ten years for all members to reach an agreement. However, there are three ways to weaken this triangle. One is plurilaterals, which means there is one agreement, but not for everybody. The second is sectorals, which applies to a certain group in certain sectors only. The third is to remove hard adjudication.

As to why I am optimistic on the Doha Round, one reason is because more than a dozen WTO ambassadors whom I have talked with are optimistic. They say that the tone of the negotiations has completely changed with the engagement of the U.S. With the new Republican majority in the House, it is time for Plan B. Plan B includes Doha, in my opinion, because President Obama is a multilateralist and wishes to bring the U.S. back into multilateral engagement; he believes that Doha could create jobs; and presenting a reasonable Doha package would be an excellent way to divide the Republicans before the presidential nomination races begin. Another reason is because I believe President Obama wishes to be bipartisan, and the Doha issue would garner support from both Democrats and Republicans. This is why I am optimistic.

Next, I wish to reply to Mr. Mizuno's comment. Certainly agricultural trade is different from the trade I am talking about. There is a set of 21st century issues in agricultural trade that could or perhaps should be brought into the WTO, but I have never been worried about agricultural protection because it is impossible or at least seems impossible. When aging farmers in rich countries eventually retire and food becomes scarce, we would not be talking about import protection, rather we would be thanking the EU for subsidizing production.

But countering that, the newly emerging countries are encountering the same social tensions that led to protection in Japan, the U.S., and EU. Protectionist agriculture has helped maintain social cohesion in the face of rapid growth, and according to Kym Anderson of the University of Adelaide, there are new protectionist tendencies coming. Therefore, I mostly agree with Mr. Mizuno.

Question and Answer

Q: What kind of discussions are taking place in Geneva in deciding what should go into the WTO and what should not, and what are your views on this issue?

One of the perspectives of 21st century regionalism is that regionalism is doing things that the WTO is not. Therefore, there is nothing wrong with having something like TPP discuss supply-chain issues while the WTO deals with issues that should be dealt with at a global level. In economics, this is called "fiscal federalism."

There are various tradeoffs that decide which issues should be set at the international, national, provincial, or local level. In the case of tariffs, it is clear that it should be set by the WTO, but for more complex forms of international commerce, it is unclear whether there is not a role for something such as the TPP. So, how to square it? I think some things should go into the WTO, and some things should not. I see no conflict between the WTO and bilaterals.

There are a couple of scenarios on how the WTO could survive. One is to consider the EU pillar system, which was established to deal with issues that had expanded as its membership enlarged. The first pillar is economic integration for the single market. It adopts majority voting to make decisions, and is supranational. The second and third pillars deal with defense and judicial affairs, respectively, and decisions are intergovernmental. Essentially, the EU has found that it needs sectorals and plurilaterals in dealing with complex issues.

Unless the WTO modifies at least one of the corners of its "impossible triangle," nothing will move forward, or something may move forward but only after taking too long. Decision-making in the WTO needs to be made easier, such as by introducing sectorals, plurilaterals, or court authority.

Q: What future differences do you see in different environments, especially in terms of financial uncertainties in world trade? Also, what do you think about China's role in bilateralism and its role in the 21st century?

The North Atlantic banking crisis was triggered by the subprime and banks that had globalized their funding sources and mismanaged them. It was a financial crisis for the U.S. and Europe, but it had nothing to do with finance for the rest of the world. Rather, the uncertainty that led to the postponement especially of durable goods consumption was what brought about the world's largest trade collapse ever. However, the trade collapse is now over, and we are seeing a two-speed recovery. I do not see this as having a primary effect on the world trading system.

In response to your second question, supply chains are highly resistant to shock, so we can expect to see continued acceleration of the internationalization of production, particularly in Brazil, India, and China. There is no doubt that China is a leading exporter and the second and soon-to-be-largest importer in the world.

However, 21st century trade is not just about trade flows, but also about factories. Since China, India, and Brazil do not export the kinds of factories that their partners seek, they could be left outside the scope of 21st century regionalism unless the WTO gets back on track. This is one of the most worrying aspects of 21st century regionalism.

Q: FUJITA Masahisa
You highlighted the movement of trade from the 19th century to the 20th and 21st centuries, but I noticed that you did not talk about trade in the 21st century and about currency issues.

You also said the world crisis may be almost over, but I think that the basic cause of the financial crisis was related to the fact that so many American factories moved to China. Broadly speaking, the currency issue, financial issue, and the trade issue are not separate, but are becoming increasing inseparable in the 21st century. I would like to hear your opinion on this.

I think that the recycling of the imbalances and other such issues will work themselves out. However, the currency issue is really centered on one very competitive country with a particular currency policy that affects other countries, so I view it as somewhat separate from trade.

I would just like to point out that the U.S. has twice taken protectionist actions against a country that was unwilling to raise its exchange rate and running a large bilateral deficit. The first time was against Germany, when Nixon added a 10% gold surcharge, and the second time was against Japan in 1985. The U.S. Congress is very protectionist and this is a cause for concern. Even so, I do not think an elaborate intellectual framework is necessary, as we are simply talking about one exchange rate.