The Challenge of Multilateralism: A critical stage to prevent the world economy from fragmentation

KIYOTA Kozo
Faculty Fellow, RIETI

In the year XXXX, a stock market collapse on Wall Street plunges the world economy into a serious recession. The following year, the U.S. government resorts to forceful action through increasing tariff rates in order to protect domestic producers competing against imports. Other countries follow suit and raise their own tariffs, bringing about a dramatic contraction in world trade. This exacerbates the worldwide recession, which in turn leads to the division of the world economy into blocs. The tariff war among the economic blocs eventually leads to armed conflict...

This is not a fictional story about the future. It is instead the actual chain of events from the Great Depression of 1929 to the outbreak of World War II. To prevent such a tariff war from recurring, a forum for multilateral trade negotiations, known as the General Agreement on Tariffs and Trade (GATT), was established shortly after WWII. The GATT was succeeded by the World Trade Organization (WTO) in 1995. Although the WTO has contributed to promote trade liberalization, the current multilateral negotiations, the Doha Round, are at an impasse.

Commenced in 2001, the Doha Round addresses a broader range of topics than previous rounds. It covers not only the liberalization in goods and services trade but also other trade-related issues such as trade facilitation and government procurement. While marking the 10th year of the talks, however, the Doha Round reached an impasse. In the concluding statement at the Ministerial Conference in December 2011, the Chair expressed the difficulty of finding a middle ground among members in the near future.

While the multilateral trade negotiations have reached a deadlock, the number of bilateral and regional free trade agreements (FTAs) has been increasing rapidly. Why should this be? Will the stalemate in multilateral talks affect the formation of bilateral and regional FTAs? Has the WTO lost its raison d'être? This column answers these questions from the economics point of view.

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First of all, why are the WTO-based negotiations on multilateral trade liberalization important? FTAs are designed to liberalize trade, but they discriminate against non-FTA members. While trade liberalization has positive effects, the discrimination has negative effects. The net effect on a member country thus is generally ambiguous. This in turn implies that FTAs do not necessarily improve global welfare. On the other hand, non-discriminatory multilateral trade liberalization always improves global welfare because it does not have negative effects arising from the discrimination. Therefore, while recognizing the importance of FTAs, a majority of economists consider FTAs as the second-best policy and regard multilateral trade liberalization as the first-best.

Why has the Doha Round reached an impasse? There are a number of reasons, one of which is the issue of the agricultural trade liberalization and market access that have arisen between developed and developing countries. The figure shows the average tariff rates for selected countries in 2010 and indicates that in developed countries, tariffs on agricultural products are generally higher than those on non-agricultural products. In addition, agricultural products are further protected by non-tariff barriers such as subsidy. Therefore, developing countries are calling on developed countries to reduce their agricultural tariffs and subsidies. On the other hand, developed countries are calling on developing countries to improve their market access. Despite a decade of negotiations, however, they have not yet reached a middle ground. Indeed, in their 2009 article, Professors Alan Deardorff and Robert Stern of the University of Michigan in the United States pointed out that the most difficult issues to address in the Doha Round were the agricultural trade liberalization in developed countries and the improvement of market access in the developing countries.

Figure: Average tariff rates for selected countries, 2010Figure: Average tariff rates for selected countries, 2010

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Will the stalemate in multilateral talks affect the formation of bilateral and regional FTAs? The stalemate in the Doha Round is one reason why FTAs have gained so much momentum. No bright idea to break the current deadlock has been found at this moment. Although there have been calls for systemic reforming of the WTO, it is difficult to expect substantial reforms for the time being because elections for national leaders will take place in several countries in 2012. Many countries, including Japan, have no choice but to continue focusing on the formation of FTAs in the short run.

Note, however, that FTAs are the second-best policy, with the first-best being multilateral trade liberalization. Over the medium to long run, the FTAs should be a building block toward multilateral trade liberalization. From medium- to long-term perspectives, there are two proposals to generate a virtuous cycle for FTAs and multilateral trade liberalization.

First, developed countries should incorporate developing countries into their FTAs, and developing countries should do the same for developed countries. This would help mitigate conflicts between them in multilateral talks. Second, FTAs should be formed without exceptions. For example, if Country A and Country B were to conclude their own respective FTAs with Country C, it is natural to imagine that Country A and Country B would conclude FTAs as well. In reality, however, this is not always the case. One reason is that FTAs tend to have several exceptions in such issues as agriculture trade liberalization and market access. As the exemptions pile up, it becomes increasingly difficult to expand FTAs further.

As things stand now, FTAs could be either stumbling blocks or building blocks to multilateral trade liberalization. A concern may be that FTAs lead to the creation of economic blocs. If FTAs are formed without exemptions, FTAs could approximate multilateral trade liberalization. In this connection, it is important to re-examine carefully the provisions of FTAs that are already concluded and amend them to resemble multilateral trade liberalization more closely.

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Finally, has the WTO lost its raison d'être? The WTO has clearly become dysfunctional in terms of new rule making, and therefore its presence is diminishing. However, the role of the WTO is not limited to making new rules. The WTO is also responsible for monitoring full compliance with rules already in place and for handling disputes that arise between members. It has achieved a measure of legitimacy in its role in resolving international disputes.

At the Ministerial Conference in December 2011, trade ministers of the WTO members approved the memberships of Russia, Samoa, and Montenegro. If it were true that the WTO has completely lost its appeal, the increases in memberships would be unlikely. The WTO has not lost its raison d'être yet. Note, however, that the future would see some FTAs possibly ignoring the WTO rules if the present circumstances continue. This undermines the WTO's significance and may result in the disappearance of the forum for multilateral negotiations.

To avoid such an outcome, the WTO should create an environment that establishes complementarity between FTAs and multilateral trade liberalization. The WTO has not played an active role in the formation of FTAs. This is because multilateral trade liberalization, which does not discriminate among trading partners, is not compatible with the FTAs. Nonetheless, the WTO could make a guideline that allows member countries to form FTAs more actively within the WTO framework.

The impasse of the Doha Round became an issue, which implies that many people expected more from the Doha Round. To prevent the world economy from separating into blocs, multilateral talks need to get back on track in the near future.

>> Original text in Japanese

* Translated by RIETI.

January 24, 2012 Nihon Keizai Shimbun

February 15, 2012