Perspectives from Around the World

21st Century Trade and the 21st Century WTO

Professor of International Economics, Graduate Institute, Geneva, CEPR Policy Director, and Editor-in-Chief


The WTO is doing fine when it comes to the 20th century trade it was designed for--goods made in one nation's factories being sold to customers abroad. The WTO's woes stem from the emergence of "21st century trade" (the complex cross-border flows arising from internationalised supply chains) and its demand for beyond-WTO disciplines. The WTO's centrality was undermined as such disciplines emerged in regional trade agreements. The future will either see multi-pillar global trade governance with the WTO as the pillar for 20th century trade, or a WTO that engages creatively and constructively with 21st century trade issues.

1. Introduction

The WTO is widely regarded as trapped in a deep malaise. Exhibit A is its inability to conclude the multilateral trade negotiations known as the Doha Round, despite 10 years of talks. This failure is all the more remarkable since it does not reflect anti-liberalisation sentiments--quite the contrary. The new century has seen massive liberalisation of trade, investment, and services by WTO members--including nations like India, Brazil, and China that disparaged liberalisation for decades. WTO members are advancing the WTO's liberalisation goals unilaterally, bilaterally or regionally--indeed almost everywhere except inside the WTO (see Figure 1).

Figure 1: Global trade liberalisation, 1947-2007
Figure 1: Global trade liberalisation, 1947-2007
Sources: RTAs: WTO online databases & Hufbauer-Schott RTA database; tariffs: Clemson and Williamson (2004) up to 1988, then World DataBank (weighte tariffs all products)

This essay argues that the WTO is in excellent shape when it comes to the type of trade it was designed to govern. Indeed, this is why WTO membership remains so popular (29 new members since 1995). The WTO's woes stem rather from the emergence of a new type of trade--call it 21st century trade. This new trade--which is intimately tied to the unbundling of production--requires disciplines that go far beyond those in the WTO's rulebook. To date, virtually all of the necessary governance has emerged spontaneously in regional trade agreements or via unilateral 'pro-business' policy reforms by developing nations. The real threat, therefore, is not failure of the WTO, but rather the erosion of its centricity in the world trade system.

This line of reasoning suggests the WTO's future will take one of two forms.

1) The WTO remains relevant for 20th century trade and the basic rules of the road, but irrelevant for 21st century trade; all 'next generation' issues are addressed elsewhere.

In the optimistic version of this scenario, which seems to be where the current trajectory is leading us, the WTO remains one of several pillars of world trade governance. This sort of outcome is familiar from the EU's three-pillar structure, where the first pillar (basically the disciplines agreed in treaties up to the 1992 Maastricht Treaty) was supplemented by two new pillars to cover new areas of cooperation ( Note 1 ). In the pessimistic version of this first scenario, the lack of progress undermines political support and the WTO disciplines start to be widely flouted; the bicycle, so to speak, falls over when forward motion halts.

The second scenario involves a reinvigoration of the WTO's centricity.

2) The WTO engages in 21st century trade issues both by crafting new multilateral disciplines--or at least general guidelines--on matters such as investment assurances and by multilateralising some of the new disciplines that have arisen in regional trade agreements.

There are many variants of this future outlook. The engagement could take the form of plurilaterals--following the lead of agreements like the Information Technology Agreement, the Government Procurement Agreement and the like (where only a subset of WTO members sign up to the disciplines). It could also take the form of an expansion of the Doha Round agenda to include some of the new issues that are now routinely considered in regional trade agreements.

In this short essay, I support these conjectures by first discussing why the GATT had so many wins while the WTO had so many woes, then explaining why 21st century trade emerged and how it is different. Finally, I pull the threads together in the concluding section.

Note that I straightforwardly ignore many of the standard issues that crop up in essays about the WTO's future: the rising number of WTO members and its consensus decision-making; the rise of new trade giants, especially China, who are both poor and too big to ignore; the agriculture-manufacturing imbalances in the existing system, etc. In my view, these are all important, and indeed critical when thinking about how the WTO should defend its centrality, but I think these factors are less important in understanding the fundamental sources of the WTO's difficulties and its options for the future.

2. Why GATT won the war on tariffs

The GATT's remarkable success in lowering tariffs globally rested on two political economy mechanisms: the juggernaut effect and the "don't obey, don't object" principle. The juggernaut mechanism draws on a political economy view of tariffs. To put it starkly, GATT did not work via international cooperation, it worked by rearranging political economy forces within each nation so that each government found it politically optimal to lower tariffs. The key is the GATT's reciprocity principle--"I cut my tariffs if you cut yours". This enabled governments to counterbalance import-competing lobbies (protectionists) with export lobbies (who do not care directly about domestic tariffs, but who know they must fight domestic protectionists to win better foreign market access). In short, reciprocity switched each nation's exporters from bystanders to pro-trade activists. This made every government more interested in lowering tariffs than they were before the reciprocal talks started.

Liberalisation continued over the decades, since each set of reciprocal tariff cuts created political economy momentum. That is, a nation's own cuts downsized its import-competing industries (weakening protectionist forces) and foreign cuts upsized its exporters (strengthening pro-liberalisation forces). In this way, governments found it politically optimal to further reduce tariffs in the next GATT Round (held five to ten years down the road after industrial restructuring reshaped the political economy landscape in a pro-liberalisation direction).

The second mechanism was the fact that developing nations were allowed to free ride on the resulting rich-nation tariff cuts ( Note 2 ). This is what let a large, diverse, consensus-based organisation operate as if it were run by a small group of self-appointed, like-minded big economies. Countries whose markets were too small to matter globally--mainly the developing nations in the GATT decades--were not expected to cut their own tariffs during Rounds ( Note 3 ). Yet the GATT's principle of "most favoured nation" (MFN) meant that their exporters enjoyed the fruits of any tariff-cutting by large economies. Developing nations had a stake in the success of GATT rounds and nothing to gain from failure. For developing nations, GATT was a "don't obey, don't object" proposition. Of course, this fudged, rather than solved, the consensus problem.

3. Why GATT magic does not work for WTO

The juggernaut effect worked exceedingly well in the economies that dominated the trade system in the 20th century--the so-called Quad (US, EU, Japan, and Canada)--and on the goods of interest to their exporters (mostly manufactures). By the WTO's founding in 1995, Quad tariffs were very low on all but a small number of goods (notably agriculture). The dynamo, however, ran low on fuel as Quad tariffs fell. To keep exporters interested in fighting protectionists in their national capitals, the GATT broadened the negotiating agenda for the Uruguay Round (launched in 1986). Guarantees of intellectual property rights, disciplines on the use of investment restrictions, and the liberalisation of services market were added (known as TRIPs, TRIMs and Services) ( Note 4 ). To balance the agenda, agriculture and textiles barriers were also added--items that were viewed as being of interest to developing nations.

A problem with this agenda-broadening was that it was inconsistent with "don't obey, don't object", application of which would have allowed developing nations to opt out of disciplines on TRIPs, TRIMs and Services while benefiting from agriculture and textile tariff cuts via MFN. In short, the consensus problem could no longer be fudged, it had to be solved directly.

The Uruguay Round's endgame tactics replaced the "don't obey, don't object" carrot with the Single Undertaking stick. That is, the final Uruguay Round package set up a new institution--the WTO--and made membership a take-it-or-leave-it proposition. All members, developed and developing alike--even those that had not participated actively in the negotiations--were obliged to accept all of the Uruguay Round agreements as one package ( Note 5 ). The old days of developing nation free-riding were over. To enforce the Single Undertaking, the flexibility of the GATT's dispute settlement procedures was greatly reduced. The new adjudication procedure--known as the Dispute Settlement Understanding--meant that everyone would have to obey.

Long story short: the Uruguay Round's closing tactics unbalanced the GATT's winning formula. Developing countries now had to obey, so they would have to object to things that threatened their interests. The Single Undertaking and hardened dispute settlement procedure pushed the WTO into decision-making's "impossible trinity"--consensus, universal rules, and strict enforcement ( Note 6 ). This is one key reason why the WTO's Doha Round is so much more difficult to negotiate than the GATT rounds were.

4. The nature of international commerce changes: Production unbundling

Without the GATT's winning formula, one might have expected trade liberalisation to grind to a halt. It did not. The reason is that world trade and the politics of liberalisation changed radically in the 1990s. The cause was the information and communication technology (ICT) revolution, but understanding this requires some background.

4.1. Globalisation as two unbundlings

Globalisation is often viewed as driven by the gradual lowering of natural and man-made trade barriers. This is a serious misunderstanding. Globalisation made a giant leap when steam power slashed shipping costs; it made another when ICT decimated coordination costs. These can be called globalisation's first and second unbundlings. Consider the first unbundling.

When clippers and stage coaches were high-tech, few items could be profitably shipped internationally. Production had to be nearby consumption; each village made most of what it consumed. Steam power changed this by radically lowering transport costs. The result was 'the first unbundling', i.e. the spatial unbundling of production and consumption. GATT rules were designed to provide the international disciplines necessary to underpin this sort of trade, i.e. goods that were made in one nation being sold to customers in another nation.

The first unbundling, however, created a paradox--production clustered into factories even as it dispersed internationally. The paradox is resolved with three points: (i) cheap transport favours large-scale production, (ii) such production tends to be very complex, and (iii) proximity lowers the cost of coordinating complexity. Think of a stylised factory with several production bays. Coordinating the manufacturing process demands continuous, two-way flows among bays of things, people, training, investment, and information. Productivity-enhancing changes keep the process in flux, so the flows never die down.

Some of proximity's cost-savings are related to communications. As the ICT revolutions loosened the "coordination glue", it became feasible to spatially separate some types of production stages, i.e. to spatially unbundle the factories. Since some production stages were labour intensive, rich-nation firms reduced costs by offshoring them to low-wage nations. This was the second unbundling ( Note 7 ).

The second unbundling transformed international commerce for a very simple reason. Offshoring internationalised the two-way flows among production bays--the things, people, training, investment, and information mentioned above. Quite simply, international commerce became much more complex and diverse, creating '21st century trade'. The heart of this new commerce is what I call the "trade-investment-services-intellectual property" nexus ( Note 8 ). Specifically, the nexus reflects the intertwining of (i) trade in parts and components, (ii) international movement of investment in production facilities, key technical and managerial personnel, training, technology, and long-term business relationships, and (iii) demand for services to coordinate the dispersed production.

In the 20th century, the trading system was mostly important on the 'demand side'; it was about helping firms sell abroad products they made at home. In the 21st century, it is also important on the 'supply side', helping firms produce goods quickly and cheaply with international supply chains.

4.2. The nature of trade barriers and trade policies changes

Emergence of the trade-investment-services-IP nexus means that trade now involves two new necessities--connecting factories, and doing business abroad. Underpinning these involved rules on things that were never considered trade issues in the GATT era.

  1. Connecting factories involves assurances on business-related capital flows, world-class telecoms, air cargo, overnight parcel services, customs clearance services, short-term visa for managers and technicians, and infrastructure (ports, road, rail and electricity reliability, etc.). Of course, tariffs and other border measures also matter.
  2. Doing business abroad involves a whole range of formerly domestic policies--so-called behind-the-border barriers such as competition policy, property rights, rights of establishment, the behaviour of state-owned enterprises, the protection of intellectual property, and assurances on investor rights are important to doing business abroad.

In this new world, any policy that hinders the nexus is now a trade barrier.

The second unbundling created a de novo impulse for liberalisation--developing nations wanted the offshored industrial jobs and technology, rich-nation firms wanted access to lower-cost labour. Both pushed for disciplines to underpin the trade-investment-services-IP nexus. The result was "deep" regional trade agreements and unilateral pro-business reforms by developing nations. The result can be seen in Figure 1--the WTO's difficulty with the Doha Round did nothing to slow global trade liberalisation.

The political economy of liberalisation also changed. It no longer is the juggernaut's "I'll open my market if you open yours", Now reciprocal deals are based on an exchange of "foreign factories for domestic reforms". Developing nations are willing to reform all sorts of behind-the-border barriers in exchange for factories and industrial jobs that come from joining a rich-nation's supply chain.

The WTO's centrality suffered. As there are no factories on offer in Geneva, the new rule-writing shifted to bilateral deals. If a developing nation wants US, EU, or Japanese factories, they talk directly with Washington, Brussels, or Tokyo.

Of course, 20th century trade is still with us, and is important in some goods (e.g. primary goods) and for some nations (international supply chains are still rare in Latin American and Africa), but the most dynamic aspect of trade today is the development of international value chains.

5. Concluding remarks

When it comes to 20th century trade and trade issues, the WTO is in rude health.

  • The basic WTO rules are almost universally respected.
  • The decisions of the WTO's court are almost universally accepted.
  • Nations--even big, powerful nations like Russia--seem willing to pay a high political price to join the organisation.
  • The global crisis created protectionist pressures, but most of the new protection conformed to the letter of the WTO law (Evenett 2011).

In short, the WTO is alive and well when it comes to the types of trade and trade barriers it was designed to govern, i.e. 20th century trade (the sale of goods made in factories in one nation to customers in another).

Where the WTO's future seems cloudy is on the 21st century trade front. The demands for new rules and disciplines governing the trade-investment-services-IP nexus are being formulated outside the WTO. Developing nations are rushing to unilaterally lower their tariffs (especially on intermediate goods) and unilaterally reduce behind-the-border barriers to the trade-investment-services-IP nexus. All of this has markedly eroded the WTO centrality in the global trade system.

The implication of this is clear. The WTO's future will either be to stay on the 20th century side-track on to which it has been shunted, or to engage constructively and creatively in the new range of disciplines necessary to underpin 21st century trade.

  1. ^ The pillar structure was removed by the 2009 Lisbon Treaty but its effect was maintained Article by Article.
  2. ^ Right from the start, the developing nations were accorded special treatment in the GATT. This became increasingly explicit from the 1956 GATT "review session"; the Haberler Report (1958) provided intellectual backing that eventually led to "special and differential treatment" embodied in the GATT by Article XVIII on Trade and Development.
  3. ^ Non-reciprocity happened automatically under the principle-supplier structure of Rounds in the 1940s and 1950s; it became explicit with GATT Article XVIII when formulas began to be used.
  4. ^ TRIPs and TRIMs are short for Trade Related Intellectual Property Rights and Trade Related Investment Measures.
  5. ^ Some developing countries welcomed the Single Undertaking as it reduced their marginalisation in the rule-making avoiding outcomes like the Tokyo-Round Codes.
  6. ^ Inspired by Mundell's exchange-rate trilemma, Ostry (1999) proposed a 'trade trilemma' that Rodrik (2000, 2002) made rigorous.
  7. ^ See, for example, Ando and Kimura (2005), Kimura, Takahashi, and Hayakawa (2007), Gaulier, Lemoine and Unal-Kesenci (2007), and Athukorala (2005) in the East Asian case, and Federal Reserve Bank of Dallas (2002) or Feenstra and Hanson (1997) on the North American case.
  8. ^ See Baldwin (2011).
  1. Ando, Mitsuyo and Fukunari Kimura (2005), "The Formation of International Production and Distribution Networks in East Asia," in T. Ito and A. Rose (eds) International Trade in East Asia, NBER-East Asia Seminar on Economics, Volume 14, pp 177-216.
  2. Baldwin, Richard (2011), "21st Century Regionalism: Filling the gap between 21st century trade and 20th century trade rules," CEPR Policy Insight No. 56, London: CEPR.
  3. Clemens, Michael A. and Jeffrey G. Williamson (2004), "Why Did the Tariff-Growth Correlation Change after 1950?" Journal of Economic Growth 9(1), 5-46.
  4. Evenett, Simon (2011), "Did the WTO Restrain Protectionism During The Recent Systemic Crisis?"
  5. Federal Reserve Bank of Dallas (2002), "Maquiladora Industry: Past, Present and Future," Issue 2.
  6. Feenstra, Robert and Gordon Hanson (1997), "Foreign direct investment and relative wages: Evidence from Mexico's maquiladoras," Journal of International Economics 42(3-4), 371-393.
  7. Gaulier, Guillaume, Francoise Lemoine and Deniz Unal-Kesenci (2007), "China's emergence and the reorganisation of trade flows in Asia," China Economic Review 18(3), 209-243.
  8. Haberler, Gottfried (1958), "Trends in International Trade, Report of a Panel of Experts," Geneva: GATT Secretariat.
  9. Kimura, Fukunari, Yuya Takahashi, and Kazunobu Hayakawa (2007), "Fragmentation and parts and components trade: Comparison between East Asia and Europe," The North American Journal of Economics and Finance 18(1), 23-40.
  10. Ostry, Sylvia (1999), "The Future of the World Trade Organization," Brookings Trade Forum, edited by Dani Rodrik and Susan Collins, Washington, DC: Brookings Institution.
  11. Athukorala, Prema-chandra (2006), "Multinational Production Networks and the New Geo-economic Division of Labour in the Pacific Rim," Departmental Working Papers 2006-09, Australian National University, Arndt-Corden Department of Economics.
  12. Rodrik, Dani (2000), "How Far Will International Economic Integration Go?" Journal of Economic Perspectives 14(1), 177-186.
  13. Rodrik, Dani (2002), "Feasible Globalizations," NBER Working Paper 9129.

June 1, 2012

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