Topic 1 The efficacy of the GATT/WTO system and DCs

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1 INTERNATIONAL ECONOMIC POLICY AND DEVELOPMENT AA Topic 1 The efficacy of the GATT/WTO system and DCs PROF. PIERLUIGI MONTALBANO pierluigi.montalbano@uniroma1.it

2 Integration & interaction link process of trade liberalisation phenomenon of increased world trade linkages There has been lively debate among economists, on the effectiveness of trade liberalisation, for centuries. Dissemination of the free trade doctrine occurred in Europe in the nineteenth century (i.e. A. Smith, 1776; D. Ricardo 1815) The 1860 Cobden-Chevalier Treaty, and introduction of the most favoured nation (MFN) clause, played a key role in trade history in the second half of the nineteenth century (Bairoch, 1976, 1989) Most favoured nation (MFN) is a status or level treatment awarded by one nation to another in international trade. Each member treats all the other members equally as most-favoured trading partners. If a country improves the benefits that it gives to one trading partner (i.e. a lower customs duty rate for one of their products), it has to give the same best treatment to all the other partners of the agreement

3 The Cobden-Chevalier Treaty Following this treaty, between 1863 and the 1866, most European countries, through treaties signed with France or the UK, became part of a dense network of spontaneous and informal free trade agreements, which became known as the network of Cobden-Chevalier Treaties. In a period of 15 years, this led to the conclusion of 56 similar PTAs in Europe, liberalising trade (mostly on manufactured goods) to a large extent. This guaranteed the development of free trade among the main trading powers for around 20 years. Economic depression and the economic and social consequences of World War I opened the way to a return of protectionism.

4 The Mother of all Spaghetti Bowls : The Cobden-Chevalier Network in 1875 Source: Lampe (2011) Note: Lines represent unconditional MFN-PTAs signed between 1857 and 1875

5 Tariff liberalisation effects: From a theoretical standpoint: Theoretical evidence Both the traditional (Lerner, 1936; Stolper, Samuelson, 1941; Metzler, 1949; Bhagwati, 1959; Graaf, 1949; Johnson, 1950, 1960) and modern theoretical approaches (Helpman and Krugman, 1985; Venables, 1990) substantially agree that tariffs produce distorting effects on the economy, leading to a suboptimal allocation of resources. Tariff liberalisation, in introducing changes to relative prices, leads to a better allocation of resources and, thus, increased production and consumption. Some exceptions: the infant industry case; the so-called second best approach (domestic market failures)

6 Tariff liberalisation and trade growth: Empirical evidence From an empirical standpoint: Divergent positions and not clearly defined relationship between trade policy and trade growth. Recent analyses have produced contrasting results, which at times contradict the theory. Positive effect of tariff liberalization on trade growth (Balassa, 1965; Krueger, 1978; World Bank, 1987; Thomas, Nash and Edwards, 1991; Papageorgoiu, Michaely and Choski, 1992; Weiss, 1992; Helleiner, 1994; Joshi and Little, 1996; Bleaney, 1999; Ahmed, 2000; Madsen, 2001; Santos- Paulino and Thirlwall, 2004; Pacheco-Lopez, 2005); Weak or nullus effect (Baldwin and Lewis, 1978; Bhagwati, 1988; Unctad, 1989; Agosín, 1991; Clarke and Kirkpatrick, 1992; Ostry and Rose, 1992; Greenaway and Sapsford, 1994; Shafaeddin 1994; Jenkins, 1996; Nenci and Pietrobelli, 2008).

7 Impact of multilateral trading system on trade

8 Multilateral integration Since 1944, much of the reduction in tariffs and other trade restrictions came about through international negotiations. The General Agreement of Tariffs and Trade was begun in 1947 (23 countries) as a provisional international agreement and was replaced by a more formal international institution called the World Trade Organization in 1995 (now 160 members). The WTO and GATT have reduced tariffs substantially in the last 50 years

9 Average of regional tariffs after World War II Legend: Asia: (Burma, Ceylon, China, Egypt, India, Indonesia, Japan, the Philippines, Siam, Turkey); Core: France, Germany, United Kingdom Euro periphery: Austria-Hungary, Denmark, Greece, Italy, Norway, Portugal, Russia, Serbia, Spain, Sweden; Latin America: Argentina, Brazil,

10 Average unweighted tariff rates by region Percent South Asia Latin America and the Caribbean East Asia and the Pacific Sub- Saharan Africa Middle East and North Africa Europe and Central Asia Industrialized economies Source: Martin (2001)

11 Impact of multilateral trading system on trade Distinguished scholars assert that the beginning of a liberal trading order started before the GATT/WTO, with the creation of the network of MFN bilateral treaties (Bairoch, 1989; Irwin,1993; O Rourke and Williamson, 1999). Other scholars debate the efficacy of GATT/WTO in liberalising trade policy and increasing trade flows. They consider the role played by the GATT/WTO system as not a determinant of world trade promotion, arguing that the formalisation of the system did not produce the expected results and did not lead to substantially different results than those produced by the previous trading system. In this respect, we need to refer to the empirical contributions of Rose (2004a, 2004b, 2005).

12 Andrew K. Rose s critique Professor of Economic Analysis and Policy University of California at Berkeley 3 key papers: 1. Rose, Andrew K. (2004a) Do We Really Know that the WTO Increases Trade? American Economic Review. 2. Rose, Andrew K. (2004b) Do WTO Members have More Liberal Trade Policy? Journal of International Economics. 3. Rose, Andrew K. (2005c) Which International Institutions Promote International Trade? Review of International Economics.

13 Rose AER 2004 Using a standard gravity model, Rose (2004 AER) estimates the effect of membership in the GATT/WTO on trade T is trade between countries i and j at year t D is great-circle distance between the countries Y is real GDP X is a vector of other controls (population, dummies for common language, money, and border, geographic characteristics, colonial characteristics, time dummies, etc.). Coefficients of interest: γ1 and γ2, which measure the effects on trade of GATT/WTO membership by both countries and one country respectively. OLS estimates, panel of data covering over 50 years ( ), 175 countries

14 Rose JIE 2004 Surprisingly, both coefficients, γ1 and γ2, were economically small and statistically insignificant. He concludes that GATT/WTO had a limited role in the promotion of world trade. Is it plausible? Second step of his research: testing if GATT/WTO membership had effect on trade policy In Rose JIE 2004, he used almost 70 measures of trade policy and liberalization to see if membership in the GATT/WTO was actually associated with more liberal trade policy. With one exception (the Heritage Foundation s index of economic freedom) the answer was a resounding no: GATT/WTO members just didn t seem to have measurably more liberal trade policy than outsiders.

15 Rose RIE 2005 Third step: In Rose RIE 2005 he compared the GATT/WTO with two other significant international institutions that are in the business of liberalizing trade, the IMF and the OECD. He found that membership in the OECD had a consistently large positive effect while accession to (but not membership in) the GATT/WTO was also associated with increased trade. Overall conclusions: no significant effects of GATT/WTO membership on trade growth and trade policy

16 Rose s critics Thanks to Roses s works, there is now a growing body of scholarly research that investigates the impact of the international trade institutions on trade. Many scholars challenge his research (all of the critiques focus on the AER 2004 paper). Key criticisms: inappropriate proxy for variable of interest; inappropriate data pooling; inappropriate handling of fixed effects; and selection bias.

17 Rose s critics: inappropriate proxy for variable of interest Low 2002 criticises Rose, challenging the quality of the trade flow measurements, and claiming that the WTO s mandate is broader than simple trade liberalisation. Piermartini and Teh 2005 advance many reasons to explain Rose s results: - no request of significant reductions in trade barriers for DCs acceding before the creation of the WTO in 1995; - transition periods for tariff reductions are allowed; - many countries already benefited from MFN treatment or preferential tariffs before accession; - many countries liberalized beforehand in order to facilitate accession; - LDCs often export fuels and minerals which face little protectionism

18 Rose s critics: inappropriate data pooling Other scholars state that looking at all trade simultaneously masks the effects of the GATT/WTO (no distinction of country and sector asymmetries in terms of de facto liberalization). Subramanian and Wei (JIE 2007) - by introducing fixed effects and asymmetries between countries and sectors in their gravity equation - find that GATT/WTO effectively promotes trade but unevenly: a) GATT/WTO membership appears to have a significant effect on trade for developed countries, but does not appear to have had a significant impact on the trade of developing countries; b) GATT/WTO did not impact positively on trade in protected sectors, such as agriculture and textile and clothing; c) WTO membership has a relatively stronger effect on new Members than on old Members. Tomz et al. (AER 2007) show that Rose s analysis overlooks a large group of countries to which the trade agreement applies and classifies them incorrectly as nonparticipants (colonies of formal Members, new sovereign states and provisional applicants to WTO). Rose ignored these informal GATT participants (de facto), and thus under-estimated its impact. They argue that the GATT/WTO membership has had substantial positive effects on trade.

19 Rose s critics: inappropriate handling of fixed effects Most of Rose s regressions do not include country-specific fixed effects in the gravity equations Subramanian and Wei (2007) reveal the weakness of Rose in not taking account of the results obtained by Anderson and van Wincoop (2003), the multilateral resistance effect - on the introduction of fixed effects by country within the gravitational equation. Many of Rose s critics include fixed effects for either countries or country-pairs (see next table). They usually find significantly positive estimates of the effect of membership on trade

20 Rose s critics: sample selection bias Selection bias due to omission of zero trade observations. He didn t explicitly deal with the extensive margin of trade (whether a pair of countries trades at all). Helpman et al. 2005, argue that disregarding zero trade observations has important consequences for the empirical analysis, as it generates biased estimates. Felbermayr and Kohler (2010) and Liu (2009) argue that members of the GATT/WTO have systematically more trading relationships, so that ignoring the effect of membership on the extensive trade margin (i.e. losing information on those who start new trade relationships) leads one to under-estimate the impact of the GATT/WTO.

21 The state of the art on this issue. Comparing recent results The subsequent studies have provided mixed results not only about the overall impact of the GATT/WTO on trade, but also on the channels through which the effect operates, and the potential asymmetries that may exist across groups of countries and periods. Most recent estimates, effect of Gatt/WTO membership on bilateral trade Authors Liu (2009) Felbermayr and Kohler (2010) Eicher and Henn (2011) Chang and Lee (2011) Herz and Wagner (2011) Dutt et al (2013) Trade margins (country Overall effect Countries effect pairs) negative positive intensive extensive industrialized developing x x x x x no effect positive effect no effect no effect negative effect x x moderatly x (product margin) positive (product extensive margin) positive (product extensive margin) Zero flows Sub-periods/rounds effect positive in pre-kennedy year ( ) and post-uruguay Round ( ) x negative during the Gatt, positive during WTO x no effect at all positive in all rounds x x

22 Possible explanations of Rose s results Why membership in the GATT/WTO doesn t deliver more trade? Developing Countries. GATT historically made few demands on most countries in terms of trade liberalization, since most entrants were developing countries eligible for special and differential treatment. If accession to the GATT/WTO doesn t force countries to liberalize, why should one expect accession to have a measurable impact on trade? And if accession isn t the time when the GATT/WTO forced countries to liberalize, is the GATT/WTO really an effective agent of liberalization? Sectors. The GATT/WTO has made almost no progress in liberalizing areas of great protectionism, such as agriculture and textiles. MFN Status. MFN status is often given freely away NTBs. Non-tariff barriers have often been increased as substitute protectionism Ceteris Non Paribus. There are many other reasons why trade has grown, including declining transportation/communication costs, higher productivity growth in tradeables, and so forth.

23 Rose s critics 2 Hufbauer, 2002 suggests that the correct test for the success of the GATT/WTO would be to compare the expansion of trade in historical periods when clubs with liberalisation mandates were born, with those periods when such clubs did not exist, rather than an analysis limited to examining the current system. Nenci 2011 tests the GATT/WTO results in terms of trade liberalisation and trade growth with respect to previous periods characterised by a nonstructured=institutionalised (or even absence of a) regime. The analysis is conducted at the aggregate level for the period (23 countries, historical reconstruction of tariff data) and at panel level for the period (same countries, standard data sources).

24 Nenci 2011 Two research questions: 1. Has tariff liberalisation accelerated the growth of world exports? 2. If so, has the GATT/WTO produced significant results in terms of trade liberalisation and trade growth with respect to previous periods?

25 Nenci 2011 results Existence of a well defined and stable relationship between the reduction in tariff barriers and growth in trade in different eras: results confirm the existence of a long-run relationship at world level. This is relevant and significant in the period pre-world War II, but gradually loses importance and significance after Effectiveness of the current multilateral trading system in promoting liberalisation and growing involvement of countries in world trade: by testing different trade Rounds, the GATT/WTO international trading system does not seem being particularly effective (partly in line with Rose s works). Greater tariff liberalisation does not appear to have been the main cause of the extraordinary growth in trade flows that occurred in the post-world War II period (but MTS important for ensuring rules and behaviours among major players).