D E V E L O P M E N T, T R A D E , A N D T H E W T O A Handbook Bernard Hoekman, Aaditya Mattoo, and Philip English, editors THE WORLD BANK Washington, D.C. © 2002 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 All rights reserved. Manufactured in the United States of America First printing June 2002 1 2 3 4 05 04 03 02 The findings, interpretations, and conclusions expressed here are those of the author(s) and do not necessar- ily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent. The World Bank cannot guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply on the part of the World Bank any judgment of the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is copyrighted. 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Inset images, clockwise from upper left: Edwin G. Huffman, the World Bank; Curt Carnemark, the World Bank; the World Bank; Edwin G. Huffman, the World Bank; PhotoDisc; Francis Dobbs, the World Bank. ISBN 0-8213-4997-X Library of Congress Cataloging-in-Publication Data has been applied for. Contents Foreword xi A Tribute to J. Michael Finger xiii Acknowledgments xix Contributors xxi Abbreviations xxiii Introduction xxvii Part I Trade Policy Reform in Context 1 1 Trade Policy Reform as Institutional Reform 3 Dani Rodrik 2 Economywide Dimensions of Trade Policy and Reform 11 Kym Anderson 3 Exchange Rate Overvaluation and Trade Protection 17 Howard J. Shatz and David G. Tarr 4 Fiscal Dimensions of Trade Liberalization 24 Liam Ebrill, Janet Stotsky, and Reint Gropp 5 Trade Policies for Poverty Alleviation 28 L. Alan Winters Part II The World Trade Organization 39 6 The WTO: Functions and Basic Principles 41 Bernard Hoekman 7 Reciprocity in the WTO 50 J. Michael Finger and L. Alan Winters 8 WTO Accession 61 Constantine Michalopoulos 9 Developing Countries and the WTO Dispute Settlement System 71 Valentina Delich 10 The Adequacy of WTO Dispute Settlement Remedies: A Developing Country Perspective 81 Robert E. Hudec Part III Selected Trade Policies Affecting Merchandise Trade 93 11 Market Access Issues and the WTO: An Overview 97 Sam Laird 12 Tariff Peaks and Preferences 105 Marcelo Olarreaga and Francis Ng iii D E V E L O P M E N T, T R A D E , A N D T H E W T O 13 Rules of Origin and Trade Preferences 114 Luis Jorge Garay S. and Rafael Cornejo 14 Nonpreferential Rules of Origin and the WTO Harmonization Program 122 Stefano Inama 15 Customs Valuation and Customs Reform 128 Vinod Rege 16 Trade Facilitation: Improving the Invisible Infrastructure 139 Brian Rankin Staples 17 Industrial Policy and Developing Countries 149 Mari Pangestu 18 Export Development Policies and Institutions 160 Philip English and Luc De Wulf 19 Trade-Related Investment Measures 171 Bijit Bora 20 Local Content Policies: Australia's Experience with Automobiles 179 Garry Pursell 21 Implementing the Agreement on Textiles and Clothing 186 Hanaa Kheir-El-Din 22 Safeguards: Making Sense of GATT/WTO Provisions Allowing for Import Restrictions 195 J. Michael Finger 23 Dealing with U.S. Trade Laws: Before, During, and After 206 Gary N. Horlick and Eleanor Shea Part IV Developing Countries and Negotiations on Trade in Services 213 24 Liberalization of Trade in Services in Developing Countries 221 James Hodge 25 The Magnitude of Flows of Global Trade in Services 235 A. Maurer and P. Chauvet 26 Quantifying Barriers to Trade in Services 247 Robert M. Stern 27 The GATS: Key Features and Sectors 259 Rudolf Adlung, Antonia Carzeniga, Bernard Hoekman, Masamichi Kono, Aaditya Mattoo, and Lee Tuthill 28 Negotiating Improved Market Access Commitments 280 Aaditya Mattoo 29 Domestic Regulations and Liberalization of Trade in Services 290 Carlo Gamberale and Aaditya Mattoo 30 Movement of Natural Persons and the GATS Major Trade Policy Impediments 304 Rupa Chanda 31 Electronic Commerce, the WTO, and Developing Countries 315 Catherine L. Mann 32 Completing the GATS Framework: Safeguards, Subsidies, and Government Procurement 326 Pierre Sauvé 33 Regional Liberalization of Trade in Services: Experiences in the Americas 336 Sherry M. Stephenson and Francisco Javier Prieto Part V Technology and Intellectual Property 347 34 International Technology Transfer and Economic Development 351 Kamal Saggi iv Contents 35 Implementing the TRIPS Agreement 359 Jayashree Watal 36 Benefiting from Intellectual Property Protection 369 Keith E. Maskus 37 Proprietary Protection of Genetic Resources and Traditional Knowledge 382 Arvind Subramanian 38 Cultural Industries and Intellectual Property Rights 390 Frank J. Penna and Coenraad J. Visser 39 Trademarks, Geographical Indications, and Developing Countries 403 Carsten Fink and Beata K. Smarzynska Part VI "Behind-the-Border" and Regulatory Issues 413 40 Multilateral Disciplines and Government Procurement 417 Simon J. Evenett 41 Standards, Regulation, and Trade: WTO Rules and Developing Country Concerns 428 John S. Wilson 42 Multilateral Disciplines and National Investment Policies 439 Bernard Hoekman and Kamal Saggi 43 Trade, Competition, and the WTO 447 Peter Holmes 44 Merger and Anticartel Policies in an Era of Integrating Markets 456 Simon J. Evenett 45 Trade and Labor: Text, Institutions, and Context 463 Simon Tay 46 Environmental Regulation and the WTO 472 Veena Jha Part VII The Trading System and Developing Countries 483 47 Developing Countries: Turning Participation into Influence 485 Diana Tussie and Miguel F. Lengyel 48 Implementation of WTO Commitments: The Development Challenge 493 J. Michael Finger and Philip Schuler 49 Special and Differential Treatment 504 T. Ademola Oyejide 50 Trade-Related Capacity Building for Enhanced African Participation in the Global Economy 509 David F. Luke Part VIII Trade Policy Questions and Guidelines 517 51 Rules of Thumb for Trade Policy 519 Constantine Michalopoulos, Maurice Schiff, and David G. Tarr 52 Arguments for and against Uniform Tariffs 526 David G. Tarr 53 Formula Approaches to Reciprocal Tariff Liberalization 535 Arvind Panagariya 54 Binding Tariffs: Why Do It? 540 Joseph F. Francois and Will Martin 55 Benefiting from Regional Integration 548 Bernard Hoekman and Maurice Schiff Appendixes 559 A Patterns of Trade and Protection: Selected Country Data 561 Francis Ng v D E V E L O P M E N T, T R A D E , A N D T H E W T O B Trade Indicators and Indices 585 Francis Ng C A Dataset on Trade and Production, 1976­99 589 Alessandro Nicita and Marcelo Olarreaga Glossary of Trade-Related Terms 593 Bibliography 605 Index 629 CD-ROMs 1 A Dataset on Trade and Production, 1976­99 Alessandro Nicita and Marcelo Olarreaga 2 Applied Trade Policy for Developing Countries: Outline,Content,and Readings for a Short Course Jaime de Melo and Marc Bacchetta Tables 3.1 Comparing "Great Depressions": Cameroon, Côte d'Ivoire, and the United States 21 4.1 Revenue Impact of Trade Liberalization 25 6.1 From GATT to WTO: Major Events 46 7.1 Control of Free-Riding in GATT Negotiations: U.S. Experience, 1947­67 53 7.2 U.S. Imports Covered by Kennedy Round Tariff Concessions (Reductions plus Bindings) as a Share of Total U.S. Imports from the Country Group 54 7.3 Tariff Concessions Received and Given at the Uruguay Round 57 8.1 Accessions to the World Trade Organization as of May 1, 2001 64 9.1 Number of Dispute Settlement Cases, 1995 through September 2000 76 11.1 Post­Uruguay Round Applied and Bound Rates of Industrial and Developing Economies by Major Product Group 98 11.2 Tariff Escalation on Products Imported by Industrial Economies from Developing Economies 99 11.3 Post­Uruguay Round Import-Weighted Applied and Bound Tariff Rates 99 11.4 Patterns of Protection in Manufacturing, 1995 102 12.1 Tariff Peaks and Imports, Quad Economies, 1999 108 12.2 Tariff Peaks and Preferential Duty Rates, Quad Economies, 1999 110 12.3 Effects of Granting Duty- and Quota-Free Access to Quad Markets to LDC Exporters 111 17.1 Evolution of Industrial Policies in East Asia, 1950s­1990s 153 17.2 Policies and Measures for Promoting Exports in Asia 155 21.1 Results of Integration Programs for ATC Stages 1 and 2 189 21.2 Number of Quotas Eliminated by Integration in ATC Stages 1 and 2 190 21.3 Restrained Trade Freed of Quotas, 1995­97 190 21.4 Expanded Market Access Attributable to Increases in Quotas (Stages 1 and 2 Combined) 190 22.1 Frequency of Use of GATT Provisions That Allow Trade Restrictions, 1948­94 196 IV.1 Summary of Selected GATS Negotiations and Domestic Policy Issues: Current Status and Desirable Outcomes 218 25.1 Inadequacies of Statistical Domains with Regard to Modes of Supply 237 25.2 Average Annual Growth of Services and Merchandise Trade, 1990­99 238 25.3 Trade in Commercial Services by Region, 1990­99 239 25.4 Share of Selected Economies in World Trade in Services, 1995 and 1998 239 25.5 Exports of Services of Selected Economies by Selected Partners, 1995 and 1998 240 25.6 Evolution of Transport, Travel, and Other Commercial Services, 1980­99 241 25.7 World Trade in Other Commercial Services by Category, 1996­98 241 vi Contents 25.8 Trade in Services by Mode of Supply, 1998 242 25.9 Shares in Inward and Outward FDI Stocks, Selected Country Groups, 1990 and 1999 243 25.10 Total U.S. Services Trade, 1994, 1996, and 1997 243 26.1 Constructed Ad Valorem Tariff Equivalent "Guesstimates" by One-Digit ISIC Services Sector, Selected Countries 250 26.2 FDI Restrictiveness Indices, Selected APEC Economies and Selected Services Sectors 250 26.3 Estimated Tariff Equivalents in Traded Services: Gravity Model­Based Regression Method 252 26.4 Average Gross Operating Margins of Firms Listed on National Stock Exchanges, 1994­96, by Economy or Region 253 26.5 Alternative Approaches to Modeling the Impact of Barriers to Trade and Investment 254 26.6 Welfare Effects of 33 Percent Reduction in Barriers to Trade in Agriculture, Manufactures, and Services 257 27.1 Main Provisions of the GATS 260 27.2 Format and Example of a Schedule of GATS Commitments 261 27.3 Number of Committed Services Sectors by Member, July 2000 263 27.4 Market Access Commitments on Insurance (Life and Nonlife) under the GATS 268 27.5 Market Access Commitments on Banking (Acceptance of Deposits and Lending of All Types) under the GATS 270 27.6 Current Status of GATS Commitments on Voice Telephone Services 273 28.1 Types of Market Access Restrictions on Commercial Presence in Services Sectors, All WTO Members, 2000 281 28.2 Developing Country Precommitments to Liberalize in Basic Telecommunications Negotiations, 1998 284 30.1 Commitments by Sector and Mode of Supply (Professional Services) 308 33.1 Specific Services Sectors Highlighted in the Subregional Integration Agreements of the Americas 342 V.1 Summary of Selected TRIPS Issues: Current Status and Possible Approaches from a Development Perspective 349 40.1 Performance Indicators for Government Procurement in Korea, 1993­98 424 41.1 Total Number of Countries That Have Established SPS Enquiry Points 435 44.1 Economies with Firms Convicted of Price Fixing by the United States or the European Commission during the 1990s 458 44.2 Cross-Border Mergers and Acquisitions in Latin America and Asia Pacific, 1991­98 459 48.1 Costs of World Bank Customs Reform Projects, Selected Countries 496 48.2 Costs of SPS-Related World Bank Projects 497 48.3 World Bank Projects Related to Intellectual Property Rights 499 54.1 Industrial Applied and Bound Tariff Rates 542 54.2 Unbound Tariff Lines by GATT Multilateral Tariff Negotiation (MTN) Category 543 A.1 Trends in Average Tariff Rates for Developing and Industrial Countries, 1980­99 562 A.2 Average Tariff Rates by Sector and FDI Inflows for All Countries in Recent Years 568 A.3 Tariff Escalation in Developing and Industrial Countries, 1994­2000 571 A.4 Pre­ and Post­Uruguay Round Nontariff Barriers for All Goods, Developing and Industrial Countries, 1984­93 573 A.5 Nontariff Barriers for All Products in Developing Countries, 1989­98 576 A.6 Tariff Peaks and Preference Margins, Canada, 1999 578 A.7 Tariff Peaks and Preference Margins, European Union, 1999 580 A.8 Tariff Peaks and Preference Margins, Japan, 1999 581 vii D E V E L O P M E N T, T R A D E , A N D T H E W T O A.9 Tariff Peaks and Preference Margins, United States, 1999 582 A.10 Comparison of MFN Applied Tariffs of Labor-Intensive Products, Selected Countries, 1997­99 583 Figures 11.1 Implications of a 40 Percent Reduction in Agricultural Trade Barriers 100 11.2 Share of Manufactures in Developing Country Merchandise Exports, Actual and Projected, 1965­2005 101 12.1 Projected Changes in LDC Export Revenues as a Result of Duty-Free Access, by Product and Importer 112 22.1 Renegotiations, Emergency Actions, and Voluntary Export Restraints (VERs), 1948­93 198 22.2 Renegotiations, Emergency Actions, Antidumping Actions, and Voluntary Export Restraints (VERs), 1948­93 200 27.1 Number of WTO Members Committing to at Least Part of an Aggregate Services Sector, July 2000 264 27.2 Market Access Commitments by WTO Members on Movement of Natural Persons (Services Mode 4) 265 29.1 Approaches toward Domestic Regulation at the Multilateral and National Levels 291 33.1 Matrix of Possible Elements in Services Trade Agreements 343 39.1 Global Demand for Trademarks and Patents 408 39.2 Nationality of Trademark and Patent Title Holders by Country Income Group, 1997 409 41.1 Number of Notifications under the SPS Agreement by Region, 1995­99 435 54.1 Implications of a Tariff Binding for the Applied Rate of Protection 545 54.2 Welfare Implications of Tariff Bindings for a Small Country 546 55.A1 A RIA Involving Small Countries 557 Boxes 4.1 Export Taxes 27 5.1 Key Questions for Determining the Poverty Impact of a Trade Reform 29 6.1 Transparency: Notification and Surveillance 45 9.1 Special and Differential Treatment and the DSU: Some Examples 73 9.2 The Advisory Centre on WTO Law 75 10.1 The Bananas Case 87 12.1 The European Union's "Everything but Arms" Initiative 106 13.1 The U.S. Trade and Development Act of 2000 115 15.1 The WTO Agreement on Preshipment Inspection 132 15.2 The International Convention on the Simplification and Harmonization of Customs Procedures: 1999 Revision of the Kyoto Convention 135 16.1 Increasing the Effectiveness of Preshipment Inspection Services 143 16.2 Improving Export Clearance in Jamaica 145 17.1 Nominal and Effective Rates of Protection 151 17.2 Instruments of Industrial and Export Promotion Policies Employed in the Republic of Korea and Japan 152 18.1 Matching Grant Schemes to Promote Exports 162 18.2 Duty Drawback for Direct Exporters: The Chilean Case 164 18.3 Subsidies, the WTO, and Developing Countries 168 21.1 The Cost of Trade Protection of Textiles and Clothing in the European Union 193 22.1 The Basics of WTO Antidumping Rules 201 22.2 The Flawed Economics of Basing Decisions on an Injury Investigation 203 24.1 Realizing the Gains from Financial Liberalization 223 viii Contents 24.2 Contribution of Inefficient Internal Transport Systems to the Concentration of China's Export Industries in Coastal Regions 225 24.3 Lessons from Reforming Argentina's Ports 227 24.4 Welfare Gains from Services Liberalization: The Case of Tunisia 229 24.5 Achieving Effective Competition in Telecommunications: The Asian Experience 233 25.1 Services Statistics and the GATS 236 25.2 Improving Data on Trade in Services 244 27.1 Financial Services: Market Access Commitments of Developing and Transition Economies 267 28.1 Services Exports by Developing Countries: Potential Gains and Current Barriers 286 29.1 Whose Regulations, and for What Purpose? Sticky Issues in Electronic Commerce 292 29.2 Assessing the WTO Telecommunications Reference Paper 293 29.3 Rules for Domestic Regulations: The Experience with Accountancy 295 29.4 Challenges in Implementing Procompetitive Regulation 297 29.5 Financial Sector Liberalization: The Need for Policy Coherence 299 29.6 Financial Liberalization and Access to Credit by the Poor 301 29.7 Pursuing Social Objectives in Competitive Telecommunications Markets 302 30.1 Immigration Patterns in OECD Countries 309 31.1 The Economics and Law of Duty-Free Electronic Commerce 319 32.1 ASEAN Proposal for a GATS Emergency Safeguard Mechanism 330 35.1 An Overview of Intellectual Property Rights 360 35.2 Combating Disease Worldwide: Fostering the Required R&D 366 36.1 Pharmaceutical Policies and the TRIPS Agreement 374 36.2 Differential Pricing 378 36.3 Health Care Systems and Essential Medicines 380 40.1 Accession to the GPA: Identifying Costs and Benefits 425 41.1 SPS Measures: The Kenya Fish Exports Case 430 41.2 Standards-Related Problems Encountered by Indian Exporters 433 41.3 Moving Forward: A Proposal 438 42.1 WTO Rules on FDI: A Positive View 441 43.1 Why Competition Policy Should Not Be Seen through a Market Access Lens 450 43.2 Free Trade and Competition Policy 452 45.1 What Are Core Labor Standards? 464 45.2 Trade and Labor Standards: Three Debates 466 46.1 Basic Principles of Environmental Regulation 474 47.1 Café au Lait Diplomacy 489 48.1 Costs of Implementing the WTO Agreements: The Jamaican Experience 502 51.1 Export Diversification in Africa: Elements of a "Business Plan" 523 55.1 Selected Major Regional Integration Agreements and Dates of Formation 549 ix blank Foreword T oday, trade policy is at the fore- markets should be more open to the goods of poor front of the development agenda, countries, and that developing countries should and it is a critical element of any strategy to fight open their markets as well as address a range of poverty. This renewed interest in trade liberaliza- institutional issues. tion does not come from dogma but instead is based The advance at Doha presents a unique opportuni- on a careful assessment of development experience ty for development, but it will require substantive over the last 50 years. participation from all countries to succeed. In partic- Developing countries that increased their integra- ular, each participating developing country will need tion into the world economy over the past two a thorough understanding of how trade liberaliza- decades achieved higher growth in incomes, longer tion can contribute to its national objectives of eco- life expectancy, and better schooling. These coun- nomic growth and poverty reduction. Such strategic tries, home to some 3 billion people, enjoyed an understanding will have to be supported by both the average 5 percent growth rate in income per capita trade negotiators and by civil society; at times, the in the 1990s compared to 2 percent in rich countries. medium-term goal of poverty reduction requires A common thread exists among these developing governments to challenge the interests of some par- countries that have been successful at generating ticular industries for short-term protection. greater growth and at lifting people out of poverty. In addition, many countries will have to break new They opened up their economies as part of a broad- ground. Today's trade issues go beyond the tradi- er development strategy that builds on two pillars: tional mechanisms of tariffs and quotas and include improving the investment climate for the private "behind-the-border" issues, such as the role of infra- sector to generate jobs and empowering poor peo- structure and governance in supporting a well-func- ple, so they can participate in growth. tioning trading economy. Many poor countries have This approach to development, with trade liberal- yet to create intellectual property regimes that make ization as one mechanism of improving the invest- traditional knowledge or cultural products into ment climate for private entrepreneurs, has gained negotiable and defensible assets; to identify options wide support among developing and industrial to upgrade and enforce national product, health, countries. All WTO member countries, including and safety standards; or to strengthen institutions those in the developing world, have reduced their for prudential and pro-competitive regulation of trade tariffs since the Uruguay Round. In its Every- services. Developing countries will have to acquire thing but Arms agreement, the European Union has quickly the needed expertise on these complex unilaterally lowered its trade barriers to the least issues, so they can negotiate more effectively and developed countries. The United States adopted the ensure that agreements serve their objective of African Growth and Opportunities Act. And in poverty reduction. November 2001, the members of the World Trade This Handbook is part of our efforts to prepare Organization launched a "Development Agenda" in developing countries to negotiate trade agreements. Doha. In doing so, they acknowledged that to make It is the product of a joint capacity-building effort progress in the fight against poverty, rich country involving a number of research institutes around xi D E V E L O P M E N T, T R A D E , A N D T H E W T O the globe. It aims to provide a summary of the eco- strong interest in, real-world trade policy making, nomics of sound trade policy and to be a guide to rather than the theory of international trade. Such many of the behind-the-border regulatory issues practitioners will be in ministries of trade, industry, that confront countries in the contexts of both and finance; parliaments; private sector associations domestic reform and international negotiations. such as chambers of commerce; consumer organi- Views and approaches to many of the issues that are zations, and policy institutes. dealt with in this volume differ substantially, and The diversity and pragmatism of the views repre- these differences are reflected here. All are motivat- sented contribute to the richness of this Handbook ed by the question of how the global trade architec- and make it a very worthwhile resource for all trade ture might be made more supportive of practitioners. It will help us "seize the moment" and development, and the question of how developing fulfill Doha's promise to focus on the need for trade countries can use international negotiations and to bring about greater growth and poverty reduction. cooperation as an instrument to further domestic reform and access to export markets. NICHOLAS STERN The Handbook is intended to be a source of SENIOR VICE PRESIDENT AND information and guidance for all practitioners, CHIEF ECONOMIST defined as those with either a responsibility for, or a THE WORLD BANK xii A Tribute to J. Michael Finger F ifteen years after the publication friends. This Handbook is dedicated to him both as of the World Bank's first handbook a practical tribute to his work and influence and in on trade policy and multilateral negotiations (Fin- the belief that his clear-sighted approach to trade ger and Olechowski 1987), the development dimen- policy will motivate researchers, analysts, and com- sions of trade policy and trade negotiations often mentators who have never had the opportunity to seem to be neglected. This is especially the case as meet him. regards trade agreements, where negotiations are Finger has noted that "trade theory is about iden- frequently driven by interest groups in high-income tifying whose hand is in whose pocket. Trade policy countries and where outcomes can have significant is about who should take it out" (Finger 1981). Both costs for developing countries, both in a monetary are important. Good policymaking requires a solid or resource-use sense and--since these obligations grounding in fact and analysis--an understanding may deflect attention and resources away from of the processes that are taking place--and a frank other, more important, tasks--in opportunity costs. recognition that, at least for international trade, The focus of much of the advice and assistance that there will be winners and losers from virtually any is offered to developing country policymakers cen- policy decision. Trade policy advice needs to pro- ters on enhancing their understanding of the rules vide this grounding, but it must also understand of the international trading game, as opposed to and internalize how the potential conflicts between determining what type of trade policy makes the winners and losers are played out in actual decision- most sense from a development perspective. The making institutions. Merely wringing one's hands latter is crucial, as only on that basis is a national and bemoaning the fact that policy advice is ignored "bottom-up" approach to the design of multilateral is not satisfactory; one needs to see why and ask rules possible. As noted by J. Michael Finger (1991a, how institutions can be designed to produce better 1991c), when it comes to the relationship between policy outcomes. the multilateral trading system and development, Five components of good trade policymaking can there is a widespread tendency to "think about be distinguished: economic analysis, information GATT only in the GATT way." Finger made this and data, political economy, operationalization of observation before the creation of the WTO and, policy advice, and a contestable market for policy characteristically, well before it became convention- research. Each is discussed below. al wisdom in the development community. Subse- quent experience has reinforced his insight.1 Economic Analysis This Handbook continues a series that Finger launched in 1987. Mike Finger, who retired from the Economic analysis is perhaps the most obvious and World Bank in 2001, has been a source of inspira- most easily provided input into the policy cocktail. tion, a guide, and a mentor to several generations of Many academic economists are active in this area, trade policy analysts. Many of the contributors to and theory is cheap. Getting concepts clear and this volume have been inspired by his writings, and showing how one thing implies another, and under a significant number have also been colleagues and what conditions, are necessary first steps toward any xiii D E V E L O P M E N T, T R A D E , A N D T H E W T O reliable policymaking. Finger's early work on the lizing support for disciplining the use of NTBs in usefulness of the concept of effective protection is the Uruguay Round. an example (Finger 1969). Such analysis might be Finger also produced the most useful summaries purely positive--describing relationships between of tariff concessions in the Uruguay Round (Finger, economic phenomena--or it might have normative Ingco, and Reincke 1996). They were useful partly dimensions in which conclusions about welfare are because he chose to measure concessions in a more inferred. Either way, it needs to be clear and logical- informative way than did national statisticians and ly watertight. the WTO. He generated the statistic, much cited in But although logical precision may be necessary, the mid-1990s, that trade reforms under IMF and it is far from sufficient for defining good policy World Bank programs liberalized more developing analysis. The other essentials--which are, regret- country trade than had the Uruguay Round. And tably, much scarcer--are that the analysis deal with recently he showed how developing countries a real problem that someone is interested in and received fewer Uruguay Round concessions (in a that it be couched in operational terms.2 Policy mercantilist sense) than they gave (Finger and research must ultimately refer to phenomena that Schuknecht 2001; Finger, Reincke, and Castro forth- can be observed--especially in terms of defining the coming). In each case, the secret was to base detailed circumstances in which the research can be applied work on the data on a well-specified question posed and the levels at which to set policy instruments-- in terms of clear operational concepts. This is, in and it must refer to policy levers that could, in prin- fact, not "mere" description but a sophisticated ciple, be manipulated. Unfortunately, all this makes marriage of theory and data that relies on simple such analysis less attractive to the editors of aca- statistics rather than high-technology econometric demic journals. Finger's work, and his publishing techniques.4 record, suggest, however, that policy analysis can be A further important dimension of good policy every bit as exciting intellectually as "pure" theory. research is to devise ways of helping policy analysts Some examples are early pathbreaking work assess- throughout the world to repeat and extend state of ing the relative impact of transport costs and tariffs the art analysis. Many theoretical analyses are easily (Finger and Yeats 1976) and assessments of the replicated, but once one begins to work with data, effects of the offshore assembly provisions in U.S. there can be high costs to replication even if there customs law (Finger 1976b). are no unforeseen difficulties to overcome. The first requirement for facilitating replication is to make data available. Great strides have been taken recent- Information and Data ly in this direction, but there are still many hurdles Great analysis will occasionally throw up universal to be overcome. For example, it is unfortunate that truths that do not require detailed empirical analy- members of the WTO continue to resist making the sis in order to be applied. More commonly, howev- Uruguay Round bound tariff rates available in a er, policy analysis is empty without a supporting convenient form for analysis.5 information base. The most obvious need in inter- The second component also focuses on conven- national trade is for data on international trade ience. Where complex operations or calculations are flows and policies, but information on the laws and required, it is essential to make tools and routines institutions that govern behavior is also essential. available to external researchers and so make it "Merely" collecting and presenting information can cheap and easy for them to carry out their own be spectacularly illuminating. For example, in the analysis. Although we tend to equate data with mid-1980s Finger inspired and managed the World numbers, it is equally important for policy analysts Bank's empirical work on nontariff barriers to have accurate representations of institutional and (NTBs); Nogués, Olechowski, and Winters (1986) is legal processes. Some of these may be summarized an example.3 At that time theory about the effects of numerically, as in, for example, Finger's compilation NTBs was not lacking, but there was almost no con- of tariff concessions granted and received in the cept of how pervasive these barriers were. Present- Uruguay Round (Finger, Ingco, and Reincke 1996). ing the data (and being clear about the adequacy or In other cases it is a matter of observing processes inadequacy of the measurements) took the debate and finding ways of distilling their essence into a much further and had a significant effect in mobi- few simple statements. The pioneering work by Fin- xiv A Tribute to J. Michael Finger ger, Hall, and Nelson (1982) on administrative pro- into an unbalanced game with a strongly biased tection (on which more below) is based on a careful outcome. The classic analysis by Finger, Hall, and institutional study of U.S. antidumping, counter- Nelson of antidumping actions makes clear how the vailing, and escape clause protection. technical process favors business interests and dis- Today, as we grapple with the subtleties and com- enfranchises consumers and users--in fact, the plexities of trade and development policies and the authors argue that this is precisely the political role of the WTO in supporting development, work function of the process. Only by covertly loading on information and data is prominent. For exam- the scales can a low-level (ostensibly nonpolitical) ple, many of the chapters on services in this Hand- process hope to resolve distributional struggles; if book deal with how to measure the progress of the loading is obvious, the matter tends to become liberalization in these areas and examine how gov- political and more difficult. Moreover, once estab- ernments have applied the agreements domestically. lished, such unbalanced processes tend to perpetu- ate themselves because the interest groups whose interests are served (including the people who man- Recognition of Political Economy age the processes) ensure that this happens. Finger, If entrepreneurs and workers respond to price sig- who has contributed massively and seminally to our nals and incentives in determining their behavior, it understanding of antidumping and safeguards over is hardly surprising that they respond to other eco- two decades, discusses the subject in Chapter 22 of nomic incentives, such as the opportunity to create this volume. economic rents by intervening in markets. Nor is it A second area in which political economy has surprising that politicians and bureaucrats also been and continues to be crucial is in the analysis of respond to incentives of various kinds. Political the GATT and the WTO. Finger (1974, 1976a) economy may be broadly thought of as exploring demonstrated the centrality of reciprocity to GATT the role of political activities and forces in shaping tariff negotiations: despite the requirement that all economic behavior. Policy analysis must take it into tariff cuts be extended to all GATT partners, nego- account not only in predicting the outcomes of par- tiators chose commodities in such a way that much ticular policy changes but also, and more particular- of the benefit of a cut went to the country request- ly, in designing institutions and policy regimes. ing it (the principal supplier), and nearly all of the Political economy and trade policy are closely benefit went to countries taking active part in the linked because every trade intervention potentially negotiations. In passing, Finger also showed that the creates conflict between winners and losers--pro- developing countries which made significant con- ducers and consumers, agriculture and industry, cessions in the multilateral negotiations received far skilled and unskilled labor. Because all political sys- more concessions on their exports than did passive tems find it difficult to deal with redistribution observers. explicitly, trade policy presents both problems and Finger (1979) was being relatively unfashionable opportunities. Supporting a trade liberalization in observing that the critical political balance of the while providing explicit redistribution to prevent GATT was internal to countries, as exporters seek- anyone from losing is a big political challenge, ing market access abroad pressed import-compet- whereas using trade intervention as a form of covert ing sectors to concede market access at home. When redistribution that is buried beneath a pile of arcane U.S. legislation provided an alternative route for technical detail often looks like an attractive way of exporters to open foreign markets, in the form of protecting or rewarding specific interests. Section 301, which authorized unilateral trade sanc- Opacity can make trade policy very attractive. tions against trade-restricting partners, the whole Finger (1981) and Finger, Hall, and Nelson (1982) dynamic of U.S. support for the multilateral system showed that the mechanisms involved can be changed (Finger 1991b). Finger was prominent extremely subtle. Making protection subject to legal among those who had argued that for developing requirements and establishing expert investigative countries the principal requirement was not to authorities to establish the "facts" of the case all open up others' markets, but to open up their own serve to remove the process from public scrutiny. By (Finger and Kreinin 1976) and that in this respect making procedures complex and expensive, one can the GATT approach (and GATT-think) based solely turn an apparently objective pseudo-legal process on reciprocity was not very useful. Developing xv D E V E L O P M E N T, T R A D E , A N D T H E W T O countries must address their own needs directly via forces and shining a light on them (Jagdish Bhag- their own policy and should not view the multilat- wati's "Dracula principle"); redressing the balance eral system as providing a shortcut to good trade of forces in trade debates to promote consumer policy or good trade outcomes; it just does not do interests; and making transparent the winners and that (Finger and Winters 1998). losers from any action (or inaction); see, for exam- These political-economy problems figure promi- ple, Finger (1982, 1986). It also illustrates the dan- nently in this Handbook, for it is only by recogniz- gers of complexity, suggesting a second aspect of ing their force that they can be overcome. Thus, for operationalization: the use of rules of thumb in pol- example, Chapter 52, by Tarr, stresses the political- icymaking. Among the rules of thumb advocated in economy advantages of uniform tariffs, which are this Handbook by some authors are the use of uni- much more robust to lobbying than tailor-made form tariffs as a robust antidote to sectoral special tariffs. Rodrik, in Chapter 1, emphasizes the impor- pleading and rent-seeking, and promotion of effec- tance of developing local institutions as local solu- tive competition as the single most important tions to local problems rather than adopting objective in services markets. uniform institutions imposed by the international community, and this analysis is consistent with Fin- A Contestable Market for Policy Research ger's point about the costs of certain Uruguay Round institutions (Finger and Schuler 2000). In An important dimension of such beneficial compe- Chapter 22, Finger explores the political economy tition relates to policy analysis. The social function of safeguard provisions, and in Chapter 7 Finger of such research is to improve policy outcomes by and Winters explore what reciprocity means in the basing them on the best possible understanding of current broad agenda of the WTO. (It has no "exter- the effects of policy. De facto, its political function is nal" definition; it is whatever deal the parties are to smooth the path of decisionmaking by ensuring willing to agree on.) that relatively minor issues do not destroy social consensus and impose huge costs in the form of strife. This second function is not unimportant (as Operationalization of Policy Advice Rodrik notes in Chapter 1), but it is often at vari- Policy analysis is ultimately sterile if it does not ance with the first. The tension between the two change behavior. How to present and package the roles of policy research is felt most immediately in findings of analysis in ways that both strike chords official policy research centers. If analysts there stick with decisionmakers and are (relatively) easy to to the objective side of their brief, they are ignored, apply is critical. Again, Mike Finger leads the way. abused for being irrelevant or obstructionist, and The clarity and directness of his writing is a model often, as happened to Finger's unit in the U.S. Trea- for all researchers. And it is substantially achievable sury, closed down. If they stress the political aspects, by them too, for while it certainly requires talent, it they discredit themselves and, ultimately, their insti- mostly relies on thinking hard--and with brutal tutions as purveyors of information; indeed, they objectivity--and on working hard (spending time may even discredit analysis itself. And by giving a refining one's prose). Finger also has a talent for the politically convenient compromise a gloss of spuri- memorable phrase or metaphor: "Antidumping is ous intellectual respectability, analysts can sow the ordinary protection with a great public relations seeds of further problems by establishing the wrong program" (Finger 1993); "Where the WTO got it basis for thinking about future decisions. The falla- wrong, it was perhaps because the World Bank did cy that trade liberalization creates jobs (perpetrated, not get it at all" (Finger and Nogués 2002, on the for example, in the debate on the North American inappropriateness of certain Uruguay Round out- Free Trade Agreement), and its refutation by experi- comes for development);"Half of domestic interests ence, have made rational trade policy more difficult have no chance to score" (on antidumping, in to achieve. The fallacy that reductions of tariffs on a Chapter 22 below, with a picture of a soccer field of developing country's exports are more important which only one end has a goal). than reductions of tariffs on its imports has led to The discussion of political economy in the pre- the waste of huge resources on instruments such as ceding section covered some aspects of operational- trade preferences, the Generalized System of Prefer- izing trade policy advice: recognizing reactionary ences (GSP), and the New International Economic xvi A Tribute to J. Michael Finger Order and, ultimately, to the false notion that the Notes GATT/WTO process and good trade policy are 1 Similar arguments are made in Finger and Kreinin (1976) and coterminous (see Finger 1975, 2001; Finger and Finger (1982). Kreinin 1976). 2 This is not to decry basic economic science but merely to place How can this tension be resolved? In his valedic- it outside the box of policy research. tory speech to the U.S. Treasury (Finger 1981), Mike Finger observed that "political responsibility is the 3 The actual collection was mostly (and continues to be) done ultimate intellectual vasectomy." What is the by the UNCTAD, but the presentation and use of the data for policy analysis was pursued more vigorously by the World answer? It is to ensure that the market for policy Bank. research is open and contestable. Governments and international organizations require research arms, 4 Another example was Finger and DeRosa (1980), which showed with the simplest of tools that the IMF's Commodity but it is vital that others, outside government, are Compensatory Fund might not have the desired effect of stabi- also able to participate fully in this market. Govern- lizing developing countries. ments thus have to make data and information eas- 5 A CD-ROM that replicates the country schedules is available, ily available publicly, accept criticism, and be but it is not an electronic file of data. prepared to justify distributive judgments and deci- sions. Finger has shown by example what type of analy- sis is necessary for better policy choices and out- comes. We hope that this Handbook, and the kind of collaborative, research capacity­building effort on which it draws, will help stimulate others to emulate the "Finger approach" to policy research and analysis. BERNARD HOEKMAN L. ALAN WINTERS xvii blank Acknowledgments T he chapters included in this Hand- (UNCTAD); Diana Tussie, LATN; Ademola Oyejide, book are a product of a collaborative University of Ibadan and AERC; Rajesh Chadha, research and capacity-building project that involved National Council of Applied Economic Research scholars in developing countries, international (NCAER), New Delhi; Hana' Al-Sagban, ERF; Thier- experts, and World Bank trade economists and that ry Noyelle, United Nations Department of Economic was designed to assess the costs and benefits of fur- and Social Affairs (UNDESA); Dominique Njinkeu, ther multilateral rule-making and liberalization. In AERC; Mari Pangestu, Center for Strategic and addition to researchers based in national research International Studies, Jakarta; Alan Winters, Sussex organizations, the project draws on the work of a University; and Stephen Yeo, Centre for Economic number of research networks, including the Latin Policy Research (CEPR), London. We are grateful as American Trade Network (LATN); the Economic well to Constantijn Claessens, Antonio Estache, Research Forum for the Arab Countries, Iran, and Carsten Fink, Faezeh Foroutan, John Hegarty, Turkey (ERF); the African Economic Research Con- Charles Kenny, Dorsati Madani, Amrita Narlikar, sortium (AERC); the Coordinated African Program Christina Neagu, Claudia Orozco, Randeep Rathin- of Assistance on Services (CAPAS); and the Trade dran, and Gomi Senadhira, who contributed part or Policy Forum of the Pacific Economic Cooperation all of the material for boxes on specific topics. Council (PECC). The views expressed are entirely Many of the papers that were prepared under the those of the contributors, and do not necessarily auspices of the research capacity­building project reflect the views of the World Bank Group, the insti- of which this Handbook is a part have been pub- tutions that the authors are affiliated with, or the lished in journals and conference volumes. Papers countries they represent. written by members of the project and dealing The project was supported by a grant from the with many of the subjects covered in this Hand- U.K. Department for International Development book can be found in the April 2000 issue of The (DFID) and by the World Bank Institute, the World World Economy; the May 2001 issue of The Review Bank Research Support Budget, the government of of International Economics; Olarreaga and Rocha the Netherlands, and the Société Générale de Sur- (2000); Hoekman and Martin (2001); Stern veillance (SGS), Switzerland. We are particularly (2001); Martin and Pangestu (forthcoming); grateful to Susan Prowse and Charlotte Seymour- Maskus and Wilson (2001); and Mattoo and Stern Smith for their encouragement and guidance. (forthcoming). The editors are indebted to Maria Kasilag, Rebecca All of the members of the World Bank's trade Martin, Ana Rivas, Rob Simms, and Lili Tabada for team have been active contributors to the project, in excellent administrative support throughout the particular Will Martin, who has played a key role in project. We thank the following people for their managing the project and provided leadership in active engagement and participation in the delivery working with partners in Asia. Carsten Fink, and of various parts of the project: Kym Anderson, Ade- Keith Maskus have been unstinting in their willing- laide University; Bijit Bora, at the time with the Unit- ness to contribute and comment on materials. Fran- ed Nations Conference on Trade and Development cis Ng played an essential role in providing data to xix D E V E L O P M E N T, T R A D E , A N D T H E W T O participants. The Trade and Production Database that helped improve the final product. We thank CD-ROM included with the Handbook is the result those who acted as readers and discussants of chap- of the painstaking work of Marcelo Olarreaga and ters and the handbook as a whole, including Claude Alessandro Nicita. Miroslava Zervoudakis and Barfield, Paul Collier, Richard Eglin, Alan Gelb, Joe Faezeh Foroutan were key contributors to the pro- Francois, Jacob Kol, Patrick Messerlin, Douglas Nel- ject's Website, , which son, David Palmeter, Garry Pursell, Jayanta Roy, has become the major dissemination vehicle for the Alan Winters, Luc de Wulf, Jamel Zarrouk, and output generated by team members. Ambassador B. K. Zutshi. The chapters included in the Handbook benefited Finally, we acknowledge the considerable time from comments and feedback obtained from par- and effort that has been devoted to the preparation ticipants in workshops, conferences, and seminars, of the second CD-ROM included with this Hand- who are too numerous to be mentioned by name book, "Applied Trade Policy for Developing Coun- here. We are very grateful to the people and institu- tries: Outline, Content, and Readings for a Short tions that hosted and helped arrange these meet- Course." Our thanks go to the principal authors, ings, in particular Richard Eglin, Sam Laird, and Jaime de Melo, Centre d'Etudes et de Recherches sur Peter Tulloch of the WTO secretariat, who organ- le Développement International (CERDI), and ized a major conference in September 1999 and a Marc Bacchetta, WTO, and to their organizations, as day-long review seminar of the first draft of the well as to Olivier Jammes (CERDI) for CD-ROM Handbook in May 2001. Members of the WTO del- development. egations in Geneva provided invaluable suggestions xx Contributors Rudolf Adlung World Trade Organization Kym Anderson Adelaide University, Australia, and CEPR Marc Bacchetta World Trade Organization Bijit Bora World Trade Organization Antonia Carzeniga World Trade Organization Rupa Chanda Indian Institute of Management Philippe Chauvet World Trade Organization Rafael Cornejo Inter-American Development Bank Valentina Delich FLACSO/Argentina and LATN Jaime de Melo University of Geneva, CERDI, and CEPR Luc De Wulf Independent Consultant Liam Ebrill International Monetary Fund Philip English World Bank Simon J. Evenett World Trade Institute, Berne, and CEPR J. Michael Finger American Enterprise Institute, Washington,D.C. Carsten Fink World Bank Joseph F. Francois Erasmus University, Rotterdam, and CEPR Carlo Gamberale World Trade Organization Luis Jorge Garay S. Inter-American Development Bank Reint Gropp International Monetary Fund James Hodge University of Cape Town Bernard Hoekman World Bank and CEPR Peter Holmes University of Sussex, U.K. Gary N. Horlick O'Melveny & Myers, Washington, D.C. Robert E. Hudec Tufts University, Boston. Stefano Inama UNCTAD Veena Jha UNCTAD Hanaa Kheir-El-Din Cairo University Masamichi Kono Financial Services Authority (Japan) Sam Laird UNCTAD and University of Nottingham, U.K. Miguel F. Lengyel FLACSO/Argentina and LATN David F. Luke Organization for African Unity Catherine L. Mann Institute for International Economics, Washington, D.C. Will Martin World Bank Keith E. Maskus University of Colorado Aaditya Mattoo World Bank Andreas Maurer World Trade Organization xxi D E V E L O P M E N T, T R A D E , A N D T H E W T O Constantine Michalopoulos Independent consultant Francis Ng World Bank Alessandro Nicita University of Geneva Marcelo Olarreaga World Bank and CEPR T. Ademola Oyejide University of Ibadan, AERC, and the Development Policy Center, Ibadan, Nigeria Arvind Panagariya University of Maryland Mari Pangestu Centre for Strategic and International Studies, Jakarta Frank J. Penna The Policy Sciences Center, Inc., New Haven, Conn. Francisco Javier Prieto Organization of American States Garry Pursell Independent consultant Vinod Rege International trade consultant Dani Rodrik Harvard University Kamal Saggi Southern Methodist University, Dallas, Tex. Pierre Sauvé OECD Maurice Schiff World Bank Philip Schuler University of Maryland Howard J. Shatz Harvard University Eleanor Shea O'Melveny & Myers, Washington, D.C. Beata K. Smarzynska World Bank and CEPR Brian Rankin Staples Trade Facilitation Services, Ottawa Sherry M. Stephenson Organization of American States Robert M. Stern University of Michigan Janet Stotsky International Monetary Fund Arvind Subramanian International Monetary Fund David G. Tarr World Bank Simon Tay Member of Parliament, Singapore Diana Tussie FLACSO/Argentina and LATN Lee Tuthill World Trade Organization Coenraad J. Visser University of South Africa Jayashree Watal World Trade Organization John S. Wilson World Bank L. Alan Winters University of Sussex, U.K. and CEPR xxii Abbreviations ACIS Advance Cargo Information System ACP African, Caribbean, and Pacific (Cotonou Convention, formerly Lomé) ACWL Advisory Centre on WTO Law AD antidumping AERC African Economic Research Consortium AGOA African Growth and Opportunity Act (U.S.) AMS aggregate measure of support APEC Asia-Pacific Economic Cooperation ASEAN Association of Southeast Asian Nations ASYCUDA Automated System for Customs Data and Management (UNCTAD) ATC Agreement on Textiles and Clothing (WTO) ATPA Andean Trade Preferences Act BDV Brussels Definition of Value BIT Bilateral Investment Treaty BTN Brussels Tariff Nomenclature CAP Common Agricultural Policy (EU) CBD Convention on Biological Diversity CCC Customs Cooperation Council (now the WCO) CCCN Customs Cooperation Council Nomenclature CEFACT Center for Facilitation of Procedures and Practices for Administration, Commerce, and Transportation (UN) CGE computable general equilibrium (model) c.i.f. cost, insurance, and freight CRM customs reform and modernization CRTA Committee on Regional Trade Agreements (WTO) CTE Committee on Trade and Environment (WTO) CTH change in tariff heading CVD countervailing duty DSB Dispute Settlement Body (WTO) DSP dispute settlement procedures (WTO) DSU Dispute Settlement Understanding (WTO) EBA Everything but Arms (EU initiative for LDCs) EC European Community EDI electronic data interchange EDIFACT Electronic Data Interchange for Administration, Commerce, and Transport (UN) EEC European Economic Community EFTA European Free Trade Association xxiii D E V E L O P M E N T, T R A D E , A N D T H E W T O EPZ export-processing zone ERP effective rate of protection EU European Union FAO Food and Agriculture Organization of the United Nations FDI foreign direct investment f.o.b. free on board FSC foreign sales corporation FTA free trade area FTAA Free Trade Area of the Americas GATS General Agreement on Trade in Services (WTO) GATT General Agreement on Tariffs and Trade (WTO) GDP gross domestic product GMO genetically modified organism GNP gross national product GPA Agreement on Government Procurement (WTO) GSP Generalized System of Preferences GTAP Global Trade Analysis Project HCC Heads of Customs Conference (NAFTA) HS Harmonized Commodity Description and Coding System ICC International Chamber of Commerce ICTSD International Centre for Trade and Sustainable Development IDB Integrated Data Base (WTO) IECC International Express Carriers Conference IF Integrated Framework for Technical-Related Assistance, Including Human and Institutional Capacity Building to Support Least-Developed Countries in Their Trade and Trade-Related Activities IFIA International Federation of Inspection Agencies ILO International Labour Office IMF International Monetary Fund IPRs intellectual property rights ISIC International Standard Industrial Classification ISO International Organization for Standardization ITC International Trade Centre (UNCTAD and WTO) ITC International Trade Commission (U.S.) ITCB International Textiles and Clothing Bureau ITO International Trade Organization LATN Latin American Trade Network LDC least-developed country (UN classification) MAI Multilateral Agreement on Investment MEA Multilateral Environmental Agreement MENA Middle East and North Africa MERCOSUR Common Market of the South MFA Multifibre Arrangement MFN most-favored-nation MRA mutual recognition agreement MTA multilateral trade agreement MTN multilateral trade negotiation NAFTA North American Free Trade Agreement NATO North Atlantic Treaty Organization NGO nongovernmental organization NRP nominal rate of protection xxiv Abbreviations NTB nontariff barrier NTM nontariff measure OAU Organization of African Unity OECD Organisation for Economic Co-operation and Development OMA orderly marketing arrangement PPM production and processing method PSI preshipment inspection PTA preferential trading agreements Quad Canada, European Union, Japan, and the United States QR quantitative restriction R&D research and development RCA revealed comparative advantage RIA regional integration agreement ROO rules of origin SADC Southern African Development Community SCM subsidies and countervailing measures S&D special and differential (treatment) SDR Special Drawing Right SGS Société Générale de Surveillance SITC Standard International Trade Classification SPS sanitary and phytosanitary STE state trading enterprise TABD Transatlantic Business Dialogue TBT technical barriers to trade TMB Textiles Monitoring Body (WTO) TPO trade promotion organization TPRB Trade Policies Review Body (WTO) TPRM Trade Policies Review Mechanism (WTO) TRIM trade-related investment measure TRIPS Trade-Related Aspects of Intellectual Property Rights (WTO agreement) TRQ tariff rate quota UNCITRAL United Nations Committee on International Trade Law UNCTAD United Nations Conference on Trade and Development UNDP United Nations Development Programme USTR U.S. Trade Representative VER voluntary export restraint WCO World Customs Organization WHO World Health Organization WIPO World Intellectual Property Organization WITS World Integrated Trade Solution (World Bank) WTO World Trade Organization xxv blank Introduction M any countries have been less than institutions, trade policies, narrowly defined, are successful in integrating into the still important in today's international economic world economy and benefiting from trade reform landscape. Barriers to exports of some products in programs. The reasons are multifaceted and com- which developing countries have a comparative prise a mix of domestic and international factors. advantage remain high--tariffs on some agricultur- Barriers to trade and investment remain high in al products are over 100 percent. Agricultural subsi- many nations, with policy regimes implying signifi- dies in OECD countries exceeded US$300 billion in cant anti-export bias. Numerous countries have 2000, contributing to global price instability and been affected by civil strife and war. And in spite of impeding the ability of developing countries to the trade preferences granted by member countries compete on export markets. of the OECD, industrial country tariff structures are Trade between developing countries began to still characterized by escalating tariffs, with high grow rapidly in the 1990s, increasing the signifi- tariff peaks for agricultural products and for labor- cance of their own trade barriers for export interests intensive products such as clothing. in these countries. Antidumping actions are no There is general agreement that many complementa- longer limited to OECD economies but have come ry policies and institutions are needed to support trade to be used intensively by a number of developing policy reforms in order to create an enabling environ- countries. Barriers to trade in services are many ment for supply-side responses that generate employ- times those that apply to trade in merchandise, ment and economic growth. As Dani Rodrik argues in especially where movement of the service provider Chapter 1 of this Handbook,if trade policy reform is to is necessary. In many cases these barriers and detri- be successful, it must be embedded in and supported mental policies can be removed only through inter- by an effective institutional setting,and it must be com- national negotiations. plemented by other reforms. A large and complex International trade agreements, in particular the "behind-the-border" agenda has to be addressed if WTO agreement, have become the focal point for trade reform is to have its intended effect. Much many discussions on trade and investment policy. depends on complementary policies that define the As a result, policymakers and citizens of developing business environment--on policies regarding invest- countries are confronted with demands that a num- ment in human capital (education),infrastructure,and ber of trade policy­related issues be addressed in the quality of public and private sector governance. the context of multilateral or regional negotiations. The Handbook focuses on a number of the elements of This offers opportunities to pursue what are regard- that agenda, as well as on more"traditional"trade poli- ed as desirable domestic reforms, but it also poses cy issues such as the design of the tariff regime. risks associated with agreements or rules that may not be supportive of development prospects. The traditional mechanism driving trade agree- Trends in the Multilateral Trading System ments has been the reciprocal exchange of commit- Although the challenges confronting developing ments to reduce trade barriers. This mechanism countries primarily concern domestic policies and results in greater welfare improvements than can be xxvii D E V E L O P M E N T, T R A D E , A N D T H E W T O obtained through unilateral reform, as it generates WTO auspices to address developing country con- liberalization both at home and abroad and makes cerns. Similar calls were put forward in the prepara- politically feasible domestic trade reforms that oth- tions for the 2001 ministerial meeting in Doha. erwise might be blocked by powerful vested inter- The Doha Development Agenda that emerged ests. International cooperation can also be a useful from the meeting clearly reflects the increased device for pursuing domestic reforms that are indi- prominence of development concerns in WTO rectly linked to trade. As tariff barriers have fallen deliberations--in turn, the result of increased par- and quantitative restrictions have disappeared, the ticipation by developing countries in the trading focus of trade agreements has increasingly shifted system. All that was done, however, was to define an toward regulatory regimes that can have an impact agenda. Achievement of a prodevelopment outcome on trade and investment. remains a major challenge. Resistance to liberaliza- Multilateral negotiations on nonborder policies, tion of "hard-core" sectors such as agriculture and administrative procedures, and domestic legal textiles that are of key interest to developing coun- regimes have proved much more complex than talks tries is very strong; conversely, many low-income on traditional market access. Because it is more dif- countries are unwilling to extend the reach of the ficult to trade"concessions,"the focus tends to be on WTO to cover new issues. Implicitly, if not explicit- the identification of specific rules that should be ly, much of the discussion and debate at Doha con- adopted. Given the disparities in economic power cerned defining the limits of the WTO. Developing and resources among countries, the outcome often countries played a central role in this debate, with reflects the status quo in high-income countries. many resisting the further expansion of the WTO These may be fully consistent with the development into the territory of domestic regulation. priorities of low-income countries, but there is no The Doha Ministerial Declaration launches nego- presumption that this will be the case. tiations on market access for manufactures, dispute Developing country misgivings regarding the settlement, WTO rules, disciplines on regional inte- rule-making dimensions of the WTO became gration, environment, and intellectual property increasingly prominent in the 1990s. These con- rights (geographical indications). These talks will cerns centered on the costs required for implement- complement ongoing negotiations on agriculture ing some WTO agreements, the lack of adequate and services, as mandated by the Uruguay Round financial assistance, and the failure of high-income agreements. Negotiations are to be concluded by countries to grant "special and differential" treat- 2005. At the next WTO ministerial meeting, in 2003, ment to developing countries. (Most of the provi- negotiations will be launched on four "Singapore sions in the WTO agreements calling for such issues"--competition, investment, trade facilita- treatment are "best endeavor" commitments that tion, and transparency in government procure- are not binding on high-income countries.) A more ment--if agreement on modalities can be obtained fundamental concern was that the rules of the game by explicit consensus at that time. were not always compatible with national efforts to Whether the end result will be prodevelopment reduce poverty and increase economic growth. will depend to an important degree on the extent to For the rules to make sense for all members, which developing and industrial country trade bar- stakeholders in developing countries must partici- riers are lowered, and on the rules that emerge. A pate in the domestic policy formation process, be key determinant of the outcome of the negotiations able to inform national representatives of their will be effective and proactive developing country views, and hold their representatives accountable participation. This, in turn, requires a good under- for outcomes. If WTO agreements were unambigu- standing of where national interests lie and a good ously seen by constituencies in developing countries understanding of the substantive issues, not just by as being conducive to (or consistent with) the government officials but also by the private sector attainment of development objectives, these agree- and civil society. There is clearly a need to strength- ments could play a much more beneficial and effec- en capacity to undertake analysis and to identify tive role. In the run-up to the 1999 WTO ministerial national reform priorities, market access con- meeting in Seattle, a number of prominent straints, and the potential merits and implications observers and policymakers called for the launch of of multilateral disciplines. This Handbook is a "Development Round" of negotiations under intended as a contribution to that effort--as a use- xxviii Introduction ful resource for analysts and stakeholders engaged views do not necessarily reflect those of the institu- in the design of trade-related policies. tions with which they are affiliated. Not everyone will necessarily agree with all the policy recommendations made by the authors. After Objectives of the Handbook all, as we noted above, on a number of issues there is A major challenge confronting developing countries no "one size fits all" answer, and this is especially is to use international negotiations and cooperation true of regulatory policies. What matters most is to as instruments for improving their terms of trade ask the right questions and to determine the status and their access to export markets and as mecha- quo in a given area. It is important to obtain as nisms for adopting and implementing domestic pol- much information as possible regarding alternative icy reforms that will raise living standards and policy options, to understand what type of analysis reduce poverty. The design of trade policy reform is is needed to provide policy guidance, and to have a a complex matter that extends far beyond tariffs and good understanding of the prevailing multilateral quotas applied at the border. It must be comple- rules of the game. mented by policies designed to ensure that enter- Although much of what is contained in the Hand- prises can compete on world markets. There is no book is motivated by the fact that the issues are on "one size fits all" package of policy reform, and no the agenda of international negotiations, the magic bullet. Approaches will and must differ across emphasis of many contributors is on economic and countries, reflecting different circumstances, endow- development dimensions. The institutions and poli- ments, legal systems, and cultures. cies that are important for development and eco- One goal of this Handbook is to provide informa- nomic growth extend far beyond the subject areas tion on the implications of--and options offered that the WTO deals with or can deal with. Although by--international trade agreements, especially the the WTO can be useful in helping countries address WTO, for developing countries that seek to use specific bottlenecks and constraints that impede trade as a vehicle for development. Contributors trade, most of the trade policy agenda is domestic. It were asked to write relatively short chapters on a is therefore vital that policymakers and civil society variety of trade policy­related topics that are have a good understanding of what their national important from a development perspective and that priorities are and what makes for good policy, are subject to or affected by multilateral rules, or informed by the experiences of other countries, in may become so. The chapters assess the economics order to determine what types of multilateral coop- of the issues, survey what cross-country experience eration can help countries benefit from trade inte- suggests are good practices, and consider the pros gration. and cons of the possibilities for using international Relatively little emphasis is given in the Hand- cooperation as an instrument for improving both book to an enumeration of WTO disciplines. There domestic policy and access to export markets. are many readily available resources that can pro- Although there is an emphasis on the WTO, many vide the interested reader with such information, of the issues addressed also arise in the context of starting with the WTO Website, . regional integration agreements. The CD-ROM provided with this Handbook, Notwithstanding its length, this Handbook can "Applied Trade Policy for Developing Countries," only partially address the many policy issues that contains all of the major agreements and many arise in the course of efforts to integrate into the other WTO documents. Therefore, only key aspects world economy. The focus is on trade policy, broad- of WTO rules are discussed. Relatively more atten- ly defined to cover both traditional instruments of tion is given to the General Agreement on Trade in commercial policy--tariffs, customs administra- Services (GATS) and the Trade-Related Aspects of tion, and so on--and "new" issues such as services, Intellectual Property Rights (TRIPS) agreement intellectual property, and the behind-the-border than to General Agreement on Tariffs and Trade regulatory agenda that has implications for market (GATT) disciplines, since a wealth of analysis and access conditions. The approach is one of multiple information exists on "traditional" trade policy voices; the contributors include many authors who instruments. The chapters in the Handbook dealing have no connection to the World Bank. In all cases, with merchandise trade issues focus primarily on contributors wrote in a personal capacity, and their those subjects that are of greatest interest to devel- xxix D E V E L O P M E N T, T R A D E , A N D T H E W T O oping countries--tariff peaks, preferences, rules of Each of the eight parts begins with a short intro- origin, customs clearance and trade facilitation, duction that is intended as a reader's guide to the local content and other industrial policy measures, issues and to further reading. Annotated references, and export promotion. drawn in part from Hoekman and Kostecki (2001), One topic that is of major importance to develop- are listed in each introduction for those who are ing countries--agriculture and agricultural trade interested in pursuing in-depth discussion and policies--is not addressed in any depth in this analysis. To facilitate consultation of the citations in Handbook because it is the subject of a companion individual chapters, we have compiled an integrated volume (Ingco and Nash forthcoming). The same is bibliography, found at the end of the Handbook. true for another major issue area: trade and poverty. The boxes included in the chapters illustrate spe- Winters, in Chapter 5 of this volume, summarizes cific points or describe specific cases. Many of these the main messages and conclusions that have boxes were prepared by the editors of the Hand- emerged from the literature on trade and poverty. book, drawing on papers prepared for this project Those seeking a more in-depth treatment should and on the literature. The chapter authors are not consult McCulloch, Winters, and Cirera (2001), responsible for the content of those boxes written which reviews the literature and good practices con- by the volume editors or by other contributors. cerning the design of trade policy reforms from a The appendix includes a glossary and a set of poverty alleviation perspective. tables that present data on trade barriers for a large sample of countries. The glossary provides a listing of major WTO articles and provisions for the con- Structure of the Handbook venience of readers who are not familiar with the This volume has eight parts. The chapters in Part I WTO, as well as succinct descriptions and defini- place trade policy reform in a development context tions of key trade-related institutions and policies. and discuss key dimensions of reform. Part II deals A CD-ROM containing data on tariffs, trade, and with the main aspects of the WTO. Parts III, IV, and production is packaged with the Handbook. The V cover the areas that are the subject of WTO rules: database is described briefly in the appendixes and trade in goods, trade in services, and the protection is more fully documented on the CD-ROM. We of intellectual property. Part VI contains discussions have also included in the appendixes and on the of a number of regulatory issues; many of these CD-ROM a short guide to the most commonly used have not been subject to multilateral rules but are indicators and indices that can be applied to the now being introduced into the WTO agenda due to data. More detailed datasets and analytical tools strong interest on the part of some high-income that can be used for negotiations are being devel- countries and nongovernmental organizations. Spe- oped in cooperation with UNCTAD; this set of tools cific process-related concerns of developing coun- will be released in mid-2002. tries are the subject of Part VII; these include A second CD-ROM contains the teaching modules participation in the WTO, capacity building, and developed by Jaime de Melo and Marc Bacchetta implementation of WTO agreements. Finally, the during their many years of conducting an intensive chapters in Part VIII summarize a number of rules two-week course for government officials, cospon- of thumb for good trade policy and review sored by the World Bank Institute and the WTO. The approaches to using the WTO (and regional agree- CD-ROM also includes an extensive set of readings ments) as instruments for promoting development. and, as noted above, official WTO documents. xxx I TRADE POLICY REFORM IN CONTEXT I t is useful to make a distinction between appropriate macroeconomic incentive environment reduction in border barriers to trade and and embedded in a comprehensive development and "behind-the-border" complementary poli- poverty reduction strategy. Complementary institution- cies that are critical in supporting trade policy reforms. al reform efforts and improvements in the legal and The first set of policies focuses on creating incentives regulatory environment that increase investor confi- for efficient growth by reducing the average level and dence are vital if trade liberalization is to serve as an the dispersion of border protection, eliminating non- engine of growth. Key elements of the associated tariff barriers (NTBs), and strengthening the public behind-the-border trade agenda include efficient regu- institutions needed to ensure that goods cross fron- latory regimes, institutions that support the participa- tiers with low transactions costs (i.e., efficient customs tion of national firms in international markets, and regimes that minimize red tape). The second set has measures to enhance the competitiveness of these firms to do with regulatory standards and policies to ensure by providing access to crucial services inputs. Dani that supply responses to liberalization are efficient, Rodrik, in Chapter 1, examines some of these issues. equitable, and enduring. Important issues here The trade agenda has become increasingly com- include liberalization of trade in services sectors to plex in the past decade, and where it starts and enhance competitiveness, policies to promote access ends is not clear. What is clear is that the standard to information and technology, and strengthening of approach found in most textbooks--which focuses institutions in order to benefit from participation in on policy instruments that are applied at the border regional and multilateral trade arrangements. and that affect the domestic prices of goods or The chapters in this part focus on aspects of the com- export prices (tariffs, quotas, export subsidies, and plementary agenda. A strategy for sustained trade taxes)--is too narrow. In practice, the trade agenda expansion and growth must be framed within an spans all policies that have the effect of discriminat- 1 T R A D E P O L I C Y R E F O R M I N C O N T E X T ing against foreign providers (suppliers) of goods, A key message that emerges from the chapters in services, and production factors (knowledge, labor, this part is the need for analysis that focuses not and capital), and it takes in the functioning of insti- only on trade policy narrowly defined but also on tutions that affect the investment climate in a coun- the complementary reforms and institutions that are try. The recognition that trade policy has a much required if trade reforms are to benefit society. Such wider ambit than border policies implies that gov- analysis should include a diagnosis of the current sit- ernments and civil society must have a broad focus uation, benchmarking in relation to good practice and must consider the interrelationships between and competitors, determination of the incentive different policy areas and the operation and effec- and redistributional implications of status quo poli- tiveness of existing institutions. Kym Anderson, in cies and possible changes, and identification of the Chapter 2, emphasizes the need for an economy- complementary actions that are needed to make wide perspective on trade policy reform. trade reform an effective component of a poverty- Key complementary factors that often determine reducing growth strategy. the success of trade policy reform are the real exchange rate and the ability of the government to Further Reading maintain revenue collection objectives. As Howard J. Schatz and David G. Tarr document in Chapter 3, Jeffrey Sachs and Andrew Warner, "Economic Reform although countries may maintain different types of and the Process of Global Integration," Brookings exchange rate regimes, allowing the real exchange Papers on Economic Activity, 1 (1995): 1­118, is a rate to appreciate significantly over time has often widely read and influential empirical study that finds led to the failure of trade reforms. Chapter 4, by an unambiguous positive relationship between open- Liam Ebril, Janet Stotsky, and Reint Gropp, examines ness and economic performance. Dani Rodrik, Has the fiscal implications of trade liberalization. Tariff Globalization Gone Too Far? (Washington, D.C.: Insti- revenue remains important for many low-income tute for International Economics, 1997), provides a countries. In pursuing further tariff reform, efforts skeptical view of the benefits of globalization for have to be made to develop alternative domestic growth and welfare in the absence of the institutions tax bases and to ensure that reliance on tariff rev- and policies needed to manage downside risks. An enues does not needlessly distort resource allocation accessible account of the effects of the inward-look- incentives. Cross-country experience suggests that ing, import-substituting development strategies pop- policy reforms can be designed so as to maintain or ular in the 1960s and 1970s, as well as the shift increase revenue collection. toward more outward-looking policies in the 1980s, Although the available research indicates that trade is given by Jagdish Bhagwati in Protectionism (Cam- liberalization reduces poverty overall, segments of the bridge, Mass.: MIT Press, 1988). Edward Buffie, Trade poor may be hurt by it, and in Chapter 5, L. Alan Win- Policy in Developing Countries (Cambridge, U.K.: Cam- ters looks at the interactions between trade reform bridge University Press, 2001), analyzes trade policy and poverty alleviation. Reform programs supporting in an integrated framework that allows for economic liberalization must be complemented by efforts to dynamics and incorporates the structural features of strengthen social safety nets. Since some of the poor developing countries. Neil McCulloch, L. Alan Win- are likely to be so destitute that any decrease in ters, and Xavier Cirera, Trade Liberalization and Pover- incomes will impose extreme hardship, it is important ty: A Handbook (London: Centre for Economic Policy to identify which of them may be adversely affected Research, 2001), provides a comprehensive treat- by reforms and to determine the most appropriate set ment of the links between trade and poverty in the of policies to complement trade reform. context of the WTO. 2 1 D A N I R O D R I K Trade Policy made and implemented, estab- lishes new constraints and oppor- tunities for economic policy more Reform as broadly, creates a new set of stake- holders while disenfranchising the Institutional previous ones, and gives rise to a new philosophy (alongside a new Reform rhetoric) on what development policy is all about. Hence, trade reform ends up being much more than a change in relative prices: it results in institutional reform of a major kind. E In the language of economics, conomists are trained to think institutional reform changes not only policy param- about trade policy reform in terms eters but also behavioral relationships. Correspond- of changes in the levels of tariffs and quantitative ingly, the resource-allocation and dynamic restrictions (QRs) and the shifts in relative prices consequences of trade reform become harder to dis- brought about by these alterations. They use eco- cern using the type of analysis that is the applied nomic models, supplemented by quantitative esti- economists' stock in trade. Household behavior and mates of elasticities, to analyze the implications of investment decisions get altered in ways that are dif- changes in tariffs and QRs for production, con- ficult to track in the absence of knowledge about the sumption, and trade. By tweaking their models suf- "deep parameters" of the economy. When the ficiently, they can predict the likely impacts on reform is well designed and consistent with the employment, poverty and distribution, macroeco- institutional needs of the economy, it can spur nomic balances, and the government budget. If they unexpected levels of entrepreneurial dynamism and are ambitious (reckless?), they will also pass judg- economic growth. When it is not, it can result in a ment on dynamic efficiency, technological progress, stagnation that will appear surprising. and long-run economic growth. Viewing trade reform as institutional reform Policymakers often have a different perspective on helps clarify the criteria by which trade reform trade reform. For them, the actual changes in tariff should be evaluated. My main argument in this schedules are typically only a small part of the process. chapter is that the relevant criterion is neither open- What is at stake is a deeper transformation of the pat- ness to trade nor consistency with existing WTO terns of behavior within the public sector, and of the rules.1 The yardstick that matters is the degree to government's relationship with the private sector and which trade reform contributes to the construction the rest of the world. The reform goes beyond particu- of a high-quality institutional environment at home. lar levels of tariffs and QRs: it sets new rules and My working hypothesis, supported by empirical expectations regarding how these policy choices are evidence to which I will refer below, is that a high- 3 T R A D E P O L I C Y R E F O R M I N C O N T E X T quality institutional environment has greater eco- oriented reforms in Latin America and the growing nomic payoffs than a liberal trade regime or adher- realization that these reforms have paid too little ence to WTO rules. attention to mechanisms of social insurance and to In practice, there may be some important safety nets. The third and most recent is the Asian spillovers among these objectives. To cite an impor- financial crisis, which has shown that allowing tant illustration, a free trade regime is likely to financial liberalization to run ahead of financial reduce the corruption and rent-seeking associated regulation is an invitation to disaster. A number of with trade interventions. Similarly, tariff bindings recent empirical studies have highlighted the under the WTO may generate greater predictability importance of high-quality institutions in shaping in incentives and solidify property rights--two economic performance (see, especially, Kaufmann, important attributes of a high-quality institutional Kraay, and Zoido-Lobatón 1999; Acemoglu, John- framework. But while free trade and WTO rules can son, and Robinson 2000). contribute to the emergence of high-quality institu- Following Lin and Nugent (1995: 2306­07), it is tions, these are not one and the same. Institutional useful to think of institutions broadly as "a set of development takes time and often requires humanly devised behavioral rules that govern and unorthodox and divergent choices. Some of the shape the interactions of human beings, in part by most spectacular cases of development in the post- helping them to form expectations of what other war period have been the product of gradualist, people will do." All well-functioning market two-track modes of institutional reform (Rodrik economies are "embedded" in a set of nonmarket 2000b). The type of investments in institution- institutions, without which markets cannot per- building required for full adherence to WTO agree- form adequately. I will highlight below five types of ments on, say, customs valuation or intellectual market-supporting institutions in particular: prop- property rights (IPRs) may not be the first order of erty rights, regulatory institutions, institutions for business for low-income countries with more macroeconomic stabilization, institutions for social urgent needs (Finger and Schuler 2000). Since insurance, and institutions of conflict management. human resources, administrative capacity, and I emphasize as well the variety of institutional political capital are scarce, especially in developing setups that is compatible with superior economic countries, policymakers need to have a good sense performance. of the priorities. An implication of this line of reasoning is that we Property Rights should think of the trade regime and WTO rules as being at the service of developing countries' institu- As North and Thomas (1973) and North and Wein- tional needs, not vice versa. Governments that gast (1989), among many others, have argued, the understand this are the ones that are likely to make establishment of secure and stable property rights the most of trade reform. has been a key element in the rise of the West and the onset of modern economic growth. It stands to reason that an entrepreneur would not have the Institutional Prerequisites for Development incentive to accumulate and innovate unless s/he Price reforms--in external trade, in product and had adequate control over the return to the assets labor markets, in finance, and in taxation--were the that are thereby produced or improved. Note that rallying cry of the reformers of the 1980s, along the key word is "control," rather than "ownership." with macroeconomic stability and privatization. By Formal property rights do not count for much if the 1990s, it had become clear that incentives would they do not confer control rights. By the same not work, or would generate perverse results, in the token, sufficiently strong control rights may do the absence of adequate institutions. Three sets of dis- trick even in the absence of formal property rights. parate developments have conspired to put institu- In Russia today, shareholders have property rights tions squarely on the agenda of reformers. One of but often lack effective control over enterprises, these was the dismal failure in Russia of price whereas in China's township and village enterprises reform and privatization in the absence of a sup- control rights have spurred entrepreneurial activity portive legal, regulatory, and political apparatus. A even in the absence of clearly defined property second is the lingering dissatisfaction with market- rights. 4 Trade Policy Reform as Institutional Reform As these instances illustrate, establishing "proper- States has both the world's freest markets and the ty rights" is rarely a matter of just passing a piece of world's toughest antitrust enforcement. The lesson legislation. Legislation in itself is neither necessary that market freedom requires regulatory vigilance nor sufficient for the provision of secure control has been driven home recently by experience in East rights. In practice, control rights are upheld by a Asia. In the Republic of Korea and in Thailand, as in combination of legislation, private enforcement, so many other developing countries, financial liber- and custom and tradition. They may be distributed alization and capital account opening led to finan- more narrowly or more diffusely than property cial crisis precisely because of inadequate prudential rights. Moreover, property rights are rarely absolute, regulation and supervision. even when set formally in the law. Each society In developing countries, where market failures are decides for itself the scope of allowable property pervasive, regulatory institutions may need to rights and the acceptable restrictions on their exer- extend beyond the standard list covering antitrust, cise. Intellectual property rights are protected assid- financial supervision, securities regulation, and the uously in the United States and most advanced like. Recent models of coordination failure and cap- societies but not in many developing countries. By ital market imperfections make it clear that strategic contrast, zoning and environmental legislation government interventions may often be required to restricts the ability of households and enterprises in escape low-level traps and elicit desirable private rich countries to do as they please with their "prop- investment responses.2 The experience of Korea and erty" to a much greater extent than is the case in Taiwan (China) in the 1960s and 1970s can be inter- developing countries. All societies recognize that preted in that light. The extensive subsidization and private property rights can be curbed if doing so government-led coordination of private investment serves a greater public purpose. It is the definition in these two economies played a crucial role in set- of what constitutes a "greater public purpose" that ting the stage for self-sustaining growth. It is clear varies. that many other countries have tried and failed to replicate these institutional arrangements. And even Korea may have taken a good thing too far by main- Regulatory Institutions taining the cozy institutional linkages between the Markets fail when participants engage in fraudulent government and chaebols well into the 1990s, at or anticompetitive behavior. They fail when trans- which point these ties may have become dysfunc- actions costs prevent the internalizing of technolog- tional. Once again, the lesson is that desirable insti- ical and other nonpecuniary externalities. And they tutional arrangements vary, and that they vary not fail when incomplete information results in moral only across countries but also within countries over hazard and adverse selection. Economists recognize time. these failures and have developed the analytical tools required to think systematically about their Institutions for Macroeconomic Stabilization consequences and the possible remedies. Theories of the second best, imperfect competition, agency, Markets are not necessarily self-stabilizing. Keynes and mechanism design, to name but a few, offer an and his followers worried about shortfalls in aggre- almost embarrassing choice of regulatory instru- gate demand and the resulting unemployment. ments for countering market failures. Theories of More recent views of macroeconomic instability political economy and public choice offer cautions stress the inherent instability of financial markets against unqualified reliance on these instruments. and its transmission to the real economy. All In practice, every successful market economy is advanced economies have come to acquire fiscal overseen by a panoply of regulatory institutions that and monetary institutions that perform stabilizing regulate conduct in goods, services, labor, asset, and functions, having learned the hard way about the financial markets. A few acronyms from the United consequences of not having them. Probably most States will suffice to give a sense of the range of important among these institutions is a lender of institutions involved: FTC, FDIC, FCC, FAA, last resort--typically, the central bank--that guards OSHA, SEC, EPA, and so on. In fact, the freer are the against self-fulfilling banking crises. markets, the greater is the burden on regulatory There is a strong current within macroeconomics institutions. It is not a coincidence that the United thought that disputes the possibility or effectiveness 5 T R A D E P O L I C Y R E F O R M I N C O N T E X T of stabilizing the macroeconomy through monetary represented well by the Japanese case, is one in and fiscal policies. There is also a sense in policy cir- which social insurance is provided through a com- cles, particularly in Latin America, that fiscal and bination of enterprise practices (such as lifetime monetary institutions, as currently configured, have employment and enterprise-provided social bene- added to macroeconomic instability, rather than fits), sheltered and regulated sectors (mom-and- reduced it, by following procyclical rather than anti- pop stores), and an incremental approach to cyclical policies. These developments have spurred liberalization and external opening. the trend toward central bank independence and Social insurance legitimizes a market economy have helped open a new debate on designing more because it renders it compatible with social stability robust fiscal institutions. Some countries (Argenti- and social cohesion. But the existing welfare states na being the most significant example) have given in Western Europe and the United States engender a up on a domestic lender of last resort altogether by number of economic and social costs--mounting replacing their central bank with a currency board. fiscal outlays, an "entitlement" culture, long-term The debate over currency boards and dollarization unemployment--that have become increasingly illustrates the obvious, but occasionally neglected, apparent. Partly because of this experience, devel- fact that the institutions needed by a country are oping countries, such as the countries in Latin not independent of that country's history. America that adopted the market-oriented model following the debt crisis of the 1980s, have not paid sufficient attention to creating institutions of social Institutions for Social Insurance insurance. The upshot has been economic insecuri- One of the liberating effects of a dynamic market ty and a backlash against the reforms. How these economy is that it frees individuals from their tradi- countries will maintain social cohesion in the face tional entanglements--the kin group, the church, of large inequalities and volatile outcomes, both of the village hierarchy. The flip side is that it uproots which are being aggravated by the growing reliance them from traditional support systems and risk- on market forces, is an important question that has sharing institutions. Gift exchanges, the fiesta, and no obvious answer. kinship ties--to cite just a few of the social arrange- ments for equalizing the distribution of resources in Institutions of Conflict Management traditional societies--lose many of their social insurance functions. And as markets spread, the tra- Societies differ in their cleavages. Some are made up ditional ways of managing the risks that have to be of an ethnically and linguistically homogenous insured against become much less effective. A mod- population marked by a relatively egalitarian distri- ern market economy is one where idiosyncratic bution of resources. Others are characterized by (individual-specific) risk to incomes and employ- deep cleavages along ethnic or income lines. These ment is pervasive. divisions often hamper social cooperation and The huge expansion of publicly provided social engender social conflict. Economists have used insurance programs during the 20th century is one models of social conflict to shed light on questions of the most remarkable features of the evolution of such as: Why do governments delay stabilizations advanced market economies. In the United States it when delay imposes costs on all groups? Why do was the trauma of the Great Depression that paved countries rich in natural resources often do worse the way for major institutional innovations in this than countries that are resource-poor? Why do area: social security, unemployment compensation, external shocks often lead to protracted economic public works, public ownership, deposit insurance, crises that are out of proportion to the direct costs and legislation favoring unions. In Europe the roots of the shocks themselves? of the welfare state reached in some cases to the tail Healthy societies have a range of institutions that end of the 19th century. But the striking expansion make such colossal coordination failures less likely. of social insurance programs, particularly in the The rule of law, a high-quality judiciary, representa- smaller economies most open to foreign trade, was tive political institutions, free elections, independent a post­World War II phenomenon. Social insurance trade unions, social partnerships, institutionalized need not always take the form of transfer programs representation of minority groups, and social insur- paid out of fiscal resources. The East Asian model, ance are examples of such institutions. What makes 6 Trade Policy Reform as Institutional Reform these arrangements function as institutions of con- tries that face the prospect of adopting the EU's flict management is that they entail a double "com- Common Agricultural Policy or its antidumping mitment technology": they warn the potential regime. It all depends on the circumstances and on "winners" from social conflict that their gains will be how national governments are able to use such cir- limited and assure the "losers" that they will not be cumstances. expropriated. They tend to increase the incentives One way that governments can use institutional for social groups to cooperate by reducing the payoff arbitrage to good effect is to enhance the credibility to socially uncooperative strategies. of domestic institutions. For example, the new disci- plines imposed on developing country governments by the WTO--in the areas of tariff bindings, quanti- Trade Policy and Institutional Reform tative restrictions, services, subsidies, trade-related What is the link between trade policy reform and investment measures (TRIMs), and intellectual these institutions? Trade reform often entails the property--can be viewed as helping these govern- importation of institutions from abroad. Sometimes ments overcome traditional weaknesses in their style this is the outcome of deliberate policy actions to of governance. These disciplines impose a certain "harmonize" a country's economic and social insti- degree of predictability, transparency, rule-bound tutions with those of its trading partners. Member- behavior, and nondiscrimination in areas of policy ship in the WTO, for example, requires the adoption often subject to discretion and rent-seeking. In the of a certain set of institutional norms: nondiscrimi- same vein, perhaps the greatest contribution of the nation in trade and industrial policies, transparency North American Free Trade Agreement (NAFTA) to in the publication of trade rules, WTO-consistent the Mexican economy was the element of irre- patent and copyright protection, and so on. Similar- versibility and "cementing" that the agreement has ly, membership in the European Union (EU) contributed to Mexico's economic reforms. In requires the adoption of wide-ranging legal and Europe the accession of Greece, Portugal, and Spain bureaucratic requirements set down in Brussels. to the EU has made return to military dictatorship in At other times, institutional arbitrage is the result those countries virtually unthinkable. of the working out of market forces. Mobility of Imported institutions, however, can also turn out employers around the world, for example, makes it to be ill suited or counterproductive. Many of the harder to tax corporations and tilts national regimes labor standards that some labor groups in the North toward the taxation of nontraded goods and factors, would like developing countries to adopt--such as such as labor. Financial integration raises the premi- higher minimum wages or restrictions on some um for macroeconomic stability and makes central kinds of child labor--may fit in this category. The bank independence look more desirable. Finally, new patent restrictions called for by the Trade-Relat- openness can change national institutions by alter- ed Aspects of Intellectual Property Rights (TRIPS) ing the preferences that underlie them. Civil liber- agreement of the WTO are at best a mixed blessing ties and political freedoms are among the most for countries such as India that have so far benefited important imported concepts in the developing from cheap pharmaceuticals. A similar argument world; the demands for democracy to which these can be made about pressures for tightening environ- ideas give rise are a direct product of openness in mental standards in developing countries. this broad sense. Successful institutional reforms typically combine Arbitrage in markets for goods and capital, in the imported blueprints with local flavor. A good exam- absence of second-best complications, is associated ple of this in the area of trade comes from Mauri- with normatively desirable outcomes; it increases tius, where superior economic performance has efficiency. One cannot make the same presumption been built on a peculiar mix of orthodox and het- where arbitrage in institutions is concerned. There erodox strategies. This economy's success derives in are no theorems stating that institutional conver- large part from an export-processing zone (EPZ), gence, harmonization, or "deep integration" which operates under free trade principles. The EPZ through trade is inherently desirable. While many of has enabled a boom in exports of garments to Euro- the examples cited above involve outcomes that are pean markets and an accompanying investment desirable (greater democracy, for instance), this is boom at home. Yet the island's economy has com- not true of all possible outcomes. Think of the coun- bined the EPZ with a domestic sector that was high- 7 T R A D E P O L I C Y R E F O R M I N C O N T E X T ly protected until the mid-1980s. The origins of this tary and phytosanitary measures (SPS), and intel- essentially dual-track strategy (not unlike that fol- lectual property rights (IPRs)--a sum equal to a lowed in China) lay in the social and political make- year's development budget for many of the least- up of the island and in the decision by policymakers developed countries. Would this be money well not to disrupt a fragile ethnic situation through an spent? Finger argues that for the vast majority of across-the-board liberalization that would have dis- developing countries, the answer is no. Although advantaged established import-substituting groups. these countries would benefit from the strengthen- The EPZ scheme, in fact, provided a neat way ing of their institutions in the relevant areas, the around the political difficulties. The creation of the reality is that "WTO obligations reflect little aware- EPZ generated new opportunities in trade and ness of development problems.""Other alternatives, employment without removing protection from the e.g., basic education for women and girls, would import-substituting groups or from the male work- have much more attractive rate-of-return numbers" ers who dominated the established industries. The (Finger 1999). It is a safe bet that any new trade segmentation of labor markets early on between round will shorten the leash on developing coun- male and female workers, with women predomi- tries further, even if pressure in the controversial nantly employed in the EPZ, was crucial, as it pre- areas of environment and labor can be fended off. vented the expansion of the EPZ from driving wages Integration into the world economy has other, up in the rest of the economy and hurting import- more subtle institutional requirements, as well. substituting industries. New profit opportunities Openness implies heightened exposure to external were created at the margin while leaving old oppor- risk and, consequently, greater demand for social tunities undisturbed. insurance. Greater provision of social insurance One can cite other instances of heterodox trade seems to be a key factor behind the empirical regu- reforms that proved successful because they suited larity that governments tend to be bigger in existing political and institutional realities. Korea's economies where trade makes up a higher share of outward orientation during the 1960s, for example, GDP (Rodrik 1998). More broadly, openness was achieved not through import liberalization (of increases the premium on institutions of conflict which there was little), but through export subsi- management (Rodrik 1999). dization (of which there was a lot). This type of It is often overlooked that the most successful reform is now prohibited under existing WTO rules "globalizers" of an earlier era--the East Asian on subsidies. Similarly, China's two-track reform "tigers"--had to abide by few international con- strategy in agriculture, industry, and trade, which straints and had to pay few of the costs of integra- maintained nonmarket institutional forms while tion during their formative growth experience in aligning incentives correctly at the margin, has been the 1960s and 1970s. Global trade rules essentially wildly successful. These are cases in which imagina- gave them a free ride, and capital mobility was hard- tive experimentation with institutional reform has ly an issue. This is why these countries can hardly be had, in all likelihood, greater payoffs than the considered poster children for today's globalization. wholesale transplantation of institutions from Korea, Taiwan (China), and the other East Asian advanced industrial countries would have had.3 economies had the freedom to do their own thing, and they used it abundantly. As noted above, they combined their reliance on trade with unorthodox Integration into the World Economy as a policies--export subsidies, domestic content Model of Institutional Reform requirements, import-export linkages, patent and WTO membership entails institutional reforms that copyright infringements, restrictions on capital are not only demanding, but also of a particular flows (including on foreign direct investment), kind. One can question, as Michael Finger has elo- directed credit, and so on--that are either preclud- quently done, the fit between these reforms and the ed by today's rules or greatly frowned on. The envi- needs of developing countries, particularly of the ronment for today's globalizers is quite different. least developed among them. Finger has calculated None of the institutional reforms needed for that it would cost a typical developing country insertion in the world economy is bad in and of US$150 million to implement requirements under itself, and in fact, many of them can be indepen- the WTO agreements on customs valuation, sani- dently desirable, as I argued above. Some can also 8 Trade Policy Reform as Institutional Reform have unintended benefits. For example, a govern- phenomena (overvalued currencies or macro insta- ment that is forced to protect the rights of foreign bility) or geographic determinants (such as location investors perhaps becomes more inclined to protect in the tropical zone) to trade policies proper. Once the basic human rights of its own citizens, too. This simple corrections are made for such problems, one was a potent argument in U.S. debates, prior to rarely finds a statistically significant relationship China's accession to the WTO, about China's per- between the level of tariff and nontariff barriers and manent normalized trade relations (PNTR) status. economic growth across countries. But one has to recognize that a strategy of institu- There are, in fact, reasons to be skeptical about tional reform based on global integration is a strate- the existence of a general, unambiguous relation- gy of trickle-down institutional reform. The ship between trade openness and growth. The rela- reforms may or may not trickle down, and even tionship is likely to be a contingent one, dependent when they do, they will rarely constitute the most on a host of country and external characteristics. effective way of targeting the desired ends, whether The fact that practically all of today's advanced those ends are legal reform, improved observance of countries embarked on their growth behind tariff human rights, or reduced corruption. Institutional barriers and reduced protection only subsequently change is costly and requires the expenditure of surely offers a clue of sorts. Moreover, the modern scarce human resources, administrative capabilities, theory of endogenous growth yields an ambiguous and political capital. The priorities implied by glob- answer to the question of whether trade liberaliza- al insertion will not always coincide with the priori- tion promotes growth. The answer varies depending ties of a more fully developmental agenda. on whether the forces of comparative advantage push the economy's resources in the direction of activities that generate long-run growth (via exter- Can We Rely on a Growth Payoff from nalities in research and development, expansion of Openness? product variety, upgrading of product quality, and Global integration carries opportunity costs because so on) or divert them from such activities. Finally, as of the institutional consequences that such a strategy I have stressed throughout, the institutional setting entails. These costs have to be traded off against the in which trade policy operates is more important expected benefits. All economists know that gains for economic performance than the levels at which from trade exist, but the standard gains from trade specific trade barriers are set. tend to be small. The tendency in policy discussions No country has developed successfully by turning has been to go considerably beyond the standard case its back on international trade and long-term capi- for trade and to claim that open trade policies pro- tal flows. Very few countries have grown over long duce significant boosts in economic growth rates. periods of time without experiencing an increase in This claim is apparently supported by a large cross- the share of foreign trade in their national product. national empirical literature. Recently, Francisco In practice, the most compelling mechanism that Rodríguez and I reviewed the extensive literature on links trade with growth in developing countries is the relationship between trade policy and growth that imported capital goods are likely to be signifi- (Rodríguez and Rodrik 2001) and reached the con- cantly cheaper than those manufactured at home. clusion that there is a significant gap between the Policies that restrict imports of capital equipment, message that the consumers of this literature have raise the price of capital goods at home, and thereby derived and the "facts" that the literature has actually reduce real investment levels have to be viewed as demonstrated. The gap emerges from a number of undesirable prima facie. Exports, in turn, are factors. In many cases the indicators of "openness" important, since that is what one purchases import- used by researchers are problematic as measures of ed capital equipment with. trade barriers or are highly correlated with other But it is equally true that no country has devel- sources of poor economic performance. In other oped simply by opening itself up to foreign trade cases the empirical strategies used to ascertain the and investment. The trick in the successful cases has link between trade policy and growth have serious been to combine the opportunities offered by world shortcomings, the removal of which results in signif- markets with a domestic investment and institu- icantly weaker findings.4 One common problem has tion-building strategy to stimulate the animal spir- been the misattribution of either macroeconomic its of domestic entrepreneurs. Almost all of the 9 T R A D E P O L I C Y R E F O R M I N C O N T E X T outstanding cases--East Asia, China, India since the along these lines. I have argued here that the first early 1980s--involve partial and gradual opening question policymakers contemplating trade reform up to imports and foreign investment. should ask is not whether the reform will result in The appropriate conclusion to draw from the evi- higher volumes of trade, render their trade regime dence is not that trade protection should, as a rule, more liberal, or increase market access abroad but be preferred to trade liberalization. There is no evi- whether it will improve the quality of institutions at dence from the past 50 years that trade protection is home. The results of trade negotiations--whether systematically associated with higher growth. The bilateral, regional, or multilateral--should be point is simply that the benefits of trade openness judged by the same yardstick. should not be oversold. When other worthwhile policy objectives are competing for scarce adminis- Notes trative resources and political capital, deep trade liberalization often does not deserve the high prior- This chapter draws heavily on several earlier papers, in particular ity it typically receives in development strategies. Rodrik 1999, 2000a, and 2000b. This is a lesson that is of particular importance to 1 It should go without saying that openness to trade and adher- countries, such as those in Africa, that are in the ence to WTO rules are not the same thing. A country can fol- early stages of reform. low free trade policies without being a member of the WTO, and many WTO rules are at variance with free trade (as in the cases of antidumping, safeguards, and regional agreements). Conclusion 2 See Hoff and Stiglitz (2000) for a useful survey and discussion. A high-quality policy environment is one that sends 3 See Kapur and Webb (2000) and Pistor (2000) for useful dis- clear signals to producers and investors, precludes cussions of the limitations of importing legal and institutional rent-seeking, does not waste economic resources, is forms from abroad. consistent with the administrative capabilities of the 4 Our detailed analysis covers the five papers that are probably government, and maintains social peace. Trade pol- the best known in the field: Dollar (1992); Sachs and Warner icy reform contributes to economic development (1995); Ben-David (1993); Edwards (1998); and Frankel and insofar as it helps build high-quality institutions Romer (1999). 10 2 K Y M A N D E R S O N Economywide taking an economywide perspec- tive when considering the effects of actual policies at home or Dimensions of abroad or of potential policy reforms. Given the significance of Trade Policy and agriculture in low-income coun- tries, the chapter focuses primari- Reform ly on the possible direct and indirect effects of policies on this sector, emphasizing the need to consider the impact of input as well as output price distortions on producer incentives. E very country has an interest in Direct Effects of Policies: A Single-Sector trade policy reform. This is true Perspective even for the most open of economies because, although that government may not be distorting Historically, the governments of poor agrarian incentives, government policies of many other economies have taxed farmers in one way or anoth- countries are distorting the prices received by the er (Krueger, Schiff, and Valdés 1988). Sometimes it open economy's exporters in international markets. has been an in-kind tax, such as a proportion of Moreover, it is relative prices that matter: the incen- grain output. In other settings, where a cash crop tives facing producers or consumers of a particular was being exported, producers often have been product can be distorted not only by policies direct- required to sell to a statutory marketing authority ly affecting the price of that product but also, and that paid them only a fraction of the export price. sometimes even more strongly, by policies affecting Either way, farmers receive less than the free-market the prices of products that are substitutes or com- price for their produce. Except in the unlikely event plements in production or consumption. Govern- that all of those taxes come back to farmers in the ment intervention in currency markets also can form of government goods and services they other- have nontrivial distortionary effects on incentives. wise would have purchased with that taxed income, Farmers, for example, may receive the international the incentive to produce and market farm products price for their produce and yet be harmed by having is reduced. to convert from foreign to domestic currency at an Governments of such agrarian economies typical- artificially low exchange rate. ly return little of the proceeds of those taxes to farm This chapter explores not just the direct but also the families, especially at early stages of the country's various indirect ways in which trade and trade-related development. Rather, the taxes tend to be used to policies affect the welfare of people in developing develop urban infrastructure, pay officials relatively countries. Its purpose is to identify the importance of high wages, subsidize food consumption, and so on. 11 T R A D E P O L I C Y R E F O R M I N C O N T E X T Until recently, it was widely believed that taxing pri- import-protection policy encourages the allocation mary producers for such purposes would not reduce of too many resources to agriculture's import-com- output significantly because farm families were poor peting industries, and it also harms consumers of or had no alternative uses for their time, land, and those importables via higher food prices. other resources. Empirical studies during the past What implications does the Krueger, Schiff, and half-century, however, have shown that farmers in Valdés study have for reforming agricultural policy even the poorest settings are quite price-responsive in the average developing country? Reducing export (Askari and Cummings 1977). When the proceeds restrictions would cause the domestic price of from growing a marketable product are reduced, exported farm products to rise by up to one-eighth, farm households divert at least some of their helping producers of those exportables but hurting resources to producing other products or to leisure domestic buyers of the products (who may be down- pursuits. Only the very poorest subsistence farmers stream processors). That reform might also encour- might be enticed by such taxes to work harder, but age producers of import-competing farm products even that response may be welfare reducing in that to switch their production to exportables that now they then have less recreational time and are likely to carry higher prices. If the country's food import live less healthy and shorter lives. restrictions also were reduced, producers of those It matters that farm household resources are importables would see their output price decline diverted from producing the taxed good because and would consider switching to other farm prod- such diversion means that society's resources are ucts. This would reinforce the encouragement of not being used where they are most productive. A exportable production in agriculture, insofar as the farmer discouraged from specializing in growing a resources used in the two different farm subsectors cash crop, for example, has less to spend on other are substitutable. Both types of reform improve the products and therefore is less able to encourage oth- efficiency of resource use in the sector by encourag- ers to specialize in doing what they do best also. ing greater exploitation of the country's agricultural Likewise, it matters if farmers have to pay more for comparative advantage. That is, reforms that boost inputs purchased from nonfarm sectors (for exam- the relative profitability of the industries previously ple, because of import taxes on these goods): they discouraged by the government's trade-restrictive then buy less of those inputs in relation to other policies tend to be welfare enhancing. inputs than is optimal. This direct effect is, however, of much less economic importance than the indi- Indirect Effects of Policies: An Intersectoral rect effect of such industrial or service sector pro- Perspective tection policies, as is made clear in the next section. Of course, not all agricultural producers in devel- The above lesson applies not just within the agricul- oping countries face artificially depressed prices for tural sector but also to interactions between it and their products. Indeed import-competing produc- other sectors. That is, farmers also can be discour- ers of some key food items enjoy protection from aged, albeit indirectly, by nonagricultural policy import competition that raises the domestic price of interventions. One source of such discouragement their produce above free-market levels. An empiri- comes from import protection to producers of non- cal study of 18 developing countries between the farm products. In an economy producing just two mid-1970s and the mid-1980s contrasted the treat- sets of goods, importables and exportables, a tax on ment of major farm export products with that of imports is equivalent to a tax of equal size on key imported foods (Krueger, Schiff, and Valdés exports whenever the two sets of goods use com- 1988). The authors found that domestic prices of mon resources such as labor and capital. Both taxes the imported foods averaged about 20 percent raise the prices of importables relative to exporta- above prices at the countries' borders, whereas bles, and by the same amount, and it is that price domestic prices for key agricultural export items ratio which determines the allocation of resources were, on average, 11 percent below international between the two sectors (Lerner 1936). levels. Both types of distortion are harmful to More generally, when domestic prices of some national economic welfare: whereas depressed industrial or services sector products are raised arti- export prices result in too few resources being ficially by restrictions on their importation or by devoted to the production of those exportables, an other price-support measures, resources are drawn 12 Economywide Dimensions of Trade Policy and Reform to those import-competing sectors at the expense of toral resource use remain and could worsen when other industries in the primary sectors, including the average level of agricultural assistance is raised. export industries (Clements and Sjaastad 1984). Second, the economy is invariably made up of more Historically, industrial tariffs have been a major than just those two sectors, so similar levels of assis- source of indirect discrimination against agricul- tance would have to be provided to fishing, mining, ture, but a wide range of other distortionary mea- and other sectors to ensure an overall improvement sures is found in service industries as well. in the efficiency of national resource use. Third, sup- The importance of this cause of inefficient pose the farm assistance were to be provided via, say, resource allocation cannot be stressed enough, as it input subsidies for fertilizer and water, as in fact has crucial implications for reform. Two examples often happens, even in poor countries. It turns out will illustrate the point. Taking, again, the average that agricultural support via input policies would be country in the Krueger, Schiff, and Valdés study, less efficient and possibly even counterproductive suppose that the agricultural sector is a net exporter because it would encourage the use of only a subset (which means the country is a net importer of non- of inputs rather than all farm inputs (Warr 1978). farm products) and that the food-importing sub- Most damning of all, manufacturers would perceive sector is almost as large as the agricultural their situation as deteriorating if support for pri- export­focused subsector. Within agriculture, the mary production were increased and, if no change in restrictions that reduce the domestic price of farm the political-economy forces had been at work, they exportables by 11 percent and raise the price of food would presumably demand a return to the status importables by 20 percent would boost the overall quo ante, perhaps through another hike in industri- average price of farm products, but by less than 10 al tariffs. Clearly, tariff compensation to farmers is a percent. Taking a single-sector perspective as in the far riskier reform strategy for improving the use of previous section might lead one to believe that national resources than the first-best strategy of eliminating those agricultural policies and thereby reducing industrial tariffs. reducing farm prices on average would be welfare improving. The Additional Indirect Effect of Distorting As it turns out, however, such a conclusion would Exchange Rates follow only if there were no distortions in the rest of the economy. If the manufacturers in this economy The Krueger, Schiff, and Valdés (1988) study also were to enjoy an average nominal rate of protection examined the extent to which unsustainable current from import competition of, say, 25 percent (for account deficits, overvalued official exchange rates, example, as a result of a uniform 25 percent tariff), and the like artificially inflate the value of a nation's then, prior to reform and notwithstanding the posi- currency from the viewpoint of farmers. Such poli- tive direct assistance to farmers, there would already cies encourage the production (and discourage the be too many resources in industrial relative to agri- domestic consumption) of nontradables relative to cultural pursuits. In that case reducing support for tradables and thereby represent another source of farming would be likely to exacerbate the inefficient inefficiency in national resource use and another resource allocation rather than improve it. To disincentive to farm. ensure a welfare-improving policy reform in this Empirically, for the 18 countries studied by case, it would be necessary to first lower the degree Krueger, Schiff, and Valdés, these macroeconomic of assistance to manufacturers and then, when the policies proved less of a disincentive to agricultural level of assistance to industry equaled that to farm- producers than did industrial protectionism. ers, phase down both simultaneously.1 Nonetheless, they added to farmers' difficulties. If it is too difficult politically to lower tariff protec- Together, the indirect negative impact of industrial tion to manufacturers, might a similar national wel- and macroeconomic policies on farmers' incentives fare improvement be achievable by raising the level was two-and-a-half times as large as the direct neg- of assistance to agriculture? In theory, maybe, but in ative effects of agricultural export policies in the practice such a tariff-compensation strategy would decade 1974­84, equivalent to depressing the price be unwise, on a number of grounds. First, if rates of of farm exportables by 38 percent, compared with assistance to different industries within each of the just 11 percent by direct measures. This indirect dis- two sectors are not equal, inefficiencies in intrasec- incentive also applied to import-competing farm- 13 T R A D E P O L I C Y R E F O R M I N C O N T E X T ers. In this sample of developing countries, the latter used intensively in the industry in which it has a enjoyed direct nominal protection of 20 percent in technological advantage. that decade, so even the most favored farmers in For nationalistic and cultural reasons, permanent those countries were being disadvantaged by the immigration of labor has not been made easy in dominance of the adverse indirect effects of non- recent decades, but numerous countries have toler- agricultural policies on agricultural incentives. ated temporary movements of labor, bringing mutu- What would be the economywide implications of al gains to the countries involved. Much more reducing import tariffs in the above case? Reducing important in the past two decades, however, has the food import restrictions alone would probably been the growth in movement of capital across boost production of exported farm goods, which national borders. Foreign direct investment can would improve resource allocation within the farm bring with it not just financial capital but also mana- sector. But it would also free mobile resources that gerial and marketing skills, technological knowl- could then move to nonfarm activities, which, on edge, and intellectual property--forms of capital average, are more protected than farming. Hence, that foreign firms might not be willing to see export- whether the overall efficiency of national resource ed if they were unable to retain control over them. use would rise or fall is an empirical question if only Developing countries seeking to exploit fully their a subset of import restrictions and exchange rate comparative advantages therefore need to relax their distortions is to be removed. Only if the most pro- restrictions on foreign investment inflows. By the tected industries were to be liberalized first would same logic they also need to allow foreign invest- resources necessarily move to less protected indus- ment outflows so that domestic owners of capital tries and sectors and thereby guarantee an improve- also can earn the highest rewards possible. ment in the efficiency of the use of these resources in producing tradables. Even then, there is the possibil- The Dynamic Consequences of ity that those mobile resources would move into the Trade Reform production of more nontradables if the currency remained overvalued. This is the reason for the value Freeing up trade in goods, services, currencies, and of comprehensive reform that simultaneously frees capital not only improves the efficiency of national trade in goods, services, and currencies. resource use and consumer welfare at a point in time but also contributes to economic growth. The mech- anisms by which openness contributes to growth are What about Markets for Factors of gradually becoming better understood, thanks to the Production? pioneering work of such theorists as Grossman and An economywide perspective on trade reform would Helpman (1991) and Rivera-Batiz and Romer be incomplete unless it also extended to restrictions (1991). In a helpful survey of the subsequent litera- on factor flows. Theorists in the 1950s pointed to the ture, Taylor (1999) identifies several channels possibility that trade in goods could be a complete through which openness to trade can affect an econ- substitute for trade in productive factors in terms of omy's growth rate. They include the scale of the mar- both the volume of product trade and the welfare ket when knowledge is embodied in the products gains from trade (Mundell 1957). That theoretical traded, the effect of knowledge spillovers, and the possibility holds only under fairly restrictive condi- degree to which redundant creation of knowledge is tions, however. More recently, attention has been avoided through openness. More important from a drawn to the possibility that trade in some produc- policymaker's viewpoint, the available empirical evi- tive factors complements rather than substitutes for dence strongly supports the view that open trade in products (Markusen 1983). That can hap- economies grow faster (Edwards 1993; USITC 1997). pen when other productive factors are sector-specif- ic and goods trade is thus insufficient to equalize What if Trade Reform Harms the factor prices across countries. In that case trade in Environment? internationally mobile factors can generate further welfare gains from trade. It can also happen when Ideally, in adopting an economywide perspective, all there are differences in technologies across coun- significant influences of trade reform on human tries; then each country should import the factor welfare should be considered. That could include a 14 Economywide Dimensions of Trade Policy and Reform whole range of so-called noneconomic policy the Krueger, Schiff, and Valdés (1988) study shows, objectives, as well as standard economic effects such the indirect effect of nonagricultural and macroeco- as those on the natural environment, poverty, nomic policies on farmers' welfare can be several unemployment, food security, and distribution of times as large as the direct influence on incentives of income and wealth across regions and households. agricultural polices affecting export-oriented farm- Space is not available to discuss each of these here, ers. This is also true within a sector, and even more but excellent treatments are available in such books so to the extent that productive factors are more as Corden (1997). The main conclusion to be drawn readily substitutable within than between sectors. from that literature is that whatever the domestic In lobbying for trade reform, care is needed to policy objectives one has in mind, trade policy ensure that trade liberalization is not accompanied instruments are virtually never first-best ways of or followed by "re-instrumentation" of support. achieving those objectives. There are numerous ways to support producers This conclusion does not mean that trade reform other than through trade policy, and many of them can be undertaken without regard for society's are even more inefficient than trade measures. It other objectives. Welfare improvement via trade lib- would be counterproductive to lobby for the eralization cannot be guaranteed if optimal domes- removal of a trade restriction if it led to such an tic policies are not in place. There is no better inferior replacement. illustration of this than with respect to the natural A major aspect of exporters' lobbying activities environment. Reducing restrictions on exports of often involves encouraging the removal of impedi- logs, for example, in the absence of any other forest ments to market access abroad. Here again, an econ- resource policies is likely to lead to excessive defor- omywide perspective is needed (as is vigilance in estation. Another example is the reduction in Mon- preventing re-instrumentation). Consider, for golia's export tax on cashmere, which encouraged example, the interests of developing countries with the excessive grazing of common pastures. In these a strong comparative advantage in agriculture. They and in many other such cases overexploitation was would be likely to benefit directly from reduction in the result of property rights being poorly defined or agricultural protectionism in advanced industrial poorly policed. Clearly, better resource and environ- countries, but they could also benefit, albeit indi- mental policies are required before optimal social rectly, from a reduction in manufacturing protec- welfare can be achieved. tion in those same countries. The most obvious Note, however, that those resource and environ- example is a reduction in the very high barriers to mental policies are warranted, regardless of the imports of textiles, clothing, and footwear. Greater degree of openness of the economy. All that trade global production and trade in those products reform requires in addition is that the levels of envi- would result from reduced protection, with the out- ronmental policy intervention be adjusted when put expansion concentrated in newly industrializ- trade is liberalized to ensure that any additional ing countries. A direct consequence would be an environmental damage which accompanies opening expanded demand for cotton, wool, and leather up is matched in value terms with the marginal inputs--but that is only part of the impact on gains from trade expansion. Of course, trade reform agrarian developing countries. Probably more need not cause additional environmental damage; important is that such reform would speed the at least equally possible is the prospect that the industrialization of the more densely populated changes in production and consumption that developing countries, which would attract resources accompany trade liberalization will actually reduce away from their farm sectors. An indirect conse- pollution or resource depletion (Anderson 1997). quence, therefore, would be increased demand for food imports by those newly industrializing coun- tries. This suggests there is scope for agrarian and Implications for Reform-Minded Producers newly industrializing developing countries to act and Trade Policymakers collectively in pushing hard for greater market A clear implication of this economywide perspec- access for farm and textile products in advanced tive for producers seeking to influence government economies. In return, developing countries would policy is that their focus should not be confined to be expected to provide more access to their markets measures directly affecting their own industries. As for the goods and services exported by advanced 15 T R A D E P O L I C Y R E F O R M I N C O N T E X T economies--another dimension of the intersectoral connectedness of the global economy.2 Notes 1 In practice, a greater degree of refinement is possible, taking into account not only input price distortions (to get a measure of effective assistance to value added rather than just the nom- inal boost to the price of output) but also the degree of inter- sectoral substitutability or complementarity in production and consumption. See Corden (1971); Vousden (1990, ch. 9). 2 For recent empirical studies on the economywide effects of global trade reform and their implications for farm production and trade, see, for example, Hertel and others (forthcoming); Anderson, Hoekman, and Strutt (2001). 16 3 H O W A R D J . S H AT Z D A V I D G . TA R R Exchange Rate Although as a group, develop- ing countries progressively liber- alized their trade regimes during Overvaluation the 1980s and 1990s, some gov- ernments continue to take and Trade actions to defend their exchange rates that are counter to their Protection long-run trade liberalization efforts. One classic pattern is to attempt to defend an overvalued exchange rate through protec- tionist trade policies.3 Experi- ence shows that protection in A defense of an overvalued lthough both fixed and flexible exchange rate will significantly retard the country's exchange rate systems (and their medium-to-long-run growth prospects. In fact, an variants) have their advantages and disadvantages, overvalued exchange rate is often the root cause of more than half the countries in the world maintain protection, and the country will be unable to return fixed or managed exchange rates.1 While we do not to the more liberal trade policies that allow growth discuss the relative merits of these exchange rate without exchange rate adjustment. systems in this chapter, we note that as a practical Moreover, a devaluation of the nominal matter, exchange rate management in many coun- exchange rate appears to be a necessary condition tries in the world has resulted in overvaluation of for achieving a large depreciation of the real the real exchange rate, in some cases leading to gross exchange rate, as virtually all real devaluations distortions.2 (For further discussion of the links (above 25­35 percent) have been accompanied by between trade and macroeconomic management, nominal devaluations (Ghei and Hinkle 1999). see the CD-ROM, "Applied Trade Policy," that Sustained efforts to use downward adjustment of accompanies this Handbook.) wages and prices as a means of restoring a compet- Since governments are frequently confronted itive real exchange rate have frequently led to with the problems of external shocks and external severe recessions or depressions. trade deficits in the context of a fixed exchange rate Worldwide experience has shown that defending regime, a concise survey of worldwide experience the exchange rate has no medium-run benefits, with the effects of overvalued exchange rates in since falling reserves will eventually force devalua- terms understandable to policymakers should be tion. It is better that the devaluation be accom- useful. This chapter presents theory, cross-country plished without further debilitating losses in econometric evidence, and important case studies reserves and lost productivity due to import con- of the effects of overvalued exchange rates. trols. Experience with devaluations shows that after 17 T R A D E P O L I C Y R E F O R M I N C O N T E X T the devaluation, the exchange rate will reach a new result, less foreign exchange is available for need- equilibrium and that the equilibrium is strongly ed imports. influenced by the policies of the central bank and · Foreign exchange may be rationed and allocated the government. inefficiently by the government. · Efforts to defend an overvalued exchange rate through very tight monetary policy can plunge The Problems of an Overvalued the country into severe recession. Exchange Rate Countries that attempt to maintain overvalued The Need to Restore Internal Balance exchange rates significantly impede their growth in the medium to long term. Theory, cross-country When a country experiences a deficit in its trade bal- statistical studies, and case histories all reinforce the ance, it is not in "external" balance. It follows from a basic findings that exchange rate overvaluation can national income accounting identity that a trade reduce economic efficiency, misallocate resources, deficit means the country is spending more than its increase capital flight, and, most perniciously, lead income. That is, the trade deficit allows the country to exchange and trade controls. to consume or spend beyond its income (or beyond the value of what it is producing). When a country's expenditure does not equal its income, it is not in The Theory "internal" balance. These external and internal Theory suggests that there are many channels imbalances can severely impede country economic through which an overvalued exchange rate hurts performance, and it is these imbalances that coun- the economy and growth: tries suffering from external shocks often face. Although a nominal devaluation is designed to · It discriminates against exports. Since a signifi- correct the problem of external balance, it will also cant portion of the costs of production is paid in be important to ensure internal balance; otherwise, domestic currency, the overvalued exchange rate the trade deficit may not be corrected by the nomi- results in a reduction of exporters' incentives and nal devaluation. For many developing countries the ability to compete in foreign markets. This chokes trade deficit reflects the government's fiscal deficit, foreign exchange receipts and damages a coun- which is often financed by monetary expansion. try's ability to purchase the imports needed for The monetary expansion in turn leads to inflation. economic activity. In this environment the impact on the real exchange · Import-competing industries are faced with rate of a nominal devaluation is likely to be eroded increased pressure from foreign companies, by inflation, since high inflation tends to appreciate resulting in calls for protection against imports the real exchange rate, making elimination of the from industrial and agricultural lobbies. The trade deficit problematical. political pressures for protection eventually prove In general, monetary or fiscal policies will have to to be overwhelming, and governments yield to be combined with exchange rate policies to achieve lobbying and impose higher tariffs on imports. both internal and external balance simultaneously. This closes the economy to international compe- This is a special case of a more general principle of tition and reduces access to needed imported economics: multiple policy targets typically require inputs and technology. As a result, growth falls. multiple policy instruments. In this chapter, howev- Devaluation serves the dual purpose of uniformly er, we focus on the experience of countries that have protecting import-competing industries and limited the use of exchange rate adjustment as an increasing incentives for exporters. economic policy instrument. · Productivity advances are less rapid because the export sectors and the import-competing sectors, Problems with "Automatic" Adjustment where productivity advances are often fastest, are Mechanisms disadvantaged by an overvalued exchange rate (Cottani, Cavallo, and Khan 1990). Unless the central bank takes offsetting action, a · Overvaluation induces capital flight among trade deficit will result in a decline in the domestic domestic citizens anticipating a devaluation. As a money supply. Thus, one response to an overvalued 18 Exchange Rate Overvaluation and Trade Protection exchange rate is to hold the nominal exchange rate with similar results, Ghura and Grennes (1993) ana- fixed and assume that domestic prices and wages lyzed the relationship between the real exchange will fall and so help bring tradable goods prices back rate and macroeconomic performance in 33 Sub- to internationally competitive levels. This is the Saharan African countries between 1972 and 1987. "specie flow mechanism" described by David Hume They found that misalignment, or overvaluation, in the 18th century. The problem with this strategy was associated with lower levels of growth of real is that in most modern economies, prices and wages GDP per capita, lower levels of exports and imports, tend to be sufficiently inflexible downward that sus- lower levels of investment, and lower levels of sav- tained and substantial periods of unemployment ings, even when they corrected for other causes. must be endured if the strategy is to have a chance of succeeding. Most countries are unwilling to Case Studies of the Effects of Overvaluation endure these high costs. (See Sachs and Larraín 1999 for a further discussion.) For example, as is The economic histories of developing countries that described below, Chile endured a deep recession in followed a classic import-substituting industrializa- 1982­83 before it devalued in 1984, and the fran- tion strategy after World War II provide good illus- cophone African countries in the CFA zone experi- trations of the negative effects of an overvalued enced disastrous consequences from overvaluation; exchange rate combined with trade controls. Latin in some, the economic contractions were compara- America, more than any other region, followed this ble to the Great Depression in the United States. strategy, but it was not alone. We select illustrative The CFA zone experience also casts doubt on the episodes from Argentina, Chile, Uruguay, Turkey, claim that countries should avoid devaluation in and the CFA zone of Africa. order to retain international investors. The zone certainly had stable prices and exchange rates, but Argentina, Chile, and Uruguay its failure to solve the problems brought on by the overvalued real exchange rate substantially Argentina, Chile, and Uruguay all followed import- decreased its attractiveness to foreign investors. substituting industrialization policies that led to a Capital flight increased in anticipation of an even- bias against exports, extremely uneven rates of trade tual devaluation (Clément and others 1996). protection across sectors, and controlled financial systems. They also experienced recurrent balance of payments crises and slow growth (Corbo, de Melo, Cross-Country Economic Performance and Tybout 1986). By the early 1970s, all three had Cottani, Cavallo, and Khan (1990) investigated the accelerating inflation, bottlenecks in production, effects of real exchange rate misalignment and vari- slow export growth, and balance of payments diffi- ability on the economic performance of 24 develop- culties (Corbo and de Melo 1987). In response, they ing countries between 1960 and 1983. They found went through two phases of stabilization and that exchange rate misalignment was strongly relat- reform, one in the mid-1970s and the other during ed to low growth of per capita GDP. Misalignment 1979­82. The second phase is most relevant for was also related to low productivity (capital did not evaluating the effects of an overvalued exchange go to the companies or sectors that could make the rate and import controls on economic perform- best use of it), slow export growth, and slow agricul- ance. tural growth. In the second phase all three countries used a A study of growth in 12 countries between 1965 nominal exchange rate anchor to halt inflation. The and 1985 (Edwards 1989) reinforced these exchange rate appreciated, and when it became findings.4 The greater the misalignment, the lower apparent that the nominal rate could not be sus- the growth during the period. Furthermore, tained, capital flight resulted. In Uruguay and exchange controls and trade impediments, proxied Argentina, where there were no capital controls, by the black-market exchange rate premium, were major capital outflows occurred. In Chile, where negatively related to growth. there were capital controls, people engaged in capi- There is strong evidence that overvaluation of real tal flight by buying imported consumer durables. exchange rates was greatly implicated in Africa's This capital flight occurred in all three countries poor economic performance. Among other studies well before the onset of the debt crisis in 1982. 19 T R A D E P O L I C Y R E F O R M I N C O N T E X T Other problems resulted. Profitability fell in the and a staged lowering of uniform tariffs, from 35 tradable goods sectors. In Argentina, which percent in 1984 to 11 percent by 1991. An important remained quite restrictive to imports throughout, feature of the new nominal exchange rate system the gross margins of exporting businesses were hurt was a crawling band, which policymakers intended much more than those of import-competing busi- to use to maintain the international competitiveness nesses. In Uruguay the rate of growth of nontradi- of Chilean exports (Dornbusch and Edwards 1994). tional exports fell sharply between 1979 and 1981. In fact, although they used the nominal rate as the In Chile the leading growth sectors during the peri- policy variable, they focused on the real exchange od were construction, internal trade, and financial rate, adjusting the nominal rate for the differential services--all nontradables--even though reforms between domestic and foreign inflation. Taking an during the 1975­79 period had reduced the bias index of 100 as the value of the real rate in 1977, the against exports significantly by June 1979. real exchange rate appreciated to 84.5 in 1981, fell to 118.2 in 1984, and then, following the introduction of the new policy, depreciated to 145.2 in 1985. It Chile: The Aftermath continued depreciating, to 180.1 in 1990 (Corbo Chile is now well known for its economic success. and Fischer 1994). In 1998 the Chilean legislature Since 1984, it has had an average annual rate of approved a further lowering of the uniform tariff to growth of real GDP of more than 7 percent. Its poli- 6 percent, in stages, and in late 1999 Chile aban- cies following the 1982­83 crises are instructive. doned the exchange rate band system for a float. Chile experienced high rates of growth in the late The improved incentives to exporters from the 1970s, following a deep contraction in 1974­75. The reduction in the import tariff and the devaluation growth surge was the result of a number of deregula- led to an expansion of nontraditional exports (by 10 tion and reform measures, including institution of a percent a year from 1985 to 1995) and to efficient uniform 10 percent tariff on all goods except auto- import substitution. Macroeconomic stabilization, mobiles. Nevertheless, inflation persisted, hurting tax reform, and cuts in government spending com- the reforms, and in 1979 Chile fought back by set- bined to promote savings and investment. And pri- ting a fixed exchange rate as a nominal anchor. Com- vatization of state-owned firms, rehabilitation of bined with other policies, this at first led to large the financial sector through recapitalization, and external borrowings, most of which were at variable strengthened bank regulation spurred private busi- interest rates. In the early 1980s the external financ- ness activity. ing dried up as confidence in the sustainability of the exchange rate ebbed. Making matters worse, Chile Turkey experienced a deterioration in the terms of trade. Then foreign interest rates rose, further hurting the Three episodes from the post­World War II history of Chilean financial and business sectors. In 1982­83 Turkey, recounted in Krueger (1995), provide another Chile experienced its worst depression since the illustration of the problems created by an overvalued 1930s, as real GDP fell 15 percent. exchange rate combined with import restrictions. During and immediately after the recession, Chile Like the Latin American countries, Turkey followed experimented with a number of policies, including an import-substituting industrialization growth strat- an increase in tariff rates to switch domestic spend- egy. Starting in 1953, export growth ceased for a num- ing to domestic products. In June 1982 the govern- ber of reasons, and inflation accelerated. The ment abandoned the fixed exchange rate, combination of inflation and a fixed nominal eliminated compulsory wage indexation, and initi- exchange rate meant a strengthened real exchange ated a series of nominal devaluations. For a short rate and a bias against exports. Foreign exchange time, Chile allowed the exchange rate to float became scarce, and the country started import licens- (Corbo and Fischer 1994). Then, however, it fol- ing in 1954. By 1957, export earnings were falling, and lowed an erratic policy, implementing five different imports were severely restricted, damaging domestic exchange rate regimes (Labán and Larraín 1995). economic activity. In 1958, Turkey could not finance In 1985 the government embarked on the strategy imports, and it appeared that the country would not it maintains to this day: an export-oriented struc- even be able to obtain gasoline for trucks to move that tural adjustment. This included steady devaluations year's harvest to ports. 20 Exchange Rate Overvaluation and Trade Protection In response, Turkey adopted an IMF stabilization countries, average growth was 2.8 percent. In addi- plan that featured devaluation, import liberaliza- tion, CFA countries achieved an annual average tion, and fiscal and monetary restraint. Real GDP, export growth rate of 7 percent. which had been declining, started growing immedi- In the mid-1980s the economic performance of the ately in response to the availability of imports. Infla- CFA zone countries began to deteriorate, for two rea- tion fell, and export earnings began to rise again. In sons: the appreciation of the French franc, and a the 1960s Turkey was among the most rapidly grow- series of primary-commodity price shocks (Azam ing developing countries. and Devarajan 1997). Devarajan (1997), in a study of In the late 1960s, Turkey's exchange rate again 12 CFA countries, found an average overvaluation of became overvalued as a result of moderate inflation 31 percent in 1993 on the eve of the devaluation, with throughout the decade (5 to 10 percent annually) Cameroon's real exchange rate the most overvalued and a fixed nominal exchange rate. The high (78 percent) and Chad's real rate the only underval- demand for imports, together with the bias against ued one.5 Eight of the 12 had overvaluations of 20 exports, caused foreign exchange to become scarce. percent or more. Making matters worse, other The resulting problems in obtaining imports led to African countries were devaluing during the 1980s, a slowdown in both production and real invest- contributing to the overvaluation of the real rates of ment. The country responded in 1970 with a nomi- the CFA zone countries compared with those of their nal devaluation, and the result was extremely rapid export competitors. Elbadawi and Majd (1996) export growth. Turkey then experienced rapid eco- showed statistically that CFA membership and, by nomic growth through 1975. implication, the high level of the real exchange rate The third episode occurred in the late 1970s. were partly to blame for the poor economic perform- Large fiscal deficits, failure to adjust the internal ance of the CFA countries in the late 1980s. price of oil following the 1973 oil shock, and an Because of the overvaluations and mounting overvalued exchange rate, made worse by extremely structural problems, such as rigidly high wages, eco- high inflation, spurred this new crisis. Once again, nomic performance started to deteriorate. The zone the country ended up with severely constrained saw no economic growth between 1986 and 1994, a imports, falling real output, and falling income. period when other Sub-Saharan African countries were growing at 2.5 percent a year (Clément 1994). In fact, some of the countries suffered an output The CFA Zone Countries contraction comparable to that of the Great The currency of the countries of the CFA zone of Depression in the United States (Table 3.1). Africa was fixed precisely to the French franc and is A number of other ill effects stemmed from the now fixed to the euro. Until the second half of the period of overvaluation in the CFA zone. Several 1980s, these countries experienced stable and posi- countries suffered large increases in poverty tive economic performance (Elbadawi and Majd (Devarajan and Hinkle 1994). For example, in Côte 1996). For example, their average annual real GDP d'Ivoire the incidence of poverty doubled between growth rate between 1973 and 1981 was 5.7 percent, 1985 and 1992, from 30 to 60 percent. Devarajan whereas for 18 non-CFA Sub-Saharan African and Hinkle also note that banking systems in a Table 3.1 Comparing "Great Depressions": Cameroon, Côte d'Ivoire, and the United States (percentage decline in per capita GDP) Measure of output decline Cameroon Côte d'Ivoire United States Purchasing power paritya 31.4 29.1 -- Purchasing power parity with terms of trade adjustmenta 38.5 34.5 -- Market pricesb 41.5 18.8 30.9 -- Not available. a. Authors' calculations for 1986­92 from the Penn World Table Mark 5.6, described in Summers and Heston (1991) and available on the Website . Data for after 1992 are unavailable. b. Authors' calculations from the peak to the trough of the depression period (1986­94 for Cameroon and Côte d'Ivoire; 1929­33 for the United States). Data are from World Bank (1999) and U.S. Bureau of the Census (1975). 21 T R A D E P O L I C Y R E F O R M I N C O N T E X T number of countries became insolvent or illiquid as countries often apply high or prohibitive trade pro- a result of private sector inability to repay debts, tection on selected products or vis-à-vis selected government and public enterprise arrears, and capi- countries. Even given a limited objective of reducing tal flight. Export earnings collapsed in response to the demand for foreign exchange, an increase in the adverse terms of trade shocks and the overvalu- imports will occur through informal channels, ation of the real exchange rate. The contractionary depending on how porous the borders are. With macroeconomic policies adopted by most CFA diverse protection, while some sectors will be pro- countries reduced import levels, and inflation tected, the burden of the costs of adjustment to the remained low, but budgetary and external deficits overvalued exchange rate will be borne by the rose. The fixed nominal rate and various policy- unprotected sectors, by those sectors that are more induced rigidities in domestic prices, particularly in susceptible to informal or illegal imports, and by the wages and nontradable goods prices, meant that export sectors. Countries typically eventually deval- adjustment had to come through reduced employ- ue, but it is better that the devaluation be accom- ment, output, and growth.6 plished without debilitating losses in reserves and Constrained by their fixed exchange rates, at least lost productivity due to import controls. two of the CFA zone countries tried to carry out As the experience cited here shows, governments "mock devaluations," with subsidies to exports and must avoid policies that contribute to an overvalued increases in import tariff rates. In Côte d'Ivoire the exchange rate. Although we do not advocate any scheme collapsed after a short trial because of particular type of exchange rate regime in this chap- administrative difficulties, inability to give the ter, we emphasize that whatever regime is employed, export subsidy plan a sufficient budget, and lack of policies should be aimed at maintaining a competi- support by the government. In Senegal administra- tive real exchange rate. tion of the plan proved difficult, and the scheme encouraged overinvoicing by exporters and smug- Notes gling and underinvoicing by importers. The plan also proved costly to the budget, as tariffs were The authors thank Arup Banerji, Julian Berengaut, Dominique already high and the increases could not generate Desruelle, Lawrence Hinkle, Fred King, Kiyoshi Kodera, Albert Mar- tinez, Will Martin, Francis Ng, Paul Ross, Maurice Schiff, and semi- much more revenue. nar participants at the World Bank for helpful comments on earlier Finally, on January 12, 1994, the countries held a drafts of this paper. "maxi-devaluation," changing the rate to the French franc from 50:1 to 100:1.7 The CFA devaluation had 1 As of the beginning of 1999, the IMF (1999: app. I) reported arrangements for 185 countries. The exchange rate regimes excellent intermediate-term effects on growth. For can be categorized as pegged (84 countries), floating (75 the 12 CFA countries in Devarajan's sample, World countries), and limited flexibility (26 countries). Of the 84 Bank data showed that real GDP growth between countries with pegged exchange rates, 37 have no separate 1990 and 1993 averaged almost minus 0.3 percent legal tender, 8 use a currency board arrangement, 24 peg to annually, weighted by GDP (World Bank 1999). another currency, and 15 peg to a composite of currencies. Of those using a floating rate, 27 maintain a managed float and From 1994 to 1997, however, growth in the sample 48 an independent float. countries averaged 5.1 percent annually, according to the same data source.8 Cameroon, the largest 2 See Global Currency Report (1999). Of 160 countries listed, 38 had black market premiums of more than 10 percent at the country in the CFA zone, grew at an annual rate of end of 1998. Of the 38, 19 had premiums of more than 25 minus 3.4 percent in the first period but by 4.5 per- percent, 13 had premiums of more than 50 percent, and 10 cent in the second period (World Bank 1999). (Afghanistan, Algeria, Angola, Iraq, the Democratic Republic of Devarajan (1997) found that a year after the devalu- Korea, Liberia, Libya, Myanmar, São Tomé and Principe, and ation, the average undervaluation for the group was Somalia) had premiums of more than 100 percent. The black- 2 percent, but with significant variance. market exchange rate is likely to be overly depreciated in rela- tion to an equilibrium long-run real exchange rate, since an actual real depreciation would increase the supply of and Conclusion reduce the demand for foreign exchange. See Ghei and Kamin (1999) for a detailed explanation and econometric evidence. Worldwide experience has shown that defending 3 Ghei and Pritchett (1999) call this the "import compression syn- the exchange rate has no medium-run benefits. In a drome." Since devaluations (which reduce imports) are often classic pattern, once reserves are drawn down, accompanied by reductions of trade barriers (which increase 22 Exchange Rate Overvaluation and Trade Protection imports), econometric evidence on the import-reducing impact of devaluation has been weak. Ghei and Pritchett argue that devaluations significantly reduce imports if there is proper adjustment for the simultaneous reduction of trade protection. 4 The 12 countries studied were Brazil, Colombia, El Salvador, Greece, India, Israel, Malaysia, the Philippines, South Africa, Sri Lanka, Thailand, and Yugoslavia. 5 The countries in the study were Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d'Ivoire, Gabon, Mali, Niger, Senegal, and Togo. 6 For example, both Senegal and Côte d'Ivoire had rigid labor laws that kept wages high throughout the predevaluation peri- od (Foroutan,1997). Clément (1994) noted that throughout the CFA zone, rising wage costs contributed to substantial drops in public enterprise profitability, expanding the public sector financing requirement. Extensive controls over both producer prices and retail prices, particularly nontradable goods prices, added to the price rigidities in many countries. 7 The Western and Central African monetary unions (comprising Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Côte d'Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo) changed their rates from 50 CFA francs: 1 French franc to 100 CFA francs: 1 French franc. At the same time, Comoros changed its rate from 50 Comoros francs: 1 French franc to 75 Comoros francs: 1 French franc. 8 The unweighted averages are 0.1 percent for 1990­93 and 4.7 percent for 1994­95. 23 4 L I A M E B R I L L J A N E T S T O T S K Y R E I N T G R O P P Fiscal Dimensions the reforms undertaken and the initial circumstances of the par- ticular country. of Trade Table 4.1 shows a taxonomy of trade reform measures and their Liberalization expected effect on the govern- ment's fiscal position. As noted above, the impact can be positive, negative,or neutral,depending on the nature of the restrictions and the characteristics of the particu- lar country. For the most part, however, the reforms will general- D ly enhance revenue collections or espite substantial trade liberaliza- will have an ambiguous effect.The sequencing of trade tion over the past decade, many liberalization in programs supported by the IMF and developing countries continue to have restrictive the World Bank normally gives the highest priority to trade regimes characterized by high tariffs and per- the removal of nontariff barriers, which tend to be the vasive nontariff barriers (NTBs). Given the now most distortionary, followed by measures to rational- well-established nexus between open trade regimes ize the tariff structure. Below, we take a brief look at and improved export and growth performance, fur- some of these measures and their implications for the ther trade liberalization to promote sustainable country's fiscal position. growth and integration into the global trade system Nontariff barriers encompass a whole range of remains essential. Because trade liberalization has practices, including quotas, bans, export and import implications for fiscal revenues, and because many licensing, and state trading monopolies. In addition low-income countries continue to rely to a signifi- to the economic efficiency arguments, the initial focus cant extent on trade taxes as a source of revenue, on removing NTBs has the advantage of also increas- attention must center on the fiscal dimension of ing fiscal revenues. Quotas and bans provide no rev- trade reform in designing a strategy for trade liberal- enue to the budget and offer ample opportunities for ization. rent-seeking behavior or for smuggling. Accordingly, the conversion of quotas into equivalent tariffs (nor- mally accompanied by a scheduled timetable for fur- The Revenue Impact of Trade Liberalization ther reduction in tariff rates) or the removal of bans Trade liberalization has often been delayed by con- will, other things being the same, have an immediate cerns that it will have a negative impact on fiscal positive effect on fiscal revenues as rents are trans- revenues and contribute to macroeconomic insta- ferred to the government in the form of trade tax rev- bility. In fact, the impact of trade liberalization on enues. For these reasons, removal of NTBs should be revenues is generally ambiguous and depends on addressed early in the reform process. 24 Fiscal Dimensions of Trade Liberalization Table 4.1 Revenue Impact of Trade Liberalization Trade reform Expected revenue impact Replace nontariff barriers with tariffs Positive Eliminate tariff exemptions Positive Eliminate trade-related subsidies Positive Reduce tariff dispersion Ambiguous/positive Eliminate state trading monopolies Ambiguous/positive Reduce high average tariffs Ambiguous Lower maximum tariff Ambiguous Reduce moderate or low average tariffs Negative Eliminate export taxes Ambiguous/negative Sources: IMF and World Bank staff estimates. Eliminating tariff exemptions (excluding export structure, or one with few tariff bands, will mini- duty drawback schemes) and trade-related subsi- mize tax evasion and ease the task of customs dies should have a direct positive effect on the gov- administrators by reducing opportunities for mis- ernment's fiscal position. Moreover, not only does classification and valuation mistakes. the existence of tariff exemptions, especially discre- If a country has already implemented substantial tionary exemptions, provide an incentive for trade reforms, at some point further reductions in importers to seek additional exemptions, but their rates (other things being the same) will result in lower proliferation also increases the incentive for classify- revenue collection, at least in the short run. Given the ing taxable products as exempt, which has a nega- longer-term growth benefits of trade reform, howev- tive impact on revenues. Thus, in addition to their er, the appropriate response would be to offset any direct positive fiscal effect, eliminating discre- potential revenue loss by using other, less distorting, tionary exemptions and other complexities can broader-based taxes (for example, a value-added tax), contribute to improved governance. applied equally to both domestically and foreign-pro- The fiscal impact of reducing tariffs depends on duced goods. The distortion to the economy from their initial levels and coverage and on the extent to taxing both imports and domestic substitutes at which they are reduced. In principle, given an equivalent tax rates is generally less than that of taxing unchanged level of imports, lowering tariffs will imports alone, and taxing both yields larger revenues. reduce trade taxes. Since, however, the lower rates For developing countries in which trade taxes are are also likely to increase the demand for imports, an important source of revenue, a further reduction the net impact on revenues will depend on the price in the average tariff could be perceived to have a elasticity of import demand. The higher the elastic- negative effect on revenues and to inhibit the pace ity is, the more likely it is that a reduction in tariffs of further reforms. In these cases mobilizing alter- will have a net positive impact on fiscal revenues. native sources of revenue and diversifying tax In countries with prohibitively high tariffs, there sources away from trade taxes is critical but is likely is a strong incentive for tax evasion, either through to be a long-term process requiring an early start misclassification or by smuggling and avoiding pay- toward a broader-based tax. Since such a process ing the tax altogether. Therefore, lowering such tar- takes time to prepare and implement, technical iffs is likely to generate higher revenues because it assistance from the IMF should be sought at an reduces the cost of compliance and increases the early stage of the liberalization process and should volume of recorded trade subject to taxation as also be used to support the trade reform measures smuggling activities subside. More generally, a by improving customs administration. But even in reduction in tariff dispersion will tend to bolster countries that are highly dependent on trade taxes, revenues by reducing incentives for tax evasion. there is no reason to delay implementing trade The reform of the trade regime in the direction of reform measures that have a positive or neutral a more uniform tariff structure could increase fiscal impact on revenues. In fact, heavy reliance on such revenues as a result of increased transparency and taxes strengthens the case for proceeding more rap- simplification of tax administration. A uniform idly with the revenue-increasing elements of trade 25 T R A D E P O L I C Y R E F O R M I N C O N T E X T reform, especially the tariffication of NTBs and the dence suggests that liberalization of quantitative curtailment of exemptions. restrictions tended to bolster revenues and that tar- Significant progress has been made in reducing iff reforms did not result in revenue losses. the role of export taxes, in part because their elimi- · Fiscal considerations were the main factors cited nation is now generally accepted as a way of as limiting the extent of targeted trade reforms. enhancing growth prospects and strengthening a Greater trade liberalization could have been tar- country's external position. The effect on revenues geted and achieved if more attention had been from lowering export taxes will depend on how given to supportive fiscal policies and to revenue- much and how rapidly the reduction expands total neutral trade measures. trade and reduces illegal activities such as smug- · The effects of trade reform on revenues also gling. Since export taxes are often claimed to be depend significantly on the accompanying substitutes for some form of income tax on hard-to- macroeconomic policies and, in particular, on an tax sectors such as agriculture, their reduction or appropriate exchange rate policy. elimination is likely to be accepted by the country authorities if it is implemented as one element of an Lessons for the Design of Trade Policy overall tax reform package for broadening the tax base. Elimination of export taxes will also have a The discussion in this chapter suggests that there is positive impact on the producers of the commodi- scope for so tailoring the pattern of trade liberaliza- ties that are affected. In the case of agricultural tion as to avoid adverse consequences for revenues. products, these producers may be among the poorer Accordingly, adjustment programs supported by the segments of society (Box 4.1). IMF and the World Bank should, at the start of the Finally, in many programs supported by the IMF reform process, focus on broad-based trade liberal- or the World Bank, substantial trade liberalization ization measures, with a front-loading of those ele- has been accompanied by a devaluation of the ments that are likely to have a positive impact on exchange rate in order to, among other things, pro- revenues. The discussion also underscores the vide incentives for exporters so that they can take importance of sound macroeconomic policies and, advantage of the more liberal trade regime. In gen- in particular, the need for an appropriate exchange eral, the effect of devaluation on trade taxes is rate and for efforts to broaden the domestic tax base. ambiguous (Tanzi 1989) and will depend on the Nevertheless, the problems posed by trade liberal- price elasticity of import demand; if import ization in cases where it is perceived to have an ini- demand is inelastic, the devaluation will result in a tial negative effect on revenue (especially in higher value of imports in local currency terms and countries that rely significantly on trade taxes) will increase revenues at any given level of tariffs. should not be minimized. Even if alternative rev- enue and expenditure measures are readily avail- able, there are likely to be political and economic Case Studies and Other Empirical Evidence challenges. In addition, the consideration of fiscal Several studies (for example, Ebrill, Stotsky, and alternatives will take place in the context of pro- Gropp 1999; Sharer and others 1998) have exam- gram design, which usually involves fiscal pressures ined the actual impact on fiscal revenues following in many areas of both revenue and expenditures, the implementation of trade reforms. These studies including outlays in support of structural reform strengthen the observation noted above that the other than trade policy. sequencing of trade reforms can be done in a way Since sustained trade liberalization could eventu- that minimizes its adverse effect on revenues. Some ally lead to a reduction in the share of trade tax rev- of the main conclusions from these studies follow. enues in total receipts, maintaining revenue performance will require compensating domestic · For countries that initially started with highly tax reforms. Given the long gestation period of tax restrictive trade regimes, trade reforms were imple- policy and administrative reforms, it is critical that mented with a view toward protecting budgetary the reform of domestic taxes be considered at the revenues, and for the most part countries were able very outset of the trade reform exercise and that to achieve significant liberalization without com- technical assistance be sought at an early stage of promising their fiscal objectives. Empirical evi- the liberalization process. 26 Fiscal Dimensions of Trade Liberalization B O X 4 . 1 E X P O R T TA X E S Developing countries often impose export taxes on GI's interventions in the domestic market had a simi- primary commodity exports. Export taxation is one lar depressing effect on producer prices, which fluc- policy instrument that is not subject to WTO disci- tuated around US$5 per kilogram during the 1980s. plines, reflecting WTO members' focus on import Who benefited from the bourbon vanilla cartel policies. This makes it particularly important to and CAVAGI's domestic policies? Indonesian pro- determine the economic effects of such policies. In ducers were clearly the winners. The losers were some cases taxes are imposed in lieu of royalties for Madagascar's producers--mainly smallholders, the extraction of minerals; in others they are used numbering about 60,000, with an average pro- to provide protection to industries that process pri- duction of 130 kilograms and an average income mary commodities. In the latter case they can have of US$650 per plantation. adverse impacts on the poor that need to be care- A recent study provides estimates of the produc- fully monitored and analyzed. The export taxes er prices that would have prevailed in Madagascar mean that primary producers and farmers receive a had the marketing board been abolished. These price below that prevailing in world markets for are close to US$26, well above the US$5 price their commodities. Elimination of the tax will raise fixed by CAVAGI. Taking into account the increase their incomes but may bankrupt established pro- in production that such a change in prices would cessing facilities that are viable only if they pay have generated, laissez-faire policies would have lower-than-world prices for their inputs. Such increased the vanilla producer surplus eightfold. plants may employ poor urban labor, giving rise to Perhaps surprisingly, given the market power that a policy conundrum. In such cases a careful analysis Madagascar had in international markets, free of the appropriate trade regime for poverty allevia- trade (no intervention) would have also increased tion and the provision of safety nets is needed. Madagascar's welfare, by 0.5 percent of GDP--the Sometimes export taxes are used in an attempt to outcome of a major gain equivalent to 2.2 percent exercise market power, and in such cases the policy of GDP for producers, partially offset by a 1.7 per- can have a very adverse effect on the poor. An exam- cent of GDP loss to the marketing board. ple is Madagascar's marketing board for vanilla. An alternative to free trade would have been for In 1960 Madagascar, the world's lowest-cost CAVAGI to eliminate its interventions in the domestic producer of high-quality bourbon vanilla, account- market but to continue to exploit its market power in ed for 60 percent of world exports of natural vanil- international markets through an export tax. Esti- la. From its dominant position, Madagascar mates suggest that the optimal export tax would organized a bourbon vanilla cartel, with Comoros have been close to US$25 per kilogram instead of and Reunion, which set high export prices. Mada- the US$61 implicit tax that CAVAGI was imposing on gascar restricted supply by regulating its domestic producers. This would still have resulted in a dou- market through a marketing board (CAVAGI) that bling of the vanilla producers' surplus and, when fixed low producer prices and required licenses for combined with the tax revenues, would have gener- growing, preparing, and exporting vanilla. ated a welfare gain close to 1 percent of GDP. If this strategy were to be assessed by the effect it A likely explanation as to why these alternative poli- had on export prices of vanilla from Madagascar, it cies were not pursued is that the marketing board's was a clear success. The export price of vanilla revenue would have declined under both scenarios. increased from US$10 per kilogram in the late 1960s This suggests that Madagascar's marketing board to more than US$65 in the early 1990s. However, pricing policies had objectives other than welfare Madagascar's share of world markets declined to 30 maximization and that the heavy implicit taxation of percent as Indonesia, which was outside the cartel, small producers generated an important income took advantage of high world prices to develop its redistribution from the rural poor to the urban elite. export capacity. The entry of Indonesia into world markets left the total value of Madagascar's exports Source: Prepared by the volume editors, based on de Melo, constant throughout the 1970s and 1980s. CAVA- Olarreaga, and Takacs (2000). 27 5 L . A L A N W I N T E R S Trade Policies ed with an eye to its direct poverty consequences. It should, rather, be set on a sound basis for Poverty overall, with recognition that some modification may be Alleviation inevitable for political and other reasons. The primary way to deal with poverty is through general antipoverty policies. Trade Reform and Poverty International trade scholars have long understood that although H owever it is defined, poverty is not for small countries, trade interventions are generally a direct result of international inefficient and wasteful, their inefficiency is usually trade. Rather, poverty reflects low earn- dominated quantitatively by their redistributive ing power, few assets, poor access to communal effects. That is, the net losses from intervention will resources, poor health and education, powerless- generally represent large positive effects for some ness, and vulnerability. It does not matter what people and households and large negative effects for causes these features so long as they exist, nor what others. Correspondingly, although removing inter- relieves them if they can be relieved. Trade policy ventions will generally be income enhancing overall, matters only to the extent that (a) it affects the it is likely to generate both winners and losers.1 For direct determinants of poverty and (b) relative to example, liberalizing an import sector typically the whole range of other possible policies, it offers redistributes real income from producers to con- an efficient policy lever for poverty alleviation sumers as prices fall, and between different factors of (more poverty bang for a buck of forgone opportu- production in such a way that some gain while oth- nities). ers lose more than average. Trade liberalization may have adverse conse- The important positive issues are empirical: does quences for some--including some poor people-- trade liberalization generally create poverty, and that should be avoided or ameliorated to the under what circumstances might it do so in specific greatest extent possible. My fundamental belief, cases? In Winters (2000a), I develop a detailed tax- however, is that trade liberalization aids growth, onomy linking trade shocks to household and indi- which, in turn, aids poverty alleviation. I also vidual poverty and extract 11 key questions that believe that a widespread reform will contain help to answer the latter question (see Box 5.1). enough positive elements so that, in general, only a Finding an instance in which a trade reform causes few people will end up as net losers. Trade policy poverty may not constitute a refutation of an intel- should therefore generally not be closely manipulat- lectually interesting hypothesis, but it does pose a 28 Trade Policies for Poverty Alleviation B O X 5 . 1 K E Y Q U E S T I O N S F O R D E T E R M I N I N G T H E P O V E R T Y I M PA C T O F A T R A D E R E F O R M Will the effects of changed border prices be passed dicting either the price effects or the factor inten- through to the rest of the economy? Trade policy sities of affected sectors can be complex, as was and shocks operate primarily through prices. If seen with the Latin American reforms of the price changes are not transmitted--for example, 1980s and 1990s. In addition, if factor supplies because governments continue to fix the internal show some elasticity, part of a trade shock will prices of goods that they have ostensibly liberal- show up as changes in employment rather than ized internationally--the most direct effects on in factor prices. At the limit, a factor with a per- poverty, whether positive or negative, will be nul- fectly elastic supply will experience only employ- lified. ment effects. This is most pertinent for labor Is reform likely to give poor consumers access to markets. If the prevailing wage is determined by new goods? Perhaps the most direct effect of subsistence levels, switching people from one trade reform on poverty is through the prices of activity to another has no perceptible effect on goods and services in which poor households poverty. If, however, the trade-affected sector have large net positions. The biggest price shocks pays higher wages (because, say, it has an institu- occur when either the initial or final price is finite tionally enforced minimum wage), increases in and the other is infinite (that is, when there is no activity will tend to reduce poverty, and declines market). A shock that completely undermines an will tend to increase it. The formal-informal divide important market--say, for a cash crop or a form is important in this respect. In all this, it is impor- of labor--is likely to have major implications for tant to remember the difference between the poverty. Similarly, making new opportunities, functional and the personal distribution of goods, or services available to the poor can great- income. Falling wages for unskilled labor gener- ly enhance welfare. ate poverty only to the extent that the poor Is reform likely to affect different household mem- depend disproportionately on such wages. bers differently? Within a household, claims on Will the reform actually affect government rev- particular goods and endowments of particular enue strongly? One's immediate reaction is that assets (labor) are typically unevenly distributed. It cutting tariffs will reduce government revenue. is possible that poverty impacts will be concen- Although at the limit this is clearly true (zero tar- trated on particular members--usually females iffs yield zero revenue), many trade reforms actu- and children, who may lose personally even ally have small or even positive revenue effects, when the household gains in aggregate. especially if they convert nontariff barriers into Will spillovers be concentrated on areas and activ- tariffs, remove exemptions, and get tariff rates ities that are relevant to the poor? The sectors of an down to levels that significantly reduce smug- economy are interlinked, and, if substitutability is gling. Even where revenue falls, it is not inevitable high, a shock will be readily transmitted from one that expenditure on the poor will decline. That, sector to another. Frequently the diffusion will be ultimately, is a policy decision. so broad that it has little effect on any particular Will reform lead to discontinuous switches in activ- locality or sector, but sometimes--for example, ities? If so, will the new activities be riskier than the where trade in services is very local--the trans- old ones? If a trade liberalization allows people to mission is narrow but deep. Then it is necessary combine "national" and "international" activities, to ask whether the second-round effects have it is most likely to reduce risk: foreign markets are serious poverty implications. Agricultural stimuli likely to be less variable than domestic ones, and can confer strong propoor benefits on local even if they are not, risk spreading is likely to economies via benign spillovers. decrease overall risk. If, however, trade reform What factors are used intensively in the most leads to more or less complete changes in activi- affected sectors? Changes in the prices of goods ties, there is a possibility that risk will increase, if affect wages according to factor intensities. Pre- the new activity is riskier than the old one. (continued) 29 T R A D E P O L I C Y R E F O R M I N C O N T E X T B O X 5 . 1 ( C O N T I N U E D ) Does the reform depend on or affect the ability of Thus, if a reform implies very large shocks for par- poor people to take risks? The very poor cannot ticular localities, mitigation through phasing, or, bear risk easily. Because the consequences of better, through compensatory and complemen- even small negative shocks are so serious for the tary policies, could be called for. There is a trade- poor, they may be unwilling to take opportunities off, however, because, typically, larger shocks will that increase their average income if the chance reflect bigger shortfalls between current and of losses also increases. This might leave them potential performance and hence larger long-run with only the negative elements of a reform pack- gains from reform. age. Similarly, if a reform makes it more difficult Will transitional unemployment be concentrated for the poor to continue their traditional risk-cop- on the poor? The nonpoor typically have assets ing strategies, it may increase their vulnerability that carry them through periods of adjustment. to poverty even if it raises mean incomes. The situation might be unfortunate for them, but If the reform is broad and systemic, will any it is not poverty strictly defined. The poor have growth it stimulates be particularly unequalizing? few assets, so even relatively short periods of Economic growth is the key to sustained poverty transition could induce a descent deep into reduction. Only if it is very unequalizing will it poverty. If the transition impinges on the poor, increase absolute poverty. there is a strong case for using some of the long- Will the reform imply major shocks for particular run benefits of reform to ease their adjustment localities? Large shocks can create qualitatively strains. different responses from smaller ones; for exam- ple, markets can seize up or disappear altogether. Source: Winters (2000a). real policy question: should we automatically con- theoretical. For this and other reasons, losers will demn a trade reform because it means that one usually be better able to articulate their interests poor person loses or one person is pushed into than gainers, and so the volume of opinion is not a poverty? I believe very strongly that we should not. sufficient indicator of the relative strengths of the Rather, the identification of hardship arising from a pluses and minuses of a policy change. This is par- generally desirable policy reform should stimulate ticularly true given that the poor are generally much the search for complementary policies to minimize less able to advertise and defend their interests than the adverse consequences and reduce the hurt that are wealthier groups. they cause. Rejecting any reform that adversely In what follows, I explore three responses to the affects any poor person is a recipe for long-run stag- possibility that trade reform can create poverty: nation and for an ultimate increase in poverty. Even manipulating trade policy itself, compensating the the requirement that no household fall temporarily losers or the poor, and pursuing complementary into poverty is likely to be extremely restrictive in policies to try to ensure that as few people as possi- poor countries. The more utilitarian view that the ble are net losers. number of households (or persons) in poverty should not increase is more appropriate, although Can Trade Policy Be Managed to Alleviate even then, consideration of the depth of poverty is Poverty? required. All judgments ultimately must be quantitative, One natural response to the possibility that trade not just qualitative. In practical circumstances, it is liberalization could exacerbate poverty in certain easier to identify losers from trade policy than sections of a society is to "manage" liberalization in potential gainers. Losers are identifiable, concrete, a way that eliminates or at least reduces the prob- and personified (see Krueger 1990), whereas the lems. At the conceptual level, this is just common gains are diffuse and appear merely prospective and sense: poverty alleviation is arguably our highest 30 Trade Policies for Poverty Alleviation priority, whereas trade policy is just a means to an growth as a cause of growth) or include much more end. It makes sense to marshal all the tools we have than just trade policy--and that their econometrics toward achieving our principal goals, and indeed, it are weak. But Rodriguez and Rodrik do not argue would be perverse to do anything different. that trade liberalization is harmful to growth, nor But on a practical level, the question is how to use do they deal with other evidence for a beneficial trade policy to achieve poverty objectives. First, relationship, such as the manifest failure of closed there is the possibility that we do actually have goals economies and the findings of a number of case other than poverty alleviation--for example, as studies (see, for example, Srinivasan and Bhagwati regards average incomes, security, foreign policy, or 1999). Thus while Rodriguez and Rodrik should environmental sustainability--and these would certainly inspire greater modesty in policy advice need to be factored in. Second, even leaving aside and renewed research efforts, they have not (yet) additional objectives, we need to decide which reversed the presumption that openness is likely to measure of poverty we are aiming at: there are boost long-run growth. choices even among income- or consumption- The difficulty of establishing an empirical link based measures, let alone among the various con- between liberal trade and growth arises at least part- cepts and dimensions that characterize modern ly from two difficulties, both of which should views of poverty. Third, there may be questions inform our policy attitude. The first is the difficulty about trading poverty in one region against that in of measuring trade stances once one comes inside another, and there will certainly be, fourth, tradeoffs the boundary of near autarchy: tariffs need to be between poverty today and poverty tomorrow. aggregated, quantitative restrictions assessed and Fifth, what else figures in the policy packages among then aggregated, and the degrees of credibility, vul- which we are deciding? Are other policy instru- nerability to lobbying, and enforcement measured ments frozen at current levels, so that the question (see Winters 2000b). This suggests that while one is only one of how trade reform impinges directly should staunchly recommend openness, one needs on the real incomes of the poor? Or can we presume to be cautious about declaring particular regimes that other policies will be optimized, so that, say, open or not. Which was the more open in 1997, boosting incomes in the top decile at the expense of Brazil, or Chile? Both had average most-favored- higher prices for the poor is acceptable because it nation (MFN) tariffs of around 11­12 percent, but will permit a redistribution via the tax-benefit sys- in Chile there appeared to be little discretion and tem that more than offsets the initial growth in the little sensitivity to industrial lobbying, whereas in income gap? These questions illustrate that saying Brazil political pressures could be observed almost "manage trade policy" is not helpful until one spec- every day. ifies how to manage it. The second difficulty is that, although liberal trade policies are likely to be beneficial under any circumstances (because they enlarge the set of Don't Do It opportunities), a quasi-permanent effect on growth One response to the fear that a trade liberalization almost certainly requires combination with other will cause poverty is, "don't do it." But even if the good policies as well. The latter point is made direct effect of a reform might be to worsen poverty repeatedly by the IMF and the World Bank in their overall, this is not generally a satisfactory response. policy advice.2 Krueger (1990) has argued that Although it has proved difficult to isolate the effects openness is likely to be correlated with better policy of trade liberalization on economic growth empiri- in a number of dimensions, and supporting evi- cally, the predominant view is that it has an impor- dence for this assertion might be detected in Ades tant role. The well-publicized cross-country studies and Di Tella (1997, 1999), on corruption, and in that supported this view in the 1990s (for example, Romer (1993), on inflation. Thus, openness brings Dollar 1992; Sachs and Warner 1995; Edwards advantages not only on its own but also as part of a 1998) have recently received rough treatment from constellation of policies designed to ensure efficien- Rodriguez and Rodrik (2001). The latter argue, with cy and competition in markets, and transparency some justification, that these studies' measures of and predictability in policymaking. openness are flawed--in particular, because they The second part of the openness-poverty link either are endogenous (at least as much due to concerns the connection from growth to poverty. 31 T R A D E P O L I C Y R E F O R M I N C O N T E X T Growth needs to be strongly biased against the poor a series of exceptions is not strong. One needs very before it is likely to worsen poverty absolutely. (The compelling evidence of the efficacy of such inter- effect on inequality is a different story but, in my ventions, and such evidence is, on the whole, miss- view, a distracting one.) There are examples of such ing. Simply appealing to the experience of East Asia a negative relationship (see, for example, White and is not persuasive; it is not beyond dispute that these Anderson 2000), but they are equally balanced by countries' trade interventions were important or cases in which growth disproportionately favors the beneficial (Lee 1996 suggests the opposite for poor. Thus, Dollar and Kraay's (2001) finding that, Korea), and it is far from certain that other coun- on average, growth is good for the poor does seem tries have the policymaking institutions to be able to be robust (as it was in the earlier work of Gallup, to replicate East Asian policy stances effectively. Radelet, and Warner 1998), and so does their con- In addition to efficiency considerations, we must clusion that growth driven by trade liberalization is recognize that trade liberalization is a political act no different in that respect. A challenge to the latter and that governments must generate sufficient view can be found in the early work of Lundberg political support to sustain the reform. Even the and Squire (2000), but on further investigation they most rigorous reforms need tempering for political too concluded that trade liberalization benefited the reasons; see, for example, Edwards and Lederman poor, albeit by less than it helped better-off house- (1998) on Chile, where certain agricultural goods holds. were granted special protection in the form of price To conclude, I would argue that although there bands. Recognizing the need for such compromise remain a number of pressing research questions in is not the same as recommending it, however, and it the area, a liberal trade regime almost certainly is important to remember that the poor are even assists poverty alleviation in the long run. Thus, lib- weaker in political markets than in economic ones. eralization should have a place in the armory of a Rarely will protecting the poor and reaping signifi- poverty-conscious government. This does not cant political support for a reform coincide. Gov- imply a call for the immediate dismantling of all ernments are well advised to do everything possible trade restrictions, and it certainly does not imply to avoid using the instruments of trade policy for that opening the border is all that is needed, but it political purposes. One of the most powerful tools does, I believe, mandate a serious and credible com- for avoiding political pressures is uniformity-- mitment to openness in the foreseeable future. explicitly treating all commodities equally. Such a motivation was clearly articulated in Chile as it entered its big reform in the mid-1970s (Edwards Don't Do It All and Lederman 1998). A second response is,"don't do it all: while everyone There may be a stronger case for exceptions to lib- is in favor of liberalization in general, certain sectors eralization for the sake of direct poverty alleviation: or products should be exempt." In fact, all countries the outcome is objectively measurable and can have such exceptions (agriculture in Europe and arguably be isolated politically from general inter- clothing in the United States, for example), but that vention. Thus, if particular products can be clearly does not necessarily make them good economics. identified with the poor as either consumption or Considering overall economic performance, there production goods, it may be justified to postpone undoubtedly are cases in which an isolated inter- their liberalization significantly. There are, however, vention in trade would be beneficial to immediate some important caveats to such a recommendation. economic welfare--where externalities, informa- First, the calculation needs to be rigorous in defin- tion failures, or just random shocks can be usefully ing "the poor" whose interests are being protected. overcome by a well-judged intervention. But given (Ravallion and van de Walle 1991 show how in the difficulty of identifying these cases, of prevent- Indonesia the poor and the very poor had conflict- ing their capture by interest groups, and of avoiding ing interests in rice liberalization.) Second, the giving a systemic signal that lobbying for interven- products do need to be tightly linked to the poor in tion pays, it is not clear that it will be beneficial order that the distributional gains of protecting overall to pursue them. Thus, although one does not them are not offset by efficiency losses elsewhere in need to progress all the way to free trade to reap the the economy. The goods concerned need to be of benefits of liberalism, the general case for planning great significance to the poor--almost always, a 32 Trade Policies for Poverty Alleviation foodstuff on the consumption side, and frequently with long adjustment periods and postponing liber- an agricultural good on the production side--and alization because "the time is not ripe." The key is of little interest to other sections of society. On the credibility that reform will actually occur. Adjust- latter dimension, for example, it was reported in the ment costs may be lower if adjustment can be 1970s that in addition to any effects on the poor that spread somewhat through time, but they are proba- Egypt's bread subsidies may have had, they also bly increased if adjustment is resisted in the hope made it worthwhile for pig farmers to feed their that the threat of liberalization will go away. Several stock on fresh bread. trade reforms have been accelerated once they have Third, close monitoring is required to ensure that been launched; examples include implementation the desired effects do actually emerge. An important of free trade in the European Economic Communi- goal to keep in mind is that the poor continue to ty, of the Kennedy Round tariff cuts, and of the tar- have access to the effects of the policy and do not get iff cuts planned in the Association of Southeast hustled out of the way by more articulate and pow- Asian Nations (ASEAN) Free Trade Agreement. erful middle-class interests. In general, the poor fare Usually the acceleration happens at the behest of the very badly in discretionary allocation mechanisms private sector, presumably because, once it is precisely because they are marginalized politically accepted that reform will occur, business is keen to and socially, as well as economically. Thus, for adjust rapidly. example, export restrictions to keep down the price Thus, undertaking a major trade liberalization in of a local staple will probably not benefit the poor if phases is probably desirable, just as the Uruguay low prices mean that nonprice rationing is required. Round, for example, permitted long adjustment Fourth, a long-term plan is needed to help reduce periods. The phasing should, however, not merely the dependence of the poor on the policy interven- entail postponing the largest adjustments longest; tion. Otherwise, the intervention just amounts to it should pay attention to the different adjustment stopping the clock, which offers little prospect of needs of different sectors and to the interactions long-run development. between different parts of the package. For exam- Overall, "don't do it all" is not a suitable policy ple, if the inputs and outputs of a particular sector recommendation. The politics, especially protecting are liberalized at very different rates, the sector the interests of the poor, will be easier if the govern- could face either negative or excessively positive ment can explicitly reject special pleading on the incentives for production during the transition.3 grounds that everyone is receiving equal treatment. Whatever the transition period, credible commit- De facto, there may be--there may have to be-- ment to the final goal is important, for without it, some slippage in such an attempt, but it seems to neither current nor potential future activities will me undesirable to go into the process expecting or look desirable, and there will be a diversion of recommending slippage. The only exception I effort into lobbying. would make would be for temporary exemptions for goods or services that can be clearly and closely Compensatory Policies for Developing linked to the poor. A high burden of proof should Countries be placed on candidates for such exemptions to prove their efficacy. If trade liberalization causes poverty among certain sections of society, the next question is whether soci- ety can offset the effect directly. Despite the theoreti- Don't Do It Now cal attractions of lump-sum budgetary transfers for "Don't do it now" is a more useful response than economists, governments are not generally attracted the others in some circumstances. For example, to them because of their cost, their transparency trade reform in the midst of recession seems likely (and the transparency of their abuse), and the to give rise to more, and more durable, transitional appearance that they do little to cure "the problems" unemployment than reform in a boom. Again, that individuals face. Rather, assistance is usually where investment is necessary to allow the produc- offered, if at all, in terms such as retraining, reloca- tion of export-quality goods, it may be desirable to tion assistance, and temporary income support. In allow time for that to occur. There is, however, a fact, while these approaches probably do have a con- world of difference between committing to policies tribution to make, even they face severe difficulties. 33 T R A D E P O L I C Y R E F O R M I N C O N T E X T Official retraining has mixed success under any cir- thresholds are set low enough; and, since relieving cumstances, and, what is worse, it is difficult to sepa- poverty is more or less universally recognized as a rate those cases where trade is to blame from those responsibility of the state, there is little argument where it is not. Unless one is willing to underwrite about the legitimacy of such interventions. almost any adjustment, identification of cases is a Targeting is a major problem for safety nets, not major difficulty. Making a general commitment, only technically but also because the middle classes however, is not attractive because of the potentially are often better able to access them than the poor. huge cost and because doing so shifts private risk to Sustainability is another difficulty; a major trade the public sector, with all the attendant moral hazard shock could put severe financial pressure on a problems. It is not the role of the state, nor is it feasi- scheme just at a time when it is most needed. Raval- ble, to absorb every negative shock that might afflict lion (1999) offers some useful thoughts on setting individuals. Yet it is difficult to make a moral case as up safety nets. Workfare is a good start, provided to why trade shocks warrant adjustment assistance that the wage is low enough, that there is little or no while other shocks do not.4 administrative discretion in its application, and that A further complication arises in giving compen- the tasks set are seen to be of communal interest. In sation in a way that encourages rather than discour- fact, Ravallion suggests that local communities ages adjustment. European agricultural policy is select the projects to be undertaken under workfare essentially designed to protect farmers from the and that better-off communities should be asked to consequences of declining comparative advantage, cofinance the projects. Workfare has to be supple- yet it has the effect of rewarding current, not for- mented, however, by schemes to provide food to mer, farmers. Compensation may be decoupled people such as the elderly and infirm who cannot from current output but not from farming as an work and to children (through, for example, food- activity. for-education schemes). These supplementary In cases where liberalization leads to the loss of schemes may be tripped on and off according to jobs, government can insist on, and perhaps help need, but they should have a permanent infrastruc- finance, redundancy payments. These payments can ture and sensitive and quick triggers. Expenditure help some people avoid poverty, if they use their on safety nets is almost by definition countercycli- money productively, but they are not guaranteed to cal, and so a firm commitment by government is do so. (See Winters 2000a on the "new poor" in required to ensure that the money does not dry up Zimbabwe.)5 Moreover, redundancy payments typi- in times of greatest need. cally reward past service, not current need, and so Examples of useful safety nets can be found in they are not particularly well targeted for poverty Bangladesh. According to the Consumer Unity & alleviation purposes. Trust Society, General compensatory policies, including safety nets, are designed to alleviate poverty from any It is generally recognized that programs such as source directly. They replace the problem of identi- Food for Education (FFE), Vulnerable Group fying the shock with the task of identifying the poor. Development (VGD), Test-Relief, and Food for Ideally, countries should already have such pro- Work positively induce alleviation of poverty. grams in place. Indeed, a major part of the effect of For example, during the unprecedented floods these programs arises from their mere existence of 1998, about 4.5 million VGD cards were dis- rather than their use: they facilitate adjustment by tributed in Bangladesh, which provided crucial assuring the poor that there is a minimum (albeit a help at a critical time. The FFE program has barely acceptable one) below which they will not be helped increase school attendance of poor chil- allowed to fall. Such schemes, if trade-adjusting dren by 21%. (CUTS 1999: 110) countries do already have them, offer the advan- tages over tailor-made schemes of automaticity, The safety nets in Zambia and Zimbabwe, by con- immediacy, and a degree of "road-testing," and they trast, are currently regarded as too poorly run and also avoid the problems associated with targeted underfunded to be able to offer serious assistance to trade adjustment assistance. If they are sensibly losers from trade liberalization. constructed, they need not entail huge expenditure; Safety nets are not the only answer to the threat of there is little chance of moral hazard problems if the increasing poverty from trade liberalization, but 34 Trade Policies for Poverty Alleviation they are an important part of the response. They relatively underdeveloped in most of the smallhold- can generally be targeted better than other policies, er areas, increasing numbers of resettled and com- and they are not very distortionary of market forces. munal households are now becoming involved as If countries do not have safety nets already, they producers of the main crops. This has primarily should consider setting them up as part of the con- been the result of "outgrower" schemes and of text for a trade liberalization that may create short- sourcing or subcontracting by large-scale commer- term poverty. The safety nets should not, however, cial farms. The Horticultural Promotion Council be trade shock­specific. (HPC) estimates that around 3,000 small-scale farmers are now growing for export on a contract basis, accounting for approximately 10 percent of Complementary Policies for Zimbabwe's exports.6 In January 1999 the HPC Better-Functioning Markets established the Small-Scale Linkage Programme, A critical issue concerning the poverty impacts of designed to provide communal and resettled farm- trade liberalization, especially for surprises connect- ers with the knowledge and skills to produce high- ed with it, is the functioning of markets. Trade liber- value, off-season export crops. alization must be accompanied by monitoring to determine whether any markets are failing. Policies Credit Markets designed to ensure that markets continue to func- tion or to develop, where required, will have high Development economics affords many examples of payoffs for both aggregate income and poverty alle- how missing credit markets have prevented devel- viation. Some important circumstances are dis- opment, and the same phenomenon is visible in cussed next. responses to trade liberalization. Thus, for example, achieving minimum consignment size might entail hiring draft power or seasonal labor, but this is not Infrastructure Support possible without credit. Similarly, establishing Potential opportunities for poor producers to bene- informal businesses in areas such as trading may fit from a more open trading regime have been lost require more capital than the poor can raise. These because critical infrastructure was either absent or cases in which the poor are not able to respond to had deteriorated. In both Zimbabwe and Zambia incentives as strongly as the less poor replicate the remote farmers found their opportunities con- results of López, Nash, and Stanton (1995) in their strained by inability to reach major market centers. panel study of Mexican agriculture. In the same way, many of the benefits from relaxed retailing regulations and from availability of new or Labor Mobility cheaper goods have been confined to urban and periurban areas. The secret of spreading the benefits of increasing labor demand widely is labor mobility. If markets are segmented for cultural or geographic reasons, Market Institutions breaking down these barriers through information The poor frequently seem unable to attain the eco- and facilitating physical mobility will have an equal- nomic mass required for the establishment of mar- izing effect. kets that, once in place, may be viable. Policy should aim at the creation of the market as an institution, Establishing Businesses not at the ongoing subsidization of market activity. One aspect of facilitating the participation of the If the regulations for establishing new businesses are poor in markets may be to find means to allow them cumbersome, if the businesses' ability to obtain to combine very small consignments of inputs or inputs (especially utilities) is weak, or if regulations outputs into reasonably sized bundles and so reduce on expansion and on labor recruitment and separa- transactions cost sufficiently to make dealing with tion are restrictive, this could curtail the willingness poor producers worthwhile. Horticulture in Zim- of entrepreneurs to start or expand operations. A babwe offers an illustration of a successful policy of success story of business deregulation is the growth this kind (Winters 2000a). Although horticulture is of maize hammer milling in Zimbabwe. Following 35 T R A D E P O L I C Y R E F O R M I N C O N T E X T domestic deregulation, 3,500 new hammer mills This is not, however, a license to postpone the opened, mainly in rural areas, and the share of ham- design, announcement, and locking in of the reform mer millers in total maize milling has increased to itself. Any of these delays--for example, announc- almost 80 percent.7 These mills are mechanically ing that liberalization is necessary but that its form simple and robust (being based on swinging or will be worked out once certain other reforms have rotating hammers in a grinding chamber) and can been implemented--would seem likely to result in be used by unskilled labor. They provide quality the worst of all worlds. It would create uncertainty maize meal products to nearby customers in poor and incentives to lobby government and, indeed, communities, saving them significant transport would look to many commentators like a de facto costs. In 1995 hammer mills were estimated to reluctance to liberalize trade. In particular, in the employ 7,512 permanent workers (751 in urban absence of a clear and monitorable plan for specific areas); when casual workers and rural activities are pieces of infrastructure, a general wish to wait until included, the sector employs some 13,000 workers. the roads or ports are "ready" is just a recipe for About 18 percent of the employees in urban ham- indefinite postponement. A credible plan for liber- mer mills are female, as are 8 percent of the employ- alizing the borders--albeit one with significant ees in rural areas.8 transition periods--will be an important stimulus to reforming these other areas in ways that will typ- ically have other benefits as well. Prerequisites or Concomitants? It is also well to record that there are disadvan- In many cases actual policy debate appears to hinge tages as well as advantages to phased adjustment. on whether complementary policies of the sort just Populations can certainly suffer from reform fatigue described should be prerequisites for a trade liberal- and would actually be more comfortable with a def- ization."Everyone accepts that trade liberalization is inite, even if ambitious, reform plan than with one desirable in the long run," the argument goes, "but that drifts into the indefinite future. Phased adjust- various supporting policies must be in place before ment implies a longer time spent out of equilibri- it is attempted." Here, even more than in the matters um, and in most discussions it is not proved that the discussed above, we have no formal analysis to fall integral of shallow adjustment costs over a long back on. There is a literature on sequencing reform period is smaller than that of deep costs over a within the trade sector and between trade and capi- shorter period.9 Moreover, delay postpones the ben- tal accounts, but there are no convincing empirical efits of full reform. Finally there are likely to be generalizations about sequencing in the sense dis- aggregate gains from trade reform even in the cussed here. Moreover, the question is only partly absence of complementary policies. A trade reform economic; part of it is political and concerns increases opportunities for desirable exchange, and whether a reform postponed is a reform preempted. these will exist even with poor infrastructure, and I argued above that there may well be a case for even though there would have been more opportu- phasing in a reform over a long period provided nities had the infrastructure been better. And this that the final destination is clear (and not likely to applies to the poor as much as to other people. It is be contested) and that the transition is well possible that in the absence of complementary poli- designed and does not amount just to postponing cies, the poor will suffer (say, because of rising all effective change until the last moment. Given prices) whereas with such policies they will gain that a well-conceived and well-executed reform because they will receive income gains to offset the generates a potentially infinite-lived stream of bene- price rises. But there is no general theorem to this fits, whether this occurs over three years or, say, nine effect; the case remains to be made. years is not that important. The same logic applies to delays required to put complementary policies in Conclusion place (or, indeed, to compensatory mechanisms if that is the route chosen). Thus, for example, there Trade reform almost invariably brings with it two may be a case for delaying the implementation of a changes that help in the battle against poverty: it liberalization while legislation on business forma- induces efficiency in the use and allocation of tion or labor market operation is put in place and resources (the economist's beloved static gains), and plans for protecting market institutions are laid. it fosters long-run growth. It also entails temporary 36 Trade Policies for Poverty Alleviation adjustment costs that reduce incomes immediately, Notes although these costs are almost always outweighed Preparation of this chapter was supported by Globkom, the Parlia- by the long-term benefits. Finally it has a host of mentary Commission on Swedish Policy for Global Development, direct and indirect effects on poverty that could go to which I am most grateful. I also thank Costas Michalopoulos for either way, depending on consumption and produc- comments on the outline and Rosie Bellinger for logistic help. tion patterns and on the nature of reform. 1 I say "generally" because second-best considerations or market The general presumption is that reform will help failures could reverse the result. alleviate poverty, but the direct and indirect effects 2 Mosley (2000) argues that the attempts of the IMF and the just mentioned make it likely that some will lose World Bank to prove this proposition have not been very suc- from liberalization--especially one that is narrowly cessful. (His attempts to prove the contrary are similarly focused sectorally--and it is certainly possible that flawed, however.) some of the poor will suffer. Still, others will gain, 3 Technically, the effective rate of protection (ERP) could and these will quite possibly include others among become very distorted. In Zambia, Oxfam and the Institute for the poor. Thus, tradeoffs are necessary. There is no Development Studies (IDS) found decreases in the ERP for alternative to case-by-case analysis if policymakers maize, as fertilizer prices (which were said to account for 76 wish to predict and preempt adverse effects, even percent of the cost of production) increased by more than out- put prices. This accounts for the loss of output there. though prediction is very difficult. One must be alive to the possibility that "predict and preempt" 4 See Decker and Corson (1995) on the U.S. Trade Adjustment policies will be captured by powerful interest Assistance Program, which doubles the length of unemploy- groups. Given these groups' strong interests in trade ment insurance coverage, from 26 to 52 weeks, for workers certified as displaced by trade liberalization. After serious abuse policy and the apparent ease with which trade poli- in its early years, when it was merely a transfer (over 70 per- cy can be captured (because its domestic costs are cent of claimants went back to work for the employer from usually hidden and the issues can be so easily pre- whom they were said to have been displaced), a training ele- sented in terms of standing up to foreigners), there ment was added. This had the effect of screening out are grave dangers in setting out to manipulate trade claimants who did not want or need training, but it apparently did nothing to increase the earning power of recipients. policy directly to avoid adverse poverty impacts. Only in the most obvious cases are the dangers like- 5 The "new poor" are retired public sector officials who have not ly to be worth incurring. managed to invest their redundancy payments sufficiently pro- ductively to maintain themselves above poverty levels. My general prescription, then, is for a rigorously liberal trade policy (even though it is recognized 6 These small-scale "outgrowers" tend to supply the four main that some slippage may occur for political reasons). packinghouses in Zimbabwe, which are the large-scale pro- General compensatory policies should then be used ducers that seek to add volume and diversify risk. to cure immediate hardship, and complementary 7 The 1995­96 Zimbabwe National Hammer Miller Status Study, policies should be pursued to enlarge long-term funded by the U.S. Agency for International Development. gains. Assessing likely impacts in the design of poli- 8 Ibid. cy reforms is of great importance. The set of ques- 9 This is not to deny the possibility--as, for example, if a major tions posed in Box 5.1 can help policymakers in the shock creates hysteresis in labor markets--but it needs to be design and implementation of reforms. proved. 37 II THE WORLD TRADE ORGANIZATION T he WTO was created in 1995 as one of discussions of the "engine" of the WTO--the princi- the outcomes of the Uruguay Round of ple of reciprocity (Chapter 7, by J. Michael Finger multilateral trade talks. The Uruguay and L. Alan Winters); the accession process (Chapter Round, which concluded in 1994 after eight years of 8, by Constantine Michalopoulos); and the dispute complex and sometimes contentious negotiations, settlement mechanism (Chapters 9, by Valentina was a landmark in the history of the trading system. Delich, and 10, by Robert E. Hudec). The last is the Agriculture and textiles and clothing became subject aspect of the WTO that attracts most attention. The to stronger multilateral disciplines, and the trading WTO is unique among international organizations system was extended to include intellectual property in that it has a well-functioning, binding dispute set- and trade in services. The WTO establishes the rules tlement mechanism. This is of great importance to of the trade policy game for its members, which developing countries, which generally will not be increasingly include developing countries. (Member- able to induce compliance with negotiated rules in ship at the time of writing stood at 144, but more bilateral disputes with large industrial economies. In than 50 developing countries have yet to join the practice, because countries value the trading sys- WTO.) A good understanding of how the WTO tem, the large and powerful tend to abide by the works and what it does is a necessary condition for rulings of dispute settlement panels, providing an maximizing the benefits of membership. incentive for developing countries to ensure that The chapters in this part discuss some of the they are able to use the system. major features of the WTO that are relevant to The ability to use the WTO system is a function of developing countries. A brief summary of the basic many factors. Among the necessary conditions are rules and the institutional mechanisms of the WTO that countries participate in the negotiations on the (Chapter 6, by Bernard Hoekman) is followed by rules of the game and that they use the WTO in a 39 T H E W O R L D T R A D E O R G A N I Z AT I O N proactive manner. Much of this Handbook is aimed Kluwer Law International, 1999). An early study of at helping countries do so. the GATT system that remains well worth reading is The chapters in Part II are not intended to provide Gerard Curzon, Multilateral Trade Diplomacy (Lon- comprehensive coverage of the WTO. Those seek- don: Michael Joseph, 1965). Robert Hudec's seminal ing an in-depth treatment of the WTO, its negotiat- Developing Countries in the GATT Legal System (Lon- ing history, and its dispute settlement case law are don: Trade Policy Research Centre, 1987) is an indis- referred to the sources listed below. pensable source for those seeking to understand the approach taken toward development issues in the WTO. An informative history of the Uruguay Round Further Reading and Sources of negotiations is presented in John Croome, Reshaping Information the Trading System (Deventer: Kluwer, 1999). The WTO Website, , provides direct Michael Trebilcock and Robert Howse, in The Regula- access to most of the documents submitted to the tion of International Trade (London: Routledge, institution, as well as to reports and case law. The 1998), provide a comprehensive treatment of WTO International Center for Trade and Sustainable Devel- rules, as well as a comparison between WTO disci- opment has links to all the major nongovernmental plines and those that apply in the European Union organizations on its Website, , and and the North American Free Trade Agreement it publishes an informative newsletter, Bridges, that (NAFTA). A recent analysis and description of the monitors WTO issues from a development perspec- economics and politics of the world trading system tive. WTO dispute settlement procedures are dis- can be found in Bernard Hoekman and Michel cussed in detail by David Palmeter and Petros C. Kostecki, The Political Economy of the World Trading Mavroidis in Dispute Settlement in the World Trade System: The WTO and Beyond, 2d ed. (New York: Organization: Practice and Procedure (The Hague: Oxford University Press, 2001). 40 6 B E R N A R D H O E K M A N The WTO: Since 1947, the GATT has been the major focal point for industrial country governments Functions and seeking to lower trade barriers. Although the GATT was initially Basic Principles largely limited to a tariff agree- ment, over time, as average tariff levels fell, it increasingly came to concentrate on nontariff trade policies and domestic policies having an impact on trade. (See the Glossary to this volume for a list of trade-related policies used T by countries.) Its success was he WTO, established in 1995, adminis- reflected in a steady expansion in the number of ters the trade agreements negotiated contracting parties. By the end of the Uruguay by its members, in particular the General Agree- Round (1994), 128 countries had joined the GATT. ment on Tariffs and Trade (GATT), the General Since the entry into force of the WTO, membership Agreement on Trade in Services (GATS), and the has grown to 144, as of the end of 2001. Trade-Related Aspects of Intellectual Property The WTO differs in a number of important Rights (TRIPS) agreement. (These and other major respects from the GATT. The GATT was a rather WTO agreements are contained in the CD-ROM flexible institution; bargaining and deal-making lay "Applied Trade Policy," which is included with this at its core, with significant opportunities for coun- Handbook.) The WTO builds on the organizational tries to "opt out" of specific disciplines. In contrast, structure that had developed under GATT auspices WTO rules apply to all members, who are subject to as of the early 1990s. binding dispute settlement procedures. This is The origins of the GATT were in the abortive attractive to groups seeking to introduce multilater- negotiations to create an International Trade Orga- al disciplines on a variety of subjects, ranging from nization (ITO) following World War II. Negotiations the environment and labor standards to competi- on the charter of such an organization were con- tion and investment policies to animal rights. But it cluded successfully in Havana in 1948, but the talks is a source of concern to groups that perceive the did not lead to the establishment of the ITO because (proposed) multilateral rules to be inappropriate or the U.S. Congress was expected to refuse to ratify the worry that the adoption of specific rules may affect agreement. Meanwhile, the GATT was negotiated in detrimentally the ability of governments to regulate 1947 by 23 countries--12 industrial and 11 develop- domestic activities and deal with market failures. ing--before the ITO negotiations were concluded.1 The main function of the WTO is as a forum for As the ITO never came into being, the GATT was the international cooperation on trade-related poli- only concrete result of the negotiations. cies--the creation of codes of conduct for member 41 T H E W O R L D T R A D E O R G A N I Z AT I O N governments. These codes emerge from the small number of contracting parties to the GATT exchange of trade policy commitments in periodic (only 23 countries), the benchmark for MFN is the negotiations. The WTO can be seen as a market in best treatment offered to any country, including the sense that countries come together to exchange countries that are not members of the GATT. market access commitments on a reciprocal basis. It National treatment requires that foreign goods, is, in fact, a barter market. In contrast to the markets once they have satisfied whatever border measures one finds in city squares, countries do not have are applied, be treated no less favorably, in terms of access to a medium of exchange: they do not have internal (indirect) taxation than like or directly money with which to buy, and against which to sell, competitive domestically produced goods (Art. III, trade policies. Instead they have to exchange apples GATT). That is, goods of foreign origin circulating for oranges: for example, tariff reductions on iron in the country must be subject to taxes, charges, and for foreign market access commitments regarding regulations that are "no less favorable" than those cloth. This makes the trade policy market less effi- that apply to similar goods of domestic origin. cient than one in which money can be used, and it is The MFN rule applies unconditionally. Although one of the reasons that WTO negotiations can be a exceptions are made for the formation of free trade tortuous process. One result of the market exchange areas or customs unions and for preferential treat- is the development of codes of conduct. The WTO ment of developing countries, MFN is a basic pillar contains a set of specific legal obligations regulating of the WTO. One reason for this is economic: if pol- trade policies of member states, and these are icy does not discriminate between foreign suppliers, embodied in the GATT, the GATS, and the TRIPS importers and consumers will have an incentive to agreement. use the lowest-cost foreign supplier. MFN also pro- vides smaller countries with a guarantee that larger countries will not exploit their market power by Basic Principles raising tariffs against them in periods when times The WTO establishes a framework for trade poli- are bad and domestic industries are clamoring for cies; it does not define or specify outcomes. That is, protection or, alternatively, give specific countries it is concerned with setting the rules of the trade preferential treatment for foreign policy reasons. policy game, not with the results of the game. Five MFN helps enforce multilateral rules by raising principles are of particular importance in under- the costs to a country of defecting from the trade standing both the pre-1994 GATT and the WTO: regime to which it committed itself in an earlier nondiscrimination, reciprocity, enforceable com- multilateral trade negotiation. If the country desires mitments, transparency, and safety valves. to raise trade barriers, it must apply the changed regime to all WTO members. This increases the political cost of backsliding on trade policy because Nondiscrimination importers will object. Finally, MFN reduces negoti- Nondiscrimination has two major components: the ating costs: once a negotiation has been concluded most-favored-nation (MFN) rule, and the national with a country, the results extend to all. Other coun- treatment principle. Both are embedded in the main tries do not need to negotiate to obtain similar WTO rules on goods, services, and intellectual treatment; instead, negotiations can be limited to property, but their precise scope and nature differ principal suppliers. across these three areas. This is especially true of the National treatment ensures that liberalization national treatment principle, which is a specific, not commitments are not offset through the imposition a general commitment when it comes to services. of domestic taxes and similar measures. The The MFN rule requires that a product made in requirement that foreign products be treated no less one member country be treated no less favorably favorably than competing domestically produced than a "like" (very similar) good that originates in products gives foreign suppliers greater certainty any other country. Thus, if the best treatment grant- regarding the regulatory environment in which they ed a trading partner supplying a specific product is must operate. The national treatment principle has a 5 percent tariff, this rate must be applied immedi- often been invoked in dispute settlement cases ately and unconditionally to imports of this good brought to the GATT. It is a very wide-ranging rule: originating in all WTO members. In view of the the obligation applies whether or not a specific tar- 42 The WTO: Functions and Basic Principles iff commitment was made, and it covers taxes and establish "ceiling bindings": the member concerned other policies, which must be applied in a nondis- cannot raise tariffs above bound levels without criminatory fashion to like domestic and foreign negotiating compensation with the principal sup- products. It is also irrelevant whether a policy hurts pliers of the products concerned. The MFN rule an exporter. What matters is the existence of dis- then ensures that such compensation--usually, crimination, not its effects. reductions in other tariffs--extends to all WTO members, raising the cost of reneging. Once tariff commitments are bound, it is impor- Reciprocity tant that there be no resort to other, nontariff, Reciprocity is a fundamental element of the negoti- measures that have the effect of nullifying or ating process. It reflects both a desire to limit the impairing the value of the tariff concession. A num- scope for free-riding that may arise because of the ber of GATT articles attempt to ensure that this MFN rule and a desire to obtain "payment" for does not occur. They include Article VII (customs trade liberalization in the form of better access to valuation), Article XI, which prohibits quantitative foreign markets. As discussed by Finger and Winters restrictions on imports and exports, and the Agree- in Chapter 7 of this volume, a rationale for reciproc- ment on Subsidies and Countervailing Measures, ity can be found in the political-economy literature. which outlaws export subsidies for manufactures The costs of liberalization generally are concentrat- and allows for the countervailing of production ed in specific industries, which often will be well subsidies on imports that materially injure domes- organized and opposed to reductions in protection. tic competitors (see Chapter 17, by Pangestu, in this Benefits, although in the aggregate usually greater volume). than costs, accrue to a much larger set of agents, If a country perceives that actions taken by anoth- who thus do not have a great individual incentive to er government have the effect of nullifying or organize themselves politically. In such a setting, impairing negotiated market access commitments being able to point to reciprocal, sector-specific or the disciplines of the WTO, it may bring this situ- export gains may help to sell the liberalization polit- ation to the attention of the government involved ically. Obtaining a reduction in foreign import bar- and ask that the policy be changed. If satisfaction is riers as a quid pro quo for a reduction in domestic not obtained, the complaining country may invoke trade restrictions gives specific export-oriented WTO dispute settlement procedures, which involve domestic interests that will gain from liberalization the establishment of panels of impartial experts an incentive to support it in domestic political mar- charged with determining whether a contested kets. A related point is that for a nation to negotiate, measure violates the WTO. Because the WTO is an it is necessary that the gain from doing so be greater intergovernmental agreement, private parties do than the gain available from unilateral liberaliza- not have legal standing before the WTO's dispute tion. Reciprocal concessions ensure that such gains settlement body; only governments have the right to will materialize. bring cases. The existence of dispute settlement pro- cedures precludes the use of unilateral retaliation. For small countries, in particular, recourse to a mul- Binding and Enforceable Commitments tilateral body is vital, as unilateral actions would be Liberalization commitments and agreements to ineffective and thus would not be credible. More abide by certain rules of the game have little value if generally, small countries have a great stake in a they cannot be enforced. The nondiscrimination rule-based international system, which reduces the principle, embodied in Articles I (on MFN) and III likelihood of being confronted with bilateral pres- (on national treatment) of the GATT, is important sure from large trading powers to change policies in ensuring that market access commitments are that are not to their liking. implemented and maintained. Other GATT articles play a supporting role, including Article II (on Transparency schedules of concessions). The tariff commitments made by WTO members in a multilateral trade Enforcement of commitments requires access to negotiation and on accession are enumerated in information on the trade regimes that are main- schedules (lists) of concessions. These schedules tained by members. The agreements administered 43 T H E W O R L D T R A D E O R G A N I Z AT I O N by the WTO therefore incorporate mechanisms mitments on trade policies that are subject to bind- designed to facilitate communication between ing dispute settlement, can also have this effect. WTO members on issues. Numerous specialized committees, working parties, working groups, and Safety Valves councils meet regularly in Geneva. These interac- tions allow for the exchange of information and A final principle embodied in the WTO is that, in views and permit potential conflicts to be defused specific circumstances, governments should be able efficiently. to restrict trade. There are three types of provisions Transparency is a basic pillar of the WTO, and it in this connection: (a) articles allowing for the use of is a legal obligation, embedded in Article X of the trade measures to attain noneconomic objectives; (b) GATT and Article III of the GATS. WTO members articles aimed at ensuring "fair competition"; and (c) are required to publish their trade regulations, to provisions permitting intervention in trade for eco- establish and maintain institutions allowing for the nomic reasons. Category (a) includes provisions review of administrative decisions affecting trade, allowing for policies to protect public health or to respond to requests for information by other national security and to protect industries that are members, and to notify changes in trade policies to seriously injured by competition from imports. The the WTO. These internal transparency require- underlying idea in the latter case is that governments ments are supplemented by multilateral surveil- should have the right to step in when competition lance of trade policies by WTO members, becomes so vigorous as to injure domestic competi- facilitated by periodic country-specific reports tors. Although it is not explicitly mentioned in the (trade policy reviews) that are prepared by the sec- relevant WTO agreement, the underlying rationale retariat and discussed by the WTO General Coun- for intervention is that such competition causes cil. (The Trade Policy Review Mechanism is political and social problems associated with the described in Box 6.1.) The external surveillance need for the industry to adjust to changed circum- also fosters transparency, both for citizens of the stances. Measures in category (b) include the right to countries concerned and for trading partners. It impose countervailing duties on imports that have reduces the scope for countries to circumvent their been subsidized and antidumping duties on imports obligations, thereby reducing uncertainty regard- that have been dumped (sold at a price below that ing the prevailing policy stance. charged in the home market). Finally, under category Transparency has a number of important bene- (c) there are provisions allowing actions to be taken fits. It reduces the pressure on the dispute settle- in case of serious balance of payments difficulties or ment system, as measures can be discussed in the if a government desires to support an infant industry. appropriate WTO body. Frequently, such discus- sions can address perceptions by a member that a From GATT to WTO specific policy violates the WTO; many potential disputes are defused in informal meetings in Gene- Over the more than four decades of its existence, the va. Transparency is also vital for ensuring "owner- GATT system expanded to include many more ship" of the WTO as an institution--if citizens do countries. It evolved into a de facto world trade not know what the organization does, its legitimacy organization, but one that was increasingly frag- will be eroded. The trade policy reviews are a mented as "side agreements" or codes were negoti- unique source of information that can be used by ated among subsets of countries. Its fairly complex civil society to assess the implications of the overall and carefully crafted basic legal text was extended or trade policies that are pursued by their govern- modified by numerous supplementary provisions, ments. From an economic perspective, transparency special arrangements, interpretations, waivers, can also help reduce uncertainty related to trade reports by dispute settlement panels, and council policy. Such uncertainty is associated with lower decisions. Some of the major milestones are sum- investment and growth rates and with a shift in marized in Table 6.1. resources toward nontradables (Francois 1997). The GATT's early years were dominated by acces- Mechanisms to improve transparency can help sion negotiations and by a review session in the lower perceptions of risk by reducing uncertainty. mid-1950s that led to modifications to the treaty. WTO membership itself, with the associated com- Starting in the mid-1960s, recurring rounds of mul- 44 The WTO: Functions and Basic Principles B O X 6 . 1 : T R A N S PA R E N C Y: N O T I F I C AT I O N A N D S U R V E I L L A N C E Transparency at both the multilateral (WTO) level enhances communication, thereby strengthening and the national level is essential to ensure owner- the multilateral trading system. Country-specific ship of commitments, reduce uncertainty, and reviews are conducted on a rotational basis, and enforce agreements. Efforts to increase the trans- the frequency of review is a function of a mem- parency of members' trade policies take up a good ber's share in world trade. The four largest play- portion of WTO resources. The WTO requires that ers--the European Union, the United States, all trade laws and regulations be published. Article Japan, and Canada--are subject to review by the X of the GATT, Article III of the GATS, and Article 63 WTO General Council every two years. In princi- of the TRIPS agreement all require that relevant ple, the next 16 largest traders are subject to laws, regulations, judicial decisions, and administra- reviews every four years, and the remaining tive rulings be made public. More than 200 notifi- members are reviewed every six years. A longer cation requirements are embodied in the various periodicity may be established for least-devel- WTO agreements and mandated by ministerial and oped countries. The trade policy review (TPR) for council decisions. The WTO also has important sur- a country is based on a report prepared by the veillance activities, since it has a mandate to period- government concerned and on a report by the ically review the trade policy and foreign trade WTO Trade Policies Review Division. TPRs are regimes of members. The WTO's Trade Policy supplemented by an annual report by the Direc- Review Mechanism (TPRM), established during the tor-General of the WTO that provides an Uruguay Round, builds on a 1979 Understanding overview of developments in the international on Notification, Consultation, Dispute Settlement, trading environment. and Surveillance under which contracting parties By subjecting the trade policies of the largest agreed to conduct a regular and systematic review industrial country markets to regular public peer of developments in the trading system. The objec- review, the TPRM shifts the balance of power in tive of the TPRM is to examine the impact of mem- the WTO ever so slightly in favor of the develop- bers' trade policies and practices on the trading ing countries (Francois 2001). Equally important, system and to contribute to improved adherence the TPRM provides domestic interest groups with to WTO rules through greater transparency. The the information necessary to determine the costs legal compatibility of any particular measure with and benefits of national trade policies. The WTO disciplines is not examined, this being left for reports are not analytical in the sense of deter- members to ascertain. mining the economic effects of various national The TPRM was originally motivated in part by policies--the size of the implied transfers and the concerns stemming from the fact that the only beneficiaries and losers under the prevailing poli- available review of global trade policies at the cies. This task is left to national stakeholders time was produced by the United States (Keesing (think tanks and policy institutes). 1998). The TPRM is an important element of the WTO because it fosters transparency and Sources: Hoekman and Kostecki (2001); Francois (2001). tilateral trade negotiations gradually expanded the There are many similarities between the GATT and scope of the GATT to take in a larger number of the WTO, but the basic principles remain the same. nontariff policies. Until the Uruguay Round, how- The WTO continues to operate by consensus and to ever, no progress was made on agriculture or on tex- be member driven. There were, however, a number of tiles and clothing. The deal that finally allowed these major changes. Most obviously, the coverage of the sectors to be subjected to multilateral disciplines WTO is much wider. A change of great importance is included the establishment of rules for trade in that in contrast to the GATT, the WTO agreement is a services and enforcement of intellectual property "single undertaking"--all its provisions apply to all rights (IPRs), as well as the creation of the WTO. members. Under the GATT there was great flexibility 45 T H E W O R L D T R A D E O R G A N I Z AT I O N for countries to "opt out" of new disciplines, and in intended to strengthen the political guidance of the practice many developing countries did not sign spe- WTO and enhance the prominence and credibility cific agreements on issues such as customs valuation of its rules in domestic political arenas. Article II of or subsidies. This is no longer the case, implying that the Marrakech Agreement that established the WTO the WTO is much more important for developing charges the organization with providing a common countries than the GATT was. Also important were institutional framework for the conduct of trade changes in the area of dispute settlement, which relations among its members in matters to which became much more "automatic" with the adoption agreements and associated legal obligations apply. of a "negative consensus" rule. (All members must Four annexes to the WTO define the substantive oppose the findings in a dispute settlement to block rights and obligations of members. Annex 1 has adoption of reports.) Finally, the secretariat acquired three parts: Annex 1A, Multilateral Agreements on much greater transparency and surveillance func- Trade in Goods, which contains the GATT 1994 (the tions through the creation of the Trade Policy Review GATT 1947 as amended by a large number of Mechanism. understandings and supplementary agreements negotiated in the Uruguay Round); Annex 1B, which contains the GATS; and Annex 1C, the TRIPS Scope, Functions, and Structure of agreement. Annex 2 contains the Understanding on the WTO Rules and Procedures Governing the Settlement of The WTO is headed by a ministerial conference of all Disputes (DSU)--the WTO's common dispute set- members that meets at least once every two years. By tlement mechanism. Annex 3 contains the Trade contrast, under the GATT a decade could pass Policy Review Mechanism (TPRM), an instrument between ministerial meetings. The more frequent for surveillance of members' trade policies. Finally, participation by trade ministers under the WTO was Annex 4, Plurilateral Trade Agreements, consists of Table 6.1 From GATT to WTO: Major Events Date Event 1947 The GATT is drawn up to record the results of tariff negotiations among 23 countries. The agreement enters into force on January 1, 1948. 1948 The GATT provisionally enters into force. Delegations from 56 countries meet in Havana, Cuba, to consider the final draft of the International Trade Organization (ITO) agreement; in March 1948, 53 countries sign the Havana Charter establishing an ITO. 1950 China withdraws from the GATT. The U.S. administration abandons efforts to seek con- gressional ratification of the ITO. 1955 A review session modifies numerous provisions of the GATT. The United States is granted a waiver from GATT disciplines for certain agricultural policies. Japan accedes to the GATT. 1965 Part IV (on trade and development) is added to the GATT, establishing new guidelines for trade policies of and toward developing countries. A Committee on Trade and Develop- ment is created to monitor implementation. 1974 The Agreement Regarding International Trade in Textiles, better known as the Multifibre Arrangement (MFA), enters into force. The MFA restricts export growth in clothing and textiles to 6 percent per year. It is renegotiated in 1977 and 1982 and extended in 1986, 1991, and 1992. 1986 The Uruguay Round is launched in Punta del Este, Uruguay. 1994 In Marrakech, on April 15, ministers sign the final act establishing the WTO and embody- ing the results of the Uruguay Round. 1995 The WTO enters into force on January 1. 1999 Ministerial meeting in Seattle fails to launch a new round. 2001 A new round of trade talks (the Doha Development Agenda) is agreed on in Doha, Qatar. Source: Hoekman and Kostecki (2001). 46 The WTO: Functions and Basic Principles Tokyo Round codes that were not multilateralized ment and between trade and competition policy, in the Uruguay Round and that therefore bind only and with the issue of transparency in government their signatories. Together, Annexes 1 through 3 procurement. Specific committees address matters embody the multilateral trade agreements. Article II relating to the GATS or the TRIPS agreement. All of the WTO specifies that all the agreements con- WTO members may participate in all councils, tained in these three annexes are an integral part of committees, and other bodies, with the exceptions the WTO agreement and are binding on all mem- of the Appellate Body, dispute settlement panels, the bers. All of these instruments are discussed further Textiles Monitoring Body, and committees dealing in this chapter or in other chapters of this volume, with plurilateral agreements. The WTO is charged with facilitating the imple- About 40 councils, committees, subcommittees, mentation and operation of the multilateral trade bodies, and standing groups or working parties agreements, providing a forum for negotiations, functioned under WTO auspices in 2000, more than administering the dispute settlement mechanism, twice the number under the GATT. Such bodies are exercising multilateral surveillance of trade policies, open to all WTO members, but generally only the and cooperating with the World Bank and the IMF more important trading nations (less than half of to achieve greater coherence in global economic the membership) regularly send representatives to policymaking (Art. III WTO). Between meetings of most meetings. The degree of participation reflects the ministerial conference, which is responsible for a mix of national interests and resource constraints. carrying out the functions of the WTO, the organi- The least-developed countries, in particular, tend zation is managed by the General Council, at the not to be represented at these meetings; often, they level of diplomats. The General Council meets do not have delegations based in Geneva. All of about 12 times a year. On average, about 70 percent these fora, plus working parties on accession (aver- of all WTO members take part in its meetings, at aging close to 30 in the late 1990s), dispute settle- which members are usually represented by delega- ment panels, meetings of regional groups, meetings tions based in Geneva. The General Council turns of heads of delegations, and numerous ad hoc and itself, as needed, into a body that adjudicates trade informal groups add up to 1,200 events a year at or disputes (the Dispute Settlement Body, or DSB) or near WTO headquarters in Geneva. Most WTO that reviews members' trade policies (the Trade Pol- business is conducted in English, but many official icy Review Body, or TPRB). WTO meetings require French and Spanish inter- Three subsidiary councils, on goods, on services, pretation. and on intellectual property rights, operate under The main actors in the day-to-day activities are the general guidance of the General Council. Sepa- officials affiliated with the delegations of members. rate committees deal with the interests of develop- The WTO--like the 1947 GATT--is therefore ing countries (Committee on Trade and something of a network organization (Blackhurst Development); surveillance of trade restriction 1998). The WTO secretariat is the hub of a very actions taken for balance of payment purposes; sur- large and dispersed network comprising official veillance of regional trade agreements; trade-envi- representatives of members based in Geneva, civil ronment linkages; and WTO finances and servants based in capitals, and national business and administration. Additional committees or working nongovernmental groups that seek to have their parties deal with matters covered by the GATT, the governments push for their interests at the multilat- GATS, or the TRIPS agreement. There are commit- eral level. The operation of the WTO depends on tees, functioning under the auspices of the Council the collective input of thousands of civil servants on Trade in Goods, on subsidies, antidumping and and government officials who deal with trade issues countervailing measures, technical barriers to trade in each member country. (product standards), import licensing, customs val- Initiatives to launch multilateral trade negotia- uation, market access, agriculture, sanitary and phy- tions and to settle disputes--the two highest-profile tosanitary measures, trade-related investment activities of the WTO--are the sole responsibility of measures, rules of origin, and safeguards. In addi- WTO members themselves, not the secretariat. The tion, working groups have been established to deal member-driven nature of the organization puts a with notifications, with state-trading enterprises, considerable strain on the national delegations of with the relationships between trade and invest- members. Many countries have no more than one 47 T H E W O R L D T R A D E O R G A N I Z AT I O N or two persons dealing with WTO matters; a large and mechanisms have therefore been developed minority has no delegations in Geneva at all. over the years to reduce the number of members that are active participants in WTO deliberations. The first and most important device is to involve Decisionmaking only "principals," at least initially. To some extent Most decisionmaking in the WTO follows GATT this is a natural process; a country that has no agri- practices and is based on consultation and consen- cultural sector is unlikely to be interested in discus- sus. The consensus practice is of value to smaller sions centering on the reduction of agricultural countries, as it enhances their negotiating leverage trade barriers. In general the "Quad" economies-- in the informal consultations and bargaining that Canada, the European Union, Japan, and the United precede decisionmaking, especially if they are able States--are part of any group that forms to discuss to form coalitions. Although recourse to voting may any topic. They are supplemented by countries that be had if a consensus cannot be reached, in practice have a principal supplying interest in a product and voting occurs only very rarely. If a vote is needed, it by the major (potential) importers whose policies is based on the principle of "one member, one are the subject of interest. Finally, a number of vote." Unanimity is required for amendments relat- countries that have established a reputation as ing to general principles such as MFN or national spokespersons tend to be involved in most major treatment. Interpretation of the provisions of the meetings. Historically, such countries have included WTO agreements and decisions on waivers of a Egypt, India, and Yugoslavia. member's obligations require approval by a three- During the Tokyo and Uruguay Rounds, con- quarters majority vote. A two-thirds majority vote is tentious issues as to which deals had to be struck sufficient for amendments relating to issues other were often thrashed out in the "green room," a con- than the general principles mentioned above. ference room adjacent to the Director-General's Where not otherwise specified, and where consen- offices. Green-room meetings were part of a consul- sus cannot be reached, a simple majority vote is, in tative process through which the major countries principle, sufficient. In practice, voting does not and a representative set of developing countries--a occur. Indeed, in 1995 WTO members decided not total of 20 or so delegations--tried to hammer out to apply provisions allowing for a vote in the case of the outlines of acceptable proposals or negotiating accessions and requests for waivers but to continue agendas. Such meetings generally involved the to proceed on the basis of consensus (WT/L/93). active participation and input of the Director-Gen- Legislative amendments are also likely to be quite eral. The convention now is to call such meetings rare, as, in practice, changes to the various agree- green-room gatherings, no matter where they are ments occur as part of broader multilateral rounds. held. The green-room process became a contentious issue during the Seattle ministerial meeting; many developing countries that were excluded from criti- Management of the Secretariat and cal green-room meetings, where attempts were Daily Operations being made to negotiate compromise texts of a draft Unlike the World Bank and the IMF, the WTO does agenda for a new multilateral trade negotiation, felt not have an executive body or a board comprising a that they were not being kept informed of develop- subset of members some of whom represent a num- ments and were not being granted the opportunity ber of countries. Such executive boards facilitate to defend their views. Proposals have been made decisionmaking by concentrating discussions with- periodically to formalize the green-room process by in a smaller but representative group of members. creating an executive committee to manage the The closest the GATT ever came to such a forum WTO agenda, based on shares in world trade was the Consultative Group of Eighteen (CG18), (Schott and Buurman 1994). To date, no progress in established in 1975. It ceased meeting in 1985 and this direction has proved possible in the WTO. never substituted for the GATT Council of Repre- sentatives (Blackhurst 1998). Conclusion As of January 1, 2002, the WTO had a member- ship of 144. Achieving consensus among such a The Uruguay Round and the establishment of the large number of members is not a simple matter, WTO changed the character of the trading system. 48 The WTO: Functions and Basic Principles The GATT was very much a market access­oriented customs valuation, a good case can be made that institution: its function was to harness the dynamics implementation should be linked to national capac- of reciprocity for the global good. Negotiators could ity and international assistance (Hoekman 2002). be left to follow mercantilist logic, and the end A lesson from post­Uruguay Round experience result would be beneficial to all contracting parties. and thinking is that trade policy should be made This dynamic worked less well for developing coun- more central to the development process and devel- tries, where the burden of liberalization rested opment strategies. This needs to be done at both the much more heavily on the shoulders of govern- national and international levels. At the national ments. Even if they wanted to, their scope to use the level it is necessary in order to ensure that govern- GATT was often limited because exporters had ments have a basis on which to resist efforts to fewer incentives and were less powerful than in negotiate agreements in an area. Governments must industrial countries. The reciprocal, negotiation- be able to identify what types of rules will promote driven dynamic also worked much less well for development and what types would lead to an inap- issues that were "lumpy" and where the terms of the propriate use of scarce resources. At the interna- debate revolved around what rules to adopt, not tional level such a change is necessary in order to around how much of a marginal change was appro- enhance the communication between trade and priate. Once discussions center on rules, especially development assistance bodies in member coun- on disciplines for domestic policy and regulations, tries. One reason for the implementation assistance it is more difficult to define intraissue compromises problems that were encountered in the late 1990s that make economic sense. Cross-issue linkage was that the best-endeavors commitments on assis- becomes necessary. Disengagement was not an tance that were made by industrial country trade option during the Uruguay Round (because of the negotiators were not "owned" by counterpart agen- "single undertaking"), so the task was to come up cies in their governments that controlled develop- with a balanced package that ensured gains for all ment assistance money. Progress on both fronts players. One can argue whether the package that would do much to ensure that future negotiations emerged from the round was a balanced one; views do not give rise to problems of the type that were on this point differ widely. created in the Uruguay Round. Whatever the conclusion, it is clear that the approach taken toward ensuring and supporting Notes implementation of WTO agreements by developing This chapter draws on Hoekman and Kostecki (2001). countries was not an effective one. Limiting recog- nition of this problem to the setting of uniform 1 The founding parties to the GATT (giving the names used at transition periods was clearly inadequate. The case the time) were Australia, Belgium, Brazil, Burma, Canada, Cey- lon, Chile, China, Cuba, Czechoslovakia, France, India, for uniform application of agreements that involve Lebanon, Luxembourg, the Netherlands, New Zealand, Nor- reducing trade barriers--tariffs and nontariff barri- way, Pakistan, Southern Rhodesia, Syria, South Africa, the Unit- ers--is very strong. But in other areas requiring ed Kingdom, and the United States. Subsequently, China, minimum levels of institutional capacity, such as Lebanon, and Syria withdrew. 49 7 J . M I C H A E L F I N G E R L . A L A N W I N T E R S Reciprocity in eralization by developing coun- tries, and an "apples versus oranges" problem that arises the WTO because the WTO spans both border trade restrictions (tar- iffs, quotas, and the like) and within-border regulatory struc- Reciprocity: Mutual or correspondent concession of advantages or tures such as standards and privileges, as forming a basis for the commercial relations intellectual property. Failure to between two countries. recognize the apples versus --The Oxford English Dictionary1 oranges problem, we argue, has led to a troublesome Uruguay Round outcome. R eciprocity has been a motivating Reciprocity in GATT Rules principle of the GATT/WTO system. Although the economics of import restrictions recog- The thrust of the GATT/WTO system is that agree- nizes that the losses from a country's own restric- ment defines reciprocity (or balance), not the other tions exceed domestic gains, the politics has not way around. An agreed outcome from a negotiating found a way to enfranchise the domestic interests round, the system presumes, is an outcome that each that bear these domestic losses--users and con- member considers advantageous, by whatever stan- sumers of imports. When trade policy involves an dard the member chooses to apply. Beyond that, vari- exchange of domestic restrictions for foreign restric- ous provisions for adjustment, such as renegotiation tions, this amplifies the voice of export interests. The and safeguard actions,attempt to maintain the balance success of the GATT/WTO system manifests the that the agreement has established. The same holds for ingenuity of reciprocally agreed liberalization as a dispute settlement. In this section we look at how reci- means of transferring political power over domestic procity enters into each of these parts of the system. import restrictions to export interests, and it also manifests the power of these interests. Negotiations In this chapter we explore the role of reciprocity in GATT/WTO negotiations and in the processes of Reciprocity serves to motivate negotiations. Partici- making adjustments and settling disputes under or pants and commentors use reciprocity, or its func- within an agreement. We look at the role of reci- tional equivalent, "balance," as a standard against procity in past agreements, and we present evi- which to evaluate an outcome. The rules, however, dence suggesting that reciprocity is not the only do not define that standard; determining the stan- force that shapes the outcome of a negotiation. We dard is part of the evaluation itself.2 then turn to two issues that relate to reciprocity: The GATT, and the Marrakech Agreement that "credit" in reciprocal negotiations for unilateral lib- established the WTO, refer in their preambles to 50 Reciprocity in the WTO "entering into reciprocal and mutually advanta- my question of what it means in negotiating prac- geous arrangements directed to the substantial tice--what countries have interpreted as equivalent reduction of tariffs and other barriers to trade." concessions, and what they have not. We take up GATT Article XXVIII bis, the article that provides this topic below. for negotiations to be held, refers also to "negotia- tions on a reciprocal and mutually advantageous Treatment of Developing Countries in Negotia- basis." Neither the GATT nor the WTO provides tions. Part IV of the GATT provides elaborate com- further specification of what is "reciprocal" or of mitments to the developing countries. For what is "mutually advantageous." The logic of the example, Article XXXVI.8 states, "The developed GATT/WTO is that in the negotiations each mem- contracting parties do not expect reciprocity for ber is sovereign to determine for itself whether a commitments made by them in trade negotiations proposed agreement is to its advantage--to decide to reduce or remove tariff and other barriers to the the criteria by which to identify the pluses and trade of less-developed contracting parties." The minuses, and to apply those criteria by whatever commitments of Part IV, however, are not legally formula the member considers appropriate. The binding. Exhortations such as the one quoted are GATT's tradition of decision by consensus rein- qualified by other phrases: for example,"The devel- forces the idea that an agreement is an outcome that oped countries shall to the fullest extent possible-- each member considers to be to its benefit. If any that is, except where compelling reasons, including one member does not find the outcome advanta- legal reasons, make it impossible . . ."(Art. geous, the proposed agreement does not go into XXXVII.1), and "The adoption of measures to give effect. effect to these principles and objectives shall be a matter of conscious and purposeful effort on the GATT Elaboration on Reciprocity in Negotiations. part of the contracting parties both individually An early (1955) GATT working party, in response to and jointly" (Art. XXXVI.9). The operational a proposal to establish rules for how concessions meaning of such phrases is to make clear that they should be measured, concluded that "governments are not legal commitments. The commitment is to participating in negotiations should retain com- a nonmeasurable "conscious and purposeful plete freedom to adopt any method they might feel effort," not to a measurable result. most appropriate for estimating the value of duty Although such statements do not express legal reductions and bindings . . ." The working party obligations, they do have behind them the weight of went on to note that "there was nothing in the moral suasion; they are intended to influence behav- Agreement, . . . to prevent governments from adopt- ior without going so far as to regulate it. This moral ing any formula they might choose, and therefore suasion has not delivered much. For example, the considered that there was no need for the Contract- Trade-Related Aspects of Intellectual Property ing parties to make any recommendation in this Rights (TRIPS) agreement, the customs valuation matter" (GATT 1994a: 912­13). Similarly, Arthur agreement, the Sanitary and Phytosanitary (SPS) Dunkel, Director-General of the GATT from 1980 agreement, and several other Uruguay Round agree- to 1992, observed, "Reciprocity cannot be deter- ments suggested that industrial country members mined exactly; it can only be agreed upon" (GATT furnish technical assistance to developing country Press Release 1312, March 5, 1982). members that request it. This provision, however, is Since the GATT and the Marrakech Agreement not a binding commitment; the developing coun- are silent on how a member might measure the tries undertook to implement bound commitments advantage it draws from the agreement, they say in exchange for unbound commitments for assis- nothing about how much one country should gain tance. Although developing countries pressed hard from the negotiations relative to another. The word at the WTO for delivery on such promises, bilateral- "balance" does not appear in the GATT/WTO text ly or through an increased WTO technical budget, on negotiations. An agreement (the outcome of a the high-income countries have done little. The negotiating round) defines balance, not the other stalemate has prompted Rubens Ricupero (2000) to way around. Although the GATT/WTO rules make suggest that in the future, negotiations on topics no demands as to what reciprocity means in a nego- that will involve expensive implementation be tiation, there remains the practical political-econo- accompanied by an "implementation audit" that 51 T H E W O R L D T R A D E O R G A N I Z AT I O N will identify concretely what developing countries involved some degree of objectivity. In the end, will have to do and what it will cost. Short of a however, appropriate compensation or retaliation is bound commitment from the high-income coun- what the parties agree on, not what an objective and tries to meet such costs, statements about imple- exogenous standard dictates. mentation assistance should be omitted. There should be no more instances of creating the rhetoric Safeguard Actions (only) of reciprocity by exchanging bound commit- ments for unbound promises. GATT Article XIX, the "escape clause," or "safe- guard" article, includes a similar provision. (The article, roughly speaking, allows a country to Renegotiations restrict imports that cause injury to domestic pro- Political reality will require from time to time that ducers.) Implicitly, the article calls on the country adjustments be made in the outcome of an agree- that takes safeguard action to provide compensa- ment, and domestic politics will demand that some tion. Explicitly it provides that exporting countries "concession" be withdrawn.3 The GATT article on may retaliate if satisfactory compensation is not renegotiations states, "In such negotiations and offered: "If agreement among the interested con- agreement, which may include provision for com- tracting parties with respect to the action is not pensatory adjustment with respect to other prod- reached, . . . the affected contracting parties shall ucts, the contracting parties concerned shall then be free . . . to suspend . . . the application to the endeavor to maintain a general level of reciprocal trade of the contracting party taking such action . . . and mutually advantageous concessions not less of substantially equivalent concessions or other favorable to trade than that provided for in this obligations under this agreement the suspension of Agreement prior to such negotiations" (Art. XXVI- which the Contracting Parties do not disapprove II. 2). If the importing country wanting to raise a . . ." (GATT Art. XIX.3[a]).4 tariff above a previously bound level does not reach The Uruguay Round Agreement on Safeguards agreement with supplying countries on appropriate mentions compensation explicitly, and, in its Article compensation, the exporting countries will, in time, 8.1, it includes the exhortation in GATT Article be entitled to retaliate-- "to withdraw . . . substan- XXVIII (renegotiations) "to maintain a substantial- tially equivalent concessions" (Art. XXVIII.3a, 3b, ly equivalent level of concessions and other obliga- 4d, 5). Adjustments of concessions should maintain tions." Retaliation, as in the GATT safeguard article, the balance that the previous agreement established. is the suspension of the application of "substantially In practice, many renegotiations have eventually equivalent concessions or other obligations . . ." been taken up as part of a next round of negotia- (Art. 8.2). In practice, the determination of what is tions, and it is not possible to identify in these "substantially equivalent" has been determined instances whether the compensation that the parties strictly by negotiation among the interested parties. agreed to was appropriate. In other instances, deter- The GATT Contracting Parties have never disap- mining what is a "substantially equivalent conces- proved of a countermeasure to an action under sion" has centered on finding an equivalent amount Article XIX (GATT 1994a: 490). of trade and an equivalent change in the degree of protection. One of the less complex--but still not Dispute Settlement simple--parts of the process has been to agree on an appropriate base period in which to measure the Although compensation and retaliation are part of amounts of trade involved. Other parts were more the vocabulary of GATT/WTO dispute settlement, difficult; for example, often what was at issue was the process primarily has to do with maintaining not simple tariffs but more complicated tariff quo- behavior within an agreement rather than adjusting tas. Many renegotiations have stemmed from cre- what was agreed.5 The GATT text that is relevant to ation of a customs union, and here the task is to compensation and retaliation reads: "If the Con- compensate for discrimination, not merely for tracting Parties consider that the circumstances are change in a tariff rate. serious enough to justify such action, they may Maintaining balance--determining what is an authorize a contracting party or parties to suspend equivalent adjustment to an agreed outcome--has the application to any other contracting party or 52 Reciprocity in the WTO parties of such concessions or other obligations Control of Free-Riding under this Agreement as they determine to be appro- priate in the circumstances" (GATT Art. XIX.2; The initial GATT rounds consisted of bilateral emphasis added). negotiations on modification of most-favored- Robert Hudec (1978) has explained that the nego- nation (MFN) schedules, conducted among a limit- tiators of the proposed International Trade Organi- ed number of countries. (For example, in the 1947 zation (ITO) and the GATT were ambiguous as to round the United States negotiated with 16 coun- whether dispute settlement concerned compensa- tries that supplied about two-thirds of U.S. tion or compliance. In the 48 years of the GATT, imports.) Efforts were made in these negotiations to there was only one instance in which the dispute limit concessions to products imported in large part settlement mechanism authorized retaliation. In the from other participants. Table 7.1, a tabulation of WTO's first six years, the WTO dispute settlement U.S. experience in early rounds, shows, for example, mechanism has twice authorized retaliation: in the that at the Dillon Round 96 percent of U.S. tariff Bananas case and the Beef Hormone case. As of late cuts--all made on an MFN basis--were on imports 2001, both were still in political dispute. from countries that made concessions in return. At that time, 66 percent of U.S. imports came from these countries. The difference between the 96 per- Reciprocity and Other Influences on an cent and the 66 percent reflects the emphasis on Agreement limiting concessions to products imported almost One can find, in the results of negotiations, clear entirely from countries that reciprocated. Attention evidence of the influence of reciprocity. One can to internalizing the concessions (that is, to limiting also find evidence that more is at play than reaching free-riding) led, however, to low coverage of the tar- a mercantilist balance of concessions received ver- iff cuts--for the United States, the reductions cov- sus concessions given. In this section we review ered 15 percent of dutiable imports in the 1956 other influences that are likely to shape a negotia- round and 20 percent in the 1960­61 round. tion. We also present scattered evidence of the influ- At the Kennedy Round, bilateral bargaining over ence of reciprocity and of other factors. tariff cuts was replaced by formula cuts. The shift to Table 7.1 Control of Free-Riding in GATT Negotiations: U.S. Experience, 1947­67 Kennedy Round, 1964­67 Geneva Annecy Torquay Geneva Dillon Major All Round, Round, Round, Round, Round, partici- partici- 1947 1949 1951 1956 1960­61 pantsa pants Percentage of dutiable imports from all countries subject to cuts 35 37 26 15 20 -- 44 Percentage of dutiable imports coming from participants 65 6 34 67 66 68 72 Percentage of dutiable imports subject to cuts coming from participants 84 39 64 89 96 81 91 --Not available. a. Austria, Canada, Denmark, European Economic Community, Finland, Japan, Sweden, Switzerland, and the United Kingdom. Source: Finger (1979): 424­25. 53 T H E W O R L D T R A D E O R G A N I Z AT I O N a formula approach did lead to broader reduc- although public works and other benefits have also tions--U.S. cuts applied to 44 percent of imports. been used.6 Exclusion of free riders took the form of negotiation Another way in which governments attempt to over "exclusion lists" and, as the figures show, did minimize the problem of compensating losers is by limit spillover to free riders to only 9 percent of con- taking advantage of the large volume of intraindus- cession imports. try trade that characterizes the modern trading sys- tem. To the extent that concessions given by an industry can be offset by concessions received on Fewer Concessions Given, Fewer Received the products exported by the same industry, the Table 7.2 provides another indication that to receive government need not develop interindustry mecha- concessions, a country has to give concessions. The nisms for balancing losers against winners. Gilbert message is obvious: the lower the degree of partici- Winham (1986: 65) notes that from the Kennedy pation in the negotiations, the lower the share of Round forward, there has evolved a tendency to exports affected by the concessions of other partici- look for such "self-balancing sectors." In regional pants. agreements such balancing can be increased through the use of rules of origin. An example is the way in which the North American Free Trade Agree- Domestic Reciprocity ment (NAFTA) and other regional agreements in At the same time, there is more to the liberalization which the United States participates condition process than concessions given over the interna- access to the U.S. market for textile products on the tional table versus concessions received. The bar- use of U.S.-made fibers or fabrics. gaining process ties access to foreign markets to the granting of access to the domestic market and Noneconomic Objectives thereby mobilizes export interests to favor import liberalization. But the domestic politics of setting War, according to Clausewitz, is the pursuit of gains for export industries against losses for diplomacy through other means. Often, so is trade import-competing industries is not frictionless. For policy. Freedom of international commerce was the a government motivated toward trade liberaliza- third of U.S. President Woodrow Wilson's Fourteen tion, the tough tradeoffs are not between it and for- Points. To Cordell Hull, secretary of state for Presi- eign governments but between domestic winners dent Franklin D. Roosevelt, the link was straightfor- and losers. ward: "Unhampered trade dovetailed with peace; Overcoming such frictions has been, in practice, high tariffs, trade barriers and unfair economic partly a matter of power--in the simple case in competition with war" (Hull 1948: 81). After World which negotiating authority must be specifically War II, leadership in Europe and in the United granted, using export industries to win more con- States saw economic union in Europe and the con- gressional votes than the opposition can rally. It has struction of an open global trading system more as also been partly a matter of compensation. Adjust- strategic objectives than as economic ones. A gov- ment assistance is the straightforward example, ernment that can mobilize noneconomic motives Table 7.2 U.S. Imports Covered by Kennedy Round Tariff Concessions (Reductions plus Bindings) as a Share of Total U.S. Imports from the Country Group (percent) Country group Share (percent) Major participants 70 Other industrial country participants 49 Active developing country participants 33 Other developing countries 5 Note: Data are for 1994 imports. Source: Finger (1979): 435. 54 Reciprocity in the WTO into significant support for trade liberalization will and intellectual property rights unless high-income be in a position to play a hegemonic role (as the countries negotiated on agriculture and on textiles United States did in early GATT rounds) and to and clothing. make larger concessions than it receives in exchange. Equal Sacrifice, Softly Applied When, however, the time came for totting up, the Locking In equal sacrifice concept was the one that delegations Developing countries that have unilaterally liberal- used.7 Particularly in the last month of the negotia- ized sometimes view binding such liberalization tions (the mopping-up phase) the negotiators internationally as a defense against the risk of back- devoted significant attention to ensuring that each sliding should political authority shift or popular participating country had made an appropriate support wane. Such an objective, like a noneconom- contribution to the tariff reduction exercise. Dele- ic one, can motivate a government to accept what a gations widely but informally accepted that the tar- calculation based strictly on considerations of mer- gets were average reductions of one-third for cantilist market access would view as a bad bargain. industrial countries and one-fourth for developing countries.8 The negotiating guidelines lacked preci- sion; for example, was the one-third cut to be a Individual Sacrifice for the Common Good weighted or an unweighted average? Over all prod- Many of the participants in the initial ITO and ucts, or only over dutiable items? GATT negotiations viewed their task as the con- Tied up with achievement of these targets was the struction of a system from which all countries would question of how countries would receive "credit" for derive significant noneconomic benefits (perhaps unilateral tariff reductions and for extensions of economic gains as well, but the emphasis was usual- bindings that did not imply tariff cuts. The agricul- ly on noneconomic considerations). This view of tural negotiations established formal negotiating reciprocity differs from the mercantilist bargaining guidelines, not only on the amounts by which model in that the benefits a participant gets are not import restrictions and other agricultural supports unequivocally identified with the particular market were to be reduced by each country but also for how access concessions that the country receives; the link agricultural nontariff barriers were to be converted between contribution and benefit is amorphous, to tariffs. resulting from the collective nature of the system These percentages were negotiating guidelines, rather than from any particular element of it. not bound commitments. Even in agriculture, Robert E. Hudec, in his 1987 book Developing where the negotiating guidelines were circulated as Countries in the GATT Legal System, builds on the a GATT document (GATT 1993b), legal commit- common-good view to provide a convincing inter- ments were the rates notified on each country's pretation of how GATT members came to accept schedule. The GATT/WTO members seem to have "special and differential treatment" as the appropri- policed these guidelines rather softly. Interviews ate attitude toward developing countries. In con- with more than a dozen delegations after the round structing any system from the contributions of its found none that had attempted to calculate the members, Hudec notes, it is difficult to ask the less depth of cut by each country, or even for major well off to contribute proportionally with the bet- trading partners. Likewise, no delegation had tabu- ter-off members. lated concessions received--that is, the coverage of its exports by concessions scheduled by other coun- tries. A number of developing country delegations The Uruguay Round Tariff Reductions pointed to the agriculture and the textiles and cloth- Scorecard: What We Learn from It ing agreements as evidence that they had paid atten- Reciprocity--"get what you pay for," or, more tion to what they would receive, but in agriculture, aggressively, "pay for what you get!"--was clearly too, although the guidelines were more precise, the motivating principle of the Uruguay Round either the numbers were checked only casually or negotiations. For example, developing countries disregard of the guidelines was widely accepted. would not negotiate in "new areas" such as services After-the-fact examination has turned up a lot of 55 T H E W O R L D T R A D E O R G A N I Z AT I O N "dirty tariffication"--tariff rates considerably in ever established for what any country should "give" excess of those that the guideline formulas generate or could expect to "receive." It is hence impossible to (Hathaway and Ingco 1996). measure the extent to which credit for unilateral lib- The interviews revealed that as the negotiations eralization was given. were being completed, selling the agreement at On the question of how to take into account home--that is, gaining approval--was an impor- bindings that did not imply tariff cuts, such as ceil- tant consideration. The issue was not the overall ing bindings, not even an unofficial approach balance of concessions; it was to make sure that evolved. Toward the end of 1990 the Mexican dele- powerful domestic constituencies were accommo- gation circulated a nonpaper arguing that credit dated. The focus was on the effect on the big trees, should be given for expansion of the scope of bind- not the forest. ings, but it did not offer a method for measuring the "tariff cut equivalent."11 Later, the chair of the GATT Market Access Group provided guidelines for Concessions Given versus Concessions Received: such measurement, including a matrix of suggested Great Differences among Countries equivalents between depth of tariff cut and scope of "Concessions given" is a familiar concept. Its com- expansion of bindings. The view of the negotiators plement, "concessions received," refers to the con- with whom we spoke was that there never emerged cessions made by trading partners that apply to a even notional agreement on how to convert exten- given country's exports.9 In Table 7.3, columns (1) sion of bindings into a tariff cut equivalent. through (3) show the depth of tariff reductions, and Giving credit for unilateral liberalization by columns (4) through (6) attempt to introduce the developing countries is part of the standard scope as well as the depth of tariff changes. pro­developing country list of what a negotiation It is hard to find equal sacrifice in this subpart of the should do. But the fact that what is an "appropriate" Uruguay Round outcome. If all the reductions were outcome is defined by the agreement and not by an equal, column (2) would show identical numbers for exogenous standard means that calls for credit for each country, as would column (5). It is also hard to unilateral liberalization are an exercise in moral find mercantilist balance. If such balance had been suasion, not an application of economic or account- achieved--that is, if each country received conces- ing science. Finger, Reincke, and Castro (2002: table sions roughly in line with the concessions it gave--all 2) found that the suasion did have an effect. Bind- the numbers in column (6) would be zero, which is ings of unilateral tariff cuts (but not unbound uni- clearly not the case. The summary statistic in the last lateral cuts) do seem to have been counted toward row reports that, on average, a country's imbalance developing countries' fulfillment of their "obliga- (positive or negative) was over half as large as the tion" to reduce tariffs by one-fourth. value of the concessions the country received.10 In sum, calls for credit for unilateral liberaliza- tion--where that liberalization has then been bound under the GATT/WTO--have been effective. Credit for Unilateral Liberalization Calling for a "credit rule," however, reveals a misun- Many developing countries undertook unilateral derstanding of how the GATT/WTO works. liberalization in the 1980s and 1990s. Credit in the reciprocal negotiations for this liberalization was Apples versus Oranges part of the informal guidelines for meeting the equal sacrifice criterion. From what delegations told The "grand bargain," as Sylvia Ostry (2000) has us in interviews, informal practice was more or less labeled it, that was struck at the Uruguay Round was to calculate tariff cuts from the rate prevailing in that the developing countries would take on signifi- 1988 to the rate bound at the Uruguay Round. cant commitments in "new areas" such as intellectu- Developing countries were given credit for unilater- al property and services, where industrial country al liberalization by allowing them to count from the enterprises saw opportunities for expanding inter- rates applied earlier, at the beginning of the 1980s. national sales. The industrial countries, in In any case, no tabulation of country-by-country exchange, would open up in areas of particular tariff cuts was made, either by the GATT secretariat export interest to developing countries: agriculture, or by individual countries, and no formal target was and textiles and clothing. 56 Reciprocity in the WTO Table 7.3 Tariff Concessions Received and Given at the Uruguay Round Mercantilist balance Percentage tariff reductiona (percentage point dollars)b (1) ­ (2) as (4) ­ (5) as percentage Concessions Concessions percentage Received Given of (1) received given of (4) Economy (1) (2) (3) (4) (5) (6) High-income Australia 0.76 3.35 ­341 21,032 88,162 ­319 Austria 2.64 3.74 ­42 74,602 108,820 ­46 Canada 0.22 0.89 ­305 5,291 26,205 ­395 European Union 1.94 2.19 ­13 578,816 627,939 ­8 Finland 3.47 2.52 27 63,924 44,021 31 Hong Kong (China) 2.36 0.00 100 60,258 0 100 Iceland 1.59 0.20 87 2,151 299 86 Japan 2.06 1.06 49 481,006 143,142 70 New Zealand 0.84 0.83 1 5,126 4,155 19 Norway 1.15 2.17 ­89 24,250 44,263 ­83 Singapore 1.96 0.85 57 50,294 32,741 35 Switzerland 2.15 0.89 59 100,659 46,829 53 United States 1.21 1.07 12 214,791 283,580 ­32 Transition Czech and Slovak Union 2.06 1.05 49 9,773 7,312 25 Hungary 1.82 1.69 7 7,755 13,727 ­77 Poland 1.36 1.26 7 8,609 7,112 17 Developing Argentina 0.98 0.00 100 6,331 0 100 Brazil 1.37 0.00 100 38,037 98 100 Chile 0.50 0.00 100 3,291 0 100 Colombia 1.25 0.02 98 6,323 81 99 India 1.22 6.16 ­405 14,380 67,172 ­367 Indonesia 0.87 0.25 71 16,222 3,355 79 Korea, Rep. of 1.87 5.99 ­220 100,809 262,918 ­161 Malaysia 1.46 1.97 ­35 36,108 28,966 20 Mexico 0.16 0.00 100 960 3 100 Peru 0.57 0.03 95 1,586 58 96 Philippines 2.43 1.29 47 19,748 12,847 35 Sri Lanka 1.36 0.01 99 1,595 33 98 Thailand 1.33 5.93 ­346 20,564 95,953 ­367 Tunisia 1.42 0.02 99 2,506 72 97 Turkey 1.72 3.00 ­74 12,557 32,661 ­160 Uruguay 0.52 0.00 100 772 6 99 Venezuela, R. B. de 0.21 0.13 38 2,051 806 61 Summary Sum of absolute differences/ Sum of absolute differences/ statistics sum of received = 86 percent sum of received = 58 percent a. Weighted average of change measured as dT/(1 + Tavg) * 100, where Tavg is the average of the before- and after-change rates, calculated across all tariff lines, including those on which there was no reduction. Why this formula? Whereas cutting by half a tariff of 2 percent saves the importer only 1 cent, cutting by half a tariff of 50 percent saves the importer 25 cents. As a part of what the importer pays, the tariff reduction relates to the tariff charge plus the price received by the seller--to Ps(1 + T) rather than simply to T. Finger, Ingco, and Reincke (1996) provide a more detailed explanation. b. Tariff cut as measured in column (1) or (2) multiplied by the value (in millions of dollars) of the imports or exports to which the import- ing country applies MFN tariff rates. A percentage point dollar is a 1 percent tariff change on 1 dollar of exports or imports. 57 T H E W O R L D T R A D E O R G A N I Z AT I O N What the North gave in this exchange was tradi- The problems that developing countries face in tional market access, reduction of import restric- the new areas largely have to do with project design tions, and in agriculture, reduction of export and cost-benefit analysis--with development eco- subsidies and production subsidies. What the South nomics, not market access. The World Bank and the gave in the new areas was different. WTO obliga- GATT/WTO are different institutions that work in tions on services, on intellectual property rights, different ways. These differences are not arbitrary; and on standards basically have to do with the they reflect what the international community structure of the domestic economy. The industrial knows about how to deal with trade issues versus countries that wanted these areas to be covered by how to deal with development issues (see Finger the WTO rationalized their inclusion by reference and Nogués 2001). to their "trade-related" attributes (although the actual motivation was the trade interests of their The Uruguay Round Scorecard enterprises). Whatever the fig leaf, regulation here is, figuratively speaking, nine-tenths concerned with The outcome of the Uruguay Round was a good one the domestic economy and one-tenth about trade. for the North. Not only did the industrial countries The two sides of the grand bargain have funda- gain from the concessions they received; the eco- mentally different economics. In real economics, nomics of the concessions they gave was also posi- giving away an import restriction is not a cost; it is tive, through the opening up of their own something that enhances the national economic agriculture and textiles sectors. And for the South? interest. GATT bargaining is a response to the diffi- On the gain dimension--market access--develop- cult politics of liberalization, not to the good sense ing countries did not achieve a mercantilist surplus of its economics. The economics of new area (Table 7.4). Their tariff reductions covered as large a responsibilities are different in two respects (see also share of their imports as did those of the industrial Chapter 48, by Finger and Schuler): countries, and their tariff cuts, measured by how these reductions will affect importers' costs, were · Implementing such responsibilities will cost deeper than those of the industrial countries. This is money--for example, for laboratories to develop true even when we take into account the tariff and enforce standards.12 equivalent of the Multifibre Arrangement (MFA) · The result can be a substantial net cost rather quotas that the industrial countries have committed than a benefit. For many developing countries the themselves to remove. economics of TRIPS is the same as the economics For developing countries as well as industrial to oil importers of oil price increases. Just the countries, concessions made in the grand bargain patent changes required by TRIPS will cost some make for difficult domestic politics. For developing countries more than they gain from the whole of countries, these concessions will also mean real eco- the market access liberalization package (see Fin- nomic costs. The scorecard on the Uruguay Round ger 2001). grand bargain? The South's concessions in the new Table 7.4 Uruguay Round Tariff Concessions, All Merchandise Industrial Developing economies economies Percentage Depth of Percentage Depth of of imports cuta of imports cuta Includes tariffication and bound reductions on agricultural products 30 1.0 29 2.3 Includes the above plus the tariff equivalent of elimination of the Multifibre Arrangement 30 1.6 29 2.3 a. Depth of cut, dT/(1 + T), is a weighted average across all products, including those on which no reduction was made. Source: Finger and Schuknecht (2001): table T-1, based on Finger, Ingco, and Reincke (1996). 58 Reciprocity in the WTO areas are, as mercantilism, unrequited--and as real 5 The WTO Dispute Settlement Understanding (Art. 3.7) establish- economics, they are costly. es explicit priorities among different outcomes: "The aim of the dispute settlement mechanism is to obtain a positive solution to a dispute; A solution mutually acceptable to the parties to a dis- Conclusions pute and consistent with the covered agreements is clearly to be preferred; Withdrawal of the measures concerned if they are Reciprocity in negotiations is a motivation and an found to be inconsistent with . . . the covered agreements; objective, not a criterion. Within an agreement, rec- Compensation . . . only if the immediate withdrawal of the pro- iprocity--better known in this context by its other vision is impractical . . . a temporary measure pending the with- drawal of the measure . . . inconsistent with the covered name, balance--comes closer to having an opera- agreements; and, the last resort . . . suspending . . . concessions tional meaning. Still, it is to a large extent some- or other obligations . . ." thing that can be agreed on but not measured. 6 Zeiler (1992) provides examples of the trades U.S. President "Credit" is moral suasion--a useful rallying cry for John F. Kennedy made to win congressional approval of the driving a better deal for the South. It is, however, authority to negotiate in what came to be called the Kennedy futile, and a basic misunderstanding of the Round. Providing quota protection for the textile industry was GATT/WTO, to think that credit can be converted one; another was an extensive waterways project for the state into the "shall" language of obligation. of Oklahoma. Mistaking clean clothes for dirty was acceptable 7 Provided that each country's trade is balanced (that is, exports when that was what both sides brought to the table. equal imports) and that there are uniform cuts with complete Each took home what its politics saw as the other's coverage (of goods and countries), "equal sacrifice" comes to dirty laundry. In economics, each was doubly better the same arithmetic as "get what you pay for." off; trading market access "concessions" was good 8 These guidelines were cited by many of the Geneva delegations economics for the giver as well as for the receiver. that were interviewed by Finger and colleagues as part of the Bringing in the new areas changed things. What the research published as Finger, Reincke, and Castro (2002). As to the origin of the figures, at the July 7­9, 1993, G-7 summit in developing countries are now asked to put on the Tokyo, the "Quad" (Canada, EU, Japan, and the United States) table can have domestic economic costs as well as trade ministers announced a substantial market access agree- domestic political costs. Reciprocal bargaining over ment, as well as their goals for what they hoped to achieve the political dimension may not be enough. overall: reductions to zero for selected products or harmoniza- Progress in these areas may require management of tion at low levels; a 50 percent cut in tariffs 15 percent and above; and, for other tariffs, a negotiated reduction of at least their economic dimensions, as well. one-third. The one-third reduction for industrial countries may thus have come from this agreement; we have not identified Notes the origin of the one-fourth target for developing countries. 9 The formula dT/(1 + T), not dT/T, was used to measure tariff 1 According to the Oxford English Dictionary, the first recorded change. Concessions given for a country are the familiar sum use of "reciprocity" in this sense can be found in the Prelimi- for the country of all its MFN tariff cuts across all tariff lines, nary Articles for the Peace between the United States and weighted by imports. For concessions received, if Dij is the Great Britain, in 1782. reduction of the MFN tariff rate of country i on tariff line (that 2 Finger, Hall, and Nelson (1982) sort decision processes into is, "product") j, and Wijk is the share or weight (by value) of country k's total exports of product j to country i, then the "political" versus "technical" ones. At the technical end of the "reduction received" (column 1 of Table 7.3) by country k is spectrum, the criteria are given, and the decision turns on whether or not the criteria are met. Examples are an the sum, across countries and across products, of Dij multiplied antidumping determination or a jury's decision in a court trial. by Wijk. To calculate percentage point dollars of concessions At the other end of the spectrum, a "political" decision received, for Wijk in that formula we substitute Vijk, the value of k's exports of product i to country j. The countries in the table involves debate over what the criteria are, as well as about are those for which data were available from the WTO Inte- whether the criteria are met. A legislative decision on tax grated Database. See Finger, Ingco, and Reincke (1996) for a reform might be an example. In this framework, reciprocity in description of the database and a more detailed explanation of a negotiation is a political concept. What it means operational- the calculations. ly is not specified by the rules of the negotiation. 10 For some of these countries, counting only the concessions 3 Finger (1998) discusses in more detail GATT/WTO safeguards made at the Uruguay Round leaves out the unilateral liberaliza- and other pressure valve provisions. tion they implemented in the 1980s. If, however, we drop from 4 There are time limits as well as notification and consultation the table all the Latin American countries plus Sri Lanka and requirements. Tunisia, the average (absolute) imbalance is still 56 percent. 59 T H E W O R L D T R A D E O R G A N I Z AT I O N 11 In GATT/WTO usage, a nonpaper is a way of circulating an idea for discussion without proposing that the idea be adopt- ed; it is a means of promoting preliminary discussion. The nonpaper was cosponsored by 19 other developing countries. 12 Although considerable amounts of money will flow in different directions as a result of a tariff reduction and the political fall- out may be severe, implementing the reduction costs nothing. The signature of an executive or ratification by a legislature does it. 60 8 C O N S TA N T I N E M I C H A L O P O U L O S WTO Accession tries applying to join the WTO, many developing countries and economies face very similar chal- lenges in establishing the institu- tions needed to implement WTO commitments. Perhaps the most important of these challenges is the need to introduce laws and institutions for the operation of private enterprises and markets free from government controls-- other than those explicitly pro- vided under WTO regulations-- A regarding, for example, standards, ccession to the WTO is a complex, sanitary and phytosanitary (SPS) provisions, intellec- difficult, and lengthy process. In tual property rights, and state-trading practices. May 2001 it was a process being faced by 28 coun- Equally important to a country's economy is the tries, 9 of them transition economies and about half introduction of greater stability in commercial poli- of the remainder, least-developed countries (LDCs). cy, which is a consequence of adherence to WTO This chapter analyzes the WTO accession process rules and legally binding agreements. Stability is and identifies the main issues and challenges faced important both to domestic producers and to by acceding countries. exporters from other countries wishing to access these economies' markets.Adherence to WTO provi- sions--for example, by binding tariffs and by speci- Benefits of Membership fying conditions for foreign direct investment (FDI) There are three main benefits of WTO membership: in the services agreement--would improve the effi- (a) strengthening of domestic policies and institu- ciency and productivity of acceding countries. tions for the conduct of international trade in both WTO membership also offers the opportunity for goods and services, which is required before acces- new members to lock in existing, relatively liberal sion into the WTO can be accomplished; (b) trade regimes. Although the trade regimes in acced- improvements in the ease and security of market ing economies vary considerably, many have estab- access to major export markets; and (c) access to a lished regimes with relatively low tariffs and no dispute settlement mechanism for trade issues. significant formal nontariff barriers. For these countries, membership provides the opportunity to lock in these regimes by assuming legally binding Policies and Institutions obligations regarding tariff levels. This not only per- Although there are significant differences in the insti- mits them to enjoy the benefits of liberal trade but tutional and policy environment of the various coun- also gives them a first line of defense against the 61 T H E W O R L D T R A D E O R G A N I Z AT I O N domestic protectionist pressures that are present in cies and institutions that have a bearing on the con- all market economies. duct of international trade; (b) the members' fact- finding phase; and (c) the negotiation phase. The last two phases, while conceptually separate, tend to Market Access overlap in practice. Throughout, the applicant is Two main dimensions of market access are of faced with meeting WTO requirements and provi- importance to acceding economies. The first is the sions, as well as demands by existing members. With extension of permanent and unconditional most- very few exceptions, negotiation is in one direction favored-nation (MFN) status, which comes with only: the applicant is asked to demonstrate how it WTO membership. At present, economies that are intends to meet the existing WTO provisions--it not members of the WTO have been granted MFN cannot change them. Existing members can ask the treatment voluntarily by major trading partners, applicant to reduce the level of protection in its but there is nothing to guarantee that they will con- markets, but the reverse does not usually occur. tinue to be accorded such treatment. For example, in the United States extension of MFN to Russia and The Formalities several other economies in transition is contingent on the economies' adherence to the provisions of After a country sends a letter to the Director-Gener- the Jackson-Vanik amendment to the 1974 Trade al of the WTO expressing its desire to accede to the Act regarding freedom of emigration.1 The second organization, the request is considered by the WTO point is the substantial evidence that the incidence General Council, which consists of representatives of antidumping actions (both investigations and of all members and which meets frequently during definitive measures) is much higher against non- the course of the year. The General Council routine- WTO members than against members. ly decides to set up a working party, with appropri- ate terms of reference, to consider the accession application, and it nominates a chairman of the Dispute Settlement working party.2 Membership in the working party is Access to an impartial and binding dispute settle- open to all members of the WTO. In the case of ment mechanism, the decisions of which have a sig- applications by large countries such as China or nificant chance of being enforced, is an important Russia, many countries participate; in the case of potential benefit for the acceding economies, many smaller countries, the working party is usually made of which are small and heavily dependent on inter- up only of the "Quad" (Canada, the European national trade. The WTO's dispute settlement Union, Japan, and the United States) plus a number mechanism has proved successful in providing of other members, including neighboring countries opportunities for members to obtain satisfaction that are significant trading partners of the appli- regarding grievances stemming from practices of cant. The formalities phase can be quite short--no other members that cause trade injury. Although more than a few months. developing countries face some problems in access- ing this mechanism, membership provides an The Memorandum opportunity that, with proper assistance, can be beneficial to new members, especially in their rela- The preparation of the memorandum on the for- tionships with large trading partners. eign trade regime by the applicant explaining its policies and institutions can be a demanding task because of the range of issues that the memoran- The Accession Process dum has to address and the degree of detail The process of accession to the WTO is demanding required. The issues include much more than sim- and lengthy. It can be divided into an introductory ply trade in goods and services, although describing phase of formalities and three substantive phases. the trade regime for services, which encompasses The three substantive phases are (a) the applicant's the financial sector, insurance, telecommunications, preparation of a memorandum on the foreign trade professional services, and the like, is a large task in regime (hereafter referred to as the "memoran- itself. Relevant subjects also include various aspects dum"), which describes in detail the country's poli- of foreign exchange management and controls, 62 WTO Accession investment and competition policy, protection of ent rules and criteria, as opposed to administra- intellectual and other property rights, and enter- tive discretion. A key issue for enterprises that are prise privatization. The preparation of the memo- expected to remain state owned is whether they randum is solely the responsibility of the applicant, operate under market conditions or enjoy special and so is any delay in its preparation. monopoly rights and privileges. Even if the original memorandum is prepared · Some issues relate to the jurisdiction and capacity quickly, if it is incomplete in its details or if the leg- of national agencies to implement policies on islation and practices described are inconsistent which commitments are being made. The funda- with WTO provisions, the subsequent question- mental concern is one of governance: do the and-answer period can be protracted. At times, agencies have the authority and capacity to imple- members have asked the WTO secretariat to review ment the commitments that they are making in draft memoranda before their circulation to prevent the context of WTO accession regarding the laws incomplete documentation from being disseminat- and regulations that affect the conduct of interna- ed. The secretariat, however, assumes no responsi- tional trade? A related concern has to do with the bility regarding the contents of the memorandum. role and jurisdiction of local authorities and whether they have the right and opportunity to nullify commitments made by the national Questions and Answers authorities in the context of accession negotia- Once the memorandum has been circulated to tions. WTO members, the accession process enters the second stage, in which members ask questions and Negotiations obtain clarifications on the applicant's policies and institutions. This typically takes several months. (In At some point during the question-and-answer the case of Russia, it took more than a year.) The phase--after most, but frequently not all, the points working party usually does not meet until the mem- raised by working party members have been orandum and the initial questions and answers have answered--the applicant is requested to submit its been distributed. so-called initial schedule of offers in goods and The purpose of the detailed review that takes services. This consists of (a) the detailed schedule of place during this phase and that may involve several tariffs the applicant proposes to impose on goods working party meetings is to make sure that the leg- and the level at which the tariffs are "bound," and islation and institutions of the applicant are in con- (b) the commitments it makes (and the limitations formity with WTO provisions. The applicant is it sets) on providing access to its market for ser- requested to submit for the consideration of the vices.3 In addition, the applicant is requested to working party members relevant legislation on a make commitments regarding the level of support it variety of issues covered by the WTO. Delays during plans to provide to its agriculture in relation to a this phase are frequent; if a member feels that the base reference period (usually three representative answers submitted to a question or the actions years before the application for accession), as well as taken to remedy an inconsistency are inadequate, it other aspects of its support for agricultural trade, simply resubmits the question for the next round. such as export subsidies. Although the issues raised in each accession Once these offers are tabled, the accession process working party vary somewhat depending on the enters its final phase, which involves specific bilater- country, some common themes emerge in the dis- al negotiations between the applicant and each cussions of accession, especially, but not exclusively, WTO member that wishes to hold such talks in the case of countries in transition. regarding the tariff level or the degree of openness of the services sector proposed by the prospective · Within the context of laws and the operations of member. The actual timing of the original offers government institutions, two broad issues typi- varies considerably, and sometimes they are tabled cally receive special attention: the degree of priva- very early in the question-and-answer phase, as tization in the economy, and the extent to which happened, for example, in the case of Georgia. government agencies involved in the regulation of Often, bilateral negotiations take place in parallel economic activity do so on the basis of transpar- with formal meetings of the working party that 63 T H E W O R L D T R A D E O R G A N I Z AT I O N continue to deal with questions and answers regard- General Council (usually a formality), the country ing the foreign trade regime. The negotiations phase is invited to sign a protocol of accession. can also be lengthy, depending on the degree of openness the applicant proposes and the demands Progress in Accession for market access made by members. When these negotiations are in the process of As of May 1, 2001, 28 working parties had been for- being finalized and the applicant has provided mally established to consider the accession applica- assurances that the legislation and institutions that tions of prospective WTO members (Table 8.1). Most would permit compliance with WTO provisions are of the working parties were established some time in place, a draft report on accession, including the ago, with the oldest, those for Algeria and China, dat- schedule of agreed commitments on goods and ing from 1987. With few exceptions (that of Algeria services, is prepared by the secretariat for considera- being one) most of the working parties are active. In tion by the working party. After approval by the practice, accession has taken, on average, a little more working party, the report is forwarded to the Gener- than five years, from the establishment of the work- al Council. Following a favorable decision by the ing party to entry into force of WTO membership. Table 8.1 Accessions to the World Trade Organization as of May 1, 2001 Establishment of Tariff Services Draft working Economy working party Memorandum offers offers party report Algeria 06/87 07/96 -- -- -- Andorra 10/97 02/99 09/99 09/99 -- Armenia 12/93 04/95 01/99 10/98, 07/99 08/99 Azerbaijan 07/97 04/99 -- -- -- Belarus 10/93 01/96 03/98 05/99 -- Bosnia and Herzegovina 4/00 -- -- -- -- Bhutan 10/99 -- -- -- -- Cambodia 12/94 06/99 -- -- -- Cape Verde 07/00 -- -- -- -- China 03/87 02/87, 09/93 04/94 09/94, 11/97 12/94, 05/97 Kazakhstan 02/96 09/96 06/97 09/97 -- Lao PDR 02/98 -- -- -- -- Lebanon 04/99 06/01 -- -- -- Macedonia, FYR 12/94 04/99 -- -- -- Nepal 06/89 02/90, 09/98 -- -- -- Russian Federation 06/93 03/94 02/98 10/99 -- Samoa 07/98 -- -- -- Saudi Arabia 07/93 07/94 09/97, 06/99 09/97, 06/99 -- Seychelles 07/95 08/96 06/97 05/97 -- Sudan 10/94 01/99 -- -- -- Taiwan (China) 09/92 10/92 02/96, 08/99 09/94, 08/99 08/98 Tonga 11/95 05/98 -- -- Ukraine 12/93 07/94 05/96 02/98, 06/98 -- Uzbekistan 12/94 09/98 -- -- -- Vanuatu 07/95 11/95 11/97, 05/98 11/97, 11/99 11/99 Vietnam 01/95 09/96 -- -- -- Yemen 07/00 -- -- -- -- Yugoslavia, FR 01/01 -- -- -- -- -- Not yet done. Source: World Trade Organization. 64 WTO Accession A number of economies are at an early stage in result in long delays while governments ascertain the negotiation process. They include Azerbaijan, consistency between existing legislation and regula- Bosnia and Herzegovina, Cape Verde, FYR Macedo- tions and WTO requirements and while they design nia, and Yemen. Several others, such as Armenia, and put in place the amendments or new legislation Belarus, Kazakhstan, Russia, and Ukraine, have been or regulations needed. This is compounded by the involved in the accession process for a long time reality that legislative processes are themselves but, for various reasons, are not yet close to com- lengthy. The WTO secretariat can be of assistance pleting it. The process was finally completed for only in a very limited way in the accession process, China and Taiwan (China) by the end of 2001. as the WTO budget allocates very few resources to accession of new members. The five staff members in the WTO Accession Division are thinly stretched Why Does It Take So Long? in servicing even the procedural needs and paper- To understand why accession to the WTO is such a work generated by more than 25 active accession long process, it is necessary to look first at the vari- working parties. ous phases of the accession process and the reasons why delays may occur. Difficulties in the Negotiations Phase The negotiations phase can be and frequently has Weak Follow-Up been the most time-consuming phase of accession. In several cases a government has taken the initial Negotiations partly have to do with whether the step to apply for accession and have a working party acceding member's policies and institutions are set up, but then it fails to follow up the accession consistent with various aspects of the WTO agree- process by preparing a memorandum on its policies ments and partly with the specific tariff bindings or taking subsequent steps, or it does so after a long and commitments in agriculture and services. interval. Working parties for Uzbekistan and Sudan Delays can occur on both sides. The acceding gov- were set up in 1994, but the memoranda of foreign ernment may be unwilling to make needed liberal- trade policy were only submitted in September ization commitments--for example, it may not 1998, for Uzbekistan, and January 1999, for Sudan. offer to liberalize nontariff barriers, or it may pro- pose binding tariffs at levels much higher than existing ones. Members, for their part, may not be Political Issues satisfied with the level of liberalization proposed or In a few cases political issues between an applicant may be unwilling to accept delays in bringing the and one or more influential WTO members have laws and institutions of the applicant into conform- introduced delays. This happened in the past to ity with WTO provisions. Sometimes, as in the cases some extent with the accessions of China (and of of Albania, Croatia, Estonia, and Latvia, delays have Taiwan, China, which is linked to it) and of FYR stemmed not from the WTO accession process as Macedonia. such but from disagreements between the European Union (EU) and the United States over the commit- ments of acceding countries in the WTO (for exam- Inherently Time-Consuming Processes ple, in audio-visual services) and the possible future Even if the above problems did not exist, accession association of these countries with the EU. is inherently a time-consuming process. The prepa- ration of the memorandum presents serious diffi- Strategy and Tactics of the Applicant Country culties for governments that typically do not have sufficient human or material resources to address Within the rules and disciplines of the WTO, each the issues that have to be discussed in detail. Most country has considerable scope as to how restrictive countries have had to seek assistance from outside or liberal its trade regime will be. There are no spe- experts funded by bilateral aid agencies, from the cific rules as to the maximum level at which a coun- WTO itself, and from the World Bank. try has to bind its tariffs, how many services it will The question-and-answer process is also time liberalize, whether to establish antidumping legisla- consuming; applicants' institutional weaknesses tion, or how fast to liberalize its agricultural trade. 65 T H E W O R L D T R A D E O R G A N I Z AT I O N Countries thus have a strategic choice to make dur- duce uncertainty about trade policy among the ing the negotiations phase: how liberal their trade country's trading partners. regime will be, consistent with overall WTO disci- Several transition countries that have recently plines. become WTO members, such as Albania, Estonia, A strategy that some countries have pursued in Georgia, the Kyrgyz Republic, Latvia, and Mongolia, their accession negotiations is to try to liberalize as pursued a different strategy. In most respects their little as is necessary to ensure accession. Since such governments adopted a liberal trade strategy as part applicants cannot negotiate significant improve- of the process of accession.4 This entails (a) binding ments in their access to other markets, they try to tariffs at the usually low currently prevailing levels maintain significant levels of protection to use as or agreeing to reduce and bind tariffs at low levels as bargaining chips for obtaining improved access in part of the accession negotiations; (b) agreeing to a future negotiating rounds. Some of the countries liberal trade regime in agriculture and services; and that are using this strategy, such as China and Rus- (c) at an early date after accession, participating in sia, also feel that significant levels of protection are such agreements as the government procurement necessary during a transition period when ineffi- code, which increases competition and transparen- cient state-owned enterprises are being restructured cy in the operation of their markets. (see Gabunia 1998). These countries have typically The fundamental benefits of such a strategy are presented initial offers that propose to bind tariffs at economic: these countries reap the benefits of liber- rates much higher than those currently applied. al trade and investment. But the strategy has a num- Similar issues arise in services. Many transition ber of other advantages as well: it tends to facilitate and developing economies feel that their services negotiations for accession; it provides governments sectors are underdeveloped and would like to limit with political cover against domestic protectionist the commitments they make to open these sectors interests that may otherwise succeed in subverting to foreign competition. This is especially an issue in an existing liberal trade regime; and the legally such areas as financial services and telecommunica- binding WTO commitments lock in reforms by tions, in which countries frequently face requests making it more difficult for future governments to from WTO members to establish liberal policies reverse the liberalization. Increased protection to regarding commercial presence. Such policies "safeguard" against serious injury to domestic would permit foreign services suppliers to establish industry is permitted under WTO rules, but it is subsidiaries or joint ventures based on the principle based on a detailed and transparent investigation to of national treatment, which prohibits discrimina- demonstrate injury, which is then notified to the tion against foreign services providers and thus has WTO and subjected to the scrutiny of other mem- a direct bearing on foreign direct investment. bers. This is far more difficult than for a powerful There are significant dangers to a "minimum lib- domestic industry to simply seek government sup- eralization" accession strategy. Individual countries, port for raising tariffs beyond the applied level but especially small developing economies, have little below the higher bound level, which a government leverage in market access negotiations, and so the can do almost without any constraint. The point potential benefits they may be able to obtain about the WTO is not that it prohibits protection through such a strategy may be very small. At the but, rather, that it permits it only according to cer- same time, maintaining protection through rela- tain rules; obeying these rules makes protection tively high tariffs and protected agriculture and more transparent as well as more difficult to initiate services sectors imposes costs on the applicants' and expand. own economies: they forgo the benefits of a more The Chinese accession, concluded in 2001, has liberal trade regime, which, in the first instance, combined elements of both strategies and has raised accrue to the country itself. If countries bind tariffs a number of additional issues. First, China has used at levels higher than those applied and assume few the process of WTO accession to stimulate and commitments regarding agriculture and services make irreversible substantial trade liberalization (both of which are possible under WTO rules), they and more broadly based reforms. Second, China, in are subject to another risk: they create an opening many ways an economy in transition, considers for domestic interests to exert political pressure for itself a developing country and has been seeking to additional protection in the future, and they pro- obtain transition periods and other special and dif- 66 WTO Accession ferential treatment that WTO agreements extend to WTO agreements. When such weaknesses are developing countries. The latter includes nonreci- brought out in negotiations, members suggest that procity, preferential market access, and different the applicant seek technical assistance, available commitments and time limits in the implementa- from a variety of bilateral and multilateral donors, tion of the provisions of various aspects of the and that it present a detailed plan regarding the par- agreements, ranging from agriculture to subsidies ticular aspects of the relevant WTO provisions in and trade-related intellectual property rights which weaknesses exist and how and within what (TRIPS). China, because of its position as a large time period it proposes to remedy them. market, has also bargained on certain aspects of UNCTAD, the World Bank, the European Union, market access, such as on textiles and on issues Switzerland, and the United States, as well the related to its designation as a nonmarket economy. WTO, have programs that provide technical assis- tance on various aspects of the accession process, especially in the preparation of the initial country Attitudes and Policies of WTO Members memorandum. Anecdotal evidence about these The demands made on newly acceding countries are programs suggests a somewhat uneven perfor- greater than WTO disciplines on existing members. mance. Most countries report very helpful contri- Based on recent accession experience, the areas dis- butions by foreign consultants and advisers in the cussed below are ones in which members typically preparation of the memorandum. In some cases, request that acceding countries make more far- however, it appears that advice provided by outside reaching commitments than those made by many experts has actually slowed the accession process existing members at similar levels of development. because the consultants suggested, and the country agreed to, a "bargaining" strategy of tariff binding at Tariffs. Acceding countries are requested to bind all high levels and limited offers on services. In addi- tariffs, whereas many developing countries contin- tion, there have been problems of coordination ue to have a large portion of their tariff schedule among the various donors, as well as between the outside agriculture unbound. Ceiling bindings have bilateral aid agencies providing the assistance and been accepted, but there is pressure to bind close to their colleagues in the trade ministries who negoti- applied rates. ate the accession. Agriculture. In addition to binding the tariff sched- Plurilateral Agreements. There is pressure for ule, commitments are expected on aggregate mea- countries to begin examining the provisions of the sures of support (AMS), export subsidies, and the plurilateral agreements (for example, on govern- like. Since many acceding countries did not provide ment procurement and civil aviation) at the time of substantial support to agriculture but, rather, penal- accession and to commit to a timetable for complet- ized it, the requests they face for reductions in AMS ing negotiations soon after accession. may not be warranted, and in any case meaningful calculation of commitments in this area is subject to "Market Economy" Issues. Although there is no serious statistical difficulties. explicit requirement in the WTO agreements that a member have a market economy, a requirement Rules and Disciplines. Acceding countries are typi- that acceding countries have, fundamentally, such cally requested to meet all commitments at entry an economy is being pushed de facto by existing with regard to, for example, TRIPS, customs valua- members as part of their leverage in the accession tion, standards, and SPS regulations, without time process.5 The pressures have been felt by all acced- limits such as those available to existing members at ing countries, including China, where explicit similar levels of development, and regardless of understandings were reached with regard to the whether institutional weaknesses make it difficult existence of state trading in specific sectors. At the for them to fulfill such commitments. Such weak- same time the Quad countries have been unwilling nesses relate broadly to the operations of a market to modify their own antidumping procedures economy; it takes time to establish the institutional regarding the designation as "nonmarket infrastructure that would enable the applicants to economies" of transition countries that have discharge their responsibilities properly under the become WTO members. Under this designation, 67 T H E W O R L D T R A D E O R G A N I Z AT I O N different, less transparent, and potentially discrimi- It is politically difficult to adopt a liberal trade natory practices can be applied in the determina- strategy at accession, especially when major trading tion of whether dumping has occurred and, in the partners, which are WTO members, take advantage case of EU safeguard actions, against imports from of opportunities that are perfectly legal under the a number of these countries, including all the mem- WTO to limit market access--for example, by bers of the Commonwealth of Independent States maintaining high levels of protection in agriculture. (CIS) and China (Michalopoulos and Winters Even recognizing the political difficulties involved, a 1997). For this reason, the nonmarket economies strong argument can nonetheless be made that if label has been a major cause of trade friction developing countries and transition economies cur- between many transition economies, on the one rently applying for WTO accession adopt a liberal hand, and the United States and the European trade strategy at entry, they will maximize the bene- Union, on the other. fits and opportunities for integration in the interna- Legal justification for using such procedures can tional community that WTO membership offers be found in GATT provisions that permit different and will accede more quickly, as well. treatment "in the case of imports from a country It is fair to ask whether countries should not which has complete or substantially complete maintain some flexibility in their initial offers, as monopoly of its trade and where all domestic prices they are bound to face demands to liberalize by are fixed by the State" (Palmeter 1998: 116). These existing members almost irrespective of the level of practices were perhaps fully justified when practical- protection they initially propose. Although there is ly all trade was controlled by state trading enter- merit in this point, it probably should not be prises or ministries and prices were fixed by the pushed too far. Experience in recent accession nego- state. Countries in transition, however, have made tiations suggests that countries which make initial great progress in introducing market forces in recent offers to bind their tariffs at levels significantly dif- years. It would be difficult to argue that, say, China ferent from the applied level encounter serious diffi- or Russia has at present "a substantially complete culties in accession--even though the practice is monopoly on trade" or that all domestic prices in widespread among existing developing country these countries are fixed by the state. Thus, continu- members, many of which have not bound large por- ation of the traditional EU and United States tions of their tariff schedule. When such an initial antidumping practices no longer appears justified in offer is put on the table (as has happened with sev- the new setting (Michalopoulos and Winters 1997).6 eral countries of the former Soviet Union, as well as Because the GATT antidumping provisions accept other applicants for accession), working party national legislation and practices as decisive, the odd members basically refuse to consider it or to enter situation can arise in which countries become new negotiations on that basis. They simply ask the WTO members but are still designated as nonmar- country to submit a revised offer with bound rates ket economies for antidumping purposes. closer to the applied ones before serious negotia- tions take place. China's accession is unique, for both political and Lessons of Experience and Issues for the economic reasons, and lessons from it have to be Future drawn with extreme care. Undoubtedly, China has The first important lesson of experience is that each used WTO accession to promote and lock in wide- accession case involves a different negotiation, with ranging reforms. China differs from most recently different dynamics. This makes it difficult to gener- acceding countries in that it has been able to negoti- alize. Nevertheless, the cases of a number of small ate a number of transition periods--for example, countries that have recently concluded the accession for eliminating quantitative restrictions, licensing, process suggest that the smaller the country and the and state trading--as well as the maintenance of more liberal its regime, the faster the accession tariff quotas in agriculture. It probably has much process. There are two reasons for this: smaller more bargaining power than all the recently acced- countries realize that the costs of protection are ing countries taken together. It is a moot point high for them, and the small size of their economies whether the time limits and extensions obtained by poses fewer market access issues for major WTO China (which were much less than it requested) are members. compatible with its economic interests or whether a 68 WTO Accession faster liberalization of its trade regime would have complex, and challenging for all countries, especial- been more conducive to the country's longer-term ly the LDCs. The process is inherently time consum- development. To WTO members negotiating ing, but there are a number of steps that acceding China's accession, it is almost irrelevant what Chi- countries and WTO members could take which nese protection does to China's economy; they are would facilitate and expedite accession. concerned about the impact of such protection on Governments seeking accession need, first, to their exports to the Chinese market and its large establish a central coordination point to provide potential. direction and manage the multiplicity of legislative At the same time, China has had to accept limita- and regulatory changes in their foreign trade regime tions on its market access that other developing that are necessary for accession. Second, they need countries have not. For example, it has agreed to be to adopt liberal trade policies, which will both con- subject to product-specific selective safeguards; it tribute to their effective integration into the inter- accepted three more years of restrictions in the national economy and facilitate WTO entry. Third, implementation of the Agreement on Textiles and governments need to focus on and identify those Clothing (ATC), from which it had been completely areas of the WTO agreements in which weaknesses excluded; and it agreed to be designated a nonmar- in their institutional infrastructure require that they ket economy for 15 years. In this context, the more delay implementation of WTO provisions. They exceptions and the longer transitions a large coun- should actively solicit technical assistance, prepare a try such as China seeks to obtain, the more WTO realistic plan for implementing remedial actions, members will strive to maintain provisions that and seek agreement to obtain suitable delays in the inhibit full access of the acceding country's prod- implementation of the agreements as part of the ucts in their markets. accession process (despite the apparent reluctance It can be argued that WTO members' insistence of members to agree to such extensions so far). on a liberal commercial policy at entry is likely to WTO members can also take steps to help expe- serve the acceding countries' long-term develop- dite the accession process. It is in their interest that ment interests, as well as WTO members' commer- the organization achieve universal membership cial objectives. But insistence on adherence to all sooner rather than later, as current members would WTO commitments at entry and without transition benefit if all countries adhered to the rules and pro- periods in areas (such as customs valuation, TRIPS, visions of the WTO. In this regard, members should standards, and SPS) where there are obvious institu- attempt to ensure that accession is not delayed on tional weaknesses in LDCs and transition account of high-income countries' own disagree- economies raises serious problems. That is, acced- ments or disputes. ing countries, motivated by their strong desire for WTO members also need to consider the institu- membership, may agree to obligations that they tional weaknesses of acceding governments and to cannot implement, leaving them open to subse- moderate their demands by agreeing to suitable, quent complaints. Alternatively, providing generous time-bound extensions in meeting WTO obliga- transition periods at a time when the transition tions. This should not mean lowering the require- periods for other countries that are already mem- ments but, rather, allowing more time to meet bers are expiring would create inequities between them. If such extensions are not provided, either the existing and new members. The solution to this negotiations become stalled or the acceding country problem may be the substantial extension of some ends up accepting obligations that it cannot imple- of these transition periods both for existing low- ment. In particular there is merit to extending and income members of the WTO and for acceding standardizing transition periods for acceding coun- LDCs and transition economies; after all, these tries in the areas of standards, TRIPS, and custom transition periods were arbitrarily set in the first valuation, where countries invariably face serious place. constraints in meeting requirements at accession. Industrial countries should continue to provide assistance to developing countries and countries in Conclusion transition that are not members in order to For a variety of reasons, the process of WTO acces- strengthen their institutional capacities so that they sion has been and is likely to continue to be lengthy, are better able to meet the requirements for WTO 69 T H E W O R L D T R A D E O R G A N I Z AT I O N accession. Such assistance needs to be better coordi- ance and receive "permanent" conditional MFN treatment. nated. The Integrated Program of Trade-Related When, however, Georgia, the Kyrgyz Republic, and Mongolia became WTO members, the United States exercised its right of Technical Assistance to the Least-Developed Coun- nonapplication under WTO Article XIII; that is, it did not pro- tries has the potential to benefit a number of acced- vide these countries with unconditional MFN status and thus, ing countries. Consistent with preserving the WTO de facto, had not accepted their accession. Subsequently, leg- as a member-driven institution, industrial country islation was enacted permitting the United States to notify the members should also consider substantially increas- WTO that it has accepted these countries' membership. In the ing the resources available to the WTO secretariat case of China, the United States had to address this important issue through amended legislation before membership negoti- for assisting acceding governments in the prepara- ations were concluded. tion of the original memorandum and in the design of legislation and regulations that would enable the 2 Usually the chairman is an ambassador, a permanent represen- tative to the WTO. Countries often request and obtain observ- applicants to meet WTO obligations. Channeling er status at the WTO to familiarize themselves with the more resources through the WTO would permit the institution before they make a formal request for accession. secretariat to play a more active role in coordinating 3 Services commitments are typically more general and open- assistance efforts in support of accession and would ended than commitments in the sphere of goods. For a discus- give greater assurance that the outside experts who sion, see Part IV of this volume. assist governments with the preparation of the 4 The trade regimes in Croatia and Jordan, which also acceded needed documentation and the modification of leg- recently, were somewhat less liberal. islation and regulations do so in ways that more effectively meet WTO requirements. A reasonable 5 GATT Article XVII calls for notification of enterprises engaging objective would be to cut the processing time of in state-trading practices. The article, however, was never intended to address problems that come up when the bulk of accessions to no more than two years, a time frame external trade is controlled by the state. Indeed the GATT that is feasible if the above steps are taken. If that accommodated several countries, such as Romania and schedule were attained by all acceding countries, the Czechoslovakia, that at the time had centrally planned WTO would be able to achieve universal member- economies. ship in the next five years--a worthwhile objective 6 In 1997 the European Commission announced proposals for for the international community. liberalization of EU policy on this issue vis-à-vis Russia and China, which would terminate their designation as nonmarket Notes economies at the country level and would permit determina- tions to be made case by case, taking into account the market 1 Belarus is subject to annual waivers (as was China, until recent- conditions prevailing in each commodity in which dumping ly); the other countries have been found to be in full compli- had been alleged (Croft 1997). This is similar to U.S. practice. 70 9 VA L E N T I N A D E L I C H Developing AB report. In these instances, only "negative" consensus can stop the process; that is, all Countries and members must agree not to pro- ceed or not to adopt panel and the WTO Dispute AB recommendations or rul- ings. This reversal of the consen- Settlement System sus rule led to a radical change in the dynamics of dispute set- tlement, making it more auto- matic and less dependent on the power of the countries involved in a dispute. Since there is an W extensive literature comparing ith the creation of the WTO, devel- the GATT and WTO systems, we confine ourselves oping and industrial countries to briefly summarizing the salient features of the became subject to the same set of rules and to simi- DSU before turning to developing country experi- lar commitments. A new Dispute Settlement ence and concerns.1 Understanding (DSU) was negotiated to enforce multilateral disciplines. The DSU is widely regarded The WTO Dispute Settlement System as one of the positive outcomes of the Uruguay Round, marking a move toward a more "automatic" The Dispute Settlement Body (DSB), which com- and rule-oriented system (Jackson 1997). This prises all WTO members, has the authority to estab- chapter evaluates the functioning of the DSU from a lish panels, adopt panel and AB reports, maintain developing country perspective. surveillance of the implementation of rulings and Although the cornerstone of the WTO dispute recommendations, and authorize suspension of settlement mechanism remains Articles XXII and concessions and other obligations under WTO XXIII of the GATT, the DSU brought about a sub- agreements (Art. 2 DSU). A member must first stantial change in the workings of the system. A request bilateral consultations if it considers that a major improvement was to remove the consensus benefit accruing to it directly or indirectly under the requirement at key stages of the process. The DSU WTO agreements is being nullified or impaired states that "where the rules and procedures of this (Art. 4 DSU). If consultations fail to settle the dis- Understanding provide for the Dispute Settlement pute, the complaining party may request the estab- Body to take a decision, it shall do so by consensus," lishment of a panel, which must be created unless but this general rule does not apply to the establish- the DSB decides by consensus not to do so (Art. 6 ment of a panel of experts, the adoption of its DSU). report, or, if the report was subject to an appeal A panel is generally composed of three panelists. before the Appellate Body (AB), the adoption of the Its deliberations are confidential, and the opinions 71 T H E W O R L D T R A D E O R G A N I Z AT I O N expressed in the panel report by individual panelists may seek to suspend concessions under another are anonymous (Arts. 6, 14 DSU). Nationals of covered agreement (Art. 22 DSU). countries that are parties to the dispute may not Suspension of concessions (retaliatory action) is serve on a panel unless the parties to the dispute the last recourse for countries in enforcing compli- agree otherwise. Panels must conduct examinations ance with DSB recommendations and rulings. Of within six months (Art. 12 DSU). Within 60 days of course, effective retaliatory measures are available to the date of circulation of a panel report to WTO countries with economic power. As noted by Hoek- members, the report must be adopted at a DSB man and Mavroidis (2000: 531): meeting unless a party to the dispute formally noti- fies the DSB of its decision to appeal or the DSB Those WTO members that can afford to either decides by consensus not to adopt the report (Art. take countermeasures or to incur the costs of 16 DSU). action being taken against them are in a better The Appellate Body, a standing tribunal created in position. When acting as complainants they the Uruguay Round, considers any appeals. The tri- will use threat and/or imposition of counter- bunal consists of seven members, of whom three measures in order to induce compliance; when serve on any given case. The members are appointed acting as defendants, they will have at least the for four years and may not be connected with any luxury of weighting the pros and cons between government. Appeals are limited to issues of law changing the domestic policies at stake (in covered in the panel report and to legal interpreta- order to avoid imposition of countermeasures) tions developed by the panel. AB proceedings are or simply keeping the domestic policies at stake not to exceed 60 days and are confidential. The intact (and see countermeasures imposed reports are drafted in the absence of the parties to against them). the dispute, and the opinions expressed in them are anonymous (Art. 17 DSU). When a panel or the AB A key principle, nevertheless, is that multilateral concludes that a measure is inconsistent with a cov- authorization of retaliatory action is required. In ered agreement, it must recommend that the mem- this regard there is a "sequencing problem." Article ber concerned bring its measures into conformity 22.6 prescribes that retaliation must be authorized with the WTO agreement (Art. 19 DSU). within 30 days of the time a country is supposed to Article 21.5 of the DSU states that "where there is comply with a WTO ruling. This deadline, however, a disagreement as to the existence or consistency does not allow enough time for completion of a with a covered agreement of measures taken to compliance review under Article 21.5.2 Valles and comply with the recommendations and rulings, McGivern (2000) conclude that three different such dispute shall be decided through recourse to precedents have been established for determining these dispute settlement procedures, including the consistency of implementing measures and the wherever possible resort to the original panel." In suspension of concessions: the Bananas model, in turn, Article 22 of the DSU foresees that "if no satis- which the arbitrators first determined the WTO- factory compensation has been agreed, (. . .) any consistency of the implementing measures before party having invoked the dispute settlement proce- assessing the level of the suspension of concessions; dures may request authorization from the DSB to the Salmon model, in which the parties provided for suspend the application to the member concerned "sequencing" on an ad hoc basis; and the Subsidies of concessions or other obligations under the cov- and Countervailing Measures (SCM) model, in ered agreements." The complaining party should which the parties used a provision of the SCM first seek to suspend concessions or other obliga- agreement to extend Article 22 retaliation deadlines. tions with respect to the same sector as that in In each case, the complaining party requested the which the panel or the Appellate Body has found a establishment of an Article 21.5 panel on the basis violation or a nullification or impairment of bene- of a bilateral agreement to extend the Article 22 fits. Then, if the party considers that such action is deadlines until after completion of the Article 21.5 not practicable or effective, it may seek to suspend review. concessions or other obligations in other sectors A number of provisions in the DSU relate to under the same agreement. Finally, if the circum- developing countries. Article 4.10 calls for members stances are serious enough, the complaining party to give special attention to the particular problems 72 Developing Countries and the WTO Dispute Settlement System and interests of developing countries in consulta- Developing Countries' Experience with the tions, and Article 12.10 allows for the extension of WTO Dispute Settlement System the consultation period in cases of measures taken by developing countries if the parties agree. Article Most of the clauses in the DSU regarding develop- 8.19 provides that a developing country involved in ing countries have proved to be more declarative a case can request that the panel include at least one than operative. For instance, the concept, in Article person from a developing country, and Article 12.11 4.10, of giving "special attention" to the particular states that in such cases the panel report is to indi- problems and interests of developing countries cate how account was taken of relevant provisions during consultations has no operative content and concerning differential and more favorable treat- has not been developed in panel or AB reports. ment for developing countries that are embodied in Although in one case this article was mentioned in the WTO agreements referred to in the dispute. a DSB meeting to support a developing country If a case is brought by a developing country, the position, there was no substantive discussion of the DSB, in considering what appropriate action might "special attention" concept. A similar problem be taken, is to take into account not only the trade arose with special and differential treatment (S&D) coverage of the measures complained of but also clauses in such agreements as that on antidumping their impact on the economy of the country con- (see Box 9.1). Although some panels have dealt cerned (Art. 21.8 DSU). Article 27.2 provides for with S&D clauses, given that these clauses have neutral legal advice (technical assistance) to be fur- been invoked in fewer than 10 cases involving nished by the WTO secretariat to developing country developing countries, it seems that they are not members. Finally, Article 24.1 calls for due restraint very relevant for these countries, either in defend- in invoking the DSU against least-developed coun- ing or in claiming their rights. 3 (See Chapter 49, by tries (LDCs), in asking for compensation, or in seek- Oyejide, in this volume; see also Whalley 1999.) ing authorization to suspend the application of DSU provisions related to the surveillance of concessions or other obligations to these countries. implementation of DSB recommendations and rul- B O X 9 . 1 S P E C I A L A N D D I F F E R E N T I A L T R E AT M E N T A N D T H E D S U : S O M E E X A M P L E S The Scallops Case cles 3(7), 4(2) and 4(5) of the DSU. This In 1995 Chile and Peru requested that a panel be request had been disregarded by the Com- established on the trade description of scallops munities thus discriminating against and drawn up by the European Communities (EC). impairing Chile's interests in deviation from The EC asked that the item be removed from the the provisions of Article 4(10) of the DSU DSB agenda, arguing that the time periods for which stated that Members "should give spe- consultations and for the inclusion of those items cial attention to the particular problems and on the agenda stipulated in the DSU had not interests of developing country Members." This been respected. According to Chile, however, was a discrimination against Chile which was not being granted the same treatment as the Communities did not take into account Canada and was not in conformity with the that consultations with Chile had already obligations of WTO members towards a been initiated when the Communities had developing country. agreed to Chile's participation in consulta- tions held with Canada on the same subject The Bed Linen Case. . . . [or that] [w]hen Canada-EC consultations In European Communities: Antidumping Duties on had been completed, Chile had requested Imports of Cotton-Type Bed Linen, India contended further consultations to resolve this matter in that the EC had not taken into account the spe- accordance with the letter and spirit of Arti- cial situation of India as a developing country. (continued) 73 T H E W O R L D T R A D E O R G A N I Z AT I O N B O X 9 . 1 ( C O N T I N U E D ) India asserted that the EC had not acted consis- provides procedural safeguards, and thus, tently with Article 15 of the Agreement on does not require any particular substantive Antidumping, which recognizes that "special outcome, or any specific accommodations regard must be given by developed country to be made on the basis of developing members to the special situation of developing country status. In the United States' view, country members when considering the applica- [Article 15] does not impose anything tion of anti-dumping measures" and calls for other than a procedural obligation to exploring constructive remedies before applying "explore" possibilities of constructive anti-dumping duties in instances where they remedies. The word "explore" cannot fair- would affect the essential interest of developing ly be read to imply an obligation to reach a country members. India asserted that the EC did particular substantive outcome; it merely not explore any such possibilities prior to the requires consideration of these possibilities. imposition of antidumping duties and did not react to detailed arguments from Indian The panel's view was that exporters pertaining to Article 15: "[D]espite repeated and detailed arguments by the Indian the imposition of a lesser duty or a price parties stressing the importance of the bed linen undertaking would constitute constructive and textile industries to India's economy, the EC remedies but we come to no conclusions failed to even mention India's status as a develop- as to what other actions might in addition ing country, let alone consider or comment on be considered to constitute constructive possibilities of constructive remedies." India sug- remedies as none have been proposed to gested that "such remedies may consist of, us. . . . In our view, Art. 15 imposes no obli- among others, the non-imposition of anti dump- gation to actually provide or accept any ing duties or undertakings." India rejected the constructive remedy that may be identified notion that any procedural mechanism, such as and/or offered. It does, however, impose simplified questionnaires or extensions of time, an obligation to actively consider, with an satisfied the requirements of Article 15. The EC open mind, the possibility of such a reme- agreed in principle and accepted that undertak- dy prior to imposition of an anti-dumping ings could be a remedy, but it argued that Indian measure that would affect the essential exporters did not offer undertakings within the interests of a developing country. time limits set by the EC regulation. The United States, a third party in this dispute, Source: WTO, WT/DSB/M/7 (scallops); WTO, argued that Article 15 WT/DS/141 (India). ings are too weak to imply any difference between transparent liaison between the state and industry the possibilities open to industrial and developing in order to obtain up-to-date information on trade countries. Article 21.7, however, mandates that problems in which developing countries have a when a matter is raised by a developing country, stake. Developing countries lack the high-level the DSB is to consider what further action might be expertise and resources to devote to such activities. appropriate to the circumstances. To date, this pro- International financing for training public officials, vision has not been used by a developing country, screening industrial countries' trade policies, and perhaps because a precondition is that the country building a network with other developing countries devote resources to analyzing and following cases. with the aim of jointly presenting cases could help This involves checking arguments, issues, and pos- address some of these problems. sibilities and comparing experiences and results; The technical assistance called for in Article 27.2 exploring new legal as well economic arguments; is provided by only a few consultants and is inade- and, domestically, building up an efficient and quate, given the large number of cases. In addition, 74 Developing Countries and the WTO Dispute Settlement System since the WTO secretariat must be impartial, its lat- ity. These proposals are supported by many devel- itude for helping developing countries with legal oping countries in particular, as there is a common strategic issues is limited. In this context, the Advi- concern regarding the costs associated with submit- sory Centre on WTO Law (described in Box 9.2) ting, pursuing, and defending cases and the scarcity could play an important role in helping developing of human resources for dealing with increasingly country governments present and pursue cases. complex issues. Venezuela has noted the need to increase the num- Finally, provisions related to least-developed ber of legal assistants to the secretariat to help countries have not been invoked at all because no developing countries and has called for the creation least-developed country has been involved in a dis- of a trust fund to establish alliances with private law pute, as a complainant or as a respondent. firms to augment developing countries' legal capac- B O X 9 . 2 T H E A D V I S O R Y C E N T R E O N W T O L AW Claudia Orozco ratification process, and the Advisory Centre On the side of the Third WTO Ministerial Confer- became operational in October 2001. ence, held in Seattle in 1999, ministers from 29 The Advisory Centre provides legal advice on WTO member countries signed an agreement WTO law to developing countries and to establishing the Advisory Centre on WTO Law economies in transition. This legal advice might (ACWL). The establishment of the ACWL is a con- take the form of advisory opinions on particular crete action toward addressing the needs of questions of law, analysis of situations involving developing countries for advice and training on trade concerns, or legal advice provided WTO law. The contractual nature of the WTO throughout a dispute settlement proceeding. In requires that members have a full understanding recognition of the differences among developing of the content and scope of their rights and obli- countries, the extent of the support to be provid- gations and that they are able to access the dis- ed will depend on the needs and requirements pute settlement mechanism. Otherwise, the of each member in each case. Examples might ever-growing complexity and breadth of the sys- include outlining the legal questions of a case, tem, coupled with the relative scarcity of special- drafting submissions, and commenting on drafts ized human resources in developing countries prepared by government officials. In addition, and the costs of specialized external legal coun- the ACWL holds regular in-house seminars on sel, would marginalize many members. jurisprudence for Geneva-based officials and To help address these needs, a legal aid facility regional yearly seminars for officials based in was proposed, with two goals: (a) training gov- capitals. Finally, and most important, the ACWL ernment officials in WTO jurisprudence, and (b) offers on-the-job training for government offi- providing specialized legal advice on WTO law, to cials in charge of a particular case and intern- include support throughout legal proceedings. ships for government lawyers responsible for The response was the establishment of the Advi- WTO issues. sory Centre as a small, independent international organization based in Geneva and open to all Note: Claudia Orozco was minister counselor at the WTO members. By March 31, 2000, the final mission of Colombia to the WTO between August 1994 date for becoming a founding member, the and July 2000. She served as legal counselor and was a treaty had been signed by 9 industrial and 22 panelist in several cases. On February 1998 she submit- developing countries. The 38 least-developed ted the project proposal for the Advisory Centre on countries that are members of the WTO are prior- WTO Law to the Netherlands, the United Kingdom, and ity beneficiaries of the ACWL's services. The Norway and led consultations with an informal group agreement entered into force in July 2001, after of WTO members. The result was a proposal that was the requisite number of countries completed the offered to all WTO members. 75 T H E W O R L D T R A D E O R G A N I Z AT I O N Developing Country Participation in matters ranging from patent protection under the the DSU [Trade-Related Aspects of Intellectual Property Rights, or TRIPS] Agreement, to balance-of-pay- As of September 2000, 207 complaints had been ments restrictions, safeguard measures, and the tax- notified to the WTO (Table 9.1). Of these, 16 were ation of alcoholic beverages" (Lacarte-Muro and active, 40 had concluded with the adoption of either Gappah 2000). The exception is intellectual proper- an AB or a panel report, 34 had been settled bilater- ty rights (IPRs), with many complaints alleging vio- ally or were inactive, and 12 were being implement- lation of the TRIPS agreement by both developing ed (WTO 2000).4 Industrial countries brought the and industrial countries. As of 1999, the number of most cases, and their share of total complaints (74 TRIPS cases had already reached 16, equivalent to percent) was greater than their share of world 10 percent of all filings under the DSU. Eleven of exports. Among the different categories of cases, these filings were brought by the United States those brought by industrial countries against devel- (Geuze and Wager 1999). As regards developing oping countries appear to have increased the most countries, Correa (2001) notes that "although the between the GATT period and the WTO era, from adoption by another Member of unilateral trade 10 to 31 percent. Over 40 percent of industrial sanctions would be incompatible with the multilat- country cases were against developing countries-- eral rules, developing countries have continued to higher than the developing countries' 27 percent be under unilateral demands by some developed share of industrial countries' exports in 1998. The countries, notably the United States in the area of proportion of cases by developing countries against IPRs, in some cases aiming at ensuring protection of industrial countries was also higher than might such rights beyond the minimum standards set have been expected (66 percent of all developing forth by the Agreement" (Correa 2001: 22). country complaints) and was higher than the share Although developing countries are likely targets of industrial countries in developing country for intellectual property rights cases, IPRs may also exports, 57 percent (Weston and Delich 2000). become their most effective means of exerting pres- Latin America and Asia are the developing coun- sure and eventually retaliating. Ecuador's threat to try regions most involved in the dispute settlement suspend its TRIPS concessions in the Bananas case process. To date, African countries have not initiat- (see Chapter 10, by Hudec, in this volume) and the ed or been respondents in any case, although sever- strategy used by Brazil with regard to public health al, including Nigeria and Zimbabwe, have made and patents would appear to be the first steps in this presentations as third parties. direction (Dyer 2001; see also Chapter 36, by No single theme dominates the substance of the Maskus, in this volume).5 Subramanian and Watal cases involving developing countries. "As respon- (2000) have proposed that "developing countries dents, developing countries have been involved in convert their TRIPS obligations into instruments of Table 9.1 Number of Dispute Settlement Cases, 1995 through September 2000 Complaint by Share of Industrial Developing Total total cases countries countries complaints (percent) Complaint against: Industrial countries 89 35 124 60 Developing countries 65 18 83 40 Total 154 53 207 100 Share of total cases (percent) 74 26 Memorandum: Share of cases under GATT (percent) 84 16 Note: Based on number of cases brought by each country. The European Union and its member countries are counted jointly. Source: Weston and Delich (2000); WTO (2000b); IMF, Direction of Trade Statistics, various issues. 76 Developing Countries and the WTO Dispute Settlement System multilateral enforcement embodying the retaliation The compliance panel would comprise the mem- possibilities in domestic legislation" (p. 415). bers of the original panel, if its report had not been According to these authors, "domestic legislation appealed, or the members of the Appellate Body implementing the TRIPS agreement must clearly that considered the appeal if the report of the origi- specify that the country's executive reserves the nal panel had been appealed. The compliance panel right to revoke or dilute these rights in the event would be required to circulate its report within 90 that partner countries are found to be in non-com- days of the date of its establishment, after which any pliance with commitments that affect the country's party to the compliance panel proceeding would be interest" (p. 411). In addition, they hold that "if permitted to request a meeting of the DSB to adopt designed with care, retaliation in TRIPS can be fea- the report within a period of 10 days. The report sible, effective, and legal. Further, it has one really would be subject to the negative consensus rule: it attractive attribute that distinguishes it from con- would be automatically adopted unless the DSB ventional trade retaliation in the area of goods: decided by consensus not to adopt. retaliation in TRIPS can be genuinely welfare Compliance panel reports would not be subject to enhancing in a way that conventional retaliation--a appeal. If the compliance panel found that the case of shooting oneself in the foot to shoot at the member concerned had failed to bring its measures other person's foot--is not" (p. 405). into compliance within the reasonable period of time determined by the original panel, the com- plaining party could request authorization from the Proposals for Reforming the Dispute DSB to suspend the application of concessions to Settlement System the member concerned or to suspend other obliga- A number of proposals have been made by develop- tions under the covered agreements. ing countries and by scholars to improve the func- The joint proposal also modifies Article 22.2 to tioning of the dispute settlement system. This entitle the complaining party to request authoriza- section briefly summarizes these suggestions. tion to suspend concessions if a compliance panel report pursuant to Article 21 bis finds that the member concerned has failed to bring its measures On Implementation of Recommendations and into compliance with the ruling of the DSB. If the Rulings and Suspension of Concessions member concerned objects to the level of suspen- Three proposals have been made: amend the system sion proposed, the proposal states that "the matter to resolve procedural problems such as the sequenc- shall be referred to arbitration. The arbitration shall ing issue described earlier; allow financial compen- be completed and the decision of the arbitrator sation for developing countries; and turn retaliation shall be circulated to Members within 45 days after into a collective action. the referral of the matter. The complaining party A large number of WTO members have made a shall not suspend concessions or other obligations joint proposal that Article 21.2 of the DSU be during the course of the arbitration." reformed to address the sequencing problem.6 The In regard to financial compensation, Pakistan has proposal foresees the creation of Article 21 bis, enti- commented that "[i]t would be useful to clarify that tled "Determination of Compliance," that would the term `compensation' used in Article 22 includes establish the following procedures. A complaining grant of financial compensation to the complaining party may request the establishment of a compli- party by the country which has been found to be in ance panel (a) any time after the member concerned violation of the rules. Panels should be authorized states that it does not need further time for compli- to recommend payment of such financial compen- ance; (b) any time after the member concerned has sation in disputes between developed and develop- submitted a notification that it has complied with ing countries where they find that as a result of the recommendations or rulings of the DSB; or (c) WTO inconsistent measures taken by developed 10 days before the date of expiration for the "rea- countries, the developing country has lost its trade sonable period of time" to comply. While consulta- in the affected product" (WT/GC/W/162). It is not tions between the member concerned and the the first time that a developing country has called complaining party are desirable, they are not for the inclusion of financial compensation in the required prior to a request for a compliance panel. dispute settlement system: a similar proposal was 77 T H E W O R L D T R A D E O R G A N I Z AT I O N made during the GATT era (see Chapter 10, by porary developments." In particular, Pakistan pro- Hudec, in this volume).7 posed that such clarification make clear that panels Proposals have also been made to make violation or the Appellate Body were not permitted to take of WTO rules a collective problem and, accordingly, into account "unsolicited information" including to require collective retaliatory actions. Pauwelyn "amicus curiae briefs from private parties" (2000: 6), for instance, argues that (WT/GC/W/162). In November 2000, at a special WTO General with the advent of the WTO--its legal refine- Council meeting, developing countries called for ment, quasi-judicial dispute settlement system, the Appellate Body to exercise extreme caution in and, in particular, major expansion into new inviting amicus curiae briefs from nongovernmental fields that directly affect individuals--it may be organizations (NGOs). (The context was the devel- time to move away from the idea of the oping countries' reaction to the AB ruling on the GATT/WTO only as a package of bilateral bal- Asbestos case.) Developing countries sought to limit ances between governments. Has the time not the Appellate Body's "interpretation powers" and to come to introduce the WTO as a truly multilat- prevent NGOs from participating in the dispute set- eral construct providing legal rules as public tlement system. Brazil, Egypt, India, Pakistan, goods that merit collective enforcement for the Uruguay, and the Association of Southeast Asian good of governments and economic operators? Nations (ASEAN) countries argued that a decision . . . [T]he enforcement of WTO rules can and to admit amicus curiae briefs was a substantive and should be seen as a collective rather than a not a procedural one and was therefore something mainly bilateral exercise. for WTO members to decide. Moreover, "develop- ing countries took the view that non-governmental In addition, Pauwelyn has proposed that "coupled organizations are not accountable to sovereign par- with countermeasures, a broad scheme of compen- liaments and have no contractual rights and obliga- sation--additional market access offered by the los- tions in the WTO. The AB had let itself be unduly ing party to WTO members--would provide influenced by the campaign of NGOs of major trad- genuine leverage to induce compliance, a move ben- ing entities. In effect, NGOs were being accorded eficial to all WTO members, and not just `compensa- privileges greater than those enjoyed by WTO tion' to the one or few that brought the case" (p. 9). Members."9 Finally, Pakistan has presented a proposal that As for the composition of the Appellate Body, Article 22.3 be amended to eliminate the possibility India has proposed that, to promote an atmosphere of cross-retaliation by industrial against developing conducive to impartial and independent function- countries. This would impede, for instance, retalia- ing of the Appellate Body, all future appointments tion against trade in goods if a developing country of AB members should be for a nonrenewable fixed has been found to be in violation of the TRIPS term of five or six years, to ensure that members agreement (WT/GC/W/162, p. 3). have no incentive to seek support for their reap- pointment (WT/DSB/W/117). On the Appellate Body On Time Lines The role of the Appellate Body--in particular, the extent to which it has gone beyond its mandate and The joint proposal mentioned earlier would shorten undertaken to "make rules" through interpretation the consultation period from 60 to 30 days; the peri- of WTO agreements--has been severely questioned od could be extended by up to 30 additional days if by developing countries.8 Pakistan has called for an one or more of the parties in the dispute were a interpretation of "the relevant provisions in the developing country and the parties agreed. In addi- DSU to make it clear that the responsibility for clar- tion, in the Working Procedures, the proposal ifying or modifying the provisions of the WTO would reduce the time for receipt of the complain- Agreements clearly rests with the WTO member ing party's first written submissions to three­four countries and that it would not be appropriate for weeks (currently, it is three­six weeks), while the Appellate Body to usurp these functions under increasing the time for the party complained against the guise of interpreting law on the basis of contem- to respond to four­five weeks instead of two­three 78 Developing Countries and the WTO Dispute Settlement System weeks, as at present. Since the proposal unifies the provisions relating to enforcement of S&D language reports (there would be a single report, including in WTO agreements are ineffective, developing the descriptive sections and the panel's findings and countries do not enjoy a "neutral" playing field. conclusions), it eliminates the period during which Although the DSU is not biased against any party in parties submit their comments on the descriptive a dispute, developing countries are less well report and, consequently, the possibility that at the equipped to participate in the process: they have request of a party the panel would hold a further fewer people with the appropriate training, they are meeting on the issues identified in the written com- less experienced, and they can bring fewer financial ments. After making other adjustments on time resources to bear. Therefore, although the DSU is an lines, the proposal states that "the total reduction of asset, developing countries must work to obtain time is up to approximately 47 days, and the time international financing for training and capacity frames in Article 20 (the reference to 9 months and building and for the establishment of a joint mech- to 12 months), and the periods in Art. 21.4 (the ref- anism among developing countries to screen indus- erence to 15 months and to 18 months) shall be trial country trade policies of interest to them--not reduced by one month" (WT/MIN[99]8, p. 7). only to reduce the costs of the screening but also to coordinate the submission of joint cases. In addi- tion, developing countries could use cases in which On Third Parties they are involved as a way to identify gaps in WTO In relation to third parties, the joint proposal retains agreements that need to be addressed through the obligation contained in Article 10 that a copy of negotiations. all documentation submitted in a case be given to Reform of the dispute settlement system does not third parties. It allows exclusion, however, of certain appear to be a priority on the negotiating agenda of factual confidential information (designated as such developing countries. Their efforts are mainly by the disputing party) and sets a period of 15 days directed toward defending their interests as best for the party to provide a nonconfidential summary they can in current cases, bridging the gap with that can be disclosed to the public of the informa- industrial countries in terms of legal expertise, and tion contained in the confidential submission. establishing more effective enforcement and retalia- tory devices. A Special Prosecutor, "Light" Procedures, and Customs Unions Notes Hoekman and Mavroidis (2000) have proposed a 1 See for example, Komuro (1995); Lafer (1996); Jackson kind of "special prosecutor," able to act on an ex (1997); Montaña Mora (1997). officio basis, to detect illegalities. They also suggest 2 On the sequencing problem, see the Salmon dispute between "light" procedures for cases involving less than Austria and Canada; the U.S.-Australian dispute over leather US$1 million of exports; in such cases a single pan- subsidies; and the Bananas case. See also O'Connor and elist would be asked to address the dispute within Vergano (2000); Rhodes (2000); Valles and McGivern (2000). three months. Turkey has proposed amending Arti- 3 Cases in which S&D clauses were invoked by a party in a dis- cle 10 of the DSU to grant all parties to customs pute were European Communities: Antidumping Duties on unions the right to participate in panel and AB pro- Imports of Cotton-Type Bed Linen, complaint by India; Korea: ceedings in disputes concerning measures intro- Measures Affecting Imports of Fresh, Chilled, and Frozen Beef, complaint by the United States; India: Quantitative Restrictions duced pursuant to a common trade policy of the on Imports of Agricultural, Textile and Industrial Products, com- union (WT/MIN[99]/15). plaint by the United States; Brazil: Export Financing Programme for Aircraft, complaint by Canada; Canada: Measures Affecting the Export of Civilian Aircraft, complaint by Brazil; and Indone- Conclusion sia: Certain Measures Affecting the Automobile Industry, com- The Dispute Settlement Understanding brought plaints by the United States, the European Communities, and Japan. There were also cases in which S&D clauses were about a positive and beneficial change for develop- invoked by a third party or some kind of statement was made ing countries. Weaker states have a better chance to about a developing country's preferential treatment on the defend their interests in a rule-oriented than in a basis of its status as a developing country. Examples include power-oriented system. However, since the DSU Guatemala: Antidumping Investigation Regarding Imports of Port- 79 T H E W O R L D T R A D E O R G A N I Z AT I O N land Cement from Mexico, complaint by Mexico; European Com- 6 See "Proposed Amendment of the DSU," WT/MIN(99)8, sub- munities: Measures Affecting the Prohibition of Asbestos and mitted by the government of Japan on behalf of cosponsors Asbestos Products, complaint by Canada; and Mexico: Canada, Costa Rica, the Czech Republic, Ecuador, the Euro- Antidumping Investigation of High-Fructose Corn Syrup, com- pean Communities (and its member states), Hungary, Japan, plaint by the United States. These cases may be found on the Korea, New Zealand, Norway, Peru, Slovenia, Switzerland, WTO Website, . Thailand, and Venezuela. 4 There was one active case on implementation of WTO rulings, 7 For a detailed discussion on the Uruguay-Brazil plan to reform as well as six adopted AB and panel reports on implementation the dispute settlement system, including financial compensa- of WTO rulings (Art. 21.5 DSU), one active arbitration on the tion, see Dam (1970): 368­73. level of suspension of concessions (Arts. 22.6­7), and four authorizations of suspension of concessions (under Art. 22.7 8 Industrial countries have also questioned panel rulings on the DSU and Art. 4.10 of the Subsidies Agreement). same grounds. For instance, when the DSB, in a case involving subsidies to an automotive leather manufacturer, adopted a 5 Brazil linked developing countries' right to access affordable panel ruling that required, for the first time, that a private medicines to patents. First, Brazil put forward a very broad and company repay in full an illegal export subsidy, the countries ambitious plan to fight HIV in its territory and pressed corpora- involved--the United States and Australia--commented that tions to reduce drug prices. Simultaneously, Brazil obtained a "the ruling should not set a precedent for future disputes"; the declaration at the World Health Organization on the virtues of European Union said that the implications needed more dis- its HIV program. Finally, at the TRIPS Council, Brazil submitted cussion; and the United States stated that "the payback reme- a document highlighting the need to interpret the TRIPS dy went beyond that sought by the US." "Canada and Brazil agreement in a way that did not impede countries' ability to expressed their serious concerns about the decision and Japan implement health policies. Brazil received rapid and wide- and Malaysia voiced misgivings" (Financial Times, weekend, spread support from developing countries (and from public February 12­13, 2000). opinion as well). As a result of this strategy, the United States withdrew the panel against Brazil on intellectual property 9 The question of amicus curiae briefs is part of a broader debate rights, and at the Doha ministerial meeting a separate declara- on the governance of the trading system; see Chapter 47, by tion was made asserting that the TRIPS agreement does not Tussie and Lengyel, in this volume. See also "Developing Coun- and should not prevent members from taking measures to tries Make Their Mark on WTO Appellate Body Controversy," protect public health. World Trade Agenda, no. 00/22 (December 4, 2000), p. 11. 80 10 R O B E R T E . H U D E C The Adequacy WTO system allow larger coun- tries to exert significantly stronger enforcement pressures of WTO Dispute against developing countries than developing countries can Settlement exert in the reverse situation. The shortcomings of the WTO legal Remedies system in this regard thus raise a legitimate issue for developing country governments when they must decide whether to employ A Developing Country Perspective the dispute settlement procedure against larger countries. In addi- A tion, these shortcomings raise ccording to conventional wisdom, the question of whether it would be worthwhile for it is a waste of time and money for developing countries to expend negotiating capital developing countries to invoke the WTO's dispute in an effort to remedy these shortcomings, and, if so, settlement procedure against industrial countries. what particular reforms should be sought. Even if, the argument runs, a developing country In this chapter, I examine the facts behind the con- obtains a clear legal ruling that an industrial coun- ventional wisdom more carefully than is usually try has violated its legal obligations, the developing done. My purpose is not to prove that the conven- country has no effective way to enforce the ruling. tional wisdom is entirely wrong. Rather, I hope to The only enforcement sanction provided by the show that the issue here, as in most issues, is not quite WTO dispute settlement procedure is trade retalia- the open-and-shut proposition that is usually tion--the imposition of discriminatory trade sanc- advanced. I think it is important that officials respon- tions by the complaining country against the trade sible for deciding these issues have an accurate of the defendant country. And trade retaliation by understanding of what is and is not wrong with the smaller developing countries, it is argued, simply remedies offered by the existing WTO system, and of does not inflict any significant harm on larger how well or how poorly the system works in practice. industrial countries. In the end, the argument con- My purpose is to outline at least some of the infor- cludes, retaliation will harm the developing country mation needed to arrive at such an understanding. imposing it far more than it will harm the industri- al country it is supposed to punish. Enforcement under the GATT Dispute The conventional wisdom has a great deal of truth Settlement System to it. The "law" of the WTO does not, in fact, give weaker countries the same protection that well- The weaknesses of the GATT dispute settlement sys- developed domestic legal systems usually afford tem, which operated from 1948 to 1994, have been their weaker citizens. The remedies provided by the described so often that they need little elaboration. 81 T H E W O R L D T R A D E O R G A N I Z AT I O N The entire system was based on consensus decision- response to legal rulings. In the 1980s, when gov- making, which meant that the consent of the defen- ernments began to use the dispute settlement sys- dant was required before the procedure--creating a tem to deal with more politically controversial panel, defining its terms of reference, appointing its matters, the success rate dropped to about 81 per- members, adopting its ruling, and authorizing retali- cent--not up to the standards of most domestic ation--could move forward at all. The central reform legal systems, but still a very impressive perfor- made by the WTO Dispute Settlement Understand- mance for an international legal regime, especially ing (DSU) was to make the procedure go forward in the politically sensitive area of trade policy automatically on the request of the complainant, (Hudec 1993: 285­94). with or without the consent of the defendant. Although complaints by developing countries did In addition to its central weakness, the formal not achieve the same level of success as those remedies provided by the GATT legal system when brought by larger countries, the results were still legal violation was found were also rather limited. A favorable in a significant percentage of the cases. ruling of violation entitled the complaining govern- Over the GATT's entire history, 28 complaints were ment to a rather general "recommendation" calling brought by developing countries. Of these, 17 ended on the defendant government to comply with its in legal rulings, 11 of which were rulings of legal obligations. The recommendation was directed only violation, and 10 of the 11 (91 percent) had a suc- toward future conduct, with no compensation for cessful outcome. Of the 22 complaints known to be harm done while the violation was in force. There based on a valid legal claim, satisfaction was was no time limit on the order to comply, and the achieved in 18 of the cases (82 percent). Even in the process of seeking compliance could drag on for more contentious cases of the 1980s, legally valid years. The complaining government could at some complaints by developing countries achieved a 73 point request authorization to retaliate by imposing percent success rate (Hudec 1993: 315­26). approximately equal trade barriers in return, but The paradoxical contrast between the voluntary the request could be vetoed by the defendant. In procedures and weak remedies of the GATT dispute modern GATT practice, only two requests for retal- settlement system, on the one hand, and its rather iation authority were made, both against the United strong record of success, on the other, contains a les- States, and both were vetoed.1 son. It teaches that the enforcement of international Despite the defendant's ability to block the proce- legal obligations cannot be explained by superficial dure, the GATT disputes procedure produced a con- analysis of dispute settlement procedures and reme- siderable number of dispute settlement complaints dies. Enforcement requires that governments be during its almost 50-year history. My own study of persuaded to reverse decisions they have taken in GATT cases from 1948 to the end of 1989 counted violation of the agreement. Governments are not 207 cases filed during that period, of which 88 pro- private litigants. They are complex institutions that duced legal rulings; of the 88, 68 were rulings of vio- make decisions in their own peculiar, often irra- lation. In the decade of the 1980s, when the GATT tional, manner, which we call "politics." Even small- system had matured, there were 115 complaints er governments are strong enough to be able to yielding 47 legal rulings, of which 40 were rulings of resist coercive forces that would move private liti- legal violation (Hudec 1993: 277­78). Provisional gants. Governments, however, usually have a data from a continuation of that study list 71 more longer-term interest in the efficacy of the legal rela- complaints in the final five years of GATT opera- tionships they have established with other govern- tions (1990 to 1994), with 22 legal rulings, 20 of ments, and so they are more inclined to act in ways which were rulings of legal violation.2 designed to preserve those relationships. Ultimately, Notwithstanding the defendant's ability to block the compliance decisions of governments are deter- adoption of adverse rulings, the great majority of mined more by calculated self-interest than by the violation rulings were in fact adopted. More- force. over, the bulk of these violation rulings, including In my view, government compliance with legal many of those not adopted, did produce a satisfac- rulings is usually the product of at least three inter- tory correction of the practice at issue. In its first related factors that influence the way in which gov- three decades the GATT system achieved almost a ernments make trade policy decisions. First, some 100 percent success rate in producing a satisfactory parts of the defendant government's decisionmak- 82 The Adequacy of WTO Dispute Settlement Remedies: A Developing Country Perspective ing apparatus usually want the conduct called for by effective, in many cases it may well be more effective GATT legal obligations to be pursued for its own than the other practical alternatives. Policy deci- sake, simply because it is good policy. Such officials, sions that focus only on the availability of retalia- and the private interest groups that share this view, tion thus run the risk of ignoring the other, quite constitute an existing political force within the valuable, gains that can be achieved from a legal rul- defendant government, and the effect of GATT legal ing alone. rulings is to give them greater influence in the national decisionmaking process. Second, many The WTO Reforms officials and private interest groups within the national government's decisionmaking process per- In the Uruguay Round, WTO member governments ceive a value in the legal system itself, believing that agreed to establish a more rigorous dispute settle- both they and their country will gain more over the ment system. As noted above, they began by making long term from an effective legal system than they the disputes procedure move forward automatically. will gain from noncompliance in this or that indi- The automaticity of the procedure makes it more dif- vidual case. Although these actors may not want to ficult for larger countries to bully smaller countries tie their country's hands through rigid commit- into giving up their legal complaints. If developing ments to a particular legal system--or may not have countries want to have a legal ruling, it will now enough political support to go that far--they will require less diplomatic confrontation to get one. nonetheless argue strongly against noncompliance The remedies granted for enforcing a binding in individual cases that would damage respect for ruling were also strengthened. In addition to mak- the system. Finally, one should not underestimate ing retaliation more readily available, the Uruguay the influence of active pressure by other govern- Round reforms adopted a number of reforms ments. If a majority of member governments intended to strengthen the effect of the ruling itself. believes in the value of an existing legal system, The primary remedy set forth in the DSU is still the those governments will have the same incentive to legally binding "recommendation" ordering the discourage noncompliance with legal rulings and defendant to bring its conduct into compliance. will express their views in the form of collective Although the recommendation is still only future- condemnation of noncompliance. directed (it provides no remedy for the harm done But even if all three factors existed in cases where by the violation so far), some steps were taken to no legal rulings were provided, legal rulings sharpen make that future-directed order more effective.3 the focus on the issue of compliance, and the nor- Panels were given explicit power to make nonbind- mative force of such rulings increases the power of ing suggestions for how compliance can be those participants who favor compliance. This is so achieved--a power that, if used, could sharpen the whether or not the ruling is enforced by coercive focus of compliance pressures. Quite a bit more sanctions. was added to the procedure for following up a rec- As noted above, the GATT dispute settlement ommendation after it has been issued. There is now procedure almost never employed retaliation as an a procedure for establishing a time limit for com- enforcement device. The fact that the GATT pliance, which, so far, has ranged from 6 to 15 nonetheless produced a large number of successful months. During that period, the illegal measure is legal rulings indicates, therefore, that the internal under periodic review, and it remains under peri- government forces just described frequently did odic review, without further action by the com- play a significant role in bringing about successful plainant, as long as noncompliance lasts. For the outcomes. This is not to say, of course, that enforce- government that does not, or cannot, retaliate, ment would not have been even more effective if these changes make it easier for the complainant to more retaliation had been employed. Other things focus and maintain community pressures for com- being equal, one would expect a better chance of pliance. compliance with a retaliation tool than without it. Retaliation is still the final remedy for eventual The key point, however, is that a legal ruling with- noncompliance. In contrast to the GATT disputes out retaliation can still be an effective policy tool for procedure, under which retaliation was a vague and a developing country seeking to reverse a legal vio- seldom-used remedy, the new WTO procedure lation by a larger country. Although not invariably appears to make retaliation the central objective of 83 T H E W O R L D T R A D E O R G A N I Z AT I O N the remedy structure. The defendant no longer has utility of the dispute settlement procedure for a the power to veto retaliation requests, making it cer- developing country complainant. tain that retaliation will be authorized whenever noncompliance is established. The use of retaliation Proposals for Additional Reforms to Cure is subject to time-limited procedures to resolve dis- the Imbalance putes over whether the defendant has in fact failed to comply with the ruling, and over the amount and This section contains background information nature of the retaliation, but these procedures only about some of the reforms that have been advanced delay the remedy slightly. in the past to cure the perceived imbalance in GATT In the light of past experience, the WTO's greater and WTO dispute settlement procedures. emphasis on retaliation as an enforcement tool would appear to be somewhat misguided. The Compensation for Harm Done emphasis on retaliation seems to have been the result of an effort to accommodate pressures for For most of the GATT's history, the prevailing view stronger enforcement. The U.S. negotiators had to has been that the only remedy for violation of a persuade the U.S. Congress that the WTO dispute legal obligation is a forward-looking order directing settlement procedure had strong enforcement pow- the defendant to comply in the future. Except for a ers. To do this, the negotiators had to satisfy the leg- string of antidumping and countervailing duty islators' rather simplistic view that enforcement can (AD/CVD) cases in the late 1980s and early 1990s, be achieved by retaliation. As is usually the case defendant governments have not been required to when negotiators try to convince domestic legisla- compensate for harm done before the illegal mea- tures to support a new trade agreement, the sure was brought into conformity. Uruguay Round negotiators probably promised The most important challenge to the exclusively more enforcement power from retaliation than forward-looking view of GATT remedies was a 1965 retaliation can deliver. Threats of retaliation can be effort by GATT developing countries to add mone- useful, but they can also become counterproductive tary compensation to the list of dispute settlement if used too forcefully or too often. Governments remedies. This occurred at a time when developing must remember that enforcement is a more com- country GATT members were using the threat of plex process than mere retaliation, involving the abandoning the GATT for UNCTAD to ask for a bet- generation of the political forces needed to bring ter deal from GATT. The developing country caucus about the desired compliance decision. made several proposals to improve the operation of The new emphasis on retaliation probably makes the dispute settlement procedure. One proposal the WTO dispute settlement system even more one- resulted in the adoption of a special accelerated pro- sided than before. Retaliation by larger countries cedure for complaints by developing countries, tends to be most effective when used against smaller which is still in force today.4 Two other proposals countries, and so, by making access to retaliation concerned the improvement of remedies: a proposal more available, these new reforms give larger coun- for monetary damages to be paid to developing tries a still greater advantage over smaller countries countries injured by GATT-illegal trade restrictions, that cannot effectively retaliate. (Needless to say, the and a proposal for collective retaliation.5 increased one-sidedness would be viewed as an The theory behind the developing country pro- advantage by industrial country governments.) posal for monetary compensation was that GATT- Once again, however, it must be stressed that the illegal trade restrictions caused serious harm to the greater one-sidedness of the procedure does not fragile economies of developing countries and that mean that legal complaints by developing coun- this harm would be multiplied by its retarding effect tries--that is, legal complaints without the retalia- on the development process. In these circum- tion option--cannot be a useful and effective policy stances, the developing countries argued, forward- tool. To the contrary, the smaller reforms made in looking remedies were not enough to remedy the the Uruguay Round do make legal complaints with- harm already done. Instead, they proposed, devel- out retaliation quite a bit more effective than they oping countries should be entitled to collect were before. One-sidedness is a problem, but it is a retroactive damages in the form of money awards. separate problem that has nothing to do with the The money would compensate the government's 84 The Adequacy of WTO Dispute Settlement Remedies: A Developing Country Perspective economic development program, rather than pri- validity of the proceedings under review. Finally, it vate interests, which would have removed many of must be recognized that the disreputable character the problems in calculating the harm. It was under- of AD/CVD measures makes them a natural target stood that the obligation to extend monetary com- for aggressive regulation. pensation would remain in force until the measure At first, it seemed that GATT governments them- was corrected. selves agreed that a refund remedy should be avail- Developing countries strenuously advocated the able in such cases. The first such ruling, in a 1985 money damages proposal through a long series of case brought by Finland against New Zealand, was committee meetings in 1965. Industrial countries adopted by the GATT Council, and New Zealand opposed the proposal with equal conviction, assert- did in fact issue a refund.8 Afterward, six subse- ing that money damages were simply outside the quent GATT panel decisions ordered refunds, but in realm of the possible. In effect, they were saying, the each case the result was inconclusive. Two of these GATT was never meant to be taken that seriously. panel reports were adopted, but only after the issues The proposal was not adopted. had become moot, and over the express reservation The GATT practice of denying compensation for of the defendant as to the panel's rulings on past wrongs clearly reflects a view of GATT law as refunds.9 The other four rulings were blocked having a lower status than domestic law. Under the entirely by the defendant government, with at least domestic law of most GATT members, taxes or part of the objection to adoption being the remedy other charges imposed in violation of national law order.10 The principal opponent of such refund are a legal nullity, and government authorities are orders was the United States, joined later by the required to refund any monies so collected. The European Community (EC).11 trade laws of such countries similarly provide for Although governments renegotiated many provi- refund of tariffs collected in violation of national sions of the GATT Antidumping Code and the tariff law. To my knowledge, however, few if any GATT Subsidies Code in the Uruguay Round, the countries authorize such refunds when tariffs or negotiations yielded no answer to the impasse over other charges are found GATT-illegal.6 By limiting refund orders. The United States then cast its posi- GATT law in this fashion, governments are saying tion in cement when the U.S. Congress adopted a that they do not want GATT legal obligations to statutory provision, in the 1994 legislation imple- have such direct legal effect. Ultimately, it is a state- menting the Uruguay Round agreements, that ment that governments do not want (or do not have AD/CVD or safeguards duties already paid in "liq- sufficient political support) to make trade agree- uidated" entries would not be refunded, although ments that binding. the GATT-illegal duties could be revoked for all The one exception to the GATT's consistent prac- "unliquidated" entries.12 The issue of AD/CVD tice of issuing only forward-looking remedies was a refund orders has come up only once so far under series of GATT panel decisions between 1985 and the new WTO dispute settlement procedure, in the 1995, all involving antidumping and countervailing Guatemala Cement case.13 The panel in that case did duties, in which panels ordered refunds of duties not rule on the issue, however, and its entire opin- imposed in violation of GATT rules. It is not clear ion was set aside by the Appellate Body on other why these panels singled out antidumping and grounds. countervailing duties for more demanding remedies In conclusion, it bears repeating that the call for than those normally employed against other GATT- refund of GATT-illegal antidumping and counter- illegal charges on imports. One GATT panel vailing duties is an exception to the perfectly consis- referred to provisions in the 1979 Antidumping tent GATT practice of denying refunds of Code requiring government to refund overcharges. GATT-illegal tariffs and all other kinds of GATT- This obligation applies only to overcharges as illegal charges. One evident reason for the absence defined by national antidumping laws, and national of a refund remedy has been that many govern- governments do seem to comply with it when they ments have lacked domestic legal authority to find that, under national law, overcharges have been refund taxes or charges in such cases. Given the made.7 Furthermore, AD/CVDs rest entirely on usual controls on contingent government expendi- specific proceedings against specific firms, and thus tures, one might expect that few governments their validity seems more clearly contingent on the would be eager to seek such authority, particularly if 85 T H E W O R L D T R A D E O R G A N I Z AT I O N it were to extend to refunds of such things as GATT- This compensatory theory of trade retaliation has illegal tariff charges. Developing countries them- run through GATT law since the days of the negoti- selves might wish to think twice about whether they ations on the International Trade Organization wish to shoulder such a refund responsibility. (ITO) in 1947­48. 14 That theory is, of course, a pol- Meanwhile, the weight of joint U.S.-EU opposition icy choice; GATT governments could always adopt a to refunds in AD/CVD cases promises to be formi- different standard if they wanted to. The signifi- dable, especially since U.S. opposition is now cance of the history of the compensatory theory is required by statute. simply that it shows a steadfast desire on the part of leading GATT members not to have a law with stronger sanctions. Other Forms of Trade Retaliation The second objection to proportional retaliation The standard complaint of developing countries is a practical one: an individual developing country about the remedy of trade retaliation is that it is too usually does not have a large enough market to weak to be effective against large countries. The assemble the amount of trade retaliation that would amount of retaliation is limited to the trade loss be needed to cause noticeable pain in a large indus- caused by the illegal trade measure in question. trial country--at least not without shutting down Since individual developing countries tend to have most of its own economy. The only way to achieve only a small share of the defendant country's mar- significantly greater retaliation would be to develop ket, their retaliation measures can affect only a small some form of collective retaliation by many coun- amount of that country's trade--usually not tries at the same time. Thus, the proposal usually enough, the argument runs, to cause any significant shifts to one for collective retaliation, asking that the hardship for the large industrial country or its pro- GATT put aside both the compensatory limit to ducers. retaliation and the notion that only the com- Academic discussions of GATT/WTO remedies plainant is entitled to retaliate. usually arrive at the question of whether In 1965 the developing country proposals for GATT/WTO trade retaliation should not be mea- reform of the GATT dispute settlement remedies sured according to a scale that would make certain included a proposal calling for collective retalia- that the amount of retaliation is large enough to be tion.15 The justification for the proposal was the meaningful against larger countries. Such proposals same as the one advanced today: individual devel- are usually justified by arguments that the law must oping countries could not impose sufficient retalia- have sanctions large enough to accomplish its task. tion to cause noticeable pain in larger industrial Two objections are usually interposed against countries. The idea was that in such cases a number such proposals for proportional retaliation. The of countries would be authorized to deny market most important is the assertion that the purpose of access to the large-country defendant. By definition, retaliation has never been to serve as a punitive this retaliation would also have been punitive in sanction; on the contrary, the right to retaliate has amount, although there were some arguments that always been viewed as a right to maintain the bal- higher retaliation levels could be based on a "devel- ance of reciprocity in GATT obligations. The start- opment multiplier" that inflated the measurement ing assumption has been that the obligations of the harm developing countries suffered from undertaken by each country involve a balance of GATT-illegal trade restrictions. benefits--the benefits granted to others in the form Industrial countries strongly resisted this propos- of a country's own obligations, balanced against the al. Beyond the objections based on unwillingness to benefits that country obtains from the obligations change the "compensatory" limit to retaliation, undertaken by others. The theory is that a breach of there were also objections based on an assertion legal obligations reduces the benefits being received that multiple retaliations would soon produce so by the complaining country and that, if the breach many new restrictions that they would choke the is not cured, the complaining country must be channels of commerce. In informal conversations, allowed to reestablish the balance by withdrawing industrial country delegates tried to point out that, obligations of its own. Such balancing, however, solidarity notwithstanding, countries not involved requires only retaliation equal to the amount of the in the dispute would soon tire of being asked to benefits lost. harm their own citizens for this purpose. Even far- 86 The Adequacy of WTO Dispute Settlement Remedies: A Developing Country Perspective ther behind the scenes, of course, was the awareness Cross-Retaliation under the TRIPS Agreement by industrial countries that the existing limitations on remedies suited them quite well, for the very In 1999 the several strands of argument claiming same reasons that developing countries did not like that trade retaliation is not a practical policy instru- them. Viewing things from the perspective of their ment for developing countries were brought togeth- role as potential defendants, industrial countries er in a new type of retaliation proceeding initiated were quite content with membership in a legal sys- by Ecuador in the Bananas case (Box 10.1).16 tem in which they could hurt others but some of the Ecuador tried to take advantage of the "cross-retali- others could not really hurt them. ation" provisions found in Article 22.3 of the WTO B O X 1 0 . 1 T H E B A N A N A S C A S E The European Union (EU) import regime for Operators that traditionally exported bananas bananas has long been a bone of contention. In from former British and French Caribbean effect, the EU maintains a system that gives pref- colonies were granted 30 percent of all import erential market access to bananas produced by licenses for non-country-specific quotas. These African, Caribbean, and Pacific (ACP) countries. licenses could be used to import ACP bananas or As a result Caribbean producers have always had could be sold to firms desiring to import from a substantial share of the EU market, to the detri- Latin America. In the latter case, which often ment of Central and South American countries. occurred, the quota allocation system resulted in Preferences predated the formation of the Euro- a transfer of rents from the (mostly U.S.-based) pean Economic Community (EEC) and, in fact, firms buying the licenses to those granted the caused problems between France and Germany quota rights. Borrell (1997) estimated that the during the negotiations leading to the creation of new regime was worse than the national ones it the EEC in 1957; Germany had a free trade replaced: total costs to EU consumers were about regime for bananas and imported from Latin US$2 billion, while ACP suppliers obtained American countries, while France maintained US$150 million--a cost per consumer of over very high barriers to support French colonial pro- US$13 for each dollar transferred. ducers (Messerlin 2001). These differences led to Latin American producers brought two cases to the imposition of national intra-EU trade barriers, the GATT contesting the national systems (in reserving the U.K., French, and Spanish markets 1992) and the new common EU regime (in for former colonies. The policies were a very inef- 1993). They won both. In 1994 the EU conclud- ficient way of assisting the former colonies: every ed a Banana Framework Agreement with four dollar transferred cost EU consumers US$5, of countries (Costa Rica, Colombia, Nicaragua, and which US$3 went to distributors and US$1 was Venezuela) under which these countries were wasted (Borrell 1997). allocated specific quotas on the understanding In 1993 the EU adopted a complex import that they would not bring a case to the WTO licensing and distribution system for the union as before 2002. In 1996 four Latin American pro- a whole, as part of its effort to create a single mar- ducers that had been left out of this agreement ket. The common market organization that was (Ecuador, Guatemala, Honduras, and Mexico), imposed was based on historical trading relation- joined by the United States on behalf of U.S. ships and was designed to continue to provide multinational fruit firms, contested the EU import preferential access for ACP countries (signatories regime in the WTO, claiming that it discriminated of the Lomé Convention). It involved two tariff against their producers and banana marketing quotas--one for traditional ACP suppliers and one companies. The object of the attack was not so for nontraditional ACP and Latin American grow- much the tariff preferences that were granted to ers--and four categories of suppliers. Out-of- ACP countries--for which the EU had obtained a quota imports were subject to high specific tariffs. waiver--but the allocation of quotas. (continued) 87 T H E W O R L D T R A D E O R G A N I Z AT I O N B O X 1 0 . 1 ( C O N T I N U E D ) The WTO panel report, published in June 1997, ened imposition of tariffs on their goods (Finan- found the EU banana import regime in violation cial Times, August 26, 2000, p. 5). of WTO nondiscrimination and market access Toward the end of 1999, Ecuador also sought rules. The dual tariff rate quota regime was found and obtained authorization to retaliate. Its request to be inconsistent with GATT Article XIII (requir- was a double first in the history of the trading sys- ing nondiscrimination), and the 30 percent allo- tem: the first request for retaliation by a develop- cation of import licenses to traditional sellers of ing country, and the first time approval for ACP bananas was ruled inconsistent with GATS cross-retaliation had been sought. Ecuador nondiscrimination rules. On appeal, the Appellate argued that its merchandise imports from the EU Body endorsed most of the panel's conclusions. were too small to allow full retaliation (set at In 1998 the EU revised its regime. It continued US$200 million by the arbitrators) against imports to maintain two tariff rate quotas, but it assigned of EU goods. It obtained authorization to suspend import quotas for non-ACP countries on the basis concessions under other agreements, including of historical market shares and abolished the TRIPS, after having exhausted the possibilities for operator categories for allocation of licenses. retaliating against imports of EU consumer goods. Consultations regarding the WTO-consistency of (The panel concluded that retaliation against the new measures were inconclusive. Just before imports of intermediates and machinery would be the January 1999 deadline for implementation, "ineffective"--that is, too costly for the economy.) the United States sought authorization to retali- This use of cross-retaliation was not foreseen by ate. To this, the EU responded that the United negotiators in the Uruguay Round, who had States should first obtain a panel finding that the envisaged cross-retaliation as an instrument to new mechanism did not conform to WTO rules. enforce the TRIPS agreement (since developing Ecuador did request that the original panel exam- countries were not major exporters of intellectual ine whether the EU measures were in compli- property­intensive goods) rather than as a vehicle ance. The Dispute Settlement Body (DSB) for developing country retaliation. reconvened the original panel to examine both At the time of writing, Ecuador had not imple- requests. Concurrently, the United States request- mented retaliatory actions, and negotiations con- ed authorization from the DSB to retaliate against tinued. In October 2000 the EU proposed a the EU in the amount of US$520 million. The EU system of three tariff quotas, to be allocated on a responded with a request for arbitration. first come, first served basis, with the adoption of The panel rejected the EU argument, given that a tariff-only regime by 2006. Latin American Ecuador had challenged it. Responding to countries objected to the move away from histor- Ecuador, the panel found that the new EU meas- ical market shares, while the United States object- ures were not fully compatible with the WTO. ed to the tariff quota for ACP bananas. The same panel determined the level of nullifica- The Bananas case illustrated that disagreements tion suffered by the United States to be equiva- between parties on the adequacy of implementing lent to US$191.4 million. Subsequently, the measures have the potential to give rise to a recur- United States was authorized to raise duties ring series of panels dealing with essentially the against the EU by that amount. The U.S. retalia- same issue. It also revealed the weakness of the ulti- tion included a provision allowing for a "carousel mate enforcement threat that is available, although approach" under which a different set of exports the innovative use of cross-retaliation threats by from the EU was subjected to retaliatory tariffs of Ecuador suggests that small countries do have up to 100 percent each six-month period. This mechanisms for putting pressure on large players. procedure was designed to maximize the political "pain" of the retaliation. In this it was successful, Source: Prepared by the volume editors, based on WTO as illustrated by the lobbying by the U.K. cash- data available at ; Porges (2000); Hoek- mere wool products industry against the threat- man and Kostecki (2001); Messerlin (2001). 88 The Adequacy of WTO Dispute Settlement Remedies: A Developing Country Perspective Dispute Settlement Understanding (DSU). These possibility of substituting input suppliers from other provisions allow a country to retaliate against a vio- countries with the observation that if inputs were in lation of obligations under one WTO agreement fact available from other suppliers on equal terms, (say, violations of the TRIPS agreement) by sus- they would already be in the market. In the end, how- pending obligations under another agreement (for ever, the panel backed away from this rather summa- example, obligations under the GATT) in cases ry dismissal of the substitute-supplier issue and where suspension of obligations under the violated relied on the conclusion that the EC had not suffi- agreement (TRIPS, in this case) would not be "prac- ciently rebutted Ecuador's claim that substitution ticable or effective." The cross-retaliation provision would involve "transitional costs" of significant mag- was originally demanded by industrial countries to nitude for a developing country (paras. 93­94). In allow them to impose trade retaliation under the sum, the panel's superficial analysis did not add GATT to sanction violations of the TRIPS or GATS much authoritative weight to the traditional develop- agreements and was adopted over strong objections ing country argument, except perhaps to suggest that by developing countries. the panel members themselves had been conditioned In the Bananas case the EC had violated GATT to accept it without much analysis. and GATS obligations. The EC failed to comply The panel then employed an equally superficial within the time allowed, and so, after the United analysis to "split the baby" by ruling that developing States had retaliated against the EC by raising tariffs country retaliation against consumer goods was not on EC goods, Ecuador decided to seek authority to "impracticable." It recognized that retaliation on retaliate as well. At this point Ecuador turned the imports of consumer goods would impose welfare tables on the proponents of cross-retaliation by losses on developing country consumers but then arguing that retaliation against EC exports of goods rather summarily dismissed Ecuador's hardship or services was not "practicable or effective" under argument by saying that Ecuador had not presented DSU Article 22.3. Consequently, it asked for author- enough evidence of hardship to justify a conclusion ity to cross-retaliate by suspending certain of its of impracticability (para. 100). Consequently, for obligations under TRIPS. GATT violations involving trade in goods, Ecuador Ecuador's arguments in support of the assertion was required to retaliate on consumer goods before that trade retaliation was not "practicable or effec- being allowed to retaliate in other sectors. tive" were the same arguments that had been made The panel also interpreted the word "effective," by developing countries for decades: that trade stating that the "effectiveness" criterion included the retaliation harms the developing country more than issue of whether the retaliation would have a mean- it harms the industrial country defendant and that, ingful political impact on the defendant country moreover, the retaliation is too small to inflict any (para. 72). This interpretation, incidentally, can be meaningful pain on the industrial country.17 In the viewed as a formal recognition of the post-WTO arbitration proceeding to review Ecuador's request tendency to view retaliation as a sanction designed for cross-retaliation, the arbitration panel was to induce compliance by economic pain, rather than required to render a judgment about Ecuador's the original view of retaliation as a form of tempo- argument--in effect, to render a formal legal judg- rary compensation for an imbalance of benefits. ment about the long-maintained claim that trade The facts of the Bananas case did not constitute a retaliation was an inadequate legal remedy for very good argument for inadequate effectiveness. developing countries. The panel's decision was less Since the value of Ecuador's lost banana exports to illuminating than it might have been, but on the the EC was uncommonly large, the dollar value of whole it gave a certain degree of official approval to Ecuador's trade losses (US$201.6 million) was actu- that argument. ally larger than the allowed amount of U.S. retalia- The arbitration panel began by interpreting the tion in the Bananas case and also larger than either word "practicable." That term was interpreted to the U.S. or Canadian retaliation in the Beef Hor- include consideration of whether retaliation would mone case. Nonetheless, the panel did make a find- harm the developing country itself (WT/DS27/ ing of ineffectiveness, albeit not a very clear one. It ARB/ECU, paras. 70, 73). The panel ruled that retali- gave two different, and apparently inconsistent, ation which increases the cost of industrial inputs answers. With regard to EC exports of industrial would not be "practicable." It tried to brush aside the inputs, the panel ruled that Ecuador's retaliation 89 T H E W O R L D T R A D E O R G A N I Z AT I O N against such industrial inputs would be ineffective I would end on a note of caution with regard to "given the fact that Ecuador, as a small developing TRIPS retaliation. As pointed out earlier in this country, only accounts for a negligible proportion chapter, there is considerable evidence that the of the EC's exports of these products" (para. 95). power of retaliation, although helpful, is not really With regard to consumer goods, the panel ruled the key ingredient in enforcement of GATT/WTO that Ecuador had failed to demonstrate that retalia- legal rulings. To reiterate the point, enforcement of tion against such goods would be ineffective, with- legal rulings is a political process involving the culti- out explaining why Ecuador's similarly "negligible" vation of a government decision to change a previ- proportion of the EC market for consumer goods ous decision. The U.S. Congress was wrong to insist was not as probative in that case (para. 100). on retaliation as the key to its enforcement The rather superficial and inconsistent answers demands. The U.S. negotiators were wrong to play on this point suggest that the panel did not have up to that misconception by trying to persuade the enough time to develop a fully coherent analysis of Congress that easier retaliation would make WTO the long-standing developing country claims about enforcement as effective as the Congress wanted. the inadequacy of trade retaliation. But the answers Developing countries would be just as wrong to do show the panel's inclination to support those think that practicable TRIPS retaliation will bring claims of inadequacy, and they also show that the about a decisive change in the political fundamen- support may be limited to the clearer case of retalia- tals of WTO enforcement. More effective retaliation tion against industrial inputs. It would not be wise will make the system work somewhat better for to read much more into the decision than this, espe- developing countries, but it is not wise to invest all cially since, in the absence of appellate review, the the eggs in that basket. next panel will not be bound by anything said in this report. On balance, the panel's rather unclear Notes response was encouraging enough to make it worthwhile for developing country officials to think 1 Both requests came in the Superfund case, United States: Taxes about the possibility of cross-retaliation in dispute on Petroleum and Certain Imported Substances, GATT, BISD, 34th Supp. 136­66 (1988). The follow-up proceedings are dis- settlement cases involving uncured violations. cussed in Hudec (1993): 210­11, 535­37. Potentially, the most significant aspect of Ecuador's retaliation proposal was the possibility 2 The continuation study has not yet been published. that retaliation under TRIPS could be both more 3 The next section discusses the single exception to the state- "practicable" and more "effective" than trade retalia- ment that the recommendation provides no remedy for harm tion. In theory, at least, denying the intellectual incurred in the past: the effort in several cases to make defen- property rights of foreign owners results in assets dant governments refund antidumping and countervailing duties imposed in violation of GATT law. See text at notes being made available to developing countries at 7­14, below. cheaper prices, which is usually a benefit to econom- ic development rather than a burden on it. Likewise, 4 See GATT, BISD, 14th Supp. 18 (1966). The procedures call for mediation and fact-gathering by the secretariat, the automatic although the amounts of retaliation in most cases establishment of a panel (a significant advance in those days), will still be "negligible," at this time in the WTO's and a considerably accelerated time schedule. history the ripple effects of even small-scale denial of 5 For a brief description of the negotiations, see Hudec (1990): intellectual property protection could cause consid- 242­43. The GATT document series recording the negotiations erably more political discomfort than the usual is COM.TD/F. The main proposals are COM.TD/F/W.1 (April small-scale case of trade retaliation. As the arbitra- 27, 1965) and COM.TD/F/W.4 (October 11, 1965). I partici- tion panel itself made clear, however, TRIPS retalia- pated in these negotiations as a U.S. delegate, and some of tion will involve a number of distinctive legal, the information given here is based on my personal recollec- practical, and economic problems for the retaliating tions. state.18 Ecuador's retaliation request in the Bananas 6 Normally, the only way to secure refunds is to try to persuade case is therefore only a very tentative first step in a national authorities to revise their interpretation of national much longer journey.A great deal more analysis, and law in light of the GATT/WTO ruling so that as a matter of national law the refund is owing. The refunds carried out after considerably more practical experience, will be adverse panel rulings made under the North American Free needed before it is clear whether TRIPS retaliation is Trade Agreement (NAFTA) Chapter 19 review of AD/CVD the key to this long-troubling problem. occur only because national legislation makes dispute settle- 90 The Adequacy of WTO Dispute Settlement Remedies: A Developing Country Perspective ment under Chapter 19 part of the domestic AD/CVD pro- 14 The text of GATT Article XXIII.2, based on the August 1947 draft ceeding and thus binding on national authorities as a matter of the ITO Charter, states that the contracting parties may of domestic law. authorize such retaliation "as they deem to be appropriate in the circumstances." The final ITO Charter text adopted in March 7 See the explanation in note 6. 1948 changed this passage to read "appropriate and compensa- 8 New Zealand: Imports of Electrical Transformers from Finland, tory, having regard to the benefit which has been nullified or GATT, BISD, 32nd Supp. 55­70 (1986). impaired," to make clear that retaliation was not to exceed the amount needed to compensate for the harm done (ITO Charter, 9 The two cases are as follows. (1) United States: Countervailing Article 95.3). See also Havana Conference, Reports of Committees Duties on Fresh, Chilled and Frozen Pork from Canada, GATT, and Principal Subcommittees, UN, ICITO 1/8 (September 1948), BISD, 38th Supp. 30­47 (1992). After the U.S. CVD had been p. 155. withdrawn, the United States agreed not to block adoption of During the history of the GATT, the only GATT panel to discuss the panel ruling, but it reserved its position on the merits. (2) the issue was the 1952 panel that adjudicated the level of the United States: Measures Affecting Imports of Softwood Lumber Netherlands retaliation against U.S. dairy restrictions. The panel from Canada, GATT, BISD, 40th Supp. 358­517 (1995). The claimed that the word "appropriate" in the (1947) text of Article United States announced that it would be refunding deposits XXIII.2 gave the panel a certain flexibility to take into account and bonds for other reasons, but it expressly reserved its posi- other factors that might aggravate the harm. But the panel tion on the validity of the panel's order that deposits and found it "appropriate" to reduce the level of retaliation by 20 per- bonds be refunded; GATT, SCM/M/67 (meeting of October cent from the amount submitted by the Netherlands, suggesting 27­28, 1993). that flexibility cut in both directions. See Netherlands: Action under Article XXIII:2, GATT, BISD, 1st Supp. 32, 62-64 (1953), dis- 10 The four cases were as follows. (1) Canada: Countervailing Duty cussed in detail in Hudec (1990), ch. 16. A similar interpretation on Boneless Manufacturing Beef, GATT, SCM/85 (October 13, of "appropriate" was offered by the GATT secretariat's legal 1987); panel report not adopted. The case is discussed briefly adviser during discussions of the Superfund case. See GATT, in Hudec (1993): 221­22, 533­34. (2) United States: C/M/220 (GATT Council meeting of April 8, 1988), p. 35. Antidumping Duties on Stainless Seamless Pipes and Tubes from In the WTO Dispute Settlement Understanding, para. 22.4 Sweden, GATT, ADP/47 (August 20, 1990); panel report not clearly states that the retaliation shall be equivalent to the adopted. The impasse over remedies in this case is discussed amount of the nullification and impairment caused by the meas- briefly in Hudec (1993): 253­54, 572­73. (3) United States: ure at issue. Thus, it returns to the original meaning of the ITO Antidumping Duties on Gray Portland Cement and Cement Clink- Charter. The WTO arbitration panels that have ruled on the er from Mexico, GATT, ADP/82 (July 7, 1992); panel report not amount of retaliation have all followed this instruction. See Euro- adopted. (4) European Communities: Antidumping Duties on pean Communities: Regime for the Importation, Sale and Distribu- Audio Tapes in Cassettes Originating in Japan, GATT, ADP/136 tion of Bananas--Recourse to Arbitration by the European (April 28, 1995); panel report not adopted. Communities under Article 22.6 of the DSU, WT/DS27/ARB/USA 11 The European Community appears to have shifted toward the (April 9. 1999) (U.S. retaliation); id., WT/DS27/ARB/ECU (March U.S. position during a 1993 complaint against Brazilian coun- 24, 2000) (Ecuador retaliation); see also European Communities: tervailing duties; it initially asked for a refund order in its com- Measures Concerning Meat and Meat Products (Hormones -- plaint but withdrew its request during the panel proceeding. Recourse to Arbitration by the European Communities under Article See Brazil: Imposition of Provisional and Definitive Duties on Milk 22.6 of the DSU, WT/DS26/ARB (July 12, 1999) (U.S. retaliation); Powder and Certain Types of Milk from the European Economic id., WT/DS48/ARB (July 12, 1999) (Canada retaliation). Community, GATT, SCM/179 (December 27, 1993), para. 200. 15 See sources cited in note 5. The EC opposed a request for refunds in the Audiocassette case (see note 10). 16 European Communities: Regime for the Importation, Sale and Dis- 12 Section 129 of the Uruguay Round Agreements Act, 108 Stat. tribution of Bananas -- Recourse to Arbitration by the European 4813, 4836, 19 U.S.C. 3501, 3538 (1994), provides partial Communities under Article 22.6 of the DSU, WT/DS27/ARB/ECU authority to revoke AD/CVD and safeguards measures in order (March 24, 2000) (decision by panel of arbitrators). to comply with WTO panel rulings. Although this is an 17 The objection to the possibility of GATS retaliation by Ecuador advance over prior law, subsection (c)(1) limits the effect of in other services sectors was based on essentially different such revocations to "unliquidated" entries that enter or are arguments, resting primarily on the nature of Ecuador's limited withdrawn from the warehouse on or after the date of the GATS obligations (WT/DS27/ARB/ECU, paras. 103­20). The order revoking the measure. issues raised by this defense, and the panel's response, are not 13 Guatemala: Antidumping Investigation Regarding Portland treated in this chapter. Cement from Mexico, WTO, WT/DS60/R (June 19, 1998) (panel report), reversed on appeal WT/DS60/AB/R (November 2, 18 The panel delivered a lengthy lecture on the prospective perils 1998) (Appellate Body report). of such retaliation (WT/DS27/ARB/ECU, paras. 130­65). 91 III SELECTED TRADE POLICIES AFFECTING MERCHANDISE TRADE T rade barriers imposed at the border Alessandro Nicita, offer the interested reader more remain high in some parts of the world. detailed data on the patterns of trade and protec- Average (unweighted) tariffs in South tion prevailing at the end of the 1990s. Asia are in the 25 percent range or higher, well Protection in industrial countries currently imposes above the 10 percent average found in East Asia, costs on developing countries that exceed the approx- Latin America, and Eastern Europe and Central Asia. imately US$45 billion in official development aid flows Nontariff barriers remain a serious obstacle in many received by these countries each year. Protection countries. At the same time, industrial countries imposed by developing countries carries a cost to the maintain high tariffs on certain "sensitive" prod- world economy of over US$60 billion per year. Global- ucts--mostly labor-intensive items that are pro- ly, tariff barriers to trade in merchandise cost the world duced by developing countries, as well as many economy about US$250 billion. This ignores the effect agricultural products. In Chapter 11 Sam Laird pro- of contingent protection (antidumping and safe- vides an overview of the remaining tariffs and non- guards) and of the red tape involved in customs clear- tariff barriers and their impact. The appendixes to ance. It is evident that the benefits of reducing market this volume, by Francis Ng, Marcelo Olarreaga, and access barriers are enormous. 93 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Much attention has centered recently on granting and looks at how these might be made more least-developed countries (LDCs) duty- and quota- responsive to the needs of developing countries. In free access to industrial country markets. This is Chapter 16 Brian Rankin Staples examines the important for these countries because existing pat- organizations and instruments involved in trade terns of protection discriminate against them, as is facilitation initiatives and summarizes the lessons demonstrated in Chapter 12, by Olarreaga and Ng. from cross-country experience in this area. Preferential access to markets will be beneficial to Many countries have sought to use export-pro- LDCs, but it comes at a cost to other developing moting policies either as a vehicle to offset the anti- countries. This cost, however, is limited, given the export bias created by other policies (overvalued small size of most LDC economies. Of greater signif- exchange rates, transactions costs, and so on) or as icance is the evidence that preferences are of limited a way of supplementing trade reform efforts. Indus- value. One reason is that they are generally condi- trial policies of various types are common in many tional on stringent rules of origin. Chapter 13, by countries: examples include subsidies, export pro- Luis Jorge Garay and Rafael Cornejo; Chapter 14, by motion, and creation of export-processing zones Stefano Inama; and Box 13.1, by Gomi Senadhira (EPZs). Two issues arise: What makes sense from a (on the U.S. African Growth and Opportunity Act) development viewpoint? And to what extent does show that rules of origin can be restrictive and can the WTO restrict the use of efficient policies for pro- give rise to high compliance (red tape) costs. moting industrialization and export development? Red tape is also an important factor in customs There may, in fact, be a good case for pursuing clearance procedures in general. Developing coun- EPZs and promoting exports; these mechanisms can tries therefore confront a large and important trade be effective ways of offsetting the high transactions facilitation agenda. In part, this agenda has to do costs that prevail in developing economies and that with market access--for example, with simplifying inhibit investment. It is important, however, to rules of origin, which can be pursued through the design such schemes in ways that limit the scope for WTO (see Chapter 14)--but it is mostly domestic. rent-seeking and reduce the likelihood of invest- The domestic part of the agenda is the most impor- ment occurring in sectors in which the country does tant and requires institutional strengthening, as well not have a potential comparative advantage. As as policy change. Of particular relevance for the dis- Mari Pangestu explains in Chapter 17 in the East cussion in Part III are customs administration reform Asian context, WTO rules do not significantly con- and trade facilitation. These are areas in which strain the ability of developing countries to pursue numerous international bodies are active and in welfare-enhancing policies. The agreements do, which the private sector can become part of the however, have implications for industrial policies, solution--for example, through the provision of cer- especially export subsidies and local content tification or inspection services. requirements. Country experience suggests that strengthening Philip English and Luc De Wulf, in Chapter 18, customs regimes and their administration to reduce examine experiences with trade promotion organi- transaction costs, antiexport bias, and corruption is zations, EPZs, subsidies, duty drawbacks, and other important in harnessing trade reform for develop- export promotion policies and mechanisms and ment. Transactions costs related to customs clear- review the options for developing countries. In ance can be a major impediment to investment in countries where tariff revenues continue to be need- tradable sectors, especially in activities that are time- ed, it is crucial that exporters have access to import- sensitive or where it is important to be integrated ed intermediate inputs at world market prices in into global production networks that operate on the order to be competitive. This requires well-function- basis of just-in-time supply chain management. ing customs regimes that efficiently refund duties Streamlining customs procedures and eliminating paid on imported inputs or, preferably, allow red tape require a concerted effort that involves exporters to import inputs duty-free without run- exploiting potential partnerships and synergy with ning afoul of WTO subsidy rules. Implementing organizations that have expertise in this area, such systems requires training and institutional including the private sector (for example, express strengthening. For example, many African countries carriers). Vinod Rege, in Chapter 15, reviews inter- lack well-functioning drawback regimes, and this national efforts to standardize customs valuation increases antiexport bias. 94 Selected Trade Policies Affecting Merchandise Trade Trade-related investment measures (TRIMs) are provisions and outline how firms should respond to sometimes used in an effort to promote industrial the various stages of the trade litigation process. development. Among them are local content Although this Handbook is not a legal reference to requirements, which, as Bijit Bora notes in Chapter the WTO, many of the chapters in this part refer to 19, have become controversial following the adop- GATT provisions. For ease of reference for those who tion of WTO rules that apply to developing coun- are not familiar with the WTO, the Glossary provides tries. (These rules were already embodied in the a summary of key GATT rules and articles. GATT but were not enforced against this country group.) Although, in principle, a case for such poli- Further Reading cies can be made--they may be appropriate for off- setting specific distortions--experience in many UNCTAD, Duty and Quota Free Market Access for countries reveals that great care must be taken in LDCs: An Analysis of QUAD Initiatives (Geneva, 2001), their use. The case study on Australia in Chapter 20, is a comprehensive and detailed discussion of cur- by Garry Pursell, illustrates that the use of TRIMs can rent initiatives to provide LDCs with preferential mean a very high cumulative cost to society. access to major industrial country markets. Rolf The final chapters in this part look at the elimina- Langhammer and André Sapir, Economic Impact of tion of remaining quotas on imports of apparel and Generalized Tariff Preferences (London: Trade Policy textiles and at the use of safeguard actions. These Research Centre, 1988), although somewhat dated, topics are closely linked: many observers expect the is a useful analysis of the economic effects of Gener- incidence of safeguard measures to increase once alized System of Preferences (GSP) schemes. The quotas under the Multifibre Arrangement (MFA) are authors argue that these schemes largely benefit fully eliminated, as required by the WTO Agreement countries which pursue export-oriented policies and, on Textiles and Clothing (ATC). Hanna Kheir-El-Din, for the most part, do not need preferences to com- in Chapter 21, discusses the implications of the ATC pete. Edwin Vermulst, Jacques Bourgeois, and Paul for developing countries. Waer, Rules of Origin in International Trade: A Compar- The so-called instruments of contingent protec- ative Study (Ann Arbor: University of Michigan Press, tion--antidumping and emergency measures--that 1994), provides a comprehensive discussion of ori- are permitted under the WTO if imports are deemed gin rules. John Raven, Trade and Transport Facilita- to injure domestic industries are a major source of tion: An Audit Methodology (Washington, D.C.: World uncertainty regarding market access conditions. Bank, 2000), is a useful set of tools for those seeking Antidumping, traditionally used by industrial coun- to identify trade facilitation bottlenecks and priori- tries, is increasingly being employed by developing ties. Gerald K. Helleiner (ed.), Non-Traditional Exports nations. As J. Michael Finger explains in Chapter 22, and Development in Sub-Saharan Africa: Experience some of these instruments, especially antidumping, and Issues (Helsinki: World Institute for Development make no economic sense and are best avoided by Economics Research, 2001), provides surveys and developing countries. More efficient instruments are assessments of the instruments used to promote available that are preferable from a development exports in low-income countries and reviews experi- perspective. A key element of such a mechanism is ence with them. Theodore Moran, Foreign Direct that it takes into account the interests of all parts of Investment and Development (Washington, D.C.: society, not just a subset of the domestic industry Institute for International Economics, 1998), offers that confronts competition from imports. This is a an extensive discussion of experience with TRIMs policy area in which further multilateral rule-making and related policy measures. J. Michael Finger (ed.), can be important for developing countries. Howev- Antidumping: How It Works and Who Gets Hurt (Ann er, as Finger notes, domestic actions to improve the Arbor: University of Michigan Press, 1993), brings economic content and rationality of these measures together case studies illustrating how antidumping is are likely to be more beneficial. In the meantime, applied in practice and assessing the implications for exporters have to live with the threat of being con- users and targets. Neil Vousden, The Economics of fronted with contingent protection. In Chapter 23 Trade Protection (Cambridge, U.K.: Cambridge Uni- Gary N. Horlick and Eleanor Shea, two practicing versity Press, 1990), is a good academic textbook on trade lawyers, discuss the relevant U.S. trade law the instruments of trade policy. 95 blank 11 S A M L A I R D Market Access importation of even minimum quantities. . ." Negotiations may be directed toward reductions in Issues and the applied tariffs or the binding of duties. They may concern select- WTO: An Overview ed products or may take place under agreed multilateral proce- dures. They may take account of the individual needs of mem- bers and industries, and flexibil- ity is afforded to developing countries to assist their econom- ic development. The application M of these guidelines, however, arket access negotiations in the depends on their acceptance by the partners in a WTO encompass trade in goods and negotiation, and it can be difficult for any one coun- services. Negotiations on goods--the subject of this try to rely on these guidelines to escape making and subsequent chapters in Part III--are essentially commitments. The results of negotiations are listed concerned with tariff reductions and the elimination in each member's schedule of commitments, or reduction of certain nontariff barriers to imports. recorded in the WTO's Integrated Data Base, which WTO rules covering contingency protection, stan- is not public. dards, and so on are not part of market access nego- The launching of multilateral negotiations has tiations per se, although they can have an important historically been decided at ministerial meetings. effect on the conditions of market access.Acceptance Modifications of scheduled concessions, however, of improved WTO rules can contribute to the secu- do not have to wait for a round to be launched but rity and predictability of market access. This chapter can be negotiated under the provisions of Article provides an overview of the key market access issues XXVIII of the GATT 1994 with those WTO mem- that confront developing countries. bers with which the concessions were originally negotiated, as well as other members deemed to have a "principal supplying interest." Such negotia- Tariff Negotiations tions are subject to consultation with any other Under the provisions of Article XXVIII bis of the member with a "substantial interest" in the product GATT 1994, tariff negotiations in the WTO are car- or products concerned. ried out "on a reciprocal and mutually advanta- The common belief that tariffs are unimportant geous basis" with the aim of achieving "substantial for future negotiations stems from the fact that after reduction of the general level of tariffs and other seven rounds of multilateral trade negotiations, charges on imports and exports and in particular industrial countries' import-weighted industrial the reduction of such high tariffs as discourage the most-favored-nation (MFN) tariffs will average 97 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E about 3.5 percent when Uruguay Round commit- escalation in industrial countries at the completion ments are fully implemented. But the devil is in the of Uruguay Round implementation. Developing details; there is considerable variation across coun- countries also have relatively high tariffs on labor- tries and across sectors. Simple average tariffs can be intensive manufactures and agriculture. In general, twice as high as import-weighted rates--the higher their tariffs are typically higher than those of indus- the tariff, the less tends to be imported. On the trial countries and also show a pattern of escalation other hand, the existence of various preference (Michalopoulos 1999a). schemes means that even applied MFN rates may As mentioned in Chapter 6, by Hoekman, in this overstate the tariffs on much trade. volume, what matters in the WTO is the level at Particularly high tariffs and tariff peaks (several which tariffs are bound. In the case of developing times the average and, in some cases, well over 100 countries, bound rates are often much higher than percent) prevail in some sectors. Many of these high the applied rates. For example, WTO members from rates are in areas of export interest to developing North Africa and the Middle East have bound rates countries--textiles and clothing, footwear, and that average 26.8 percent, whereas applied rates agriculture (Table 11.1). Agricultural tariffs are gen- average 14.4 percent (Table 11.3). This creates a erally higher than those on manufactures. The degree of uncertainty about market access in such impact of tariffication of agricultural nontariff bar- countries. riers (NTBs) in the Uruguay Round was so great in The stylized facts are, therefore, sectoral patterns some cases as to increase average tariffs. of tariffs that remain highly dispersed, with signifi- Industrial countries' tariff escalation, by which cant gaps between applied and bound tariff rates. tariffs are increased at later stages of processing in The reasons for this relate partly to evolution in sec- order to encourage domestic processing, may nega- toral policy and partly to the participation of WTO tively affect industrialization in developing coun- members in negotiations. Agricultural policy in tries. Table 11.2 provides a picture of tariff many countries is rooted in the history of food Table 11.1 Post­Uruguay Round Applied and Bound Rates of Industrial and Developing Economies by Major Product Group (percent) Industrial economies Developing economies Product group Applied Bound Applied Bound 1. Agriculture, excluding fish 5.2 7.2 18.6 19.9 2. Fish and fish products 4.2 4.9 8.6 25.9 3. Petroleum 0.7 0.9 7.9 8.4 4. Wood, pulp, paper, and furniture 0.5 0.9 8.9 10.3 5. Textiles and clothing 8.4 11.0 21.2 25.5 6. Leather, rubber, and footwear 5.5 6.5 14.9 15.4 7. Metals 0.9 1.6 10.8 10.4 8. Chemical and photographic supplies 2.2 3.6 12.4 16.8 9. Transport equipment 4.2 5.6 19.9 13.2 10. Nonelectrical machinery 1.1 1.9 13.5 14.5 11. Electrical machinery 2.3 3.7 14.6 17.2 12. Mineral products; precious stones and metals 0.7 1.0 7.8 8.1 13. Manufactures, not elsewhere specified 1.4 2.0 12.1 9.2 Industrial goods (rows 4­13) 2.5 3.5 13.3 13.3 All merchandise trade 2.6 3.7 13.3 13.0 Note: Weighted averages, excluding trade within free trade areas. The applied rates are those for the base period; the bound rates are those applying after implementation. In some instances this means that the applied rates are higher than the bound rates. Source: Finger, Ingco, and Reincke (1996). 98 Market Access Issues and the WTO: An Overview Table 11.2 Tariff Escalation on Products Imported by Industrial Economies from Developing Economies Product Post­Uruguay Round bound tariff (percent) All industrial products (excluding petroleum) 4.3 Raw materials 0.8 Semimanufactures 2.8 Finished products 6.2 All tropical products 1.9 Raw materials 0.0 Semimanufactures 3.5 Finished products 2.6 Natural resource­based products 2.7 Raw materials 2.0 Semimanufactures 2.0 Finished products 5.9 Source: GATT (1994a). Table 11.3 Post­Uruguay Round Import-Weighted Applied and Bound Tariff Rates (percent) Country group or region Applied tariff rate Bound tariff rate Industrial economies 4.0 4.7 Developing economies 13.1 20.8 Latin America and the Caribbean 10.1 18.6 East Asia and Pacific 9.8 16.6 South Asia 27.7 56.1 Other Europe and Central Asia 9.6 14.9 Middle East and North Africa 14.4 26.8 Sub-Saharan Africa 16.5 19.8 Note: Unweighted averages, excluding trade within free trade areas. The applied rates are those for the latest year available, generally 1997, 1998, or 1999. The data on applied rates cover 96 developing countries and 23 industrial countries. Data on bound rates were available for only 65 developing countries. See Appendix A, Table A.2, of this Handbook for country details on applied tariffs. Sources: WTO, IDB CD-ROM 2000; WTO, Trade Policy Review, various issues; World Bank (2000e). security and a perceived need for self-sufficiency. As undertaken by developing countries in the 1980s a result, agriculture was effectively excluded from and 1990s. It is also an outcome of the increasing negotiations before the Uruguay Round. In devel- prevalence of regional trade agreements (Crawford oping countries high tariffs reflected import-substi- and Laird 2000), as well as the application of unilat- tution industrialization policies. By virtue of eral preferences such as those under the Generalized provisions for special and differential treatment, System of Preferences (GSP), the Cotonou Agree- these countries were not required to make conces- ment (successor to the Lomé Convention), the sions in the early GATT rounds. As a result, they Caribbean Basin Initiative, and special preferences received little in return, so that many of their to improve market access for the least-developed exports continue to face high tariffs. countries. When MFN bound rates are reduced in The gap between bound and applied rates has multilateral negotiations, the value of such prefer- much to do with autonomous reform programs ences is decreased, and this may have led some 99 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E countries to resist MFN tariff reductions or to take by 40 percent, although the uncertainty in the degree less interest in multilateral negotiations. Negotiated to which such producer payments are linked to pro- MFN tariff rates, however, are more secure than duction decisions makes such analysis difficult. The preferences, and in the longer term it is desirable to percentage real income gains associated with this adapt industrial structures to freer trade in order to liberalization, reported in the first bar for each coun- benefit from comparative advantage. try or region shown in Figure 11.1, are largest in developing regions such as South Asia (other than India) and Southeast Asia (other than Indonesia). Gains from Further Liberalization Virtually all developing regions except the net food- Developing countries have a large stake in the importing Other Middle East region are expected to achievement of significant agricultural liberaliza- experience overall gains from multilateral reduc- tion. Hertel and others (forthcoming) build a model tions in agricultural protection. The bulk of these of the world economy in 2005--at which time gains derives from efficiency improvements generat- Uruguay Round commitments will have been fully ed in the developing countries themselves (the sec- phased in--and estimate that another 40 percent ond bar in each set in the figure), reflecting the fact reduction in agricultural tariffs and export subsidies that most of the potential gains from liberalization will bring about an increase in global real income of arise from removal of own protection. around US$60 billion per year. This figure increases There has been a sweeping change in the structure by US$10 billion if domestic support is also reduced of international trade in the past two decades. In the 11.1 Implications of a 40 Percent Reduction in Agricultural Trade Barriers Percentage of 2005 income 1.2 1 0.8 0.6 0.4 0.2 0 EIT ROW Japan BrazilIndia China OthSEAAusNZLWEurope OthSSA TurkeySoAfrCU(China) NAmerica Indonesia ­0.2 OthSoAsia OthLatAmOthNICs OthMENA Taiwan ­0.4 Region Real income Efficiency Source: Hertel and others (forthcoming). 100 Market Access Issues and the WTO: An Overview mid-1960s manufactures exports accounted for A simulation analysis of the impact of a 40 per- only around a quarter of developing country cent cut in applied tariffs on manufactures by all exports, and by the early 1980s they had only risen countries suggests that global trade volume would to around a third. Since then, growth has accelerat- expand by about US$380 billion in 2005, or about ed. As of the mid-1990s, the share was about three- 4.7 percent of projected merchandise and nonfactor quarters, and it is projected to go on rising (Figure services trade (Hertel and Martin 2000). The largest 11.2). The share of exports of developing countries efficiency gains (as a share of income) occur in going to other developing countries has also risen developing economies, and the countries or regions sharply as the importance of developing countries where tariffs are highest in the 2005 base (China, in the world economy has increased. Developing Other South Asia, and India) gain the most. countries therefore have a strong interest in seeking further reductions in tariffs on industrial products. Tariff Negotiating Issues and Modalities The average OECD tariff on imports from develop- ing countries is four times higher than on those It is recognized that developing countries should originating in the OECD (Table 11.4), reflecting receive credit for autonomous liberalization under high tariffs on products such as textiles and cloth- their own reform programs. Some countries take ing. Estimates of the implied tariffs paid suggest the view that for developing countries to qualify for that the barriers developing countries face in other such credit, the low, reformed rates need to be developing countries account for more than 70 per- bound. This is particularly difficult in a request- cent of the total tariffs levied on their industrial offer approach to negotiations, where developing exports (Hertel and Martin 2000). countries have relatively small markets and little 11.2 Share of Manufactures in Developing Country Merchandise Exports, Actual and Projected, 1965­2005 Percent 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Year 1 Agriculture 2 Minerals 3 Manufacturers Source: Hertel and Martin (2000). 101 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Table 11.4 Patterns of Protection in Manufacturing, 1995 Importing region High-income Developing Exporting region economies economies Import-weighted average tariffs (percent) High-income economies 0.8 10.9 Developing economies 3.4 12.8 World 1.5 11.5 Implied tariff paid (billions of U.S. dollars) High-income economies 16 93 Developing economies 23 57 World 40 150 Source: Hertel and Martin (2000). negotiating power. Formula approaches that call for NTBs. One way to prevent such exceptions is to proportionately higher cuts on high tariff rates can agree on a minimal cut on each tariff line. In the help reduce tariff peaks and escalation (see Laird, Uruguay Round agriculture tariff cuts were made 1999b; see also Chapter 53, by Panagariya, in this on the basis of simple averages. Import-weighting volume). A formula approach can also help over- was not a practical proposition because prohibitive come difficulties related to how to grant credit. nontariff barriers mean that some products are not Another option may be to carry out early reduc- imported. tions (that is, before the conclusion of a negotiating Many tariff types are legitimate under the WTO. round) and to make deeper cuts in MFN tariffs on In addition to percentage or ad valorem rates, duties products of particular export interest to developing may be specific (for example, US$1.00 per kilo- countries or to the least-developed countries, as was gram), alternative (US$1.00 per kilogram or 10 per- done on tropical products in the Uruguay Round. cent, whichever is higher), or mixed (US$1.00 per Prior to the Seattle Ministerial, some Asia-Pacific kilogram plus 10 percent). Switzerland is exception- Economic Cooperation (APEC) countries proposed al in that all its rates, other than zero rates, are an "early harvest" of products for accelerated liber- expressed in specific terms. Specific tariffs are often alization (see the analysis by Dee, Hardin, and designed to offset low international prices for the Schuele 1998). Proposals have been made to reduce affected product, in lieu of variable levies, which are very low rates (nuisance tariffs) to zero. But deeper prohibited under the WTO Agreement on Agricul- tariff cuts on raw materials and components than ture.1 This practice is sometimes said to impart a on finished goods can increase effective protection, bias against imports from low-cost suppliers--in producing a perverse result for resource allocation. most cases, developing countries. Ad valorem tariffs Simplification of the structure of tariff rates can would be more transparent. Requiring members to increase transparency and help reduce distortions provide information on the ad valorem incidence of in trade and production, so that a negotiation can other rate types would be useful. be used to restructure sectoral and fiscal policy. Tariff quotas or tariff-rate quotas are tariffs that Most WTO members have a range of tariff rates-- increase above a certain value or volume of imports. typically, zero for raw materials, a low to moderate They are used for agricultural imports of commodi- rate for intermediate products, and higher rates for ties subject to minimum import requirements. For finished goods--but some countries have hundreds example, the duty for the first 1,000 tons of a prod- of different rates. uct imported in a fiscal year may be 10 percent, but If agreed average cuts are import-weighted, as has the duty after the first 1,000 tons might be 50 per- been the case for industrial products in the past, cent.2 Some duties of this kind are also expressed as countries may be able to avoid cutting rates on specific rates. The WTO Agriculture Agreement products subject to prohibitively high rates or does not stipulate how tariff quotas are to be 102 Market Access Issues and the WTO: An Overview administered--that is, who gets to import at the in- Agriculture quota or lower rate and who must pay the higher rate. To put the issue in perspective, among all WTO The main NTBs that directly affect market access members 1,371 tariff quotas are in operation. primarily concern the agricultural sector and Although in some instances the out-of-quota rate is involve subsidies and tariff rate quotas (TRQs). For- not being applied even when imports exceed the mally, under Article IV of the WTO Agreement on quota amount, and average quota fill rates in 1999 Agriculture, market access negotiations are strictly were only about 50 percent, there are estimates that defined as the tariff negotiations, but market access the out-of-quota rate exceeds 100 percent for some will also be directly affected by further reductions in affected products (Elbehri and others 1999). the use of domestic subsidies, which are already covered in the negotiations mandated by the Uruguay Round agreement. Nontariff Barriers To put the mandated negotiations into context, it Strictly speaking, market access negotiations in the is important to understand that before the Uruguay WTO are concerned only with tariffs. In the case of Round there had been little discipline in the agricul- NTBs, which certainly affect market access, the tural sector. As a result of the round, agriculture was main focus of negotiations is in the area of rules, largely brought under the main WTO disciplines. which set conditions for the use of such measures. Import measures had to be eliminated or converted Examples include contingency protection (safe- to tariffs ("tariffied"), and the tariffs were then sub- guards, antidumping, and countervailing mea- ject to progressive reduction commitments, except sures), technical barriers (including sanitary and for rice and some staples that were subject to mini- phytosanitary measures), local content require- mum access commitments--that is, TRQs. It was ments, subsidies, import licensing, state trading, also agreed to reduce the level of domestic support, and rules of origin.3 except for exempted "green-box" policies and de Under the WTO Agreement on Safeguards, vol- minimis amounts. Industrial countries were to untary export restraints were to be eliminated in reduce domestic support (the aggregate measure of return for some flexibility in the use of safeguards. support, or AMS) by 20 percent over 6 years, while There remain, however, some measures with very developing countries were to reduce their domestic similar effects: production restraints (e.g., on alu- support by 13 percent over 10 years. The agreement minum and petroleum), sectoral consultations also included reductions in outlays on export subsi- (automobiles), and the use of price restraints dies (for industrial countries, a reduction of 36 per- ("undertakings") as the outcome of antidumping cent over 6 years, and for developing countries, one investigations. Technically, any discussion of these of 24 percent over 10 years) and in the volume of cases would also come under the rules negotiations, subsidized exports (reductions of 21 percent over 6 one of the functions of which is to ensure that tariff years by industrial countries and 14 percent over 10 liberalization is not undermined by NTBs. years by developing countries). Special safeguards There are a number of areas in which negotia- (increased duties) can be triggered by increased tions are designed specifically to reduce or eliminate import volumes or price reductions (by comparison NTBs rather than establish how they may be used. with average 1986­88 prices expressed in domestic In the case of industrial products, the main NTBs currency). A peace clause, intended to constrain the are currently in the textiles and clothing area, and use of countervailing measures until 2003, is some- these are being eliminated as the sector is progres- times seen as setting a time limit on the current sively integrated into GATT 1994.4 In principle, no negotiations. further negotiations on quota elimination should Before the official launch of the mandated negoti- be required in this sector, but the fact that the main ations in agriculture, work had already begun in the liberalization has yet to take place has given rise to WTO under an exercise on the analysis and fears that the industrial countries may be unable to exchange of information. The formal negotiations meet their obligations under the WTO Agreement are conducted in special sessions of the WTO Com- on Textiles and Clothing (ATC). (For further dis- mittee on Agriculture, which was established by the cussion on textiles and clothing, see Chapter 21, by WTO General Council in February 2000. The terms Hanna Kheir-El-Din, in this volume.) of the negotiations are laid out in Article 20 of the 103 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Agreement on Agriculture and were revised in the Conclusion Doha Ministerial Declaration to acknowledge that "without prejudging the outcome . . . we commit Clearly, much remains to be done to liberalize ourselves to comprehensive negotiations aimed at: access to markets in both industrial and developing substantial improvements in market access; reduc- countries. Further reduction in tariffs remains tions of, with a view to phasing out, all forms of important--the tariff agenda is by no means a mar- export subsidies; and substantial reductions in trad- ginal one. The market access agenda also includes ing-distorting domestic support." Account is also to nontariff measures such as agricultural subsidies, be taken of nontrade concerns, special and differen- tariff rate quotas, antidumping, and restrictive tial treatment for developing country members, and product standards. The market access agenda in the objective of establishing a fair and market-ori- services, not discussed in this chapter, is large (see ented agricultural trading system. Part IV of this Handbook). Making significant Through March 2001, 47 negotiating proposals progress will be a major challenge, yet, given the had been submitted by 125 members. (A full list of magnitude of the remaining barriers to trade in these proposals is given on the WTO Website, and, goods, there is substantial scope for "trade conces- in a sign of new transparency in this area, the docu- sions" in the market access areas (Hoekman 2002). ments themselves can be downloaded.) Briefly, the proposals cover market access (tariffs, tariff quotas, Notes food quality, and special and differential treatment for small economies), export competition (subsi- Helpful comments on an earlier version of the chapter were dies, credits, and export taxes), domestic supports received from Rolf Adlung, Bernard Hoekman, Costas Michalopou- (blue-box, green-box, and transitional issues), non- los, Christopher Moir, and Peter Tulloch. trade concerns, development issues (including spe- 1 Some WTO members assert that only rates in excess of com- cial and differential treatment for developing mitments are prohibited, rather than the systems per se. countries), and state trading. Putting aside tariff issues, nontariff measures, other than "pure" rules 2 Seasonal tariffs are sometimes used to protect domestic agri- cultural production during the growing season. Since the in- issues that impinge directly on market access, season high rates cannot exceed bound levels, they are usually include the use of domestic support, the operations expressed as temporary reductions in the bound MFN rate in of state trading enterprises, and export taxes. Con- the off season. tentious issues relating to domestic support include 3 WTO rules specify that charges related to trade, other than tar- the possible extension of coverage of "green-box" or iffs, are to be based on the cost of the service provided. Other- permitted subsidies to attain "multifunctionality" wise, they may be construed as a tariff and included within the or nontrade objectives; a possible development box tariff commitment. In practice, a number of such charges are that would allow subsidies for economic develop- levied as a percentage of the unit value and are unrelated to ment; and the elimination or reduction of export the cost of the service. Examples include consular or visa fees, port handling charges, customs processing fees, lighthouse subsidies in value or volume terms. Rules issues charges, statistical taxes, and the like. Antidumping and coun- include environmental issues, sanitary and phy- tervailing duties and surcharges for safeguard or balance of tosanitary (SPS) measures, the operations of state payments purposes are not covered by WTO commitments on trading enterprises, the virtual exclusion of agricul- tariff bindings. ture in many regional trading agreements, and the 4 Exporters complain that the main liberalization has been possible elimination of special safeguards. Many of delayed until near the end of the transition period ("back-load- these topics are addressed at greater length in the ing") and that liberalized sectors have been subject to special chapters that follow. In-depth analyses of the agri- safeguards, antidumping measures, and so on. cultural trade policy and negotiating agenda can be found in Ingco and others (forthcoming). 104 12 M A R C E L O O L A R R E A G A F R A N C I S N G Tariff Peaks and da, the European Union (EU), Japan, and the United States. The preferential access grant- Preferences ed by Quad members to devel- oping countries through the Generalized System of Prefer- ences (GSP) and related schemes, as well as through reciprocal trade agreements such as the North American Free Trade Agreement (NAFTA), should, in principle, help devel- oping country exporters over- D come these high tariffs. In espite generally low average most- practice, preferences tend to be limited in that "sen- favored-nation (MFN) import duties, sitive" products are often excluded from the the tariff structure in many industrial countries still schemes or some type of quantitative limitation is contains rates above 100 percent. These tariff peaks imposed. The latter may restrict the amount that are often concentrated in products that are of can be imported under the preferential rates (a tar- export interest to developing countries, including iff rate quota) or constrain the countries that are eli- major agricultural staple food products such as gible (Michalopoulos 1999c; Hallaert 2000). sugar, cereals, and fish; tobacco and certain alco- Tariff peaks are generally defined by UNCTAD holic beverages; fruits and vegetables; food industry and the WTO as duty rates that exceed 15 percent. products with a high sugar content; clothing; and Understanding the prevalence and pattern of tariff footwear. peaks is important for a number of reasons. First, In part, the existence of these peaks and the result- peaks affect commodities that account for a signifi- ing dispersion in tariff rates reflect the fact that, as cant share of total exports from least-developed Finger and Winters note in Chapter 7 of this volume, countries. Second, from a political-economy point developing countries did not participate in the of view, tariff peaks are where the "action" is--they reciprocal exchange of liberalization commitments are the products with the highest protection in the under the GATT. The Uruguay Round of multilater- Quad, and they therefore have the greatest impact on al trade negotiations increased tariff dispersion, as exports to Quad markets. Tariff peaks are among the tariffication of nontariff barriers (NTBs) in agricul- priority trade policy issues that need to be addressed ture led to the imposition of very high duties on in a negotiating context by developing countries. agricultural products that had previously been In large part, the significance of tariff peaks reflects quota-constrained. As a result, tariffs that are more the success achieved in the Uruguay Round in elimi- than three times higher than the average MFN tariff nating NTBs. Only 1.2 percent of tariff lines remain are not uncommon in the Quad economies--Cana- subject to NTBs in Canada; the share is 4.2 percent in 105 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Europe, 2.6 in Japan, and 2.9 in the United States oping countries for these tariff peak products, and (OECD 1997a). These NTBs, however, apply to cloth- the prevailing pattern of developing country ing--a sector that is of great interest to developing exports.1 It concludes with an assessment of the countries, and one that will remain constrained by impact on developing countries of the elimination quotas until 2005 (see Chapter 21, by Kheir-El-Din, in of tariff peaks by the Quad and with an evaluation this volume). In the case of agriculture, although the of the initiatives by some OECD members to grant Uruguay Round led to tariffication of all NTBs (with least-developed countries duty- and quota-free the exception of rice in Japan), tariff rate quotas are access to their markets. Examples include the EU often used; these involve two-tier tariff systems with "Everything but Arms" initiative discussed in Box out-of-quota imports subject to higher tariffs. 12.1 and U.S. actions to provide improved access to This chapter provides a brief description of the U.S. markets to Caribbean and Sub-Saharan African extent and importance of existing tariff peaks in the countries. The challenge will be to extend such ini- Quad, the preferential treatment granted to devel- tiatives to a broader set of poor countries. BOX 12.1 THE EUROPEAN UNION'S "EVERYTHING BUT ARMS" INITIATIVE In February 2001 the European Union (EU) grant- African, Caribbean, and Pacific (ACP) states, was ed duty- and quota-free access for all goods origi- eliminated by the Cotonou Agreement. The EU nating in least-developed countries (LDCs), with can now offer better market access to least-devel- the exception of armaments. The "Everything but oped ACP states without extending it to ACP Arms" (EBA) initiative was enacted by Council countries that are not in the least-developed cate- Regulation 416/2001--amending European gory, as Article 174(2)(b) would have required. Community (EC) Regulation 2820/98--which The EBA, like the existing GSP scheme, also allows applied a multiannual scheme of generalized tariff for diagonal cumulation of origin between the preferences for the period July 1, 1999, to Decem- LDCs, on the one hand, and, on the other, Associ- ber 31, 2001. The amendment extended duty- ation of Southeast Asian Nations (ASEAN) mem- free access without any quantitative restrictions to bers, South Asian Association for Regional 919 agricultural products originating in LDCs; Cooperation (SAARC) members, and the EU. more than half of these items were meat and dairy There are several ways in which the EBA differs products, beverages, and milled products. The from the EU's GSP scheme. First, in contrast to the EBA entered into force on March 5, 2001. GSP, the EBA is not subject to renewal and revision The EBA was adopted as an amendment to the and has no time limitation. The European Com- existing Generalized System of Preferences (GSP) mission will review the functioning of the EBA in scheme to ensure its compatibility with WTO 2005, when amendments can be introduced if rules. The basis for the EBA under the WTO is necessary. Second, new provisions allow the EU to paragraph 2(d) of the Enabling Clause of 1979, introduce safeguard measures when imports of which allows special treatment to be granted to products originating in the LDCs increase massive- LDCs in the context of any general or specific ly in relation to the usual levels of production and measures in favor of developing countries. Thus, export capacity. Specific safeguard measures apply at least from this legal point of view, the EBA ini- especially with regard to sensitive products such as tiative is tied to the existing GSP scheme. This bananas, rice, and sugar should imports cause seri- fact, however, does not impose any constraint on ous disruptions to the EU mechanisms regulating the EU with regard to the scope and nature of the these products, in particular, the Common Agricul- LDC preferential trade regime. tural Policy (CAP) and the ACP-EU protocols. The EU also had to ensure the WTO-compatibil- ity of the EBA by avoiding a constraint imposed by Product Coverage Article 174(2)(b) of the Lomé Convention. This All products are included in the EBA initiative. article, which enjoined nondiscrimination among Only three products are not liberalized immedi- 106 Tariff Peaks and Preferences B O X 1 2 . 1 ( C O N T I N U E D ) ately: bananas, rice, and sugar. Duty-free access withdrawal are manifest cases of unfair trading for these products will be phased in as follows: practices on the part of a beneficiary country or manifest infringements of the objectives of inter- · Bananas. Duties are to be eliminated gradually national conventions concerning the conservation over five years in equal 20 percent annual and management of fishery resources. reductions starting in January 2002. All duties A safeguard clause in Article 28 states that MFN are to be eliminated by January 1, 2006. duties on a product may be reintroduced if that · Rice. Liberalization will occur over four years, product originating from a developing country is starting in September 2006 with a 20 percent imported on terms that cause or threaten to cause reduction, to be increased to 50 percent on serious difficulties to a EU producer of like or directly September 1, 2007, and to 80 percent on Sep- competing products. In examining the possible tember 1, 2008. Elimination of duties is to be existence of such serious difficulties, the European complete by September 2009. During the tran- Commission takes the following factors, among sition period, LDC rice exports will benefit from others, into account: reduction in market share of a tariff rate quota (TRQ). The initial quantities of EU producers, reduction in their production, this quota are to be based on best LDC export increase in their stocks, closure of their production levels to the EU in the recent past, plus 15 per- capacity, bankruptcies, low profitability, and low cent. The quota will grow every year by 15 per- capacity utilization, employment, trade, and prices. cent, from 2,517 tons (husked-rice equivalent) The EBA initiative modifies this scheme by: in the 2001/02 September-to-August market- ing year to 6,696 tons in 2008/09. · Adding to the grounds for the possible tempo- · Sugar. The arrangements for sugar are similar rary withdrawal of preferences massive to those for rice. Full liberalization will be increases in imports into the EU of products phased in between July 1, 2006, and July 1, originating in LDCs, in relation to their usual 2009. During the transition period, LDC raw levels of production and export capacity. This sugar can be exported duty-free to the EU addition will allow the European Commission within the limits of a tariff quota, which will be to "react swiftly when the Communities' increased from 74,185 tons (white sugar financial interests are at stake." equivalent) in 2001/02 to 197,355 tons in · Inserting a new paragraph in Article 28 of the 2008/09. The provisions of the ACP-EC Sugar GSP allowing for the suspension of the prefer- Protocol will remain valid. ences provided by this regulation for bananas, rice, and sugar "if imports of these products Safeguard Provisions cause serious disturbance to the Community While the EBA initiative clearly breaks new ground markets and their regulatory mechanisms." in granting full market access for the least-devel- Here it becomes clear that while the EU is gen- oped countries, it also provides for mechanisms to erally ready to extend preferential market avoid disruptions to the EU market. Under the access to sensitive products, it also wants to EU's current GSP scheme, preferential tariff treat- provide for special safeguards regarding the ment may be temporarily withdrawn, in whole or three most sensitive ones. The Commission in part, in the case of certain activities such as slav- announced that whenever LDC imports of ery, forced labor, export of goods made by prison bananas, rice, and sugar exceed or are likely to labor, manifest shortcomings in customs controls exceed the previous year's level by more than on export or transit of drugs, failure to comply 25 percent, the Commission will automatically with international conventions on money launder- examine whether the conditions for applying ing, fraud, or failure to provide the cooperation GSP safeguard measures are met. required for the verification of certificates of ori- gin. Other circumstances qualifying for such a Source: European Commission (2001): UNCTAD (2001). 107 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Tariff Peaks and Imports in the Quad than 85 percent of the tariff peaks are for industrial Economies products, whereas in the EU and Japan most peaks affect agricultural products (91 percent in the EU Between 6 and 14 percent of Quad tariff lines at the and 77 percent in Japan). The maximum tariff rates six-digit level of the Harmonized Commodity at this level of aggregation in the Quad economies Description and Coding System (HS) are above 15 are, for Canada, 340 percent (butter); for the EU, percent (Table 12.1).2 There are 200 to 300 such 250 percent (edible bovine offal); for Japan, 170 lines in the United States, the EU, and Japan; Cana- percent (raw cane sugar); and for the United States, da has more than 700 tariff peaks. The average tariff 120 percent (groundnuts in shell). in the Quad over all tariff peak products is 28 per- In 1999 the value of Quad imports of products cent, or 4.5 times the unweighted total average tariff subject to tariff peaks was US$92.8 billion. More of 6.2 percent. The highest average tariff for peak than 60 percent (US$55.2 billion) of Quad imports products, 40.3 percent, is found in the EU. (The EU of these products originate in developing countries average for the entire tariff universe is a much lower and potentially face an average tariff of 28 percent.3 7.4 percent.) In the United States and Canada more This represents about 5 percent of total developing Table 12.1 Tariff Peaks and Imports, Quad Economies, 1999 Tariff peak product United All Quad (at HS six-digit level) Canada EUa Japan States economies Number of tariff peak products (MFN rate 15 percent) 732 317 233 307 1,077b Agricultural products 85 290 178 48 364b Industrial products 647 27 55 263 713b Tariff peak products as percentage of all tariff lines 14.3 6.2 4.6 6.1 7.8c Average unweighted MFN tariff rates (percent) Tariff peak products 30.5 40.3 27.8 20.8 28.0 All products 8.3 7.4 4.3 5.0 6.2 Maximum rate 342.7 251.9 170.5 121.0 221.5 Total imports of tariff peak products (billions of U.S. dollars) 8.7 27.1 15.8 41.2 92.8 All preferential and GSP countries 7.6 16.5 4.8 26.3 55.2 Least-developed countriesd 0.09 0.3 0.03 0.9 1.3 Share of tariff peak products in total imports (percent) 4.6 3.4 4.9 4.6 4.2 All preferential and GSP countries 4.8 4.9 2.8 6.6 5.2 Least-developed countriesd 30.2 2.8 2.6 15.0 11.4 Import revenue collection in tariff peak products from world (billions of U.S. dollars) 1.6 8.9 6.3 5.4 22.2 All preferential and GSP beneficiaries 0.7 4.3 1.4 4.6 11.0 Least-developed countriesd 0.02 0.03 0.001 0.2 0.2 Note: MFN, most-favored-nation. a. Excludes all intra-EU trade in world totals. b. Number of nonoverlapping categories. c. This is the simple (unweighted) average across Quad countries. Note that of the 5,032 tariff lines at the six-digit level of the Harmonized System, for 21 percent (1,077/5,032) there is a tariff peak item in at least one Quad member. d. Based on the UN classification of 48 countries. Sources: For MFN tariff, OECD data; for preferences, WTO tariff files; for trade, UN COMTRADE Statistics. 108 Tariff Peaks and Preferences country exports to the Quad. LDC exports are dis- beneficiaries are only 9 percent in Canada, 18 per- proportionately affected by tariff peaks in the Quad; cent in Japan, and 23 percent in the United States. products subject to tariff peaks represent 15 to 30 For LDCs, the margins fall to 25 percent in Canada percent of these countries' total exports to the Unit- and 30 percent in the United States and Japan. The ed States and Canada. EU, by contrast, has a 50 percent margin for GSP beneficiaries and a 70 percent margin for LDCs in tariff peak items. Tariff Peaks and Preferences for Developing Thus, although existing schemes grant significant Countries preferences to developing countries, preferences are Most developing countries enjoy preferential access concentrated in products that already enjoy low tar- to Quad markets, either through unilateral schemes iffs (between 0 and 15 percent) rather than on tariff such as the GSP or through free trade agreements peaks. In other words, preferential schemes offer lit- such as NAFTA or EU association agreements. In tle protection against tariff peaks in the Quad, the cases of Canada, Japan, and the EU around 170 except in the EU.5 developing countries benefit from GSP (or better) preferences.4 In the case of the United States 29 Tariff Peaks and LDC Exports developing countries are excluded from the GSP, so that only 140 developing countries benefit from Total LDC exports in 1999 were US$22.7 billion, of some sort of preferential access. which US$17 billion went to the Quad economies. Preferences granted by the Quad are of a cascad- More than US$5.5 billion of LDC exports to the ing nature: countries with free trade agreements world--25 percent of their total exports--are (FTAs) generally get the best treatment, followed by potentially affected by tariff peaks in Canada; that LDCs and other developing countries (Table 12.2). is, tariff peaks in Canada affect product categories The United States grants preferences to the mem- that account for 25 percent of the global exports of bers of the Andean Pact and the Caribbean Com- LDCs. Most of these affected exports are in apparel munity and to Mexico under NAFTA. For the EU, and clothing (HS 61 and 62). More than 99 percent we report both Cotonou preferences (ACP) and the of LDC exports of apparel to the world are affected FTA preferences granted to Eastern European and by the average tariff peak of 22 percent in Canada. Mediterranean countries. Two different groups of There is almost no preferential access for LDCs in LDC countries are constructed in the EU case: these items (the preference margin is only 8 per- LDCs that are not ACP members, and LDCs that cent). Exports of other developing countries poten- are. For Canada, developing countries are grouped tially affected by Canadian tariff peaks are also into several categories: those benefiting from LDC, concentrated in apparel, and preference margins are GSP, or Caribbean preferences, and Mexico and even smaller, around 3 percent. Chile, which benefit from FTA status. Finally, for Similarly, more than US$3 billion of LDC Japan, developing countries are divided into GSP exports to the world, or 14 percent, is potentially beneficiaries and LDC beneficiaries. affected by tariff peaks in the United States. These On average, these preferential schemes are quite exports are again concentrated in apparel, which generous. In the EU the average tariff faced by LDCs accounts for US$2.6 billion. They face an average or ACP members is below 1 percent, compared with tariff of 19 percent and do not benefit from prefer- the 7.4 percent average MFN tariff. GSP preferences ential access. Tariff peaks in Japan affect about in the EU are lower but still imply more than a 50 US$500 million in LDC exports to the world, and percent margin. Japan and the United States follow tariff peaks in the EU affect about US$800 million. with a 50 percent preference margin under their LDC exports affected by EU tariff peaks are con- GSP regimes and an average 60 percent preference centrated in meat and fish products (HS 16), fish for LDCs. Canada gives a 25 percent preference to and crustaceans (HS 03), sugar (HS 17), tobacco GSP countries and 45 percent to LDCs. (HS 24), and footwear (HS 64). The EU's "Every- Preferences are much less generous for tariff peak thing but Arms" initiative ensures that with the products. Except in the EU, preference margins are exceptions of sugar, rice, and bananas, all of these significantly below the average across all products. exports now benefit from full duty-free access to Preference margins on tariff peak items for GSP the EU. In the case of sugar the preference margin 109 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Table 12.2 Tariff Peaks and Preferential Duty Rates, Quad Economies, 1999 Average unweighted preferential duty rate (percent) Tariff All goods at Preferential trade Number of peak HS six-digit agreements/GSP countries products level Canada United States 1 7.1 1.6 Australia 1 28.2 7.8 New Zealand 1 28.2 7.8 Mexico 1 15.9 3.1 Chile 1 12.2 2.4 Israel 1 11.8 2.5 Caribbean countriesa 18 23.3 4.3 GSP-only beneficiariesb 108 28.2 6.2 Least-developed countriesc 47 22.8 4.4 Other countries (MFN rate) (30.5) (8.3) European Union 15 Eastern Europe and Middle Eastd 30 20.1 1.8 GSP-only beneficiariese 42 19.8 3.6 Least-developed ACP countriesf 37 11.9 0.8 Other ACP countriesg 32 12.4 0.9 Other least-developed countriesh 11 12.6 0.9 Other countries (MFN rate)i (40.3) (7.4) Japan GSP-only beneficiariesj 127 22.7 2.3 Least-developed countriesk 42 19.0 1.7 Other countries (MFN rate) (27.8) (4.3) United States Canada 1 0.6 0.1 Mexico 1 1.6 0.3 Israel 1 0.6 0.1 Andean Pactl 4 14 1.7 Caribbean Communitym 22 13.5 1.6 GSP-only beneficiariesn 80 16 2.4 Least-developed countrieso 38 14.4 1.8 Other countries (MFN rate) (20.8) (5.0) a. Includes 18 Caribbean countries or territories under Commonwealth Caribbean Countries Tariff. b. Excludes eight developing countries: Albania, Aruba, Bosnia and Herzegovina, FYR Macedonia, Mongolia, Oman, Saudi Arabia, and Yugoslavia. c. Excludes Myanmar. d. Includes countries with reciprocal and nonreciprocal trade agreements with the EU. e. Includes most developing economies in Latin America and Asia; excludes Hong Kong (China), Republic of Korea, and Singapore, which are non-GSP economies. f. Includes 37 ACP and least-developed countries under the Lomé Convention. g. Includes 32 ACP countries under the Cotonou Convention but not under the group of least-developed countries. h. Includes 11 least-developed countries that are not ACP members. i. Includes all industrial countries as well as Hong Kong (China), Korea, Singapore, and 14 transition countries. j. Includes 127 countries; excludes Albania, Bosnia and Herzegovina, Estonia, Latvia, Lebanon, Lithuania, FYR Macedonia, Moldova, Viet- nam, and Yugoslavia. k. Excludes three LDCs: Comoros, Djibouti, and Tuvalu. Three others (Democratic Republic of Congo, Kiribati. and Zambia) are included in the GSP group. l. Includes Bolivia, Colombia, Ecuador, Peru, and República Boliviariana de Venezuela under the Andean Trade Preference Act. m. Twenty Caribbean countries covered by the Caribbean Basin Economic Recovery Act, as well as The Bahamas and Nicaragua. n. Includes 80 developing countries or territories under the GSP scheme but excludes 29 other developing economies. o. Based on the UN list of 48 least-developed countries but excludes 10 countries, including Senegal. Source: WTO files. 110 Tariff Peaks and Preferences granted to LDCs is quite small; their exports face an States. Exports from other developing countries average tariff of 29 percent. would fall by some US$1.1 billion, which represents LDC exports to the world that are affected by 33 percent of the total increase in LDC exports but Japanese tariff peaks include sugar (HS 17), raw only 0.05 percent of developing country exports. hides and skins (HS 41), and footwear (HS 64). Of Thus, diversion is significant but does not add up to these three products, sugar is the only one for much, given the small share of LDCs in world trade. which almost no preference is granted. The 5 per- The distribution of changes in export revenue cent LDC preference margin for sugar brings the across products and countries will vary across mar- tariff faced by LDC exporters to 66 percent. Full kets (Figure 12.1). In the case of the European Union, duty-free access is granted for raw hides and skins, 65 percent of the increase in LDC export revenue is while for footwear an 80 percent preference margin concentrated in sugars and confectionery (HS 17), is granted to LDCs, bringing the tariff down to less with the primary beneficiaries being Malawi, Zam- than 8 percent. bia, and Mozambique. The EBA initiative, however, will be applied to LDC exports of sugar only in 2009. In Japan, as well, most of the increase (90 percent) is Effects of Eliminating Tariff Peaks in the in sugars and confectionery. For Canada and the Quad United States most of the increase in exports occurs Tariff peaks are important for all developing coun- in apparel and clothing (HS 61 and 62) and, to a tries, but, as explained above, they are relatively much smaller degree, in footwear, with Bangladesh more restrictive for LDCs. Unilateral initiatives to expected to be the main beneficiary, given its large grant duty- and quota-free access have focused pri- export potential in these sectors. marily on LDCs. Such preferential access will be beneficial to recipients but comes at the cost of Conclusion greater discrimination against non-LDC developing countries. That is, there is likely to be trade diver- The gains from preferential access are conditional sion (see Chapter 55, by Hoekman and Schiff, in on the ability to redirect and expand exports, which this volume). Studies of the impact of granting full, requires the establishment of strong business rela- unrestricted access to LDC exports in Quad markets tionships and a good reputation as a supplier in new suggest that the increase in export revenue could be markets. The benefits of preferential access are also as large as US$2.5 billion, or 11 percent (see Table heavily dependent on the extent to which other 12.3). Most of the increased export revenue for policies that affect market access constrain exports LDCs would be earned in Canada and the United from LDCs. Rules of origin and the threat of contin- Table 12.3 Effects of Granting Duty- and Quota-Free Access to Quad Markets to LDC Exporters (millions of U.S. dollars) European United Quad Canada Union Japan States economies Change in LDCs' exports 1,602) 185) 496) 1,107) 2,497) (7.20) (0.83) (2.23) (4.97) (11.22) Change in GSP beneficiaries' exports ­558) ­100) ­292) ­387) ­929) (­0.03) (­0.01) (­0.02) (­0.04) (­0.05) Change in all developing country exports 1,013) 72) 204) 654) 1,362) (0.03) (0.00) (0.01) (0.02) (0.04) Change in imports by Quad economies 15) 2) 3) 108) 117) (0.01) (0.00) (0.00) (0.01) (0.01) Change in LDC welfare 1,159) 122) 332) 915) 1,694) (0.67) (0.07) (0.19) (0.53) (0.99) Note: Figures in parentheses are percentages of values at the base year (1996­98 averages). Source: Authors' calculations. 111 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E gent protection--antidumping, countervailing the MFN tariff. Sapir (1997) has shown that in 1994 duties, and safeguard actions--are examples of only half of total European imports that could policies that can be so used as to greatly reduce the potentially benefit from the GSP entered under this value of duty-free access. Examples abound of pro- preferential regime. The other half paid the MFN tectionist lobbying in Quad economies aimed at duty as a result of the combined effect of rules of tightening GSP rules of origin to restrict the benefi- origin and tariff quotas. The threat of instruments ciaries' ability to significantly expand exports (see of contingent protection can also reduce the incen- Bovard 1991 for some U.S. examples). Rules of ori- tive to undertake investments to benefit from duty- gin that require high levels of local value added can free access. Noteworthy in this regard are the imply that developing countries are forced to pay European EBA safeguard provisions (see Box 12.1). 12.1 Projected Changes in LDC Export Revenues as a Result of Duty-Free Access, by Product and Importer Canada European Union Footwear 1% Headgear 1% Flour; malt and starch 2% (Bgd 55%, Cam 15%, Cpv 9%) (Bgd 96%, Npl 2%, Mdg 1%) (Npl 61%, Bdg 14%, Myr 9%) Residues and food waste 5% Others 5% Other textile Others 2% (Myr 35%, Cgo 17%, Npl 16%) articles 2% (Bgd 80%, Mwi 7%, Meat and Npl 6%) edible meat 10% (Sdn 52%, Mdg 22%, Vut 18%) Cereals 13% (Myr 39%, Mdg 14%, Sdn 13%) Apparel and Apparel and clothing, clothing, knitted 39% not knitted 55% Sugars and (Bgd 65%, Cam 11%, (Bgd 79%, Cam 5%, Myr 4%) confectionery 65% Hti 7%) (Mwi 27%, Zmb 19%, Moz 15%) Japan United States Oil seed and Flour; malt Footwear 2% Meat and misc. grain 1% (Sdn 92%, Myr 2%, and starch 1% (Bgd 55%, Cam 20%, edible meat 1% Afg 2%) (Npl 60%, Bdg 14%, Oil seed and Cpv 9%) Others 0% (Mdg 33%, Sdn 31%, Eth 8%) Vut 28%) misc. grain 2% Others 3% (Gmb 50%, Sdn 38%, Cereals 4% Mwi 3%) (Myr 37%, Moz 25%, Mdg 24%) Tobacco 30% (Mwi 76%, Tza 13%, Uga 3%) Apparel and Sugars and Apparel and clothing, clothing, confectionery 90% not knitted 30% knitted 36% (Mwi 22%, Zmb 16%, Moz 15%) (Bgd 84%, Myr 5%, (Bgd 71%, Cam 9%, Cam 3%) Hti 7%) Note: Afg, Afghanistan; Bgd, Bangladesh; Cam, Cambodia; Cgo, Congo, Dem. Rep.; Cpv, Cape Verde; Eth, Ethiopia; Gmb, The Gambia; Hti, Haiti; Mdg, Madagascar; Moz, Mozambique; Mwi, Malawi; Myr, Myanmar; Npl, Nepal; Sdn, Sudan; Tza, Tanzania; Uga, Uganda; Vut, Vanuatu; Zmb, Zambia. Source: Authors' calculations, based on Hoekman, Ng, and Olarreaga 2001. 112 Tariff Peaks and Preferences Notes 1 Under preferential treatment we include both unilateral schemes such as GSP, Lomé, or LDC preferences and those granted under bilateral agreements, such as NAFTA, Canada- Chile, and the Euro-Med agreements. 2 The WTO and UNCTAD define tariff peaks as all tariff lines above 15 percent (at the HS six-digit level). 3 "Potentially" because tariff preferences granted to developing countries through bilateral or unilateral schemes will bring down the tariff faced by these exporters. 4 The EU was the first customs territory to grant GSP preferences to developing countries, in 1971. For a detailed description of the EU GSP, see Kennan and Stevens (1997); Hallaert (2000). 5 Data on the average MFN import duties on tariff peak prod- ucts at the HS two-digit level, and preference margins granted by the Quad to different groups of developing countries, are provided in Appendix A, Tables A6­A9, in this Handbook. 113 13 L U I S J O R G E G A R A Y S . R A F A E L C O R N E J O Rules of Origin occurred most recently. "Signifi- cant" or "substantial" is defined as sufficient to give the product and Trade its essential character. Rules of origin aim at prevent- Preferences ing what is technically known as trade deflection. This may arise when goods from third coun- tries confront different tariffs in FTA member countries, creating an incentive to bring merchan- dise into the FTA through the member country with the lowest T tariffs and then ship it as a duty- he application of trade prefer- free item to countries in the FTA with higher tariffs. ences, whether unilateral (such as The same incentive is created by GSP regimes for the Generalized System of Preferences, or GSP) or firms located in nonbeneficiary countries. Requir- granted as the result of free trade agreements ing a minimum level of substantial transformation (FTAs), requires guidelines that enable the origin of aims to prevent such practices by limiting the appli- goods to be defined so as to ensure that preferences cability of trade preferences to those goods that sat- benefit only those products originating in the bene- isfy rules of origin. ficiary countries. Preferential trade agreements Origin regimes can result in inefficient produc- therefore include origin regimes that stipulate the tion and discrimination (by favoring the companies provisions and procedures for determining country that are best able to adapt to and satisfy the require- of origin. ments); an unequal distribution of benefits among Commercial exchanges involve goods that are factors of production, activities, and countries; and wholly obtained or produced in the exporting administrative and transactions costs.1 Stringent nation or that contain components from third rules of origin can severely restrict the sourcing of countries. For the second type of merchandise, it is inputs from outside an FTA, thereby leading to necessary to define the conditions, types, and investment diversion--decisions by multinational amounts of imported components that these goods firms to locate production facilities within the can contain and still be considered as originating region. If the region is not large and dynamic, this inside the country or region to which preferences may negatively affect firms' efficiency and competi- have been granted. The general approach taken in tiveness (Barfield 1996; Winters 1997). The opera- most jurisdictions is that the origin of a product is tional and administrative costs of certifying and determined by the location where the last substan- verifying origin are potentially large and can tial transformation took place; that is, the country increase efficiency losses. Net operating costs can be in which significant manufacturing or processing expected to rise with increased administrative com- 114 Rules of Origin and Trade Preferences plexity, lack of transparency, multiple qualification verification and administration equal about 3 per- criteria, and the proliferation of "rules of origin cent of product prices (Garay and Quintero 1997).2 families." In Europe the costs of collecting, manag- The complexity of rules of origin regimes is illus- ing, and storing the information needed for origin trated in Box 13.1. B O X 1 3 . 1 T H E U . S . T R A D E A N D D E V E L O P M E N T A C T O F 2 0 0 0 Gomi Senadhira for SSA countries therefore provides greater security for potential investors. The act also The U.S. Trade and Development Act of 2000 eliminates the competitive-need limitations in contains two important sections providing for the GSP program for AGOA beneficiaries. Final- preferential access to the U.S. market. Title I of the ly, the AGOA countries receive significant bene- law consists of the African Growth and Opportuni- fits for apparel exports. ty Act (AGOA), which extends significant trade benefits to Sub-Saharan African countries. Title II Apparel Provisions of the AGOA contains similar preferences for Caribbean coun- Under the apparel provisions, SSA countries tries; these are not discussed here. would get duty- and quota-free access for: The AGOA recognizes that trade and invest- ment can be powerful tools for promoting sus- · Apparel assembled in SSA from U.S. fabric, tainable economic growth, and it provides a formed from U.S. yarn cut in the United number of market access concessions to the States. countries of Sub-Saharan Africa (SSA). To be eligi- · Apparel cut and assembled in the SSA from ble to receive benefits, an SSA country has to be U.S. fabric formed from U.S. yarn and stitched designated a beneficiary country by the president with U.S. thread. of the United States. Necessary conditions for this · Apparel made from African regional fabric are that the SSA country has established (or is (fabric formed in one or more SSA countries making progress toward) a market-based econo- from U.S. or SSA yarn), subject to a tariff rate my, the rule of law and political pluralism, eco- quota set at 1.5 percent of total U.S. apparel nomic policies to reduce poverty, a system to imports in the 12 months preceding October combat corruption and bribery, protection of 1, 2000, to be increased over the next seven internationally recognized workers' rights, and years by equal increments to a level of 3.5 per- elimination of barriers to trade and investment. cent by October 1, 2007. Beneficiary countries may not engage in activities · Apparel made in designated "lesser devel- that undermine U.S. national security or grossly oped" SSA countries with a 1998 per capita violate human rights. income below US$1,500, from fabric of any Under the AGOA, beneficiary countries origin, subject to the same tariff rate quota. receive preferential access for 1,835 tariff line This would only apply for a period of four items, in addition to the standard GSP list of years. approximately 4,600 items available to all GSP- · "Knit to shape" sweaters from third-country eligible countries. This additional list includes a yarn such as cashmere and merino wool. number of important products that were previ- · Apparel made from fabric or yarns not avail- ously excluded from GSP benefits such as able in commercial quantities in the United footwear, luggage, handbags, watches, and flat- States. ware. These benefits for AGOA-eligible countries · Products that are hand-loomed, handmade, would continue to September 30, 2008, seven or folklore articles. years longer than the present extension of GSP benefits to the rest of the world. In recent years AGOA eligibility alone does not provide a SSA U.S. GSP benefits have been renewed every two country with these benefits. To qualify for these years. The eight-year duration of GSP benefits concessions, a country must establish an effective (continued) 115 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E B O X 1 3 . 1 ( C O N T I N U E D ) (textiles) visa implementation system and Impact on Other Developing Countries enforcement mechanism to prevent illegal trans- It is difficult to predict the impact that preferential shipments. As of August 1, 2001, only six coun- access for SSA countries will have on the countries tries had been listed as eligible for benefits under excluded from these arrangements. The market AGOA apparel provisions, but in the following distortions created by prevailing quota arrange- three months five more were added. All but three ments, as well as the caps and other limits on knit (Botswana, Mauritius, and South Africa) are apparel and apparel made from regional fabric or entitled to ship apparel manufactured with fab- third-country fabrics, may limit the adverse impli- rics of any origin.* cations for other developing country exporters. However, a number of countries have indicated to Implications of the AGOA for Beneficiaries U.S. authorities that the trade preferences granted The most significant feature of the apparel provi- to SSA countries under the Trade and Develop- sions of the AGOA is the need to use U.S. fabric or ment Act of 2000 would weaken countries' ability yarn in manufacturing apparel. Given the rela- to compete in the U.S. market. Among these tively higher cost of U.S. fabric, the less efficient countries are the beneficiaries of the Andean transport logistics in Sub-Saharan Africa, and the Trade Preferences Act (ATPA), as well as Asian limited size (or the absence) of apparel industries apparel exporters such as Bangladesh and Sri in most SSA countries, it is unlikely that many Lanka. The concerns of the ATPA countries were countries will benefit from the provisions for taken into consideration in the Andean Trade Pref- export of apparel manufactured from U.S. fabric. erences Expansion Act, introduced in the U.S. Less-developed SSA countries may find it difficult Congress in March 2001. The further expansion to attract investors to take advantage of the duty- of such arrangements would weaken the compet- and quota-free access for apparel manufactured itiveness of countries outside the arrangements. with third-country materials. Although these The smaller countries in Asia, in particular, are countries would receive an average duty advan- concerned that as they move toward the full tage in the U.S. market of around 17 percent, the implementation of the WTO Agreement on Tex- regional cap on such imports and the time limit tiles and Clothing in 2005, they are being placed (the facility expires in September 2004) reduce in a position of competitive disadvantage. the incentive to undertake major investments in the poorest countries in Sub-Saharan Africa. For the relatively more efficient producers that have * Revisions to the act, proposed under AGOA II, may the necessary infrastructure, however, short-term extend this privilege to Botswana. benefits can be significant. Lesotho has emerged The AGOA also appears to have served as a catalyst as the single largest beneficiary, followed by for general expansion of dutiable textile and apparel Madagascar and Kenya. exports from Africa. Criteria for Origin Qualification 1.A change in tariff classification. This involves a requirement that the tariff classification of the Origin regimes define a good as originating inside finished (processed) good differs from that of the an FTA when it is produced or obtained entirely foreign components or materials (from third within the member nations. If it embodies compo- countries outside the integrated area) used in the nents from non-FTA countries, whether the production process. For example, a change in the required levels of substantial transformation have tariff heading--defined at the four-digit level of been achieved has to be determined. Possible crite- the Harmonized Commodity Description and ria for doing so are: Coding System (HS) tariff classification--is often 116 Rules of Origin and Trade Preferences the basis for the preferential rules of origin system Bolivia, Costa Rica, and Colombia and República used in Latin American FTAs, as described in the Boliviariana de Venezuela and for Chile's agree- next section. A problem with the application of ments with Canada and Mexico. The CACM stands this criterion is that the HS was not designed to at an intermediate point between the two. serve as the sole instrument for determining the NAFTA-type FTAs such as the G3 agreement by origin of goods; it is meant to be used for classify- Colombia, Mexico, and República Boliviariana de ing merchandise in terms of other criteria. Venezuela and Mexico's bilateral treaties tend to be 2. A minimum value added threshold; that is, a mini- more comprehensive than the ALADI type in that mum value of national or regional content incor- they cover issues such as investment and public pro- porated in the product. This criterion suffers curement. They also contain more specific and from several shortcomings. It tends to penalize detailed origin regimes. Traditional integration the use of more efficient, cost-saving techniques schemes in Latin America have relied on rules that and is highly sensitive to changes in the factors are less selective and more uniform than those that determine countries' production costs, such found in NAFTA-type agreements, which employ a as exchange rates, interest rates, wages, and work- multiplicity of "rule families" at the tariff item level. ers' fringe benefits. It can also increase the cost of What follows compares the principal features of compliance, given the need for laborious and three regimes that are used as reference frameworks: demanding accounting, operational, and finan- ALADI, NAFTA, and the CACM. cial procedures to be carried out by customs authorities and manufacturing firms. Finally, it The ALADI Regime may sustain imbalances in the distribution of benefits among countries by favoring those with Resolution 78 of the ALADI agreement establishes more vertically integrated production (that is, the general origin regime for the ALADI member industrial nations) and penalizing those with low nations. The basic criterion for origin qualification wages (Garay and Estevadeordal 1996). is a change in the tariff classification in terms of the 3. Use of a specific technical process or of certain com- four-digit level of the HS, or, alternatively, a region- ponents in manufacturing a product. In addition to al content value equal to or greater than 50 percent the technical difficulties of keeping an updated, of the free on board (f.o.b.) cost of the merchandise. comprehensive inventory of the productive This applies to practically all tariff classifications, processes available at any given time--which are with the exception of a group of goods, specially constantly changing--this criterion is discre- negotiated by the member nations, for which specif- tionary because of the absence of classification ic origin requirements apply. These specific require- elements that objectively guarantee the equiva- ments take precedence over the general criteria and lence of different degrees of transformation in the may be more or less stringent than the general rule. production of different goods. Resolution 78 allows differential treatment for rela- tively less developed countries (Bolivia, Ecuador, and Paraguay), for whose exports a lower national or regional content is admissible. One requirement Types of Origin Regimes Used in the of Resolution 78 involves an obligatory certificate of Americas origin, using a special form and issued by a public Regional integration agreements in the Americas or private agency authorized for the purpose by the include the Latin American Integration Association member states. The lack of precision as to compli- (ALADI), the Central American Common Market ance with qualification criteria and certification and (CACM), the Andean Community, the Common administration of rules of origin has, in practice, Market of the South (MERCOSUR), the Caribbean hindered the strict observance of this provision Community (CARICOM), and the North American (Devlin, Estevadeordal, and Garay 1997). Free Trade Agreement (NAFTA), as well as other Although the main elements of the origin regimes agreements signed in recent years. ALADI has of MERCOSUR and the Andean Community are served as a model for MERCOSUR, the Andean similar to those of Resolution 78, there are some Community, and CARICOM. NAFTA has been noteworthy differences. For some goods, the MER- used as a model for Mexico's agreements with COSUR regime demands a 60 percent level of 117 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E added value and, in addition, a change in tariff 2.It applies changes of tariff classifications in a heading. When substantial transformation cannot much more versatile fashion than do the other be measured by a shift in tariff classification, the regimes. Classification shifts are not unique for all MERCOSUR regime states that the price of third- tariff classifications but are defined according to country inputs, inclusive of cost, insurance, and merchandise type broken down by chapter, head- freight (c.i.f.), shall not exceed 40 percent of the ing, and subheading and, in some cases, even by f.o.b. cost of the merchandise. Furthermore, MER- tariff item (the HS eight-digit level of disaggrega- COSUR Decision 16/97 sets specific origin require- tion). The different levels of tariff liberalization ments for a list of goods from the chemical, iron are used both to define the required changes in and steel, data processing, and communications classification and to limit their scope by providing sectors, and these requirements take precedence the option of excluding certain tariff levels from over the general criteria. Although the MERCOSUR the main requirements. Slightly more than 40 regime contains no provisions for differential treat- percent of the existing tariff items use a movable ment, agreements with Bolivia and Chile do provide classification shift for determining their origin, for differential treatment in that they set less strin- and a number of these goods also have more than gent requirements for goods from Paraguay and one alternate qualification rule. Bolivia. 3.It uses the regional content criterion for around a The Andean Community has an origin regime third of all items, either alone or, more frequently, similar to that of Resolution 78, and it also admits in combination with one of the other criteria. It special requirements in exceptional cases. In addi- establishes a minimum regional content value of tion, it grants Bolivia and Ecuador preferential 50 or 60 percent, depending on the method, and treatment. The Andean Community used some spe- calculations use the net cost or transaction value cial requirements in the 1970s as part of its import- method. substitution and industrial sector planning 4.It includes concepts not used in earlier regimes, strategies. The Andean Community's origin regime, such as the de minimis clause, accumulation, and established by Decisions 416 and 417 of July 1997, the introduction of self-certification by exporting introduced important provisions regarding origin companies.3 administration. These stipulated in detail the func- tions and obligations of the member countries' The NAFTA approach exhibits much greater competent government authorities in this area and selectivity, specificity, and detail than the general specified procedures for requesting the General Sec- regimes of ALADI or unilateral trade preferences retariat's intervention and guidelines for its deci- such as the GSP. This NAFTA level of detail can be sions. They also detailed the sanctions applicable to seen in the official Mexican bulletin General Rules certification agencies and officers for issuing for the Application of the Customs Provisions of the improper origin certificates and specified the North American Free Trade Agreement, in which the requirements to be met by nongovernmental agen- rules of origin run to almost 100 pages. cies empowered to certify the origin of merchan- dise. Finally, they regulated the criteria and The Central American Common Market Regime procedures for setting specific origin requirements. (CACM) The CACM regime is a combination of the ALADI The NAFTA Regime and NAFTA systems. The main criterion is tariff NAFTA, launched in January 1994, gave rise to a classification change, but it is applied more flexibly new type of regime for origin rules, with the follow- than under ALADI Resolution 78. Instead of being ing elements, among others: applied uniformly at the HS four-digit level, it is measured in terms of changes in chapter, heading, 1.It is a system of specific rules at the tariff-item and subheading. In a number of cases the CACM level that are arrived at by combining some or regime allows exceptions to be made to the primary even all of the three qualification criteria change in tariff heading that is specified. Only with described above; frequently, there is more than regard to some specific goods does it set additional one rule for determining a good's origin. specific criteria, such as regional content and tech- 118 Rules of Origin and Trade Preferences nical requirements. To date, these have rarely been Alternation applied. Use is made of concepts such as the de min- imis clause; there is no provision for differential The regimes also differ in their application of the treatment for less-developed countries. qualification criteria at the level of individual The CACM regime also introduces a series of goods. Alternation is to be understood as the appli- rules and procedures to ensure correct administra- cation of more than one rule in classifying the ori- tion of and due compliance with the rules of origin. gin of a given good. In ALADI, MERCOSUR, the The use of tariff shifts as the basic criterion, but CACM, and the Andean Community alternation is applied differently across the full range of tariff clas- uniform across all tariff classifications, with the sifications, appears to be an attempt to combine additional feature that each rule is based exclusively administrative simplicity with greater detail and on a single qualification criterion: for example, the selectivity in the rules of origin applied to different first criterion is based on a change in tariff heading types of goods. and the alternate one on a specific regional content value. In contrast, NAFTA, the G3, and the Mexican and Chilean bilateral agreements frequently offer a Differences among Systems variety of alternate rules for determining a good's The principal differences among origin regimes origin, without each rule necessarily being based on have to do with whether they follow uniform or dif- a single qualification criterion. ferentiated application of the rules, apply multiple The set of alternate rules applicable at the individ- criteria, and use value-added tests. ual item level is defined as a "rules of origin family," which, at least in principle, should stipulate equiva- lent demands in terms of substantial transforma- Diversity tion. In practice, however, the levels of stringency The three types of criteria used to determine origin within a family differ as a result of the different can be employed uniformly or selectively. Thus, the requirements of the criteria used to determine ori- tariff classification change criterion is applied uni- gin. If there are goods for which the implied degree formly in the ALADI regime at the HS four-digit of transformation varies between the alternate level, regardless of the type of merchandise. In con- applicable rules, de facto inconsistencies and trast, under NAFTA and G3 the required tariff inequalities can arise among different types of com- change varies according to the good in question, panies in the FTA and its member countries. Similar and in different cases a change in chapter, heading, consequences tend to arise when different rules of subheading, or even tariff item may be required. origin families are applied to goods that, in terms of their production techniques or economic nature, are strictly similar, or when a single rules of origin Multiplicity family is used to qualify goods produced through Although the regimes in force in the Americas different processes. include more than one criterion for classifying ori- gin, they differ in the relative weights they assign to Calculation Method each. The origin regimes in MERCOSUR, the CACM, the Andean Community, and ALADI are The method used for calculating regional content basically defined in terms of the tariff classification value varies among regimes. ALADI, MERCOSUR, change criterion or, alternatively, a given level of and the Andean Community require the f.o.b. or regional content; in some exceptional cases a com- c.i.f. transaction value of the merchandise to be bination of criteria is used for specific lists of goods. used in calculating its regional or national content. In contrast, the NAFTA and G3 regimes and some These values are well known, clear, and published, of Mexico's bilateral agreements are based on a mul- and they require neither the exporter nor the cus- tiplicity of criteria, which prevents any one criterion toms authorities to keep special records or employ from being singled out as the guiding principle for additional controls. NAFTA and some of Mexico's determining origin. In part, this multiplicity reflects bilateral agreements use two alternate methods for the high degree of detail and selectivity contained in calculating regional content: net cost and transac- "new-generation" agreements tion value. Estimating the value of regional content 119 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E using the net cost method requires detailed records compliance with origin requirements would be less of and information on merchandise promotion and sensitive to evolution in variables external to pro- sales costs. The CACM regime stands midway duction processes themselves. This is also the between these two groups in that it uses two meth- approach that is being pursued in defining origin ods to determine regional content: transaction for nonpreferential trade (see Chapter 14, by Inama, value, defined in accordance with the WTO's Cus- in this volume). toms Valuation Code, and normal price, calculated The chief U.S. negotiator for rules of origin in the from the f.o.b. price of the exported goods and the NAFTA has recommended (a) eliminating the re- c.i.f. price of third-country components. gional content value requirement because of associ- The "new-generation" agreements contain novel ated demands for information storage, processing, concepts aimed at, among other goals, increasing and auditing, which makes it "Byzantine in its com- the flexibility of the tariff classification change crite- plexity"; (b) using simple rules of origin based on rion by introducing de minimis clauses; facilitating tariff classification changes, in particular avoiding the regional integration of production processes by changes at a level of detail beyond the HS six-digit allowing the accumulation of regional components level; and (c) creating "sectoral customs unions" to in calculating regional content values; and stream- allow the elimination of rules of origin in the corre- lining the origin certification process by enabling sponding sectors.4 exporting companies to issue their own certificates. In general, emphasis should be placed on choos- They also specify verification, control, and sanction ing principles aimed at (a) specifying the goal procedures and activities with greater detail and sought by the origin regime; (b) keeping the num- precision --aspects that an origin regime must ber of criteria for determining origin as low as pos- address and that were not dealt with adequately in sible; (c) ensuring consistency between alternate some "first-generation" agreements. Although, it rules of origin and the levels of productive transfor- should be noted, some of these stipulations or inno- mation demanded; (d) maximizing the simplicity vations can increase the cost of administrating the and transparency of procedures for overseeing com- rules of origin for both the public and private sec- pliance with the rules; (e) duly assessing the advan- tors, they do guarantee adequate rigor in the appli- tages of adopting alternate transparent policy cation of the regime. measures, other than restrictive rules of origin, such as prolonging the period over which the market is extended or reducing differentials between the The FTAA and Origin Regimes national tariffs imposed on third countries; and (f) At the Summit of the Americas, held in Miami in ensuring, to the extent possible, consistency with December 1994, it was agreed to begin working the origin regime to be adopted by the WTO (Garay toward the creation of the Free Trade Area of the and Estevadeordal 1996). A key challenge con- Americas (FTAA), with negotiations due to con- fronting negotiators is the multiplicity in the origin clude in 2005. Twelve working groups were set up to regimes that are currently applied in the hemi- analyze common problems associated with an inte- sphere, giving rise to the question of which is most gration project of this size. One of these groups was appropriate and how to progress toward greater charged with studying customs procedures and harmonization. rules of origin. The country representatives in the working group Conclusion agreed that, in principle, changes in tariff classifica- tion should be the basic criterion for determining Given the prevalence of preferential trade arrange- origin, supplemented, as appropriate, by regional ments, in particular free trade agreements, the ques- content value, and allowing for exceptions. Using a tion of rules of origin is of particular policy relatively consistent regime for changes in tariff relevance. In light of the many economic impacts classification across all tariff items, while allowing and the problems in predicting the restrictiveness of for exceptions to be made according to the level of rules of origin, it is essential that clear-cut principles transformation demanded by a specific good's pro- and criteria for determining the origin of goods be duction process, would substantially facilitate the adopted in order to ensure their transparent and administration of rules of origin and ensure that objective application. Rules of origin will tend to 120 Rules of Origin and Trade Preferences vary among FTAs depending on the underlying between FTA members' third-country tariffs are "sensitivity" to intraregional competition and on minimal or when their tariff levels are low. Finally, member countries' strategic goals. efforts should be made to harmonize external tariffs The proliferation of FTAs and GSP regimes has on a sectoral basis in areas where the nature of pro- generated a problem of multiple rules of origin, duction processes and the internationalization of which entail costs of origin administration for both production make administrating rules of origin governments and individual manufacturing and particularly complex. exporting companies and which give rise to ineffi- ciencies in resource allocation and specialization Notes patterns. Efforts to establish basic principles for greater harmonization of the rules applied by FTAs 1 For a more detailed treatment of these issues, see Garay and and those to be agreed on by the WTO should Estevadeordal (1996). therefore be pursued. Although this will be a com- 2 What follows focuses primarily on free trade agreements, but plex task, a number of basic, transparent principles the discussion is equally applicable to preferential trade in gen- eral. for the harmonization process can be applied. In particular, preferential rules of origin should use 3 De minimis is a clause under which a good can be classified as being of regional origin provided that the value of the raw nonpreferential (WTO/World Customs Organiza- materials which fail to meet the tariff classification change tion) rules as a reference point (see Chapter 14, by requirement does not exceed a given percentage of the good's Inama; see also Hoekman and Kostecki 2001). The value. rules should also be as consistent as possible with 4 Presentation by J. P. Simpson, U.S. Department of the Treasury; regard to the classification criterion used. Rules of partially reproduced in Inside NAFTA, vol. 4, no. 6 (March origin should not be used when the differences 1997). 121 14 S T E F A N O I N A M A Nonpreferential determining origin. In the case of preferential rules of origin, if the origin criterion is not met, Rules of Origin the preferential tariff will not be applied; there is no need to fall and the WTO back on alternative methods. In order to administer trade policy Harmonization measures in the case of nonpref- erential origin rules, if the pri- Program mary origin criterion is not met, there must be an alternative method for determining the origin of the good. Thus, other R criteria are needed to define ori- ules of origin have long been con- gin when the primary rule has not been met; cus- sidered a technical customs issue toms administrations have to be able to determine having little bearing on trade policy. Determina- where goods come from. Such ancillary rules to tions of origin may, however, have far-reaching determine origin in cases where the primary rule is implications, with linkages to domestic disciplines not met are commonly referred to as "residual regulating the marketing of products to final con- rules." sumers, the geographic denomination of goods, and the definition of domestic industries. The impact of The WTO Agreement on Rules of Origin rules of origin as a "secondary trade policy instru- ment" can only be fully grasped when they are con- The WTO Agreement on Rules of Origin calls for a sidered in association with the primary policy Harmonization Work Program (HWP) to create a instruments that they support, such as tariffs, con- common set of nonpreferential rules of origin. Pref- tingency protection measures, trade preferences, erential rules of origin are covered by a common and enforcement of health and safety standards. declaration, but they are not subject to the harmo- Rules of origin are often associated with prefer- nization program. Article 1 of the agreement states ential trade regimes, in that satisfaction of origin that nonpreferential rules of origin are to be utilized criteria is a precondition for the application of a to determine the origin of goods for the following preferential tariff. (Preferential trade regimes are purposes: discussed in Chapter 13 in this volume.) Nonpref- erential rules of origin apply to trade flows that do · MFN tariffs and national treatment not benefit from tariff or other trade preferences. · Quantitative restrictions One of the main differences between nonpreferen- · Antidumping and countervailing duties tial and preferential rules of origin is that the for- · Safeguard measures mer must provide for an exhaustive method for · Origin marking requirements 122 Nonpreferential Rules of Origin and the WTO Harmonization Program · Any discriminatory quantitative restrictions and arose regarding how to maintain the integrity of tariff quotas certain trade policy measures or regimes pertaining · Government procurement to a particular product or product area. A recent · Trade statistics. submission by Japan on the relationship between harmonized rules of origin and labeling require- A principal objective of the Agreement on Rules ments for foods identified the problems that may of Origin is to harmonize nonpreferential rules of arise from the implementation of the HWP, as well origin (Art. 9) and ensure that they are applied as other non-WTO agreements such as the Codex equally for all purposes (Art. 3). The agreement General Standard for the Labeling of Prepackaged embodies a built-in agenda for achieving this. Foods. Provisions contained in a non-WTO agree- Although the work program was to be completed ment may exceed what is required for rules of origin within three years of the entry into force of the purposes, since the objectives are different. In the WTO (that is, in mid-1998), this did not happen-- case of the Codex, the aim is consumer safety-- some say, because of the complexity of the issues. something that goes beyond customs administra- The HWP is carried out by a technical committee tion purposes. that works under the auspices of the World Cus- A possible solution to this impasse suggested by toms Organization (WCO) and the WTO Commit- the United States would be to agree that the provi- tee on Rules of Origin. As of mid-2001, negotiations sion on applying rules of origin "equally for all such were primarily conducted in the latter committee, purposes" does not necessarily mean members have as most of the technical aspects of the rules had "to use rules of origin for all such purposes." For become well understood. Article 9, paragraph 2(c) some members, this à la carte approach would facil- states that the technical committee is to develop itate agreement on the HWP. For other members, harmonized definitions of: however, such flexibility may greatly diminish the value of the HWP exercise, as it would impair the "(i) wholly obtained products and minimal oper- legal certainty and predictability that the agreement ations or processes; was designed to provide in this area. Developing "(ii) substantial transformation--based on the countries, and especially least-developed countries, product concerned undergoing a change in may find some attraction in a flexible interpreta- tariff classification subsequent to being tion, as they would then not be obliged to imple- processed (transformed) in the country of ment the results of the HWP. (The HWP might turn export, and out to be excessively complicated for their import "(iii) supplementary criteria, upon completion of requirements and burdensome for their customs the work under subparagraph (ii), in cases administrations to apply.) Exports originating in where substantial transformation cannot be developing countries, however, would remain sub- determined on the basis of a change in tariff ject to the disciplines of the HWP when shipped to heading alone." those WTO members that decide to apply the agree- ment. An alternative procedure suggested in sub- missions to the WTO is to conduct an examination The Issue of "Equally for All Purposes" of the possible implications of the HWP for other Articles 1 and 3(a) of the WTO Agreement specify WTO agreements through communication with all that on implementation of the HWP, WTO mem- the other WTO bodies responsible for the matters bers shall "apply rules of origin equally for all pur- outlined in Article 1. This approach, although in poses as set out in Article 1." Uniformity contradicts principle attractive, would further limit the possi- prior practices of some WTO members, and rules of bility of concluding the HWP work any time soon. origin are a novelty for most developing country members. To date, only 34 WTO members have Impact of Alternative Nonpreferential Rules notified nonpreferential rules of origin. of Origin The possible implications of common rules of origin for the implementation of other WTO agree- The application of origin rules may have unexpect- ments such as that on antidumping have been a fac- ed and unintended consequences for developing tor impeding consensus on the HWP. Concerns country exporters. In many instances, especially in 123 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E the agriculture and processed foodstuffs sectors, originating in the region. Thus, domestic producers origin may be attributed to another country as a of dried and seasoned meat could use cheaper result of relatively simple processing. This can have imported meat while retaining origin and labeling as effects on the application of tariff quotas or of sani- high-quality regional products. tary and phytosanitary measures. For example, if a There is a close link between rules of origin and rule of origin regarding manufacture of shoes from geographical indications. (The latter are also cov- shoe parts is based on where assembly operations ered by Articles 22.1 and 23 of the Agreement on are carried out, and if assembly is carried out in Trade-Related Aspects of Intellectual Property many different countries, this will imply the pro- Rights, or TRIPS.) If the HWP applied equally to duction of "originating shoes" across many coun- origin under TRIPS, there might be implications for tries. Conversely, if origin rules state that origin products that are not produced in a specific region depends on specific manufacturing operations such but do meet the origin requirements according to as the making of shoe uppers, from an "origin point the HWP, and vice versa. For instance, some mem- of view" the production of shoes may become more bers have argued that making wine from imported concentrated, possibly facilitating the invocation of grape must (unfermented juice) should be consid- contingent protection measures such as antidump- ered an origin-conferring operation. This proposal, ing. Depending on production and industrial if adopted, could have implications for the protec- strategies, industries will have different incentives in tion of geographical indications under TRIPS Arti- lobbying for alternative rules of origin. cle 23, since some wine producers could argue that To give another example, if a country is a big pro- they are producing originating Bordeaux because ducer and exporter of cotton fabrics, which is com- they are fulfilling the origin requirement laid down monly a "sensitive product" subject to quotas under in the HWP. That is, making wine from imported the ATC, it may have an interest in ensuring that grape must (from France, in this case) would be ori- printing and dyeing are origin-conferring opera- gin conferring. Not surprisingly, traditional wine tions. In that case, all the cotton fabrics exported to producers have opposed this view, arguing that the third countries for printing and dying will change production of wine is origin conferring only if the origin status once they are shipped out of the coun- wine is made from grapes grown and harvested in try. The fabric-producing country's exports will the same country where the wine is made. A com- become less concentrated and specialized, possibly promise proposal has been put forward that consid- reducing the threat that exports of cotton fabrics ers the production of wine an origin-conferring will trigger contingent protection. Conversely, if operation only if the whole process, from grapes to printing and dyeing are not considered to be origin wine, is performed in the same country. This would conferring, even if these operations are carried out allow grapes (but not grape must) to be imported. in third countries this will have no effect on the ori- In some cases a country may have an interest in gin determination of the fabric. "retaining" origin even if the exported product is In some other cases, countries may be interested in processed in a third country before being sold to a "obtaining" origin even if the amount of working final consumer. For example, Colombia argued in and processing carried out is minimal. This can the technical committee that the processes of decaf- occur with agroprocessing and foodstuffs. For feination and roasting were not origin-conferring instance, in discussions in the technical committee, operations. The United States, the European Union one delegation argued that the drying and seasoning (EU), and Japan took the opposite view. If roasting of imported meat was an origin-conferring opera- and decaffeinating are considered to be origin con- tion. The domestic industry involved sold a dried ferring, most of the Colombian coffee roasted or meat product in the domestic market that usually decaffeinated in the EU and the United States could fetched high prices, given consumer perceptions that be marketed as EU and U.S. products. This could this product had a distinctive character. Traditional- severely diminish the image value and marketing ly, the meat used also originated in a particular potential of Colombian coffee as a quality product region. Local manufacturers, however, had begun to with a distinct character and taste.1 use imported meat. If the processing were to confer To sum up, a major issue for countries with origin, the dried and seasoned meat obtained from respect to harmonization of origin rules is to decide imported fresh meat could legitimately be sold as whether to "lose," "retain," or "obtain" origin. The 124 Nonpreferential Rules of Origin and the WTO Harmonization Program difficulty is that this must be done by product or by ary, residual rules should be available to determine categories of product; the best rule for each country origin. Given the existence of multistage, multi- may depend on considerations of industrial strategy country manufacturing operations, failure to pro- or structure at the national and global levels. vide exhaustive residual rules would leave a The relationship between the compilation of loophole in the predictability of the harmonized set trade statistics and harmonized rules of origin is of nonpreferential rules of origin. another issue. Applying the same origin rules for The basic question confronted by the technical both statistical and customs purposes is almost committee is how to determine the sequence of the unprecedented in world trade. In most cases, application of residual rules and their implementa- import statistics are classified according to the tion; that is, how to specify what happens when the country of origin as indicated in the invoice. This is, goods cannot be subject to the primary rule of ori- for the most part, the country of exportation and gin and the residual rules come into play. Two basic not necessarily the origin of the goods for customs approaches have been discussed. One approach, purposes. Moving toward greater consistency supported by the United States, is that if the pri- between customs origin rules and collection of mary rule is not met for a country, then the primary trade statistics could have significant implications rule should be applied to countries farther up the for the measured magnitude of trade flows and production chain to ascertain whether the rule has trade balances. been met in any of them. Only when the primary There is also a strong linkage between customs rule has not been met in any "preceding" country rules of origin and marks of origin that are intend- would the use of residual rules be warranted. This ed to inform consumers of a product's country of can be called the tracing-back option. A second origin. The issue of the relationship between marks approach, supported by the EU, would limit the uti- of origin (how a finished product is to be labeled lization of the primary rule to the country where before being marketed to final consumers) and ori- the last production process has taken place. Thus, if gin for customs purposes is addressed in Article IX the primary rule is not met in the country where the of GATT 1994. A change of the country of origin last production process took place, residual rules will also imply a change in the mark of origin. This should be utilized. can have important consequences for consumer The issue, then, is to assess the potential implica- choice, especially where brand names or goods of a tions of these alternative secondary rules. Under the certain quality are commonly identified with cer- tracing-back proposal, the customs administration tain countries. Environmental or humanitarian would have to trace back, on the basis of the avail- concerns may influence consumer choice toward able documentation, the origin through the preced- products from countries that are recognized as ing countries. In some cases this procedure may be respecting human rights, labor laws, or environ- difficult, as it requires that origin certificates be pro- mental treaties. Although the globalization of pro- duced for the different manufacturing stages the duction has rendered outdated the notion that a finished product has undergone. Commercial con- product is wholly produced and obtained in a par- siderations may also be an impediment to the trac- ticular country, consumers may still identify prod- ing-back method. For developing country ucts of a certain quality with specific countries or exporters, producers, and administrations, the geographic regions. application of this rule demands a certain degree of customs cooperation. Moreover, the provision of relevant information and documentation may Secondary or Residual Rules of Origin require an extensive knowledge of the rules and As noted above, nonpreferential rules of origin are awareness of the possible implications on the part aimed at assigning origin to all goods imported into of exporters, producers, and customs administra- a country. Thus, there must be an origin determina- tions. tion in all cases, as the customs authorities must be Under the EU approach, origin determination able to ascertain the origin of the goods in order to relies to a greater extent on the ability of the cus- administer trade and other policy instruments. If toms administration to determine origin at the time the primary origin criterion (change in tariff head- of importation. If the primary rule is not satisfied, ing or processing requirements) is not met, second- the customs official will immediately have to resort 125 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E to general residual rules, that is, value-added crite- will always have to determine origin, apply the rules, ria. This approach also has significant implications, and enforce them. This may be one reason why the as it seems to empower the customs authorities to elaboration of the harmonized rules has involved a make a final origin determination at the time of level of technical detail and sophistication that is importation. almost unrivaled by other WTO agreements. A basic In November 1999 a partial agreement was issue is that the rules of origin that are being negoti- reached on this issue. The tracing-back approach ated are tailored to the industrial and technological was rejected for the most part but was retained in processes used in industrial countries and do not the residual rules and, to some extent, in the list of necessarily mirror the needs, abilities, and resources rules on wholly obtained products in Appendix II of developing countries and their customs adminis- (that is, as an alternative to a value-added criterion). trations. The benefits of transparency and pre- No final agreement has been obtained on the con- dictability of harmonized rules are certainly positive tent and sequencing of the application of these for the multilateral trading system. When translated residual rules. into a WTO commitment, however, they may become an additional burden for administrations that are not adequately equipped. Rules of Origin and Anticircumvention of Moreover, the WTO Agreement is silent on sever- Antidumping Actions al issues related to implementation, such as certifi- Once the HWP has been completed, the rules of cates of origin. For instance, it is not clear whether, origin may help resolve the issue of third-country following the implementation of the HWP, WTO anticircumvention actions in antidumping cases. members may request certificates of origin for each These measures, which became controversial in the import transaction, nor is it clear who should be early 1990s, involve actions against imports of prod- issuing and certifying such certificates. The latter ucts subject to antidumping duties from countries issue has already attracted considerable attention not originally subject to such actions. Such anticir- following a U.S. request for information on aspects cumvention actions were taken on the basis of of the German policy pertaining to certificates of claims that the firms previously found to be dump- origin. Apparently, release of certain goods in Ger- ing had shifted to production facilities located in many and other EU member states was made sub- third countries. As was pointed out by the Republic ject to the presentation of a certificate of origin of Korea, the WTO Agreement on Antidumping is issued in the United States or to other related for- not clear-cut on the issue of rules of origin since, in malities. The United States had no mechanism for Articles 2.2 and 2.5, it refers to both "exporting certifying determinations made by its local cham- country" and "origin country" (see G/RO/W/65). bers of commerce and did not give legal recognition Some countries have argued that the issue could to these certificates or sanction their issuance. It be addressed through the use of harmonized resid- therefore raised a number of questions concerning ual rules of origin in cases of alleged third-country the consistency of this practice with the agreement circumvention, coupled with Rule 2(a) of the Har- and with the needs of a modern economy.3 monized System.2 In the absence of an agreement on the issue of third-country circumvention, a substan- Conclusions tial number of WTO members, including not only the United States and the EU but also Latin Ameri- It is impossible to determine the best rule of origin can developing countries, have unilaterally adopted or the best proposal without being product-, coun- anticircumvention provisions. Thus, nonharmo- try-, and industry-specific. The fact that the harmo- nized, nonpreferential rules of origin continue to be nization process involves some 10,000 specific used to enforce antidumping duties and, conse- products, each involving a certain industrial quently, to combat third-country circumvention. process, further complicates matters. That said, some general guidelines can be drawn from efforts to date to agree on rules of origin. Implementation Issues The most important inputs into the formulation Business life evolves at a faster pace than multilateral of a national position on a specific rule are provided trade negotiations, yet customs and trade officials by domestic producers or by importers and 126 Nonpreferential Rules of Origin and the WTO Harmonization Program exporters. The input of domestic producers is criti- the institutional memory and domestic bodies of cal, as they are the only ones with detailed informa- laws prevailing in the major trading nations. Most tion on the use of imported inputs, the structure of of the implementation burden can therefore be the production chain, their own cost structure, and expected to fall on the developing countries. The the implications of alternative origin rules for their difficulties in meeting the requirements of preferen- competitors. Without this input, trade negotiators tial rules of origin, especially where the issuance of and customs experts cannot arrive at a sound nego- certificates of origin is concerned, should be duly tiating position. taken into account. The HWP should not result in a The question of the impact of "retaining,""obtain- set of unnecessary administrative formalities that ing," or "losing" origin of a product should be care- conflict with recent initiatives on trade facilitation. fully evaluated at the country and subregional levels to better define the possible implications as regards Notes other WTO agreements and the implications for ori- gin marking, statistics, and so on. 1 In this specific case, it appears that Café de Colombia is a pri- Early consideration should be given to the imple- vate trademark owned by a private federation. mentation aspects of the harmonized rules of origin 2 The first part of Rule 2 (a) extends the scope of any heading and especially to the requirement to apply these referring to a particular article to cover not only the complete rules equally for all purposes. This latter require- article but also that article incomplete or unfinished, provided that, as presented, it has the essential character of the com- ment may have decisive and different implications, plete or finished article. The second part of Rule 2(a) provides depending on the country and product involved that complete or finished articles presented unassembled or and on the direction of trade (that is, import or disassembled are to be classified under the same heading as export trade flows). As has been emphasized here, the assembled article. When goods are so presented, it is usu- applying a harmonized set of rules is a sophisticated ally for reasons such as the requirements or convenience of and technical affair requiring a highly trained packing, handling, or transport. administration and an informed private sector. The 3 The matter was discussed at the Committee on Rules of Origin rules that will apply will largely be "inherited" from on May 18, 2001. 127 15 V I N O D R E G E Customs value of the imported goods).2 The incidence of such duties depends on the systems that cus- Valuation and toms administrations adopt for determining the dutiable value Customs Reform of imports. The benefits that accrue to trade as a result of binding of tariffs would be con- siderably reduced if customs officials had significant discre- tion not to use the actual invoice price as the basis for determining P rocedures for determining the dutiable value. The rules that are applied for valua- dutiable value of imported goods tion of goods are of crucial importance in ensuring and for their clearance have been the sub- that the incidence of duties levied is not higher than ject of international negotiations since the early the bound tariff for the good concerned. 1920s. This chapter briefly describes the provisions of GATT Article VII provides that "the value for cus- the WTO Agreement on Customs Valuation, the gen- toms purposes of imported merchandise should be esis of the agreement in the Tokyo Round, and its based on `actual value.'" Article VII allows countries evolution during the Uruguay Round. It then dis- substantial flexibility in defining the "actual value" cusses why many developing countries have been of imports, thus permitting GATT contracting par- reluctant to apply its rules. A key prerequisite for ties to use widely differing valuation practices. In securing universal application of the rules of the 1950, in an effort to achieve greater harmonization agreement and for helping countries that are already of valuation practices, 13 European governments applying the rules is the provision of assistance for developed the Brussels Definition of Value (BDV), modernizing and reforming customs procedures. I under which the price of imported merchandise is argue that while it may be desirable to provide assis- to be determined on the basis of the price of the tance for applying the standards of the revised World merchandise or the price that the "merchandise Customs Organization (WCO) Kyoto Convention on would fetch" if sold on the open market under fully good procedures and practices in customs clearance competitive conditions for export to the country of and control, it may not be possible for some develop- importation. The concept implies that there is a ing countries to accept all these standards.1 "notional price" which can be determined by cus- toms on the basis of the available information, tak- ing into account the conditions and other GATT Provisions and the Negotiating History circumstances relating to the specific transaction of the Agreement on Customs Valuation being valued. Most countries levy customs duties on an ad va- By the beginning of 1970, over 100 countries were lorem basis (for example, a 10 percent duty on the applying the BDV, but Australia, Canada, New 128 Customs Valuation and Customs Reform Zealand, and the United States steadfastly refused to cases in which imported goods were undervalued to join in. These four countries used a "positive" con- reduce the incidence of duties. Underinvoicing, they cept (in contrast to the BDV's notional concept), argued, was more prevalent in developing countries reflecting a desire to restrict customs authorities' because the average level of tariffs in those countries discretion in determining value. These positive was higher, and thus the use of transaction values norms laid down standards that were based on the would lead to a significant loss of revenue. These prices actually agreed on in sale either for export or pleas by developing countries were ignored by the for domestic consumption. industrial nations. The protracted negotiations that In the preparatory phase of the Tokyo Round, the ensued resulted only in agreement on provisions European Union (EU) was the main demandeur for that, among other things, would delay the applica- improvements in the GATT rules on valuation. Ini- tion of the rules by five years for developing country tial negotiations resulted in a tentative ad referen- signatories. dum agreement on Draft Principles and Draft Under the 1948 GATT, countries could decide Interpretative Notes for the uniform application whether or not to join agreements that were negoti- and interpretation of GATT Article VII. The draft ated to supplement or clarify the original GATT texts were based largely on the BDV and its explana- rules. Most developing countries chose not to join tory notes. Developing countries participating in the valuation agreement. As noted in earlier chap- these negotiations fully supported the drafts. These ters in this volume, the situation changed with the texts would have required Australia, Canada, New Marrakech Agreement that established the WTO. Zealand, and the United States to change their sys- The Agreement on Customs Valuation became tems so as to bring them into conformity with the binding on all developing country members. The principles and rules in the draft--something they WTO agreement, however, is different from the were far from willing to do. The situation changed Tokyo Round code in that a provision entitled dramatically at a November 1977 meeting, when EU "Decision Regarding Cases Where Customs Have negotiators announced that the EU had agreed to Reasons to Doubt Truth or Accuracy of the make a fundamental change in its valuation systems Declared Value" was added. This decision shifted by opting "for a positive approach" instead of the the burden of proof: in cases where customs author- "notional approach of the BDV." They argued that ities have reasonable doubts as to the truth or accu- the new proposals were based on what they racy of the transaction value declared by the "believed to be a good feature of the United States importer, the decision allows customs to ask valuation system."3 importers to provide explanations, documents, or The draft agreement provided that in almost all other evidence to establish that "the declared value cases customs value should be determined on the represents the total amount actually paid or payable basis of "price paid or payable" for the imported for the imported goods." That is, it is not up to cus- goods in the particular transaction. This meant that toms to prove that the invoice is inaccurate. If the customs should, as a rule, accept the "invoice price" customs authorities are not satisfied and consider in the transaction being valued. An "extremely limit- that "reasonable doubts" regarding the truth or ed number of cases" were listed for which customs accuracy of the declared value remain, they may use could reject the transaction value. In these cases value an alternative valuation basis as laid out in the was to be determined by using five specified meth- agreement. ods, which were to be applied in the hierarchical order in which they were listed (see the next section). Main Provisions of the Agreement on To developing countries, the change in the EU Customs Valuation negotiating position came as a total surprise. Many had recently changed over to the BDV system, and The basic purposes of the Customs Valuation agree- all of those actively participating in the negotiations ment are to require countries to adopt a valuation had supported the initial EU position that the inter- system that is "fair, neutral and uniform" and to pre- national valuation system should be based on an vent the use of arbitrary or fictitious values. Toward improved BDV.4 They noted that requiring customs this end, the agreement requires countries to deter- to accept the transaction value reflected in invoices mine the customs value of imported goods on the submitted by importers would impede detection of basis of the price paid or payable for export to the 129 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E country of importation (for example, the invoice The agreement prohibits the determination of price), adjusted, where appropriate, to include cer- customs value on the basis of the selling price in the tain payments made by buyers, such as cost of pack- domestic market of the goods produced in the aging and containers, assists, royalties, and license importing country; the price of goods in the fees. Buying commissions may not be included in domestic market of the country of exportation; the the transaction value, discounts obtained by sole price of goods for export to countries other than the agents and concessionaires must be accepted, and no country of importation (third-country prices); add-ins or exclusions other that those provided for minimum values; or arbitrary or fictitious values. in the agreement may be made to the invoice price. Because, however, a large number of developing Customs may reject the transaction value by fol- countries use "minimum values" to determine cus- lowing the procedures laid down in the WTO deci- toms duties, particularly for products the prices of sion on shifting the burden of proof when they have which fluctuate widely, the agreement allows devel- doubts about the truth or accuracy of the transac- oping countries to make a reservation enabling tion value declared by the importer. In all such cases them to maintain these values for a reasonable peri- the agreement limits the discretion available to cus- od of time on a limited and transitional basis. toms in deciding on the dutiable value, requiring The agreement requires customs authorities to that the value be determined by applying the fol- accept transaction values not only in cases of lowing five methods, in the hierarchical (sequential) "arm's-length transactions" but also in instances order in which they are listed: where transactions are between "related parties." Such relationships may result, for example, from · Value of identical goods sold for export to the partnership, control by one company of the other, same country of importation or transactions among parent companies and their · Value of similar goods sold for export to the same subsidiaries or affiliates. In all these cases the agree- country of importation ment urges customs authorities not to reject cus- · Deductive value calculated on the basis of the unit toms value unless they consider that the price at which identical or similar imported relationship has influenced the value declared by goods are sold in the domestic market, less appli- the importer. It further provides that customs must cable deductions for costs incurred within the accept the declared value if the importer demon- country of import strates, on the basis of prices charged in transac- · Constructed value computed on the basis of cost tions between "unrelated parties" for identical or of production similar goods or on the basis of deductive or com- · Finally, the "fallback" method described below. puted value arrived at in accordance with the provi- sions of the agreement, that the value declared In the case of identical or similar goods, consign- reflects the correct value of the goods. ments should have been imported at or about the same time as the goods being valued. In cases where Problems and Issues Relating to the value is to be determined on the basis of deductive Implementation of the Agreement value, the unit price of goods sold in the domestic market within a period of 90 days of importation The Agreement on Customs Valuation allows devel- has to be taken into account. oping countries to delay application of the agree- Where value cannot be determined under any of ment for a transition period of five years after the the first four approaches, other reasonable methods entry into force of the WTO. For developing coun- ("fallback") that rely on information available in the tries that were not members of the Tokyo Round country of importation may be used. These should code, this period expired on January 1, 2000. For be consistent with GATT Article VII and with the countries that have acceded to the WTO since 1995, provisions of the Customs Valuation agreement. For the five-year period is counted from the date of instance, rather than determining the value of accession. The agreement provides that the Com- goods by comparison with identical or similar mittee on Customs Valuation may, on request, agree goods imported from the same country of exporta- to grant an extension of the transition period. As of tion, customs could consider the value of goods early 2001, all industrial countries were applying the imported from other countries. agreement. About 23 developing and transition 130 Customs Valuation and Customs Reform economies that acceded to the WTO after 1995 are cal assistance in this area must be broadened and in the process of changing over to the transaction- reoriented to create confidence among assistance- based valuation system, and another 11 countries receiving countries that the adoption of the system have been granted an extension or have submitted will result in full collection of revenue due and will requests for one. For the remaining 25 or so coun- facilitate rapid clearance of imported goods. tries, many of which are in the least-developed group, no definite information is available on their Implementation Issues and Possible Solutions plans to change over from their existing valuation systems to the WTO system, although the transition As noted above, the agreement lays down five stan- period has expired. dards on the basis of which customs value may be There are three major reasons for the difficulties determined when customs authorities decide not to developing countries confront in implementing the accept the transaction value. The first two methods Customs Valuation agreement. First, many coun- call for determination of value on the basis of the tries do not feel any urgency about changing over, as transaction value of identical or similar goods they have no feeling of ownership toward the agree- imported at about the same time. For a number of ment. Most countries were not directly involved in developing countries, particularly least-developed the decisions requiring them to abide by the agree- countries, small economies, and other low-income ment's obligations. As argued by Finger and Schuler countries, imports are spaced over time because of (2000), the agreement was "imposed on them in an the relatively small domestic demand, and there is imperial way with little concern for what it will cost usually a significant gap between import consign- [them to change over from BDV to the new system], ments. Moreover, import trade is often dominated how it will be done or if it will support their devel- by a few importers that determine the countries and opment efforts."5 firms from which they want to import. Conse- Second, and more important, not only do devel- quently, there are greater possibilities for collusive oping countries not see any immediate advantages; deals or informal understandings on prices between they are apprehensive that the changeover may importers and the exporting firms. result in loss of revenue. Customs revenue still gen- In many such cases value cannot be based on erates a relatively high proportion of total revenue prices for identical or similar goods, and the cus- in many developing countries; for some least-devel- toms authorities will have to turn to the other two oped countries it could be 30 percent or higher.6 methods: deductive value (based on price for sale in The possibilities of raising additional revenue the domestic market), and constructed value (based though other direct or indirect taxes to compensate on cost of production). The first is costly for cus- for the loss are nonexistent or limited. toms and is time consuming; from importers' point Third, customs officials are apprehensive that the of view, it could result in delays in customs clear- application of the WTO standards may create prac- ance. The second method requires cooperation by tical problems because of the differences in trading the producer in the exporting country and for this environments and the absence in developing coun- reason will ordinarily be used in transactions tries of computer systems and databases that can be between related parties where the price is deter- used for price comparison purposes. mined on the basis of transfer pricing. These fears are not unfounded. Proposals to make In most cases, therefore, value must be determined the agreement more responsive to the needs of on the basis of the last method--the "fallback" developing countries have been made in the context method. Although no definitive information is avail- of more general discussions in the WTO on the able, it appears that developing countries applying problems of implementing WTO agreements. the agreement use the fallback method to determine To persuade developing countries that have not customs value for a relatively high proportion of yet started to apply the valuation agreement to transactions. Some of these countries have suggested change over to the system, a two-pronged approach that in order to facilitate determination of dutiable at the international level can be considered. First, value under this method, the "residual restrictions" proposals to improve and further clarify the agree- on the type of prices that could be used should be ment should be examined and the necessary removed. In particular, they have proposed that the changes adopted. Second, and more crucial, techni- prohibition on determining value on the basis of the 131 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E price of the goods in the domestic market of the available on prices of identical or similar goods exporting country or of the price of goods for export imported from other exporting countries. Although to the country other than the country of importa- the agreement prohibits use of prices charged by the tion be removed (WTO, WT/GC/M/56). exporting firm in third-country markets, the Agree- It is important to note in this context that under ment on Preshipment Inspection permits the use of the fallback method a country may use information such prices (see Box 15.1).7 B O X 1 5 . 1 T H E W T O A G R E E M E N T O N P R E S H I P M E N T I N S P E C T I O N Over 40 countries, many of them in the least- panies should not "arbitrarily impose the lowest developed group, use the services of preship- price upon the shipment." ment inspection (PSI) companies to assist their These provisions, which permit PSI companies customs authorities in detecting undervaluation to base the value they recommend on prices or overvaluation of imported goods and other charged for exports to third countries, conflict customs malpractices such as misclassification of with the provisions of the Agreement on Customs goods with the aim of reducing the incidence of Valuation, which stipulates that customs value customs duties. Such companies physically should not be based on prices charged to coun- inspect the goods to be imported in the export- tries other than the country of importation. The ing country to ensure that they conform to the reasons for this anomalous situation are related to contract terms. They then give their opinion as to the negotiating history of the PSI agreement. At whether the price charged by the exporter the time the negotiations were being held, all reflects the correct value of the goods. countries employing PSI services were using as Exporting enterprises have claimed that in their the basis for their valuation systems the Brussels "clean report of findings," PSI companies often Definition of Value (BDV), which does not pre- recommend prices that are arbitrary. This led to clude use of third-country export prices in deter- the negotiation in the Uruguay Round of an mining customs value. PSI-using countries Agreement on Preshipment Inspection that, argued that the ability of the companies to detect among other provisions, lays down rules which under- or overvaluation would be considerably the governments of PSI-using countries must reduced if they were prevented from using third- require the companies to follow in carrying out country export prices. physical inspections and verifying prices. The Some industrial countries argued against the rules state that in order to ascertain the true value use of such prices on the grounds that this would of goods used for price comparison, PSI firms not be consistent with the rules of the Customs should use prices of identical or similar goods Valuation agreement. In response, the PSI-using offered for export from the same country at countries maintained that since they had not about the same time, or prices charged to differ- acceded to the agreement and did not have ent export markets (third-country export prices). immediate plans to do so, it would not be appro- Where, for price comparison purposes, prices priate to incorporate its provisions into the PSI charged for exports to third-country markets are agreement. used, the rules recognize that exporting firms The compromise solution reached was to add a often charge different prices in different markets, footnote to the provisions on verification of prices reflecting demand and growth potential, as well in the PSI agreement.* The note clarifies that PSI- as factors such as per capita income. The PSI using countries are to be bound by the obliga- agreement stipulates that when third-country tions imposed by the Agreement on Customs prices are used for price comparison purposes, Valuation when using opinions on prices given by the factors responsible for variations in the prices PSI companies for determining customs value. charged to importers in different countries The aim of the clarification is to ensure that cus- should be taken into account, and the PSI com- toms administrations in countries having 132 Customs Valuation and Customs Reform B O X 1 5 . 1 ( C O N T I N U E D ) recourse to PSI services use the prices recom- declared reflect the true value of the goods. Such mended by the PSI companies only as test values importers have a right to expect customs to give or advisory opinions in checking the truth or them the opportunity to produce documentary accuracy of the importer's declared value. Cus- and other evidence to justify their declared price. If, toms could use such recommended prices as test after examination, customs still perceives that the values even when the recommended prices are price declared by the importer involves either arrived at on the basis of the prices charged by under- or overvaluation, it cannot, under the provi- exporters to third-country markets. sions of the Agreement on Customs Valuation, Customs, however, cannot automatically deter- determine the value on the basis of the PSI-recom- mine dutiable value for levying customs duties on mended price. It will have to determine it by fol- the basis of prices recommended by a PSI compa- lowing the methods laid down in the agreement ny. An examination has to be carried out in each for the determination of value when the transaction case. If, on the basis of the examination and a value declared by the importer is not acceptable. comparison of the price declared by the importer and the one recommended by the PSI company, * The footnote reads as follows: "The obligations customs finds that the latter reflects the correct of the Member with respect to the services of the price, and the importer does not contest the find- pre-shipment inspection entities in connection ing, the value can be determined on the basis of with customs valuation shall be the obligations that price. which they have accepted in GATT 1994 and There will always be importers who will contest other Multilateral Trade Agreements included in the PSI-recommended prices that are acceptable to Annex I of the WTO Agreement." The latter customs and maintain that the prices they have include the Agreement on Customs Valuation. Information Issues and Cooperation among tion. PSI companies are also understood to be Customs Authorities preparing to offer such data to countries. Both sources of price data would be available for a fee. The It is increasingly recognized that efficient and effec- ability of customs to benefit from such services tive operation of the WTO valuation system is feasi- therefore depends on how willing and able their gov- ble only if steps are taken to build computerized ernments are to bear the cost of obtaining the data. price databases that enable customs to detect cases An alternative suggested by some WTO delegations of under- or overvaluation and other customs is a formal arrangement under the agreement for frauds. Most industrial countries have computer- mutual cooperation and assistance among customs ized systems that flag invoices showing prices that authorities. This would enable developing country differ from base values derived from previous trans- customs administrations to seek and obtain informa- actions and automatically refer these to the valua- tion on prices from their counterparts in exporting tion directorate for investigation on the basis of countries in cases where this is considered necessary other available data. The customs administrations to determine whether goods are under- or overval- in developing countries must develop such data- ued.8 These ideas are not new; the WCO Nairobi bases and keep them up to date to ensure that cases Convention aims at encouraging cooperation among of undervaluation are detected and the full revenue customs administrations to facilitate action against due is collected. custom fraud. The convention, however, has only Information technology companies are develop- been ratified by a limited number of countries, and ing computerized international centralized data- most industrial countries have been reluctant to bases that could help provide developing country accept these obligations. Some industrial countries valuation units with data on prices that could be argue that the obligation under the convention used as test values in transactions under investiga- applies only in cases where importing countries 133 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E requesting information allege that fraud has been reform of customs procedures. Building up the committed, as the industrial country governments comprehensive databases that are required for are otherwise prohibited by law from furnishing ascertaining whether goods are undervalued is not information on prices (WTO, WT/GC/M/56). It has possible without computerization. The adoption of also been argued that because of budgetary con- the ASYCUDA customs software developed by straints on customs departments in industrial coun- UNCTAD would also assist these countries in tries, it would be difficult to provide the required streamlining and reducing customs forms and pro- price information if requests started pouring in from cedures. a large number of countries. Technical assistance programs should recognize The foregoing should not be construed to imply that valuation is only one of the many functions of that countries which have not yet taken steps to customs. The emphasis placed on this function in apply the agreement should wait until solutions are the past in the technical assistance provided by found to these practical problems. All countries are international organizations such as the WTO and obliged to implement the WTO valuation system, the WCO and by the countries providing assistance and the transition period that applied to developing on a bilateral basis was directed toward enabling countries has expired. However, the difficulties dis- countries to fulfill their WTO obligations, not nec- cussed above do point to the need for provision of essarily toward general modernization and reform effective and adequate technical assistance. of customs clearance methods and procedures. Some programs failed even to recognize that with- out computerization and well-developed databases Technical Assistance on prices it would be difficult for customs adminis- Technical assistance to help developing countries trations of countries where undervaluation is wide- improve their customs procedures is provided by ly prevalent to apply the agreement's rules. international organizations and countries on a This is not the case with the assistance provided bilateral basis. Among the international organiza- by institutions such as the World Bank and the IMF, tions that are most active in the customs area are the which have a wider mandate. Such projects, howev- WCO, UNCTAD, the IMF, and the World Bank. er, can involve high costs. The estimated cost of a UNCTAD and the WTO, as well as organizations project in Tanzania, for example, was US$8 million such as the Asia-Pacific Economic Cooperation to US$10 million over three years (Finger and (APEC) and the Commonwealth Secretariat, have Schuler 2000). Covering all least-developed coun- programs that focus specifically on assisting coun- tries, low-income countries, and small states under tries in adopting the WTO agreement. Initially, the comprehensive programs of this kind would involve emphasis of these programs was almost entirely on significant outlays. explaining the rules, supported by case studies and A related question that needs to be addressed is simulations, and on providing assistance in reform- whether programs aimed at assisting countries to ing national legislation. Although such programs apply WTO rules should also provide support for were found useful in improving customs officials' these countries to apply the standards and recom- understanding of the rules of the system, they were mendations of the 1999 WCO Kyoto Convention. far from effective in allaying apprehensions that the The convention is expected to provide a blueprint Uruguay Round decision on shifting the burden of for procedures that customs administrations could proof would not be sufficient to enable customs to adopt for customs control and facilitation of clear- deal effectively with undervaluation or other fraud- ance (see Box 15.2). The WCO is arranging semi- ulent practices. Some of the new programs there- nars and courses to familiarize customs officials fore emphasized on-the-job training at customs with the provisions of the convention and to facili- ports, under which senior customs officials tate its acceptance. Although many developing obtained practical training in how to handle such countries participated in the negotiations to revise cases effectively. the convention, opinion at the national level among In addition to assistance provided under these both customs and trade associations appears to be WTO-focused programs, technical assistance for divided on the extent to which it is possible for least-developed and small economies must provide developing countries with entrenched customs cor- support for computerization, modernization, and ruption to apply all the procedural standards the 134 Customs Valuation and Customs Reform convention lays down. For instance, it is generally dards such as those requiring customs officials to believed that it may be possible for all developing ensure that they carry out physical inspections on countries to adopt and apply standards relating to or verify the prices of consignments only as war- the UN layout key for documentation, payment of ranted by properly conducted risk assessment, or to duties and taxes, cooperation with trade associa- allow "authorized persons" with a record of compli- tions, and the establishment of procedures for ance with customs requirements to clear goods by appealing decisions taken by customs administra- providing minimum information and to pay duties tions. The same cannot be said of some other stan- on the basis of self-assessment. B O X 1 5 . 2 T H E I N T E R N AT I O N A L C O N V E N T I O N O N T H E S I M P L I F I C AT I O N A N D H A R M O N I Z AT I O N O F C U S T O M S P R O C E D U R E S : 1 9 9 9 R E V I S I O N O F T H E K Y O T O C O N V E N T I O N In 1999 the WCO completed a full revision of its and the use of information technology, which 1973 Kyoto Convention. The goal of the changes provides the key to keeping procedures simple was to provide customs administrations with a while ensuring adequate customs control. modern set of uniform principles for simple, No reservations may be entered against the effective, and predictable customs procedures standards and transitional standards set forth in that also achieve customs control. The revised the General Annex. In recognition, however, of convention is intended to be the blueprint for the fact that many countries may not be able to standard and facilitative customs procedures in apply a number of the standards immediately, the 21st century. This revision was necessary the revised convention provides a transition peri- because of the radical changes in trade, trans- od during which present and new contracting port, and administrative techniques that have parties are to make any necessary changes in taken place since the original adoption of the their national legislation. Contracting parties convention. have up to three years to implement the stan- dards and five years to implement the transitional General Annex standards. The General Annex contains the core procedures and practices for clearance of goods that are Specific Annexes common to all customs procedures. Acceptance The revised convention has 10 Specific Annexes of the annex is an obligatory condition for acces- containing a total of 25 chapters and dealing sion and implementation by contracting parties. with the following customs procedures: The annex, which contains 10 chapters, covers areas relating to: · Annex A. Formalities prior to the lodgment of the goods declaration; temporary storage of · Clearance of goods goods · Payment of duties and taxes · Annex B. Clearance for home use; reimporta- · Customs cooperation tion in the same state; relief from import · Information to be supplied by customs, and duties and taxes appeals in all customs matters · Annex C. Outright exportation · Areas of concern to both customs administra- · Annex D. Customs warehouse; free zones tions and the trading community. · Annex E. Customs transit; transshipment; cab- otage The annex also deals with customs control, · Annex F. Inward processing; outward process- including risk management, audit-based controls, ing; drawback; processing of goods for home administrative assistance between customs use administrations and from external organizations, · Annex G. Temporary admission (continued) 135 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E B O X 1 5 . 2 ( C O N T I N U E D ) · Annex H. Customs offences sions of the General Annex and the Specific · Annex I. Travelers; postal traffic; means of Annexes on the request of contracting parties. transport for commercial use; stores; relief consignments Acceptance of the Protocol · Annex J. Rules of origin; documentary evi- The revised convention will be put into force by a dence of origin; control of documentary evi- protocol of amendment. Forty of the current con- dence of origin. tracting parties have to accede to the protocol for it to enter into force. As of July 2000, five con- Management Committee tracting parties had acceded to the protocol, and A management committee, which is required to nine had signed it, subject to ratification. Many meet at least once every year, will administer the other contracting parties are carrying out the revised convention. This will ensure that the con- necessary internal consultations and legislative vention's provisions are kept up to date and, if processes for their accession to the protocol. The necessary, are revised at appropriate times to WCO secretariat is conducting technical assis- meet the needs of customs and trade. The man- tance missions and regional seminars to promote agement committee is also empowered to extend the revised convention and to assist contracting the time periods for implementation of the provi- parties with accession. The procedures and practices mentioned above These considerations suggest that the decision as to are increasingly being adopted by industrial coun- which aspects of the Kyoto Convention a country tries. A number of middle-income developing coun- will adopt must be left to its own discretion, taking tries that have been able to reform and modernize into account the trading environment and realities their customs and reduce or contain corruption have prevailing in the country. also adopted or are considering adoption of the Discussions in the WTO on possible work on trade Kyoto norms for physical inspection and verification facilitation have included suggestions by industrial of prices on the basis of risk assessment techniques. countries that new WTO rules in this area include a Not all countries, however, should be required to do binding obligation on WTO member countries to this. As Finger and Schuler note, "Where tariffs are accept and adopt the standards laid out in the revised high, and where accounting experience and access to Kyoto Convention. Many developing countries have electronic information is limited, shifting to a risk- argued that the limited progress achieved to date in based valuation system that depends on in-depth computerization and modernization of their cus- examination of a sample (15 to 20 percent) of ship- toms procedures makes it difficult for them to accept ments might increase rather than reduce the number any binding obligations. The proponents of a trade of shipments on which importers attempt to under- facilitation proposal have therefore revised it to state invoice. Traders might view the change as giving that the aim of WTO negotiations should be to clari- them a better not a worse chance to get away with fy and elaborate the GATT articles which lay down under-invoicing" (Finger and Schuler 2000: 13). rules relating to trade facilitation, taking into account Similarly, in countries where there are widespread the relevant standards in the revised Kyoto Conven- doubts in the public mind about the integrity of cus- tion and in the instruments adopted by other inter- toms officials, governments may find it difficult to national organizations.9 adopt the practice of designating authorized compa- nies. The general public, as well as importers who Conclusion have not been able to secure authorized status, would always look with suspicion at any such deci- Two lessons can be drawn from the experience with sions and allege that the firms had secured author- past negotiations in the customs administration ized status by corrupt means or political contacts. and valuation area. The first is confirmation of the 136 Customs Valuation and Customs Reform basic contention of public choice analysts that in Notes multilateral trade negotiations on rule-making, The author is thankful to Janet Chakarian-Renouf and Markus Jelito rational actors are not always fully informed about of the WTO secretariat for factual verification of the text and con- the economic and noneconomic factors that make it structive suggestions and to Vandana Aggarwal, Habib Ahmed, S. necessary for other countries to adopt administra- Palayathan, Simone Rudder, C. Satapathy, and K. J. Weerasinghe tive rules and practices different from their own. for helpful comments and discussions. Overcoming such "rational ignorance" about condi- 1 The next section draws on Rege (1999). tions in other countries is possible, but it involves 2 Alternatives are specific duties (for example, US$1 per kilo- costs. Industrial country negotiators are willing and gram or per liter) and mixed duties combining ad valorem and able to incur such costs by arranging discussions on specific rates (for example, 10 percent on the value of the a bilateral basis and, where necessary, by financing good plus US$2 per kilogram). joint studies with a view to improving their under- 3 GATT, MTN/NTM/W/126, November 1977. The proposal standing of the procedures followed in counterpart reflected a secret understanding with the United States. countries with similar bargaining positions. They 4 The new EU proposals made irrelevant papers prepared by the do not generally make such efforts if the countries GATT secretariat and UNCTAD under technical assistance pro- expressing concerns about the proposed rules are grams explaining the provisions in the text agreed on an ad those with less political and economic clout and referendum basis and the advantages that would flow from its weaker bargaining positions and are on the periph- acceptance. The Customs Cooperation Council (CCC, now the ery of negotiations. This puts the onus on develop- World Customs Organization), which had so far relied on the ing country negotiators to educate the main players EU to develop an international valuation system based on the BDV, felt that it had been let down with no warning. During regarding the conditions prevailing in developing the subsequent two years, the CCC was concerned as to countries that make it difficult for them to imple- whether it would have any role to play in the customs valua- ment the proposed rules. (For more detailed discus- tion field. In the end, these concerns were met by establishing sion, see Rege 1999.) A major challenge for (under the Customs Valuation agreement) a technical commit- developing country negotiators in a future round of tee in the CCC responsible for the examination of the techni- cal matters relating to customs valuation. negotiations is to improve the knowledge and understanding not only of bureaucrats and negotia- 5 Finger and Schuler (2000: 523) also observe that "the customs tors but also of the general public in industrial valuation agreement . . . provides neither appropriate diagno- sis nor appropriate remedy. It addresses only a small part of countries regarding their situation. Developing least developed countries' problems with customs administra- countries must be able to explain why it may be pre- tion and . . . provides no remedy over other parts. Over the mature for them to adopt procedural rules and small part of the problem it covers, it provides an inappropri- practices that are applied effectively and efficiently ate remedy, one incompatible with the resources they have at by industrial country administrations with access to their disposal." highly computerized systems and other modern 6 See also Kubota (2000), who notes that the average share of information technology tools and with effective import duties in total revenues was 25.9 percent for low- mechanisms in place for controlling corruption. income countries, 15.5 percent for low-middle-income coun- A second important lesson is that unless the rules tries, 16.1 percent for high-middle-income countries, and 0.5 percent for the OECD countries. that are adopted are responsive to the needs of the countries that must implement them, persuading 7 The rationale for these rules is based on the premise that these countries to apply negotiated rules by provid- determination of value by the customs administration would be facilitated and costs for importers would be reduced if cus- ing technical assistance only results in misdirection toms authorities based decisions on the information available of financial resources given by the donor countries in the importing country. Since, however, preshipment inspec- and of the time and manpower resources of the tion companies verify prices using information in the exporting assistance-receiving countries. In order to build countries, the Agreement on Preshipment Inspection (PSI) confidence and improve the overall credibility of requires that the companies rely only on information available the WTO system, it is necessary for WTO members in the country of export. This explains why the Customs Valua- tion agreement prohibits use of prices charged by exporters to to give high priority to resolving the problems and third-country markets for valuation purposes, while the PSI issues that have arisen in the implementation of agreement permits it. Developments in information communi- WTO agreements. cation technology have eliminated some of the difficulties that 137 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E previously confronted customs administrations in obtaining information from exporting countries. 8 The establishment of such an arrangement would also help countries using preshipment inspection companies secure such information and reduce their dependence on the companies. 9 The relevant GATT articles include Article X, Publication and Administration of Regulations; Article VII, Fees and Formalities connected with Importation and Exportation; and Article V, Freedom of Transit. 138 16 B R I A N R A N K I N S TA P L E S Trade tion initiatives. The complexity of international trade is increas- ing, as well. Whereas previously Facilitation: the primary objective of inter- national corporations was to Improving the identify the most cost-effective location for producing a fin- Invisible ished product, today the intense pressures of globalization have Infrastructure forced multinationals to identify the most cost-effective locations for the production of the sub- assemblies that go into a final N product. These commercial pat- ational customs authorities are hav- terns have led to an explosion in regional free trade ing to process ever-higher volumes agreements around the world. Such agreements of trade with the same or a declining number of usually feature complex and confusing rules of ori- employees, at the same time as traders are demand- gin, placing considerable additional administrative ing faster clearance for their goods and increased burdens on both the public and private sectors. administrative efficiency in all programs related to In addition to the greater volumes and complexity international imports. The Internet and e-com- of trade, there is the issue of trade velocity. Product merce are transforming shipments that once would life cycles are now measured in months, not years, have been transported in a single container and and modern supply chain management techniques cleared on a single entry into dozens of individual- have increased the use of "just-in-time" manufactur- ized shipments, each requiring separate customs ing, global production sharing, and outsourcing. documents and clearance procedures. This is a Trade now moves, and must move, at higher speeds major challenge for customs authorities and for than ever before. In this environment, businesses express couriers with customers who expect goods simply cannot afford to have imported or exported to be cleared immediately. goods tied up for weeks or even days because of Not only are trade volumes growing steadily; unnecessary or antiquated trade formalities. The because of foreign direct investment, there is also interaction of all of these issues and factors has led to dramatic growth in trade transactions between heightened awareness of the importance of trade related parties. Imports and exports increasingly facilitation in attracting trade and investment. take place between the same corporate entity. The result is to heighten the visibility of unnecessary Trade Facilitation: The Plumbing transactions costs to transnational corporations that are under intense competitive pressure to What exactly is trade facilitation? Although initia- reduce these costs, primarily through trade facilita- tives such as improvement of transport infrastruc- 139 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E ture, trade liberalization, and trade promotion do, Chapter 14, by Inama). These agreements deter- in a sense, facilitate trade, they do not constitute mine the tariff classification of an imported prod- what is known today as trade facilitation. Rather, uct, its country of origin, and its value for duty trade facilitation involves reducing all the transac- purposes. The HS is a legal and logical international tions costs associated with the enforcement, regula- product nomenclature developed through the Brus- tion, and administration of trade policies. Trade sels-based WCO and introduced by international facilitation, by its nature, is technical and detailed. It convention on January 1, 1988. Contracting parties has been referred to as the "plumbing" of interna- have committed to apply the HS uniformly at the tional trade. six-digit level, which covers 1,241 headings. The objective of trade facilitation is to reduce the Although the HS is primarily designed for tariff cost of doing business for all parties by eliminating classification purposes, it is also used extensively to unnecessary administrative burdens associated with determine the goods subject to import and export bringing goods and services across borders. The controls, freight tariffs, the application of (or means of achieving this objective are the modern- exemption from) value-added tax regimes, trade ization and automation of import procedures to statistics, and origin. The HS provides a common match established international standards. The "trade language" for all public and private actors in meaning and implications of trade facilitation have the international trade arena, and the concept of changed since as recently as a few decades ago. Trade trade facilitation is dependent on a complete under- facilitation in previous generations revolved around standing and mastery of the HS. attempts to harmonize different regimes or to Other WTO agreements that have an effect on the establish an element of mutual recognition between trade facilitation agenda include: different customs and related policy regimes. Today, the WTO and various World Customs Organization · The Agreement on Import Licensing Procedures, (WCO) conventions set forth a common set of which is designed to ensure that the process of international standards or customs good practices administering import-licensing systems is for all countries. The current challenge is, much nondiscriminatory and neutral and does not more than in the past, one of implementation and restrict trade of convergence in procedures and customs opera- · The agreements on Technical Barriers to Trade tions based on these international norms. From a and on Sanitary and Phytosanitary (SPS) Mea- trade facilitation viewpoint, asymmetrical customs sures, which are discussed in Chapter 41, by regimes create uncertainty and, therefore, costs for Wilson international traders. · GATT Articles V (on freedom of transit), VIII It should be emphasized that use of the term (calling for the simplification of fees and formali- "trade facilitation" does not imply abandonment of ties related to the importation and exportation of efforts to improve trade compliance. On the con- goods), and X (requiring the timely and compre- trary, trade facilitation, using modern risk analysis hensive publication of all laws, guidelines, and techniques, allows compliant importers access to decisions that may affect imports or exports and improved, automated import procedures and gives the establishment of judicial or administrative tri- customs authorities the opportunity to concentrate bunals to review customs administration and resources on noncompliant traders. decisions) · The Agreement on Preshipment Inspection (PSI). International Agreements and Programs Trade facilitation became the subject of WTO dis- The World Trade Organization. A number of inter- cussions in 1997, following the 1996 (Singapore) national agreements have direct implications for ministerial meeting. At the Doha ministerial meet- trade facilitation. In the WTO these fundamental ing in 2001, it was decided to launch negotiations in tools of international trade regulation include the 2003, subject to consensus on the modalities of Harmonized Commodity Description and Coding negotiation. Any such negotiations will have to System (HS), the Customs Valuation agreement draw on the work of numerous other specialized (discussed in Chapter 15, by Rege, in this volume), bodies, the most important of which are discussed and the Agreement on Rules of Origin (discussed in briefly below. 140 Trade Facilitation: Improving the Invisible Infrastructure The World Customs Organization. Of all the interna- porary Admission (1993), which deals with tempo- tional organizations, the WCO's activities and man- rary admission of goods, means of transport, and date are the most closely aligned with the issue of animals. trade facilitation. The WCO, founded in 1953, has a United Nations Agencies. The United Nations membership of 142 economies. Its objective is to Conference on Trade and Development (UNCTAD) increase the efficiency and effectiveness of customs is actively involved in trade facilitation and encour- administration around the world by reviewing the ages the input and participation of developing technical aspects of customs programs and sharing economies in trade facilitation initiatives. UNC- the results of these studies cooperatively with cus- TAD's Automated System for Customs Data and toms administrations. A major international con- Management (ASYCUDA), a customs software pro- vention designed to promote the standardization gram, is used in more than 70 developing countries. and simplification of customs procedures world- ASYCUDA simplifies and automates customs func- wide is the International Convention on the Simpli- tions with a view toward increasing revenue collec- fication and Harmonization of Customs Procedures tion, speeding clearance of cargo, and improving (the Kyoto Convention), which contains general data collection and dissemination. Much of UNC- provisions and special annexes dealing with cus- TAD's trade facilitation activity has involved the toms procedures. The convention, originally estab- transport sector. Transport initiatives include port lished in 1973, underwent a major revision in 1999, development; development of an electronic trans- resulting in improved provisions for automation, port management tool, the Advance Cargo Infor- electronic commerce, postentry or audit-based mation System (ACIS); and the concept of national reviews, and risk management techniques. The trade and transport facilitation committees that revised Kyoto Convention is the most comprehen- bring together all transport stakeholders within a sive existing instrument for promoting internation- country to create and promote policies which al trade facilitation (see Chapter 15, by Rege). Many enhance the efficiency of trade facilitation. in the private sector would like the WTO to eventu- In October 1994 the UN hosted a ministerial-level ally incorporate the Kyoto Convention, or at least International Symposium on Trade Efficiency, held related principles, into its structure, thereby making in Columbus, Ohio. The focus of the symposium such provisions binding and enforceable. was customs procedures and other microeconomic The WCO maintains a customs reform and mod- features that prevent full realization of the potential ernization program (CRM)--an evolving technical trading benefits negotiated in the WTO. At the sym- assistance product that supports customs reform posium, a set of detailed recommendations, referred through training in diagnostic study and in customs to as the Columbus Declaration, was adopted. These needs analysis. The program helps domestic cus- recommendations have become critical guidelines toms authorities implement the required changes in the pursuit of trade facilitation. The symposium that have been identified and evaluate their impact also established UNCTAD's Trade Point Global Net- on trade facilitation and customs compliance. work, a program that aims to create approximately Another major instrument is the 1993 Declaration 180 "trade points" in 109 countries. These trade Concerning Integrity in Customs (the Arusha Dec- points will be electronically linked to national cen- laration), which addresses the issue of corruption ters for trade facilitation and will act as providers of within customs administrations. The Arusha Decla- trade-related information and data. ration is indirectly linked to the CRM and the Another relevant UN body is the Center for Facil- revised Kyoto Convention in that it promotes stan- itation of Procedures and Practices for Administra- dardized customs procedures, electronic commerce, tion, Commerce, and Transportation (CEFACT- and improved relations between customs brokers UN/ECE). Since 1960, this organization has pur- and customs. sued the harmonization and automation of customs The WCO is responsible for literally dozens of procedures and information requirements and it additional programs, guidelines (such as the issued the internationally recognized UN/ECE Trade Express Consignment Guidelines), resolutions, Facilitation Recommendations. CEFACT is perhaps norms, recommendations, and conventions best known for its work on electronic data inter- (including the HS). A particularly important instru- change (EDI), a form of electronic commerce that ment is the Istanbul Customs Convention on Tem- uses a structured exchange of data between two par- 141 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E ties, and for the development of the UN Electronic customs operations, the free flow of trade and of Data Interchange for Administration, Commerce, enforcement information, and a common and Transport (EDIFACT). EDI and EDIFACT have approach, wherever possible, to customs valuation. become important instruments for reducing cus- Trade facilitation has also figured on the agenda of toms paperwork and exchanging trade-related the Group of Seven countries; an example is an information between parties that typically handle effort in 1997 to standardize and simplify customs international trade transactions (for example, insur- procedures. ance firms, customs, freight forwarders, and customs Trade facilitation is a major focus of the Free brokers). In addition, the United Nations Commis- Trade Area of the Americas (FTAA), as well. The sion on International Trade Law (UNCITRAL) has FTAA has developed a series of recommendations, developed significant conventions on the interna- known as business facilitation measures, that incor- tional sale of goods, the carriage of goods by sea, and porate trade facilitation principles such as electron- arbitration rules, as well as the UNCITRAL Model ic compatibility and risk analysis. Law on Electronic Commerce. Regional Integration Initiatives. A number of The Private Sector regional efforts have been undertaken to facilitate trade. Two major trade facilitation initiatives under Most of the nongovernmental entities that actively the North American Free Trade Agreement support trade facilitation programs are, not surpris- (NAFTA) are the Canada-U.S. Shared Border ingly, international transport organizations. They Accord and the Heads of Customs Conference include the International Express Carriers Confer- (HCC). The Shared Border Accord, signed by Cana- ence, the International Air Transportation Associa- dian and U.S. customs and immigration agencies, tion, the International Chamber of Shipping, the creates a set of common objectives for a joint International Road Transport Union, the Interna- approach toward trade facilitation and trade com- tional Federation of Freight Forwarders Associa- pliance. The HCC holds regular trilateral meetings tions, and the International Federation of Customs of Canadian, Mexican, and U.S. authorities to Brokers Associations. The International Chamber of review common customs issues, including enforce- Commerce (ICC), based in Paris, is an important ment cooperation and ways to improve the process- nongovernmental actor in trade facilitation and has ing of the cross-border movement of goods. For pursued customs simplification and harmonization example, the HCC endorsed the North American since the early 1920s. It promotes harmonized busi- Trade Automation Prototype, which uses EDIFACT ness practices through a variety of instruments, syntax and is designed to facilitate trade by stan- including the Commission on International Com- dardizing data elements and electronic customs mercial Practices, the Standing Committee on procedures. Extortion and Bribery, and the ICC Incoterms, With the launching of the Osaka Action Agenda which are standard trade terms and definitions for in 1996, members of the Asia-Pacific Economic use in international contracts. The ICC, in conjunc- Cooperation (APEC) committed to standardizing tion with the WCO, also administers the ATA Car- customs requirements throughout the region. In net System for the temporary entry of goods. The 1997 APEC trade ministers agreed to align national ICC has issued a set of 60 international customs norms with international standards and to recog- guidelines relating to a wide variety of trade facilita- nize each other's national standards. Recognizing tion matters. These include the reduction of paper- that simplification and harmonization of customs work and the increased use of electronic commerce; procedures can make a major contribution to trade the introduction of risk assessment techniques (pre- facilitation, ministers noted the importance of find- clearance and postclearance audits); and profes- ing technological solutions to expedite clearance of sional training for customs employees. frequent travelers. An example is the project for an The ICC was instrumental in having the issue of APEC business travel card. trade facilitation introduced at the 1996 Singapore The European Union (EU) has concluded cus- ministerial conference of the WTO. There, ministers toms cooperation and mutual assistance agree- directed the WTO Council for Trade and Goods to ments with several countries. These agreements draw on the work of other relevant international cover the simplification and computerization of organizations in the area of simplification of trade 142 Trade Facilitation: Improving the Invisible Infrastructure procedures to assess the scope for WTO rules in this modernization. It has also called for harmonization area. The ICC has encouraged the WTO to concen- of nonpreferential rules of origin, greater reliance trate on customs modernization as an essential on preshipment inspection (discussed in Box 16.1), complement to WTO rules on customs valuation and political support for making the revised Kyoto and to establish a WTO working group on customs Convention a binding multilateral agreement. B O X 1 6 . 1 I N C R E A S I N G T H E E F F E C T I V E N E S S O F P R E S H I P M E N T I N S P E C T I O N S E R V I C E S Preshipment inspection (PSI) refers to the verifica- want the services because they reduce available tion of unit prices and to the examination and rents. Unless governments consistently use a rec- reporting of the quantity and quality of exports onciliation system and act on the information before they are shipped to the importing country. generated, PSI will not contribute much to rev- PSI can help control over- or underinvoicing of enue collection. To ensure sustainable revenue imports, misclassification of imports, undercollec- collection, customs modernization and institu- tion of taxes on imports, and misappropriation of tional reform are also needed, and the strategy donor funds and can assist with monitoring of should specify how PSI services will be phased origin, compliance with national regulations and out over time (Low 1995). tariff exemption schemes, trade facilitation, and consumer protection. PSI services are provided Trade facilitation. Opponents of PSI often argue by private companies in the exporting country. that PSI hinders trade by creating additional cost- Thus, PSI can be thought of as a temporary quasi- ly steps for traders that may duplicate control privatization or contracting out of selected cus- functions imposed by customs administrations. toms functions to meet specific objectives. It The Indonesian Chamber of Commerce, howev- should not be viewed as a substitute for an effec- er, has argued that PSI facilitated trade by speed- tive program of customs modernization and insti- ing up the customs clearance process. tutional reform, which is the proper route to Overall, experience suggests that if PSI is to long-term gains in efficiency and growth. make a positive contribution, several conditions Because institution building takes time, PSI can are essential: play a useful interim role in three main areas: · Transparent procurement rules for the pre- Disbursement verification. One motivation for PSI shipment inspection contract is to monitor the use of donor funds. Where gov- · Preshipment inspection values and classifica- ernments have poor statistical capacity, PSI can tions that are an integral part of import docu- provide useful evidence. ments · Good use of provided services (with reconcilia- Revenue collection. Probably the most important tion by the ministry of finance, at a minimum) reason that governments use PSI is to deal with · Arbitration provisions to settle disputes swiftly inefficient or corrupt customs administrations. without holding up goods (Revenue collection shortfalls of up to 50 percent · Enhanced competition for service provision are reported to have occurred in some countries.) and fee setting. The effectiveness of PSI in this regard depends on how well it is implemented. Although reported Competition among service providers (split revenue savings generally exceed PSI fees, which contracts) can reduce fees but could increase are about 1 percent of the value of inspected transactions costs for users. Serial competition goods, case studies suggest that the information (bidding for a time-bound monopoly franchise, provided by PSI companies has often been disre- either at the country level or within a certain garded; customs administrations often do not area) can avoid conflicts of interest by eliminating (continued) 143 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E B O X 1 6 . 1 ( C O N T I N U E D ) the ability of importers to threaten to switch to may be a basic conflict of interest in appointing a another service provider if they are not assessed PSI company as the primary external agent sufficiently low duty payments. For serial compe- responsible for customs modernization. If the tition, the challenge is to design and supervise a company is successful in modernizing customs bidding process that awards contracts often administration, its success closes off more prof- enough to render the market contestable. With itable flows from PSI work. Governments should either contract option, termination clauses in therefore consider separating PSI support from case of poor performance are desirable. It is also customs modernization assistance. This does not desirable to explore the commercial feasibility of preclude use of the customs modernization skills allowing fuller price competition, where pricing of PSI companies, but it does mean that a distinct reflects actual services rendered, rather than the agent, perhaps another PSI company not current ad valorem practice. For instance, bulk involved in the country's PSI work, should be goods such as wheat or petroleum could be responsible for modernization. Such unbundling exempted or should face lower fees. can also facilitate different fee structures for dis- Competition to strengthen customs adminis- tinct lines of business, making it easier for prices tration should be an element of PSI contracts. A to reflect services rendered. number of countries have been using PSI for more than 10 years without seeing concomitant Source: Prepared by the volume editors, based on Dutz customs modernization. This suggests that there (2001). Policy and Practical Implications time expense and its benefits are long-term--are also a consideration. Possibly the single most signif- It has been estimated that costs stemming from icant challenge is that trade facilitation itself is customs and related import formalities are on the predicated on trade reform in general and customs order of 2 to 5 percent of the value of merchandise reform in particular. For example, computerization trade. Trade facilitation, defined as pertaining to is a critical element in the trade facilitation process, the standardization and modernization of customs but computerizing outdated procedures and techniques, is therefore a potentially very cost- requirements is not very useful. In 1995 UNCTAD effective way of reducing the costs of trading. The performed an in-depth study of its widely used main concerns of traders include excessive docu- ASYCUDA automated system and concluded that it mentation requirements; lack of automation and "cannot be successfully implemented without first limited use of information technology; lack of undertaking a major reform of customs procedures. transparency; unclear and unspecified import and This may include elimination of unnecessary pro- export requirements; inadequate procedures, espe- cessing steps, simplification and elimination of cer- cially a lack of audit-based controls and risk assess- tain forms, streamlining of the document ment techniques; and lack of cooperation among processing flow within the office, and adoption of customs and other government agencies. Other international codes." concerns are the need to implement improved Recognizing that obstacles and challenges will be management techniques and to reorganize man- encountered on the path toward comprehensive agement structures to manage the changes required trade facilitation is not to say that the difficulties are by trade facilitation. insurmountable. In the first place, given that trade For facilitation to be effective, it has to be execut- facilitation is primarily concerned with the stan- ed properly and to be closely coordinated with other dardization and modernization of customs proce- reform priorities, such as tax administration. The dures, the process of reform can draw on costs of trade facilitation--even though it is a one- internationally based standards, such as the new 144 Trade Facilitation: Improving the Invisible Infrastructure Kyoto Convention, that are largely based on multi- · A great number of trade facilitation initiatives are lateral obligations and agreements. In contrast to taking place around the world, and this can some- other policy reform matters--in taxation, for exam- times lead to confusion. The Kyoto Convention, ple--there is a common base and a common lan- including its draft revisions, provides the most guage for all facilitation initiatives. In addition, the comprehensive and convenient expression of WCO's Customs Reform and Modernization Pro- trade facilitation objectives, mechanisms, and gram provides many of the tools necessary for per- best practices. forming an audit and needs analysis, which are · Trade facilitation should be perceived not solely essential for effective customs reform. as a risk to customs revenues but primarily as a The goal of trade facilitation is clear: streamlined way of reducing the cost of operating customs and modernized customs procedures. The process regimes while at the same time attracting of achieving this objective can, however, be rather importers and investment. (See Box 16.2 for an complicated. The following summary provides a example from Jamaica.) personal perspective of policy measures and best · The current world trading system is characterized practices: by much potential and much uncertainty. Around the world, regional groupings are actively review- · Protection of customs revenue is paramount. ing and considering dozens of free trade agree- Facilitation measures such as the expedited ments and preferential trading practices. At the release of goods imported by parties with "clean" same time, a new WTO round is beginning. As customs records have to be counterbalanced by interesting and exciting as these projects may be, compliance mechanisms (that is, penalties). Pro- their completion is far from guaranteed. Trade tection of customs revenue implies that the issue facilitation and customs reform may represent a of customs integrity has to be addressed directly. better return on investment. B O X 1 6 . 2 I M P R O V I N G E X P O R T C L E A R A N C E I N J A M A I C A The experience of Jamaica illustrates that customs In 1993 the government decided to take a top- reform may have no implications for revenue col- down approach to the issue of export clearance. lection, while facilitating exports. In the early Rather than try to analyze individual steps and 1990s the Jamaican customs administration was procedures and seek agreement with customs and operationally inefficient; administrative practices other authorities to eliminate or simplify them, were poor; and corruption was widespread. Ille- targets, determined by the top management of gal narcotics trade had led to a regime of strict the Ministry of Finance and Customs, were estab- cargo control. Although the restrictions were well lished for export clearance. The emphasis was on intentioned, exporters complained that the collecting statistics on national trade movements regime simply added costs and augmented and on ensuring that no goods were exported delays. that were on the list of controlled items. Outside Clearance of export consignments required 23 technical assistance was then sought to draft an steps. It took two or three days for a typical ship- action plan to achieve these two objectives with ment to complete all clearance procedures. Par- minimum costs and delays. The advantage of this ticularly damaging was the uncertainty created approach was that it encouraged policymakers to by the procedures; a holdup of a day could result identify policy objectives and then ask whether in an exporter's missing a scheduled vessel. As and how customs had to be involved in their real- such vessels tend to visit Jamaica relatively infre- ization. The alternative bottom-up approach quently, the resulting delay could span several assumes implicitly that procedures are valuable weeks, leading to the possible cancellation of the and must be continued. letter of credit and, in the case of time-sensitive By 1995, the reforms that were instituted as a goods such as apparel, to loss of contracts. result of this rethinking had reduced clearance (continued) 145 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E B O X 1 6 . 2 ( C O N T I N U E D ) time for export consignments to 10­20 minutes. inspects only 10 to 15 percent of shipments, This dramatic improvement was achieved using clearly specified risk criteria. In addition, through three changes: lack of statistical information is no longer a jus- tification for holding up a consignment. · The implementation of a single-point clear- · The introduction of a binding, comprehensive ance mechanism, allowing exporters to go manual of procedures setting out all customs straight to the dockside with their documents rights and responsibilities in export clearance. instead of having to go to customs offices sep- This manual is published, so that exporters arately and then having to match documenta- and their agents know what the rules of the tion to cargo at a later stage. game are. · The introduction of selective inspection based on risk assessment instead of discretionary Source: Prepared by the volume editors, based on World physical inspection of consignments. Customs Bank, "Ethiopia Export Development Strategy" (1997). · As mentioned earlier, it makes no sense to simply administrations accept passively civil service transform outdated and unnecessary customs rules, including controls on organization struc- procedures from a paper format to an electronic ture, job classification, and salary levels, instead of format. That is, trade facilitation requires cus- striving for control of their own organizations. toms reform, and reform implies modernizing · Lack of understanding of the need for coordination and streamlining customs programs to interna- and cooperation between tax and customs adminis- tional standards, which are primarily found in the trations. Kyoto Convention. · High levels of corruption that plague many admin- istrations, causing loss of tax revenue and eco- nomic costs. Common Problems and Rules of Thumb In June 1994, in a speech before the Customs Coop- Tanzi went on to outline solutions and ways for- eration Council (later renamed the WCO), Vito ward. Tanzi, director of the IMF's Fiscal Affairs Depart- Make customs administrations technology based. ment, identified the following major problems in The eventual goal is paperless processing systems trade facilitation and customs reform: that include electronic reporting of import and export transactions through electronic data inter- · Out-of-date customs procedures that have not kept change; selective checking based on risk assessment pace with developments in transport and technology. techniques supported by extensive computerized · Inadequate legislation that makes it difficult to databases; periodic declaration and payment; and introduce the changes required to support new increased application of postrelease controls. All of ways of doing business, and administrations that these procedures are already operational in many often use excuses related to legislation to delay or countries. Countries with less developed infrastruc- fail to adopt new systems or procedures instead of tures will encounter difficulties. Yet almost every working to change the legislation. country has industries such as airlines and banking · A belief that computerization is the answer to all in which sophisticated technology is already opera- problems, with little thought to understanding the tional. It is, therefore, not unrealistic to expect such role of computers, the need to simplify proce- technology to be applied in the customs environ- dures, and the use of information produced by ment. computerization to control operations effectively. Rely more on postrelease audits. Experience shows · Inadequate attention to the organization and that reliance on postrelease audits yields better staffing needs of a modern administration; many results than traditional controls. An IMF technical 146 Trade Facilitation: Improving the Invisible Infrastructure assistance mission found that an audit office with a For the administration to function well, all its com- staff of 22 had issued assessments totaling US$70 ponents must be in order: its operational proce- million over a five-year period, whereas there were dures; its organizational structure and management virtually no results from more than 350,000 physi- systems, including information systems, superviso- cal inspections of containers, employing hundreds ry systems, and internal control; its human and of staff, over the same period. Little thought had financial resources; and its legislative basis. been given in this case to reallocating staff from the Comprehensively redefine the operational role and unproductive physical inspection activities to the procedures of customs. It is time for many cus- postrelease audit. Of course, countries with a well- toms administrations to rethink the way they are developed administration and a more sophisticated doing business. New control strategies need to be trading community will be able to move more introduced that result in minimal interference with quickly to a postrelease audit system of control than trade yet ensure proper enforcement of fiscal and countries in which the administration has inade- trade laws. Experience has shown that importers quate human resources or where bookkeeping stan- are more willing to pay what is due if procedures dards in the trading community are low. are efficient and customs has a service-oriented Forge a closer working relationship with the tax attitude. department and exchange information and data on Adopt innovative and flexible management sys- the foreign trade activities of importers and tems. This involves decentralization of responsibili- exporters. These measures can help improve rev- ties and decisionmaking and more autonomy and enue assessment. The tax department needs to accountability for administrators in the field. Head- know the amounts of value-added tax (VAT) paid quarters should concentrate on central manage- on imports, and it needs to know that export goods ment functions, including administrative policy, have actually left the country. In some cases there strategic planning, review of the operational sys- are benefits to joint audits by the customs adminis- tems, analysis of performance, and internal audit. tration and the tax department, particularly for Strive for autonomy in the management of value-added taxation. resources. Decisions related to human, physical, and Promote service orientation and good relations with financial resources should be the responsibility of the trading community to improve compliance. the administration. Autonomy must, of course, be These goals can be achieved through clear, transpar- combined with greater accountability through per- ent procedures; regular meetings between customs formance evaluation. officials, importers, brokers, freight forwarders, and Privatize functions that can be effectively performed port and airport authorities; joint training sessions at lower cost by the private sector. Laboratory ser- and seminars; establishment of services offices; and vices, receipt of duty and tax payments, and devel- dissemination of information. Often, customs opment and operation of computer systems are all administrations in developing countries do not activities that could and perhaps should be carried provide sufficient information to the trading com- out by the private sector. Warehouses should not munity. belong to or be operated by customs, although this Inculcate professionalism and a high level of still happens in some countries. integrity. Both can be more easily developed Invest in human resources. Traditional approaches through increased autonomy of the customs to recruiting and training will have to change. administration, meaning the ability to control Methods that rely mainly on recruitment at lower budgets and implement changes, as well as through levels and on learning on the job need to be altered accountability for performance and the require- if the administration is to keep pace with develop- ment to seek out and remove corrupt officials. ments. If customs administrations are going to rely in the future on technology- and audit-based sys- tems, different skills will be required. Getting There Establish firm management control, in particular as An efficient customs administration must be flexi- it relates to integrity. Integrity in an organization ble and able to respond quickly to the needs of gov- requires a clear, well-articulated code of conduct, ernment. It is not enough to introduce sophisticated willingness to take disciplinary action, and effective technology; this alone will not guarantee success. internal control systems. 147 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Elements of the Trade Facilitation Toolbox sense customs is vital to the flow of international trade in goods, which totals US$6 trillion each year. Trade facilitation is an objective; comprehensive Pursuing the objectives of trade facilitation on the reform of customs and related import requirements national level will make the domestic public and are the means of achieving this objective. Customs private sectors more efficient and will also play an reform does not take place in isolation but in a larg- important role in securing and attracting foreign er context that includes other considerations, such investment. Clearly, for many countries, achieve- as transport policies, and other actors, such as ment of trade facilitation objectives will be a long- importers and carriers. Recently, in an explicit term process requiring substantial technical and recognition of all these factors, the director general financial assistance. In order to determine what role of the International Express Carriers Conference the WTO could usefully play to attain national facil- published an audit methodology (Raven 2000) con- itation objectives, countries must start by defining taining detailed questionnaires intended to supple- these objectives and determining where reforms are ment personal interviews during a trade facilitation needed. audit. Such an audit should be the first step taken by countries concerned with reducing trade costs.1 Note Conclusion 1 Individual questionnaires focus on forwarders/agents/customs brokers/multimodal transport operators; exporters; importers; Every year, the private sector spends considerable shipping lines; road carriers; airlines; express operators; ports; sums of money to design and develop seamless sup- airports; border-crossing points; customs; commercial banks; ply chains for intercompany transactions and for exchange control/central banks; preshipment inspection agen- cies; chambers of commerce; and departments of trade/exter- transactions with suppliers and customers. National nal trade. Further information and tools, including the audit, import and export requirements are a major obsta- can be obtained from the Trade and Transport Facilitation cle to achieving the seamless supply chain. In this Website, . 148 17 M A R I PA N G E S T U Industrial Policy not limited to the manufactur- ing sector; it also encompasses the processing of agricultural and Developing and mining products, as well as services industries, both of Countries which sectors add value to man- ufactures. In practice, industrial policy often has multiple objectives, including short-term employ- ment, increased output, more even income distribution, more equal regional distribution of I economic activity, and enhanced ndustrial development is an inte- technological capacity. There are often also noneco- gral part of any economy's growth nomic objectives, including national pride and strategy. Most countries pursue some kind of indus- prestige and the perceived need to promote "strate- trial policy, although their objectives and approach- gic" domestic industries. These objectives are fur- es may differ radically and may change over time. ther confused to the extent that many developing Given the changing global and domestic environ- countries are concerned about foreign ownership ment, developing countries need to reassess the and how it can affect domestic capabilities.2 It is options open to them for conducting an effective, important to pursue an industrial policy that has WTO-consistent industrial policy. limited and clearly defined objectives, as there may not be sufficient policy instruments to meet multi- ple objectives. Moreover, different objectives may be Objectives and Scope of Industrial Policy inconsistent with each other. The economic literature and the lessons from implementing industrial policy emphasize that an Justifying Industrial Policy effective industrial policy or strategy needs well- defined objectives, justification, and scope. The The economic case for government intervention World Bank has provided a working definition of designed to achieve long-run productivity improve- industrial policy as "government efforts to alter ments rests on the need to correct alleged market industrial structure to promote productivity based failures stemming from externalities, missing mar- growth" (World Bank 1992).1 This definition is use- kets, or other failures, while taking into account ful because it focuses on the objective of economy- potential side effects on other sectors in the econo- wide factor productivity growth rather than on my. The traditional economic argument for provid- merely changing the structure of industrial outputs ing government assistance to certain industries is to or dealing with certain sectors. Industrial policy is protect infant industries.3 Import protection in the 149 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E form of a tariff or a subsidy based on the output of best policy requires the unrealistic requirement of firms (the two instruments have an equivalent effect perfect knowledge of all aspects of the economy so on output of a particular industry) is justified on that the net effect of the intervention can be known. the basis of some dynamic externality such as learn- Third-best interventions made in ignorance of the ing-by-doing or on-the-job training that reduces true values of some behavioral parameters may lead costs. Under this rationale, only learning processes to further distortions and reduce welfare. external to the firm should be assisted, since the Other justifications for industrial policy rest on firm cannot obtain rents or profits from such train- the rationale of technology development. The ing and will thus not invest in it. appropriate policy under that rationale would call There are important qualifications to the infant for technology-based intervention, not an output- industry argument. First, the reductions in cost over based intervention such as subsidies, or for assis- time should compensate for the higher costs during tance for technology development and policies to the period of assistance. Second, the provision is not encourage foreign direct investment (FDI), which is for blanket assistance to all firms in an industry; the an important vehicle for the transfer of technology. existence of an externality and provision of the (See Chapter 19, by Bora, and Chapter 34, by Saggi, assistance should be linked to performance by the in this volume.) recipient (for example, to increased efficiency or cost reduction) and the assistance should be phased Instruments of Industrial Policy out over time. Third, the appropriate instrument for realizing the positive externality from the expansion In practice, countries have used a wide range of of domestic industry may not be a tariff or a sub- instruments in the name of industrial policy. These sidy, both of which are output based. A more appro- can be categorized as external, product, and factor priate policy is a subsidy related to the process, job, market interventions. or product that creates knowledge or learning. External market interventions involve protecting The appropriateness of policy instruments follows domestic industries from imports, using instruments a more general theme in the literature on govern- such as import tariffs,quotas,licensing,and local con- ment intervention (see Bhagwati 1971; Corden tent programs, as well as export promotion measures 1974). Each externality or market failure calls for a to assist industries to catch up and break into new tax subsidy whose base is the variable that generates markets. Common export promotion instruments the externality or market failure, and the tax subsidy are export subsidies, export promotion zones, and rate will be the rate that has the optimal effect. Any subsidized credit (sometimes tied to export targets). tax subsidy other than the optimal tax subsidy causes Product market interventions to promote competi- what Corden (1974) called by-product effects, which tion in domestic markets include competition poli- impose undesired costs elsewhere in the economy. cy (to ensure fair competition between domestic The economywide effects of intervention in one players as well as for foreign players) and domestic industry also need to be borne in mind. One way to market entry regulations. do this is to focus on the effective rate of protection, Factor market interventions include policies such as which takes account of the impact of a tariff on performance requirements and restrictions on FDI both inputs and outputs. For instance, a tariff on an designed to influence the operations of foreign affili- input will cause the effective protection of the ates so that the host country realizes a net benefit downstream user to decline (see Box 17.1). from FDI (UNCTAD 1999a). Factor market interven- Another economic argument for government tions in the capital market and the financial sector are intervention--what is known as the second-best aimed at correcting financial market imperfections, argument for tariffs or subsidies for some goods-- promoting infant industries, and protecting or phas- has to do with the presence of "unremovable" dis- ing out declining industries. These measures include tortions in the form of tariffs or other import setting up development finance institutions, provid- protection.4 In practice, intervention to correct ing direct capital subsidies to selected industrial enter- such distortions poses several problems. First, it is prises, furnishing capital subsidies and capital not clear why the preferable (first-best) policy of assistance to declining or mature industries and pro- removing the distortion cannot be implemented. viding priority access to credit (often at subsidized Second, the correct determination of the second- rates) by requiring financial institutions to lend to 150 Industrial Policy and Developing Countries B O X 1 7 . 1 N O M I N A L A N D E F F E C T I V E R AT E S O F P R O T E C T I O N The nominal rate of protection (NRP) can be trade prices is the same, except that in this case defined as tariffs do not exist (the value of t is 1). For example, suppose 1 ton of steel is worth NRP = (P ­ P*)/P* US$1,000 on the world market. To produce it, a where P is the domestic tariff-inclusive price of a factory has to buy 1 ton of iron ore at a world good and P* is the free trade price. As the latter price of US$600. Assume, for simplicity, that noth- cannot be observed in practice, most empirical ing more is needed for steel production. Under studies take the world price as a measure of P*. these circumstances, the value added per ton of The effective rate of protection (ERP) can be steel in the factory will be US$400. If a 20 percent defined as the proportional increase in value nominal tariff rate is imposed on steel imports and added per unit of a good produced in a country there is no tariff on iron ore, the effective rate of in relation to value added under free trade (no protection in those circumstances will be protection). The magnitude of the ERP depends (1,200 ­ 600)/400 = 1.5, or 50 percent. not only on the nominal tariff on the final prod- uct concerned but also on the tariffs applied to The ERP in this example is more than double the the inputs used and the importance of those 20 percent NRP on steel. If no tariff is imposed on inputs in the value of the final product. A simple steel but a nominal tariff of 33 percent is imposed formula for calculating the ERP is on imports of iron ore, the ERP would be ERP = (V ­ V*)/V* [1,000 ­ (600 + 200)]/400 = 0.5, or ­50 percent. where V is the domestic value added per unit of This example illustrates that an NRP of zero the final good (including the tariffs on that good does not necessarily imply that trade is undistort- and on its inputs) and V* is value added under ed. As another example, assume that cocoa free trade. Value added per unit, in turn, is beans account for 95 percent of the production defined as the gross value of output minus the cost of cocoa butter. The imposition of a 5 per- cost of inputs used in production: V = tfPf ­ tiPiX, cent nominal tariff rate on cocoa butter would where tf and ti equal 1 plus the tariffs on the final then imply an effective rate of protection for the good and on inputs, respectively; Pf and Pi are the cocoa butter industry of 100 percent. prices; and X is the amount of input used to pro- duce a unit of the final good. Value added at free Source: Hoekman and Kostecki (2001). particular sectors or types of companies. Intervention in the external environment. For the sake of con- in the labor market may have efficiency and equity creteness, this section focuses on examples from objectives. The former have to do with human East Asia, but much of what is said applies to all resource development through education and train- developing countries. ing; the latter include minimum wage requirements Industrial policy in East Asia has evolved over the and social safety net schemes. past three decades (Table 17.1) as import substitu- Box 17.2 gives examples of the types of industrial tion has given way to export orientation and, subse- policy instruments used in the Republic of Korea and quently, to development of a knowledge-based Japan in the early phase of their industrialization. infrastructure. Shifts in policy approaches and instruments have been influenced by internal fac- tors such as the size of the market, the need to adjust Evolution of Industrial Policy to adverse shocks, the ineffectiveness of import- The approach to industrial development and the substitution industrialization strategies, and the range of instruments used have evolved over time as need to attract FDI for technology and to gain mar- a result of changes in development paradigms and ket access. Policy has also been influenced by exter- 151 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E B O X 1 7 . 2 . I N S T R U M E N T S O F I N D U S T R I A L A N D E X P O R T P R O M O T I O N P O L I C I E S E M P L O Y E D I N T H E R E P U B L I C O F K O R E A A N D J A PA N Export Promotion and Import Restrictions Product and Factor Market Interventions · Import restrictions, both general and specific · Lax enforcement of competition policy, · Preferences for particular sectors and, in some including the extensive use of cartels cases, particular firms in export promotion · Government creation and promotion of con- · Export targets for specific firms as conditions glomerates (Korea) for the provision of subsidies (Korea) · Tax concessions to corporations to increase · Interest rate subsidies and credit and foreign investment exchange availability for favored firms that · Promotion of a close, long-term relationship meet export targets between finance and industry (which was crit- · General export promotion through JETRO ical to the implementation of the industrial (Japan) and KOTRA (Korea) policy) · Provision of infrastructure, including human · Labor repression to ensure labor peace in a capital, in support of exports period of structural change (Korea) · Tax relief on imported inputs and for research · Establishment of state industries to enhance and development expenditures industrial development (Korea) · Permission to favored conglomerates to import · Extensive administrative guidance. capital goods and foreign technology and to raise cheaper finance on international markets. Source: Adapted from Singh (1996). nal factors such as increased competition, techno- restructuring. The main challenge for many East logical change, pressures from major trading part- Asian developing countries is to maintain tradition- ners to become signatories to GATT codes, al comparative advantage (based on unskilled and multilateral rules negotiated under the WTO, and low-cost labor and on resources) while building up the financial crisis that erupted in 1997. new sources of comparative advantage and "gradu- Rapid changes in transport, communications, ating" to higher value added production embodying production, marketing, and distribution technolo- more technology and human capital. gies, as well as management processes, have acceler- To address the structural issues faced by East ated globalization and reduced traditional Asian countries, a number of policy responses are comparative advantage in mass production. The appropriate, many of which have been adopted by production of components and parts, and final pro- governments. One is to maintain competition in the duction itself, are increasingly outsourced or spread domestic market. Imports can influence productivi- among different locations on the basis of cost and ty through embodied technology and can be an market considerations. The decentralization of pro- effective way to assimilate new techniques and duction and production processes that occurred in knowledge (see Chapter 34, by Saggi, in this vol- the 1990s in East Asia provides a strong example of ume). Other factors conducive to exports are the how the region has been integrated through trade promotion of FDI and participation in internation- and investment linkages. Technological develop- al production networks; appropriate macroeco- ments will continue to be an important source of nomic policy; efficient infrastructure and pressure for continuous industrial restructuring. supporting services; and policies to enhance human The decline in export growth before the crisis, in capital and technological capability, such as research part stemming from structural factors such as and development, education, and creation of indus- declining competitiveness and low productivity trial clusters. East Asian countries have, in general, growth, also points to the need for industrial shifted their focus on such complementary policies 152 Industrial Policy and Developing Countries Table 17.1 Evolution of Industrial Policies in East Asia, 1950s­1990s Economy 1950s 1960s 1970s 1980s 1990s 1965­76 1977­78 1980s 1990s China Defense/industry Plant Coastline Infrastructure (heavy industriali- importation liberalization High zation) (light industries) technology 1950­ 1979­ 1990s Hong Kong EO (laissez-faire, education, infrastructure, institutional Improved Upgraded (China) support) institutional support for support for technology industry 1967­73 1974­85 1986­ Indonesia Stabilization Strong IS Liberalization Beginning IS EO 1950­58 1959­ 1967­ Mid-1980s Japan IS EO Liberalization Deregulation International- ization 1961­72 1973­79 1980­ 1990s Korea, Rep. EO EO Liberalization Deregulation of IS (heavy (trade, invest- since mid-1980s Industry) ment, finance) (innovation oriented) 1950­70 1971­85 1986­ Malaysia Moderate IS Continued IS Liberalization Added EO EO 1950­ 1980s 1990s Philippines IS Continued IS Liberalization Continued (political liberalization instability) (strengthened political stability) 1950s 1960s­1980s 1990s Singapore IS (while EO Strategic still part independence of Malaya) (high tech- nology and services) Regionaliza- tion 1953­57 1958­80 1986­ Taiwan IS EO Liberalization (China) 1961­71 1971­86 1986­ Thailand IS IS (capital goods, EO beginning in 1981) Technology- intensive industries Some EO Note: IS, import substitution; EO, export orientation. Source: Masuyama, Vanderbrink, and Chia (1997): table 1.1. 153 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E and now endeavor to provide an environment con- countries with incomes per capita above $US1,000 ducive to the development of competitive industries and lays out rules for the use of countervailing and to enhance the economy's flexibility in measures to offset injury to domestic industries responding to changes. Table 17.2 provides a sum- caused by foreign production subsidies.8 The SCM mary of the policies pursued by East Asian agreement covers financial contributions made by economies just before the 1997 financial crisis. The or at the direction of a government that provide a response to that crisis reinforced the need for a benefit to a specific enterprise, industry, or region.9 more comprehensive approach to policy reform, to Subsidies that are conditional on exports are pro- some extent mandated by IMF reform packages. hibited, as are subsidies that encourage the use of Countries not supported by IMF programs have domestic rather than imported inputs. Taking also been induced to pursue similar reforms. 5 action against subsidies requires a determination that subsidies exist and have a negative effect on the trade of another member. This is done by showing Multilateral Rules Regarding Use of that there is harm to another member in the form of Industrial Policy Instruments injury, serious prejudice, or impairment and nullifi- An important question concerns the extent to cation of benefits.10 The SCM agreement and its which WTO provisions constrain the policy mea- provisions relating to developing countries are dis- sures that members can use to protect domestic cussed in greater detail in Chapter 18, by English suppliers and promote exports and transfer of tech- and De Wulf, in this volume. nology. This section contains brief summaries of The SCM agreement has important implications the major WTO rules regarding industrial policy for industrial policy. Take, for example, the case of instruments. Many of these are discussed in greater Korea, which has been notorious for its use of tar- depth in other chapters of this book. geted subsidies. Before 1995, Korea offered 26 dif- ferent types of subsidies, totaling about 2.5 trillion won per year. In 1995 it reduced the number to one Tariffs, Antidumping, and Safeguards subsidy to small and medium-size enterprises, only Most developing countries have undertaken tariff 15.2 billion won in amount (WTO 1996b). In con- reduction programs in the past two decades. They trast to the voluntary Subsidies Code negotiated have also undertaken to bind many of their tariffs, during the Tokyo Round, all countries are bound by although frequently at relatively high tariff rates the WTO agreement, and the SCM agreement that provide considerable scope for raising applied extends to subnational governments. It should be tariffs (see Chapter 54, by Francois and Martin, in noted, however, that the disciplines on subsidies this volume). Although the average level of tariff constrain primarily export subsidies; constraints on protection has declined, there continue to be peak production subsidies are weak. For developing tariffs in "sensitive" industries in both industrial countries, the SCM agreement is a two-edged and developing countries, and the dispersion of sword: it contains a number of loopholes that allow protection remains substantial in many countries.6 them to continue to use subsidies to promote indus- Import protection can also be imposed through trial policy objectives, but these also apply to indus- antidumping or safeguard measures, which are trial countries. Thus, developing countries have no often used by industrial countries to protect declin- prospect of using subsidies to gain a competitive ing industries. The WTO Antidumping Agreement advantage vis-à-vis industrial countries. imposes disciplines on the use of antidumping by countries and contains a number of provisions The Agreement on Trade-Related Investment Mea- aimed at reducing the extent to which antidumping sures can be used against developing countries that are trying to develop their exports.7 Under the Trade Related Investment Measures (TRIMs) agreement, a number of investment per- formance­related measures that have an effect on Export Promotion and Export Subsidies trade were to be notified and eliminated by January The Agreement on Subsidies and Countervailing 2001 (January 2003 for least-developed countries). Measures (SCM) prohibits export subsidies by The trade-related performance requirements that 154 esY -- -- -- No -- -- esY esY -- -- esY seY esY esY seY seY (continued) Japan Kong seY o o N No -- No N No seY seY -- -- -- -- -- seY -- esY (China) Hong No seY esY o N esY seY Fall esY -- seY -- -- -- esY esY seY o o N N Indonesia esY esY seY seY o N No No seY seY -- seY seY esY o N seY No seY seY Singapore of seY o o N No No N No No esY esY seY esY esY seY seY esY esY esY esY Korea, Rep. esY seY No esY seY -- -- seY -- seY seY No esY seY seY seY seY Partly Thailand seY esY esY seY esY o N allF -- esY -- esY esY o No N esY esY esY No Philippines Asia in No seY seY esY -- -- -- seY seY -- seY seY No seY seY seY seY No Bangladesh Exports esY esY esY -- esY esY -- esY esY esY esY esY esY esY esY esY esY esY Malaysia Promoting for India seY seY seY -- Fall Fall Fall seY -- seY seY seY -- seY seY seY seY seY Measures policy and production targeting y y regulations depreciation Policies R&D affecting incentives rates subsidy marketing assistance development industr protection training subsidies/facilities for measure measures controls assistance 17.2 and of subsidy Measures Strategic/domestic Export Import Price Investment Credit concessions Holiday/exemptions Reduced Accelerated arrangements ableT ypeT 1. Industrial General Specific/industr Support Manpower Investment Deregulation axT Production Input Assistance Pricing Regional Adjustment 155 o N esY esY o o o N No N N seY esY No esY seY seY No esY esY Japan (China) seY seY seY seY o o No N N No seY No seY A esY esY o No N Hong MF Kong seY esY esY esY esY o o N N No esY No esY seY seY No seY esY ndonesiaI seY seY seY o N seY o o N N No seY No seY esY No No No seY Singapore of seY esY esY o N esY o o N N No esY No esY seY No No No No Korea, Rep. seY seY seY seY seY seY seY No seY No seY No esY two others others Thailand On A, A, MF MF seY esY esY esY esY No esY No esY esY esY o others others inimal N No A, Philippines M A,F MF M seY seY seY o N seY A esY seY No seY seY seY seY seY esY AF M MF Bangladesh seY esY esY o N esY o N No No esY esY esY esY esY o o others N N Malaysia A,F M India seY seY seY seY seY seY No No seY seY seY seY seY seY seY A MF inputs exports zones and II. exports management prices imported subsidies on formance affecting Arrangement. requirements restraints annex y (continued) affecting finance insurance quality per cash cartels promotion export licensing prohibitions taxes/levies quotas (1996): measure drawback/tax Multifibre 17.2 incentives guarantees requirements organizations of Export Export Export Export-processing Export Export Export Export measures oluntarV A, available. Singh exemptions MF Measures Duty Registration Export Export Export Minimum Export ce: ableT ypeT Not 2. Export Other -- Note: Sour 156 Industrial Policy and Developing Countries must be removed include local content and trade- industrial policy. This has happened to some extent balancing requirements, both of which are and have with bindings in tourism, but not in other sectors. been important policy instruments of industrial From an industrial policy viewpoint, liberaliza- policy. Some developing countries have yet to notify tion in the area of infrastructure is extremely and phase out these measures, and many are seeking important for developing countries. Given that the to extend the length of the transition periods. Many disciplines on subsidies and performance require- developing countries are also strongly resisting any ments are forcing developing countries to think of extension of the list of prohibited TRIMs in future more neutral ways to develop export capacity (Laird negotiations. (See Chapter 19, by Bora, for a more 1997), improvements in infrastructure--in particu- comprehensive discussion.) lar, in telecommunications, financial, and transport services--constitute an important mechanism for improving competitiveness. Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) Infant Industry Protection Perhaps more than any other WTO agreement, implementation of the TRIPS agreement involves GATT Article XVIII, Sections A and C, allows substantial changes in national legislation and members that are in "early stages of development" strengthening of enforcement institutions. The to use trade barriers to protect domestic industry. required strengthening of protection of intellectual Section B of Article XVIII affords developing coun- property rights (IPRs) has implications for indus- tries flexibility in imposing trade measures to pro- trial policy. In the case of domestic firms, it implies tect their balance of payments. Before the Uruguay both a need to and greater incentives to innovate Round, little use had been made of Section C, on and compete dynamically; reverse engineering and infant industries, in part because the use of this imitation have become less feasible. For foreign provision requires the payment of compensation firms it means that, where permitted, market access and in part because developing countries had few through a commercial presence may become more tariff bindings. Instead, many countries used Sec- attractive as IPR protection improves. Given that tion B, which does not require compensation and developing countries do not in general have a com- which provides leeway for selective intervention. parative advantage in innovation, attracting FDI as The WTO has tighter balance of payments disci- a means of transferring and diffusing technology is plines that constrain the scope and duration of this important for them. Thus, TRIPS implies a greater exception (Singh 1996: 166). As tariff bindings need to improve FDI policies. An important provi- expand, developing countries may have to rely sion for developing countries from an industrial increasingly on Article XVIII, along with safe- policy perspective is TRIPS Article 66.2, which guards and domestic subsidy programs, to protect requires industrial countries to support technology domestic industries. transfer to least-developed countries. So far, little is known about the extent to which this provision has Special and Differential Treatment been implemented (UNCTAD 1999a). The WTO has numerous "special and differential" (S&D) treatment provisions in favor of developing General Agreement on Trade in Services countries, and there is scope for S&D treatment in The General Agreement on Trade in Services the application of industrial policy under each of (GATS) allows sectoral commitments (bindings) to the agreements mentioned. In addition to transition be made for the four modes of supplying services: periods allowing for delay in implementation, some cross-border, consumption abroad, commercial agreements (such as those on SCM, safeguards, and presence, and movement of natural persons. antidumping) include exemptions and less strin- Through the inclusion of commercial presence as a gent disciplines for developing countries. There is mode of supply, rules on foreign investment in ser- mounting concern on the part of developing coun- vices have now become part of the multilateral trad- tries, however, that these provisions do not suffi- ing system. Members can therefore use foreign ciently promote their interests and are not being investment liberalization commitments as tools of implemented (UNCTAD 1999a). 157 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E Implications of WTO Rules for Industrial ronment that is conducive to investment and inno- Policy vation. Moreover, because development of the man- ufacturing and resource-processing sectors depends Some common features of the agreements that dis- on the existence of an efficient services industry, cipline the use of government policy to promote regulatory reform and liberalization must span the particular industries deserve to be highlighted in services sector. order to understand the impact on industrial policy Multilateral rules are developing in line with the instruments under the present agreement, as well as shift toward the use of more generic policies for in the future. promoting industrial development. Since export First, the agreements take a trade, not a balance of subsidies can no longer be used to promote exports, payments, approach to disciplining policies. Since policy should move in the direction of reducing fis- nondiscrimination is the cornerstone of the WTO cal and procedural constraints on exports (Laird system, any nonborder policy that affects trade in 1997), trade facilitation, and implementation of goods and services (that is, by resulting in discrimi- non-sector-specific (generic) policies to make the nation) is subject to discipline or requires an country more competitive. The effect of the WTO exemption. rules is not to eliminate the role of government but Second, the rules are ownership neutral. Apart to shift its emphasis toward the supply side. Policies from the GATS and TRIPS, in which a national related to infrastructure, human capital formation, treatment standard is applied to covered invest- innovation, and diffusion of technology are now ments, disciplines on policies such as subsidies and critical for export competitiveness. These policies local content protection do not distinguish between need to be complemented by stable exchange rates foreign affiliates and domestic enterprises. What is that do not penalize or favor exports and by a com- important is the "trade effect" of the instrument. petition policy that promotes rivalry among pro- This means that countries seeking to apply a partic- ducers that contest the domestic market, including ular policy to foreign-owned firms must find a pro- foreign companies. These are generic prodevelop- vision in an agreement that allows the use of the ment policies that are not confined to--and do not policy; they can then apply it to a foreign firm as favor--particular industries or producers. long as there is no "trade effect." The appropriate response to fears of anticompeti- Third, policies for promoting industries tive behavior by foreign companies is not to impose (designed to stimulate investment or export performance requirements and restrictions but to growth) are restricted to generic instead of specific put in place an effective national competition law to policy instruments. This has the effect of leveling ensure fair competition. Many countries have the playing field for international trade by not begun to introduce or are preparing to introduce allowing countries to develop specific industries competition laws. The crucial issue here, however, is through specific policy instruments. having the right institutions and mechanisms, able Finally, the approach to S&D treatment in the to implement the law objectively and to conduct the WTO has typically been limited to transitional necessary investigations. Given capacity constraints, arrangements, complemented by de minimis provi- this process will take time in many developing sions (see Chapter 49, by Oyejide, in this volume). countries. It is therefore important to focus on lib- eralization of trade in services, domestic regulatory Conclusion reform, FDI, and other factor markets and to ensure that policies in these areas are subject to WTO rules Shifts in development paradigms, technologies, and and disciplines. One advantage of the WTO rules in multilateral rules imply that an effective and WTO- this context is that they are neutral between foreign consistent industrial policy for developing countries and domestic producers, helping to ensure that in the 21st century must be comprehensive, rather domestic and foreign producers are able to compete than target specific sectors. Recognition of the on equal terms. importance of complementary policies for ensuring There is still considerable scope for using indus- competitiveness has shifted the policy focus toward trial policy instruments such as tariffs (within enhancing the efficiency of infrastructure, improv- bound rates); subsidies for regional development, ing human capital formation, and creating an envi- R&D, and the environment; and export promotion 158 Industrial Policy and Developing Countries measures such as credit and insurance schemes at second-best set of tax subsidies. Discussion of other second- subsidized rates, concessional tax and duty provi- best instruments such as local content can be found in Rodrik (1987); Greenaway (1992); Chao and Yu (1993); Richardson sions, and export-processing zones. Developing (1993); Morrissey and Rai (1995); and Moran (1998). For a countries intending to use such policies (or seeking discussion of export subsidies, see Harris and Schmitt (1999). to extend transition periods to allow the use of 5 In the case of the crisis-affected countries that were under an other, WTO-inconsistent policies) need to assess the IMF program--Indonesia, Korea, and Thailand--the reforms extent to which policies favoring particular produc- undertaken have been comprehensive in terms of liberalization ers are in their national interest. At the same time, of market access in goods and services, and for FDI and com- the appropriate transition period for changing to a petition policy. Implementation is still at issue, but the steps more generic policy stance needs to be based on a taken have been dramatic. realistic assessment that reflects the country's devel- 6 It is useful to distinguish between sunset and infant industries. opment strategy and the need to build up institu- The former are industries that are declining; the latter are tions, capacity, and capability. Finally, the pursuit of industries that are expanding and, owing to market failures, industrial policies needs to be subjected to the crite- require protection from competition. ria identified at the beginning of this chapter: clear- 7 See Chapter 22, by Finger, who notes that these instruments ly defined objectives; a determination that the are increasingly being used by developing countries; see also policy instrument is the most appropriate one for Laird (1997). meeting the objective; and implementation that 8 The agreement applies only to nonagricultural products; the responds to clear criteria and is transparent, prefer- WTO Agreement on Agriculture contains separate, and more ably with clear performance and exit requirements. comprehensive, disciplines on agricultural subsidies. 9 The agreement contains a list of types of measures that would be considered to be financial contributions: grants, loans, equi- Notes ty infusions, loan guarantees, fiscal incentives, and the provi- This chapter draws on Bora, Lloyd, and Pangestu (2000). sion of goods and services. Since a government is defined to include any public body within the territory of a member, sub- 1 Martin and Mitra (2001) show that the productivity growth national governments, public bodies, and state-owned compa- rate in agriculture is higher both on average and for groups of nies are covered. The definition of a benefit has not been fully countries at different stages of development. resolved in cases where indirect financial contributions are involved. 2 For a discussion of how foreign ownership matters in the con- text of development, see UNCTAD (1999c). 10 Injury is defined as harm to a domestic industry caused by sub- sidized imports into the territory of the complaining member. 3 See Kemp (1964) for the first careful statement of the infant Serious prejudice is defined as adverse effects in the market of industry argument; also see Baldwin (1969). the subsidizing member or in a third market. Nullification of 4 See Lipsey and Lancaster (1956) for the first theoretical exposi- benefits can arise when improved market access resulting from tion; see Lloyd (1974) and Hatta (1977) on the nature of the a bound tariff reduction is undercut by the subsidy. 159 18 P H I L I P E N G L I S H L U C D E W U L F Export Trade Promotion Organizations Development The creation of the Internation- al Trade Centre (ITC) in the Policies and mid-1960s led to the establish- ment of export promotion or trade promotion organizations Institutions (TPOs) in many countries. These were to be "focal point" institutions to assist exporters in penetrating foreign markets. The TPOs have largely been state organs that provide com- M mercial intelligence, market any countries, at all levels of devel- research, services to foreign buyers, group promo- opment, have made use of policies tions, and advice on shipping, transport, and pack- designed to promote exports. Sometimes these aging. Some TPOs also administer incentive policies are intended to offset distortions created schemes, train exporters, provide export licenses, by other policies, such as an overvalued exchange and engage in investment promotion. rate. They may also be motivated by market fail- A consensus has emerged that, except in a few ures--for example, asymmetric information, cases (Australia, Finland, Ireland, New Zealand, and which means that potential exporters do not know Singapore), TPOs have not lived up to expectations. about market opportunities and cannot obtain The experience with TPOs suggests that there are access to finance. Almost all countries maintain seven characteristics or elements that determine policies to ensure that exporters are not subject to whether they are likely to be effective. double taxation; thus, duties and taxes collected on inputs embodied in exported goods are gener- 1.An overall incentive framework that is favorable to ally rebated. This chapter deals with aspects of exports. TPOs can only function well if the overall export development policies, including trade pro- incentive framework is not stacked against motion organizations, matching grants, duty exports. They can overcome some antiexport bias drawback and temporary admission schemes, of the incentive system, but there are limits, and export-processing zones, and trade finance. The the fact that many TPOs operate in an environ- intention is not to be exhaustive but to discuss ment characterized by a strong antiexport bias in cross-country experience, identify good practices part explains their failure. The antiexport bias fre- in these areas, and assess the WTO-compatibility quently stems from an overvalued exchange rate, of such policies. a tariff structure that provides high nominal and 160 Export Development Policies and Institutions effective protection, nontariff barriers resulting ship" of the problem and its solution to the from dysfunctional customs practices and poorly exporter community. Thus, trust is important. designed quality control mechanisms, the absence Although--since country circumstances differ-- of trade finance, costly infrastructure services there is no single model for such a partnership, (roads and ports), and excessive bureaucratic many recommend that TPO boards have a major- control of trade procedures. Special mechanisms, ity of recognized exporters and be headed by a such as export-processing zones, duty drawbacks, well-respected business leader of acknowledged and temporary admissions, can be devised to integrity. For example, in the Philippines the pri- shelter exporters from the worst effects of import vate sector is represented on the Export Develop- protection, and export-financing facilities can ment Board by a private accredited export help compensate for the lack of a well-function- organization, which rotates every three years and ing financial system. Even if these mechanisms are which has to coordinate the private sector posi- made to work well, however, they cannot substi- tion and defend it before the board. In Finland tute for the establishment of a truly export- the export promotion strategy is a joint venture friendly incentive system. between the government and the private sector 2. Autonomy of operations. The TPO must be able to and is designed and executed on the basis of a influence policy, mobilize the resources and ser- consensus among government, industry, and vices needed to support an export drive, and labor. These examples contrast with the reality in deliver these services when and where required. most developing countries, where very few TPO This argues for a flexible and autonomous institu- heads have significant export experience. tion that operates with top-level political support, 4. A balance between offshore and onshore objectives. and maintains close formal and informal links Export promotion means promotion of competi- with public and private sector actors. Such a TPO tiveness and goes to the heart of how business is can react quickly to new requests and changing done. Competitiveness has to do with pricing; circumstances without having to obtain time- quality standards; the ability to interface with new consuming clearances and permissions. An business modes that emphasize timeliness of autonomous TPO is more likely to enjoy the con- delivery, outsourcing, and business-to-business fidence and mutual trust that is required to relations; and availability of supportive infrastruc- engender and sustain a supportive relationship ture services (telecommunications, finance) and with the business community and overcome the of quality domestic inputs. The traditional TPO suspicion or conflict that often dominates rela- emphasis on offshore activities--information tions between the state and the private sector. In gathering, market research, trade representation, reality, most TPOs operate under the trade min- fairs, and the like--ignores much of this agenda. If istry, which is often badly positioned to deal with TPOs were to focus on being attentive to supply the main issues that affect external competitive- conditions, they would address firm-specific sup- ness and has little power to mobilize the necessary ply bottlenecks faced by potential exporters resources. As public agencies, most TPOs are through well-targeted enterprise support. A well- handicapped in influencing exporters or arguing designed matching grant program could help against public policy that hurts them. reduce production costs and enhance output qual- 3. A demand-driven strategy. The private sector ity (Box 18.1). Such a scheme may well be run by should play a dominant role in defining, imple- other entities, but the TPO can be an advocate for menting, and monitoring the TPO strategy. it. Helping enterprises obtain International Orga- Although the government must set the ground nization for Standardization (ISO) certification is rules of the export "game," it is the private sector another example. In general, instances abound in that does the exporting. (The export performance which consultant advice can lower production of public enterprises has often been dismal.) costs and wastage. Such enterprise services can be Export promotion is not an analytical issue; diag- supplied by both private and public providers, but nosis of the problems is usually relatively straight- the two should compete on equal terms, and the forward. Bringing the solution home is more emergence of private sector services providers complex and requires the transfer of the "owner- should be encouraged. Enterprise support should 161 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E B O X 1 8 . 1 M AT C H I N G G R A N T S C H E M E S T O P R O M O T E E X P O R T S Disillusionment with the performance of trade examine these questions was conducted for a promotion organizations has led to experimenta- scheme in Mauritius, which happened to be one tion with other techniques of export develop- of the most successful as measured by its apparent ment. Among these are matching grants: effect on exports (Biggs 1999). The study con- projects proposed by individual firms receive cluded that nearly half of the firms assisted would grants that have to be matched with the firm's have carried out their projects anyway and that capital. The justification for these schemes is gen- the existence of externalities could not be proved. erally that there exist exporting firms that would For example, little new demand was generated for like to increase their exports and nonexporters local suppliers who might then have been in a that would begin to export were it not for lack of better position to serve other exporters. The eval- crucial information and services--for example, uation called for better targeting of beneficiaries. information about export markets, production This leads to a second issue: the selection techniques, packaging and delivery require- process. Some analysts argue that a targeting ments, and product standards. It is also usually approach will introduce bureaucracy and asserted that these firms underestimate the bene- increase the scope for discretion, slowing dis- fits of successful exporting, or overestimate the bursements and undermining the momentum risks, and therefore are unwilling to undertake necessary to build a market for services suppliers. the necessary effort and investment. Hence, there They defend the first come, first served approach, is a case for reducing their exposure to risk by which is the one almost always applied in prac- supplementing the investment they are willing to tice. Judging, however, by the rate of disburse- make through a grant. The case for a grant ment across schemes, the momentum effect has (rather than a loan or an equity infusion) is based not been good. on the premise that external benefits will accrue A third question concerns the cost-effectiveness to other firms and to the economy in general as a of the schemes, including the effect of firm size. result of the grant-receiving firms' export success. The administration and monitoring of grants are Such benefits operate through demonstration easiest when grants are large and few in number. effects, increased awareness of and interest in the The task becomes almost impossible when there country on the part of foreign buyers, and trans- is a very large number of small grants. This cre- fer of knowledge and experience acquired by the ates a dilemma because it is likely that larger firms innovating firm through labor turnover. Another applying for larger grants are least in need of increasingly important objective is to spur the them and are most likely to undertake the project development of specialized services providers in any case. This was confirmed in the Mauritius that can be beneficial to all sectors of the econo- evaluation. my. Some matching grants are therefore made Finally, it is difficult to insulate the grant available to these services suppliers, as well as to process from local lobbies and political pressures. potential exporters. There are plenty of anecdotes among practition- Various questions have been raised concerning ers concerning misuse of grants, especially of for- matching grant schemes. First and most impor- eign travel that was, in practice, only marginally tant, it is not clear whether they have actually devoted to such purposes as contacting foreign increased exports and generated external bene- buyers and exploring other export opportunities. fits. Generally, exports have increased significant- In the future, more attention needs to be paid ly, but this does not justify either the program or to the economic justification for such schemes, in the subsidy element; there needs to be evidence particular to ensure that there are not bigger pol- of additionality (the firm would not have exported icy or institutional obstacles that impede new as much without the grant) and of positive exter- exporters. When grant schemes are introduced, nalities (other firms have benefited indirectly). governments need to have a clearer understand- One of the few in-depth evaluations that tried to ing of their rationale, as well as an appreciation of 162 Export Development Policies and Institutions B O X 1 8 . 1 ( C O N T I N U E D ) the need for autonomous and streamlined man- that once the project has begun, its implementa- agement. The focus should be on small and tion will not be slowed. medium-size enterprises, and more resources should go to services suppliers. The targeting Source: Prepared by the volume editors, based on issue should be addressed in the design stage so Phillips (2001). be well targeted with respect to producers, com- Fee-based services may also lead to underprovi- modities, and markets. In the short term, existing sion of public goods (externalities) that such serv- exporters should be targeted, while selective sup- ices may generate: improvement of the country's port for potential exports may constitute a good image abroad, overall quality enhancement of medium-term target. Many TPOs have wasted industry, strengthening of the foreign exchange resources on firms with little or no export poten- reserve position, and so on. The funding prob- tial. In many successful exporting countries, small lems of some TPOs have come about because of and medium-size firms have proved to be power- dwindling budget allocations, requirements to ful innovators and exporters, and such firms may transfer fees raised to the treasury, and piecemeal benefit the most from well-targeted support. and badly structured donor financing. 5. Quality staffing. Staffing is crucial for the success 7. Evaluation of the results. The effectiveness and of a TPO. A good TPO must be able to pay salaries efficiency of TPO activities must be periodically that are similar to those paid by the private sector evaluated so that policymakers can learn from to talented staff with business experience. In most experience, refine strategies, and avoid self-per- cases TPO staff operate under civil service rules petuating activities. It should be kept in mind, that make discipline and accountability difficult however, that the process of evaluating these ser- and all too often imply unattractive pay and low vices is not an exact science. The impact of TPO motivation. Civil service staffing practices bring activities may well be felt after some delay, and bureaucracy into the TPO, with the result that exports are affected by many variables, only some staff often do not have the requisite commercial of which are under the control of the TPO. experience to interact efficiently and credibly Nonetheless, the export performance of the econ- with the private sector. A partial solution to this omy as a whole, as well as that of the enterprises problem could be to give TPOs greater autonomy which have benefited from the services of the in setting recruitment and salary standards and to TPO, can be documented and can be supplement- draw on the expertise of external consultants. ed by client surveys and reviews of the business 6. Adequate funding. A sustainable TPO should have plans of the enterprises. adequate revenues, derived mainly from domestic sources. Donor support can play a useful role in Duty Drawback and Temporary Admission starting up the TPO, demonstrating the returns to be gained from good TPO work, and bringing A number of economies that have experienced rapid best practice to bear, but such support should be growth in trade and GDP did so in the context of temporary and should be followed up with suffi- trade regimes characterized by significant import cient domestic resources. Much is to be gained by controls on the domestic market. The Republic of charging fees for services rendered because fees Korea, Taiwan (China), and Japan (in the early act as a rationing mechanism and ensure that the stages) are the main examples. The key to under- services provided are valued by the recipient. standing these experiences is to look at all the factors There are, however, clear limits to levying fees. that affect competitiveness and the incentives to pro- Some potential exporters will not have the neces- ducers to export or not. Protection creates incentives sary resources or will not fully appreciate the to sell to the domestic market; that is, it creates a bias services offered until they succeed in exporting. against exports. Protection of intermediate products 163 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E and services seriously handicaps export industries inputs and components, including machinery, at because it raises their costs to levels that are higher world prices through duty drawback or temporary than those of their potential competitors in world admission schemes. markets. As Shatz and Tarr discuss in Chapter 3 in this volume, the effect of protection on the real Benefits and Shortcomings of the Schemes exchange rate also discourages export industries. The East Asian countries managed elaborate systems Duty drawback involves repayment of duties paid that offset the bias against exports. A key element of on imported inputs that are used in the production these systems was to allow exporting firms to import of exports (Box 18.2). A problem with duty draw- B O X 1 8 . 2 D U T Y D R AW B A C K F O R D I R E C T E X P O R T E R S : T H E C H I L E A N C A S E Refunds of duties and indirect taxes on imported subsidy element. The maximum rate of subsidy is inputs used in export production can be made in around 6 percent, corresponding to the 10 per- two ways. Individual drawback systems refund cent drawback rate (which applies if exports are taxes actually paid. Fixed drawback schemes refund less than US$10 million for the entire tariff line). taxes on the basis of an estimate of the duties and The magnitude of the subsidy depends on the indirect taxes that enter into the cost of production extent to which imported inputs are used. of exports. Processing of rebate claims is generally This simplified drawback offers moderate and based on the ratio of inputs to exported outputs-- self-extinguishing subsidies for new export prod- known as input-output coefficients. These may be ucts. It is especially valuable for small exporters, self-declared by exporters or predetermined by the who may find it costly to access the regular draw- authorities, who use standard coefficients uniformly back scheme. It has emerged as an important for all exporters. The latter is more appropriate in export incentive: in 1994 the state paid a total of countries with weak legal regimes and weak US$150 million under the simplified system, administrative capacity. In many countries a major compared with just US$26 million on the regular source of delay in granting rebates is that authori- drawback. Although no careful econometric ties apply ad hoc checks, question the coefficients studies have been done on the impact of the sim- claimed by exporters, or do not (cannot) apply plified drawback on the emergence of new pretabulated standard input-output coefficients. exports, after its introduction the number of The Chilean experience with drawback provides exported manufacturing products and the values an example that could be replicated in other exported grew rapidly. Given the construction of countries. Since the mid-1980s, two duty draw- the scheme, many of the exports were "new" back systems have been in use: a regular draw- and were thus likely to be associated with exter- back, in force since 1988, under which duties on nalities related to information gathering. Over imported inputs used by exporters are rebated ex time, as exports grow, such externalities disap- post, and the so-called simplified drawback, intro- pear. This makes the automatic elimination of the duced in 1985 for nontraditional exports. The subsidy, once exports of the item exceed US$20 simplified plan applies to exports of goods that million, an attractive feature of the scheme. have not yet reached the level of US$20 million Although Chile will have to eliminate this subsidy for a given tariff line. For such exports, exporters by 2002 to comply with WTO rules (see Box 18.3, receive a cash subsidy of 3, 5, or 10 percent below), countries with a per capita income less (depending on the total value of exports for the than US$1,000 would be allowed to implement tariff line concerned) on their export value in lieu similar policies under Annex VII of the WTO Agree- of a regular drawback. Although the scheme has ment on Subsidies and Countervailing Measures. been justified on the grounds that it makes life easier for small exporters, it does in fact contain a Source: Agosin (2001). 164 Export Development Policies and Institutions back schemes is that their administration can be ners. Indirect tax rebate and drawback schemes are costly and can lead to cumbersome procedures and not considered export subsidies if they do not result delays when tariffs are high. The empirical evidence in rebates in excess of what was actually levied on suggests that in countries without well-functioning inputs consumed in the production of the exported public administrations, duty drawback is ineffec- product (see Box 18.2).1 Normal allowance for tive. Drawbacks are very difficult to administer at waste must be made in findings regarding con- tariff rates of more than 15 or 20 percent because of sumption of inputs in the production of the export- leakage, delays in payment, and fraudulent claims ed product. Drawback or duty suspension systems (Mitra 1992). Delays are particularly detrimental to on capital goods do, however, constitute an export small and medium-size enterprises and small- subsidy if they are conditional on exporting. farmer organizations. On receipt of a complaint that an indirect tax Temporary admission (also called duty suspen- rebate or drawback scheme acts as a subsidy sion) can be more effective in allowing tariff-free through overrebate or excess drawback of charges access to intermediate inputs for exporters in these on inputs consumed in the production of an situations. Temporary entry regimes do not involve exported product, the investigating authorities of payment of duties on imported inputs; rather, they the importing country must determine whether the allow entry on a duty-free basis with a requirement government of the exporting country has in place that firms document ex post that the imported and applies a system or procedure to confirm which inputs have been used in the production of exports. inputs are consumed in the production of the The main potential problem with this approach in exported product and in what amounts. Where such low-income countries with weak administrative a system or procedure exists, its reasonableness, capacity is leakage of goods into the economy (that effectiveness, and consistency with generally accept- is, the goods are not used for export production). A ed commercial practices in the exporting country frequently employed option for controlling such must be determined. To the extent that the proce- leakage is the bonded warehouse or, on a larger dures are determined to meet this test and to be scale, an export-processing zone, as described effective, no subsidy should be presumed to exist below. These are specific territories that are con- (Hoekman 1995). trolled by customs. Imports into these territories are Where there are no monitoring systems, or where not taxed on entry, but goods are taxed if they are these systems are not applied effectively, a determi- sold on the domestic market. nation of the actual inputs involved in the produc- Programs such as duty drawback and temporary tion of the exported good must be made, including admission, if properly administered, allow exporters a "normal allowance for waste." Determination of duty-free access to imported intermediates. To avoid whether the claimed allowance for waste is "nor- antiexport bias more completely, these schemes mal" must take into account the production must be extended to indirect exporters (firms that process, the average experience of the industry in do not themselves export but that sell to exporters). the exporting country, and other appropriate tech- Administration of such mechanisms is substantially nical factors. The existence of a substitution draw- more complicated, however, as most schemes in back provision under which exporters are allowed developing countries exclude small producers and to select particular import shipments on which indirect exporters. The experience of many develop- drawback is claimed cannot of itself be considered ing countries with drawback and temporary entry to convey a subsidy. Excess drawback of import has been mixed. Notably, the institutions needed for charges is deemed to exist if governments have paid effective implementation of duty drawback systems interest on any monies refunded under their draw- have been shown to be ineffective in most Sub-Saha- back schemes, to the extent of the interest actually ran African countries (World Bank 2000a). paid or payable.2 Requirements under WTO Rules Export-Processing Zones It is important that drawback mechanisms be Export-processing zones (EPZs) are enclaves within designed in a WTO-consistent manner to avoid the which governments attempt to provide a policy imposition of countervailing duties by trading part- environment and associated infrastructure that are 165 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E conducive to investors seeking to produce for policies. Experience suggests that investors weigh export.3 In a sense, EPZs are akin to duty drawback economic and political stability, labor skill compati- and temporary admission customs regimes except bility and productivity, and other similar factors that they are limited to a certain geographic loca- carefully. Incentives such as overgenerous tax pack- tion. Many, however, go beyond these customs ages or legal investment assurances may not attract regimes by addressing infrastructure and related the right type of investors (or any investors at all). issues. EPZs are generally used to achieve three Furthermore, forgoing tax revenues may be expen- goals: promotion of investment and employment in sive, especially if major public investments are made export-oriented production; increased foreign to develop the zone. exchange earnings from nontraditional exports; and When well set up and well managed, EPZs have encouragement of foreign direct investment (FDI) led to income generation and employment creation, in countries where legal, administrative (red tape, especially opportunities in nontraditional jobs for corruption), and infrastructure-related weaknesses women in the formal sector. In Bangladesh most impede investment in exportables. An added objec- employees in EPZs are women; for example, 70 per- tive is the transfer of technology and know-how cent of the employees in the Chittagong EPZ are from the EPZs to the rest of the economy. female, a much higher ratio than the national aver- EPZs are a second-best solution compared with age (ILO 1998). EPZ employment is seen by many generalized economywide reforms, but where coun- as an important factor in reducing the proportion trywide reforms are difficult to implement, they can of female poor in the Dominican Republic, from be a useful instrument in the development arsenal of 22.6 percent in 1986 to 15.8 percent in 1993. Wages governments confronting large reform agendas. They in EPZs tend to be higher, on average, than wages in allow the public and private sectors to cooperate in the rest of the country. creating the preconditions for efficient export pro- EPZ experiences range from the success stories of duction in a small geographic region, as opposed to Mauritius and Mexico to several failed zones, as in pursuing reforms and undertaking investment on an Senegal. EPZs in Mauritius managed to create more economywide basis. One of the most successful than 90,000 jobs in 1991, or 17 percent of national examples is Mauritius, where, in the mid-1990s, EPZs employment. Mexico's maquilas employed about generated more than two-thirds of gross exports and 900,000 workers in 1997, and the sector is among employed one-sixth of the work force. Net foreign the highest generators of foreign currency (second exchange earnings as a percentage of gross vary wide- to oil in 1992). By contrast, the Senegal EPZ ly, from a high of 63 percent in the Republic of Korea employed only 600 workers in 1990 and exported and Taiwan (China) in the mid-1980s to a low of 12 just US$15 million. Most experience with EPZ percent in Jamaica. The more developed the local experiences falls between these two extremes. In the economy, the higher the net foreign exchange earn- Philippines in 1996 the 4 public and 43 private EPZs ings, since backward linkages are greater. had approved investments totaling over US$2.5 bil- Effective EPZs combine clear private property lion, employed more than 150,000 people, and rights and investment regulations, no restrictions exported US$6.5 billion worth of goods. Nonethe- on foreign exchange, tariff-free imports for export less, the high exports have not meant greater back- production, moderate levels of taxation, stream- ward linkages with the domestic economy; these lined administrative procedures, and private sector generally depend on economywide reforms. The management. Public provision of basic infrastruc- consequence has been high import dependency, low ture outside the zone--telecommunications, roads, net exports (41 percent), and low net foreign and ports--can have positive spillover effects for exchange earnings. the local and national economies by facilitating eco- Attempts to use EPZs in Africa have, except in nomic activities. However, development of EPZs, Mauritius, been much less successful than else- including provision of infrastructure and manage- where. Some argue that the basic concept is flawed. ment, should be privately handled. Blame has also been placed on Africa's lack of ade- The success of an EPZ is highly dependent on a quate infrastructure and services to support the hospitable host country economic environment. business community, on the timidity or ignorance EPZs have tended to work better when the country of investors, and on the lack of indigenous entrepre- pursued sound macroeconomic and exchange rate neurs. Important reasons for the disappointing per- 166 Export Development Policies and Institutions formance of African EPZs include government are typical features of EPZs, could, in principle, be interference and the distortions introduced in the contested, to the extent that they represent subsidies operation of free trade and capital regimes. In Sene- to companies that are required to export most, if gal excessive administrative red tape and strict labor not all, of their output. Countries currently relying laws were responsible for the failure of the EPZ. The on EPZs would do well to seek clarification on their Gambia, too, has a highly regulated labor market, compatibility with WTO rules and so preempt the which raises port loading and unloading costs possibility of future disputes. sharply. These problems are not unique to Africa; similar shortcomings have undermined the EPZs in Trade Finance Jamaica and Panama (although Panama's has suc- ceeded as a free trade zone). Export finance is one of the primary constraints Quality of infrastructure is a major determinant inhibiting exports in many low-income developing of success. When the Colon Free Zone in Panama countries. Inadequacies may result from the overall was starting up, there was a good port in Colon and weakness of the financial sector, or it may reflect a reasonable road to the airport in Panama City. The difficulties in assessing the creditworthiness of Dominican Republic developed excellent air, sea, traders or the fact that traders do not have sufficient and road transport infrastructure in support of its assets to be judged creditworthy. Small firms and EPZs. Mauritius also has excellent port and airport the poor may face special difficulties in obtaining facilities. By contrast, with a few notable exceptions, access to the trade credit they need, just as they face much of Africa's transport infrastructure is in poor difficulties in accessing other parts of the financial condition. Parastatal operating companies often sector. Although ensuring the availability of trade provide poor services; economic conditions have finance is a matter that needs to be left to the private impeded public investments; and budgetary prob- sector, governments can use a number of mecha- lems have shortchanged basic maintenance. nisms to promote access to finance, especially for The establishment of a successful EPZ program smaller firms. requires simultaneous removal of most, if not all, of Two mechanisms that are sometimes used are for- the bottlenecks in infrastructure, the customs ser- eign currency revolving funds and preshipment vice, and labor regulations. A country must master export finance guarantee schemes. The revolving the creation of a probusiness environment, the pro- funds provide finance for imported inputs needed vision of infrastructure and services, international for export production. An exporter must obtain a marketing, and investor relations--and master letter of credit from a buyer; this letter allows the them all at the same time. Watson (2000) concludes exporter's bank to access the fund's foreign that the management of the socio-political-eco- exchange to pay for the imports. The guarantee nomic process of bringing about change on a broad schemes cover exporters' manufacturing nonper- front is the key constraint on success in Africa and formance risks and are generally targeted at smaller elsewhere. The reform process requires the presence firms and new entrants into the export area that of four critical factors: vision, consensus, concerted have difficulty in satisfying banks' collateral require- action, and continuity. Watson goes on to argue that ments but have obtained export letters of credit. it is typically easier for a weak state to start coordi- Note that preshipment export finance guarantees nating its actions on a small scale through an EPZ are not export credit insurance schemes; the latter while it works on nationwide reforms. insure against nonpayment by foreign buyers. EPZs are not defined or referred to in the WTO Another, more recent mechanism used by a number agreements. To the extent that subsidies are provid- of countries is grants that are conditional on match- ed through EPZs, however, the rules of the Agree- ing contributions by enterprises (see Box 18.1). ment on Subsidies and Countervailing Measures All these mechanisms for alleviating trade finance apply. Restrictions on export subsidies could constraints can be designed to comply with WTO impinge on countries' ability to employ EPZs in rules. What matters under the WTO is whether pro- future. This is especially true for countries with vision of the subsidy is conditional on exporting. As income per capita of more than US$1,000 (see Box discussed in Box 18.3, export subsidies are prohibit- 18.3, below). Lower tax rates, special credit facilities, ed for WTO members with per capita incomes and publicly provided infrastructure, all of which above US$1,000. This dimension of WTO rules is 167 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E actively enforced by members. Subsidized export craft, in which the panel found that Brazil's financ- financing has given rise to a number of disputes in ing terms for foreign buyers of its Embraer aircraft the WTO, including cases against developing coun- were illegal export subsidies. Most cases in this area tries. An example was a case brought by Canada have, however, been brought against industrial against Brazil's export financing program for air- countries. Examples are the U.S. tax treatment of B O X 1 8 . 3 S U B S I D I E S , T H E W T O , A N D D E V E L O P I N G C O U N T R I E S The types of subsidies used by governments to tries to offset the effects of foreign subsidy pro- support economic activities include direct pay- grams are not abused. A subsidy is deemed to ments or grants, tax concessions, soft loans, and exist if there is a financial contribution by a gov- government guarantees and equity participation. ernment (or public body). This may involve an They may be firm- or industry-specific, or they actual or potential direct transfer of funds (such may be generally available. In practice, it may be as grants, loans, equity infusions, or loan guaran- difficult to determine whether a subsidy is, in tees), forgoing of government revenue (tax con- fact, specific. Subsidies that are sector-specific cessions or credits), or the provision or purchase (say, to health, education, or transport) may have of products other than general infrastructure. economywide objectives. Conversely, subsidies Government funding of a private body to carry that are economywide in scope may be effective- out a function that would normally be vested in ly industry-specific. An example is the pursuit of the government, and any form of income or price an environmental objective the attainment of support, is also covered by the definition. In all which requires taxes or subsidies that primarily these cases the measure must confer a benefit on affect specific sectors such as the chemical or the the recipient or recipients. The General Agree- automotive industry. ment on Trade in Services (GATS) contains no subsidy disciplines for services (see Chapter 32, WTO Rules regarding Subsidies by Sauvé); special rules apply to agriculture, as The WTO rules concern specific subsidies, since discussed in Ingco and others (forthcoming). economywide subsidies are presumed not to dis- Until recently, three categories of specific subsi- tort the allocation of domestic resources with dies were distinguished in the agreement: pro- regard to tradables. A subsidy is considered non- hibited, actionable, and nonactionable. There specific if eligibility for, and the amount of, the were three types of nonactionable subsidies: subsidy is determined by objective criteria. An those provided to support research, to aid disad- example would be subsidies that focus on firms of vantaged regions, and to facilitate the adaptation a particular size (micro or small and medium-sized of plants to new environmental regulations. How- enterprises). The subsidy must not be conditional ever, as there was no consensus in the Commit- on export performance or the use of domestic tee on Subsidies and Countervailing Measures to inputs, in which case it is deemed to be specific. extend the relevant provision beyond 1999, this Equally, a subsidy that is limited to an enterprise, provision--and thus the category of nonaction- industry, or enterprises within a designated geo- able subsidies--is understood to have lapsed. graphical region is considered to be specific. There Currently, therefore, specific subsidies are either are, therefore, four types of specificity within the prohibited or actionable. meaning of the WTO Agreement on Subsidies and Subsidies that are contingent--either formally or Countervailing Measures (the SCM Agreement). in their effect--on export performance or on the The WTO subsidy rules attempt to strike a bal- use of domestic over imported goods are prohibit- ance between the need to agree on minimum ed, except for some developing countries, as noted standards regarding those subsidies that may not below. An illustrative list of export subsidies be used because they distort trade and the need annexed to the WTO SCM Agreement cites the to ensure that measures used by importing coun- provision of products or services, including trans- 168 Export Development Policies and Institutions B O X 1 8 . 3 ( C O N T I N U E D ) port, for use in export production on terms more from a command to a market economy were per- favorable than for use in the production of domes- mitted to apply prohibited subsidy programs, and tically consumed goods. The list also cites export debt forgiveness was not actionable. Least devel- credits and guarantees or insurance provided at a oped countries (as defined by the UN) and certain cost that is inadequate to cover the long-term oper- other countries with a GNP per capita below ating costs and losses of the insurer, unless, where US$1,000 are exempted from the prohibition on export credits are concerned, a WTO member export subsidies.* In the case of this latter group, applies the interest rate provisions of the OECD once their GNP per capita reaches US$1,000, non- Arrangement on export credits. If a dispute settle- conforming subsidies must be eliminated within ment panel finds that WTO members are using eight years. Developing-country WTO members at export or import substitution subsidies, the remedy or above the threshold income level are subject to will be a requirement that the measures be with- a standstill requirement and must also phase out drawn, generally within a three-month period. their export subsidies by January 2003. All devel- Actionable subsidies are those that are permit- oping countries may request a further extension of ted but may, if they cause adverse effects to the this phaseout period, and certain developing interests of a WTO member, give rise to consulta- countries are eligible for an extension for particular tions, invocation of dispute settlement proce- export subsidies under procedures adopted in dures, or the imposition of countervailing duties November 2001. If an extension is granted in by the affected importing country. Adverse either case, annual consultations with the Subsi- effects include injury or threat thereof to a dies Committee must be held to determine the domestic industry, nullification or impairment of necessity of maintaining the subsidies. Developing tariff concessions, or serious prejudice to the countries that have become competitive in a prod- country's exporting interests. Serious prejudice uct--defined as having a global market share of at may arise if the subsidy reduces exports of other least 3.25 percent--must phase out any export WTO members, results in significant price under- subsidies over a two-year period. cutting, or increases the world market share of Under the GATT, developing countries were the subsidizing country in a primary product. free to use export subsidies. This is no longer the case under the WTO. The introduction of the pro- Provisions Affecting Developing Country Members hibition on export subsidies has implications for Developing countries benefit from higher de min- countries approaching the $1,000 per capita imis thresholds in countervailing duty investiga- income threshold that assist firms in penetrating tions of their products by trading partners. If the new markets through, for example, advertising subsidy is less than 2 percent of the per unit value campaigns or matching grant schemes. Such of products exported, developing countries are schemes could be regarded as export subsidies if exempt from countervailing measures (whereas the provision of the grant element is made condi- this figure is 1 percent where a product from an tional on exports. industrial country member is under investigation). An exemption also applies if the import market * A formula has been established to adjust this thresh- share of a developing country under investigation old income level, originally set in 1994, to account for is less than 4 percent, provided that the aggregate inflation. share of all developing countries under investiga- To be eligible for an extension under these proce- tion with shares less than 4 percent is below 9 per- dures, the developing country's share of world mer- cent of total imports. chandise export trade must be no greater than 0.10 Special provisions for developing and transition percent, and its gross national income for 2000 must be economies are included in Articles 27 and 29 of at or below US$20 billion. the SCM Agreement. Through December 2001, WTO members in the process of transformation Source: Editors, based on Hoekman and Kostecki (2001). 169 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E so-called foreign sales corporations (FSCs), under relevant to other low-income countries (Harrold, which U.S. firms with exports that have at least 50 Jayawickrama, and Bhattasali 1996): percent U.S. content can reduce tax burdens by 15 to 30 percent, and the preferential government · Support for on-the-job training, through payroll loans on noncommercial terms granted by Aus- tax refunds rather than subsidies, as well as for tralia. In both instances dispute panels found that public training institutions that are demand the measures violated WTO rules (Hoekman and driven Kostecki 2001). · Technical assistance to enterprises for access to technology and design skills and for development of external markets Conclusion · Export credit support mechanisms, especially Much has been made of the extent to which some preshipment finance high-performing East Asian economies used export · Development of simple duty-exemption schemes promotion policies to support their impressive · Development of industrial parks and export-pro- export drives and of the fact that some of these mea- cessing zones. sures are no longer available to latecomers. It is true that the rules of the game have evolved. Yet it is also None of these, with the possible exception of true that many governments have tried and failed to EPZs, currently present problems in the context of replicate various elements of the East Asian model of the WTO. export promotion--sometimes at considerable More fundamental to replicating the East Asian expense in terms of government revenue and misal- success are an unequivocal commitment on the part located resources. Furthermore, poor countries can of government to working with the private sector in ill afford to engage in competitive subsidization of the pursuit of joint goals and a long-term vision that their exports, which will often benefit relatively rich places export development at the heart of the nation- consumers abroad, and they will inevitably lose out al development strategy. Many countries have yet to in any such contest with richer countries. It is clearly establish these basic preconditions, without which in their interest to discipline the use of export subsi- microeconomic interventions are likely to be wasted. dies. Export industries are still often taxed implicitly, if not explicitly, by inefficient government services or Notes poorly functioning markets. There is plenty of work 1 Indirect tax rebate schemes allow for exemption, remission, or to be done on these fronts, and there is an ample deferral of prior-stage cumulative indirect taxes levied on range of instruments compatible with WTO rules inputs that are consumed in the production of the exported that developing country governments have yet to product. Drawback schemes allow for the remission or draw- master and that would go a long way toward reduc- back of import charges levied on inputs that are consumed in the production of the exported product. ing the antiexport bias in their economies. In a review of the lessons from East Asia for 2 This rule strengthens the incentive to use temporary admission African trade and industrial policy, five priorities and duty waiver mechanisms rather than drawback. were identified at the project level that are equally 3 This section draws on Madani (1999) and Watson (2000). 170 19 B I J I T B O R A Trade-Related The Agreement The fact that there is a separate Investment text called an "agreement" is a paradox. In essence, all the Measures TRIMs agreement does is to clarify the application of GATT Articles III.4, on national treat- ment, and XI.1, on quantitative restrictions. It does not even define a trade-related invest- ment measure. Instead the approach that was taken was to A include an illustrative list of lthough it is only five pages long, measures that are inconsistent with these two key the WTO Agreement on Trade- paragraphs of the GATT. The list covers both Related Investment Measures (TRIMs) has become TRIMs that are mandatory or enforceable under a central issue in the debate on the relevance to domestic law and measures for which compliance is developing countries of the multilateral trading necessary to obtain an advantage. There is no text agreements and the WTO. A combination of factors that specifically addresses issues related to granting led to the inclusion of investment in the work pro- national treatment to investors. gram of the Uruguay Round negotiations. These The agreement allowed for a notification period of included a changing perception of the role of for- 90 days, beginning January 1, 1995, for WTO mem- eign direct investment (FDI) in development and bers to notify the WTO of measures that were not in the intense debate on the linkage between GATT conformity with the agreement. After notification, a rules and foreign investment policy stemming from member was allowed a transition period, the length the U.S.-Canada dispute on Canada's application of of which depended on its level of development, to performance measures to foreign firms.1 Despite an bring its laws into conformity with the agreement. ambitious start to the negotiations, the final text Developing countries were allowed five years; least- was limited in scope and coverage. developed countries were allowed seven years. The purpose of this chapter is to assess how well The agreement is a rather modest attempt at dis- the TRIMs agreement has been implemented and ciplining policies that are targeted at foreign enter- to identify lessons or issues that may be relevant to prises, and it was the outcome of conflicting the mandated review of the agreement and to the positions about the extent to which investment future multilateral trade negotiations on invest- issues should be covered by the WTO. In the ment called for in the 2001 Doha Ministerial Decla- Uruguay Round, many developing countries resist- ration. ed the extent to which market access for foreign 171 S E L E C T E D T R A D E P O L I C I E S A F F E C T I N G M E R C H A N D I S E T R A D E firms would be covered. As a result, the negotiations was some variance in the approach taken in the focused on policies that applied to the operations of application of these policies. The automotive indus- foreign firms. Even then, the negotiations proved try was the one most frequently subject to such difficult, as there was no agreement on whether or policies, but some members applied local content not a specific policy instrument was trade distort- schemes in a general fashion across all industries. ing. Furthermore, some developing countries took The second most prominent sector was agriculture. the position that they should have access to policy Thus, in the context of notification it would seem instruments that could be used to offset any per- that the agreement worked well in that approxi- ceived negative effects associated with the opera- mately 20 percent of the WTO membership gave tions of transnational corporations (Mashayeki notification that they had adopted policies which 2000). contravened the agreement. (After all, an agreement When the TRIMs agreement is compared with which imposed disciplines but resulted in no mem- other investment provisions, or with plurilateral bers notifying that they had policies inconsistent attempts at investment rules, including nonbinding with these disciplines would not add much to the ones such as those of the Asia-Pacific Economic international trading system.) None of the coun- Cooperation (APEC) or the World Bank Guide- tries, however, were developed or least-developed lines, it falls considerably short in terms of coverage. countries. Furthermore, some developing countries Nevertheless, as a multilateral instrument, the complained that the notification period was too agreement has allowed investment issues to be dis- short and that a country which was unable to notify cussed in the context of multilateral negotiations. in the time allowed would not be able to enjoy the These discussions have continued through the benefit of the transition period.2 Working Group on Trade and Investment (created in 1996 at the WTO ministerial meeting in Singa- Disputes pore), where members have further explored the linkages between trade, FDI, and development. Given that any member can initiate dispute pro- ceedings against any other member, it makes little sense to simply add up the number of disputes. Implementation Using that approach, one would find that 16 No established template exists with which to evalu- requests for consultation were initiated, with 2 pro- ate the implementation of an agreement. Neverthe- ceeding to an actual dispute panel. The problem less, there are some sensible criteria that can be here is that one WTO member may find itself adopted. For example, is the agreement neutral with defending a particular policy against a number of respect to its application? Has it been successful in other members. This was the case of the notifica- terms of both avoiding and settling disputes? The tions against Indonesia, when Japan, the European responses to these questions will be taken up below Union (EU), and the United States each filed notifi- in the context of three issues: notifications, disputes, cations citing the same policy. Similarly, Japan and and adequacy of the transition periods. the EU filed notifications against Canada. Once this double counting is allowed for, only seven coun- tries--four developing countries and three indus- Notification trial countries--had to defend their policies. The TRIMs agreement allowed any member access An interesting aspect of the notifications for dis- to an extended transition period for bringing its pute is that in each case the complaint listed other policies into compliance with the agreement, if and policies in addition to those that were claimed to be only if these policies were notified within 90 days of inconsistent with the TRIMs agreement. This is an the commencement of the agreement. Twenty-six important point in that it reflects on the use of mul- members, all developing countries, notified a vari- tiple types of measures in the context of general ety of policies. The economic characteristics of industrial policy objectives as opposed to an isolat- these countries varied considerably. The most com- ed or targeted use of intervention. The complaints mon policy adopted by these countries was local always listed as additional areas of conflict GATT content schemes, and the second most frequently articles and also the Agreement on Subsidies and used policy was foreign exchange balancing. There Countervailing Measures (SCM). In one recent case 172 Trade-Related Investment Measures the Agreement on Trade-Related Aspects of Intellec- tract between the government and a firm included a tual Property Rights (TRIPS) was cited. 3 policy that was not in compliance with the TRIMs Two of the notifications, against Canada and agreement, but the policy's removal would have had Indonesia, could not be resolved outside the dispute legal consequences for the government. settlement mechanisms and had to proceed to panel The most often cited reason for requesting exten- reports. In both cases the complainants were indus- sions was the financial crises that some developing trial economies: Japan, the EU, and the United countries suffered in 1997­98. Argentina, Malaysia, States in the first case, and Japan and the United the Philippines, and Thailand each cited economic States in the second. The decision in each case went crisis as a primary reason for requesting an exten- against the defending party and required it to bring sion, since the reforms needed to comply would its laws into conformity with the TRIMs agreement. exacerbate the structural adjustment problems stemming from the crisis. Colombia and Pakistan each gave specific development reasons for their Adequacy of the Transition Periods requests. Colombia noted the difficulties in trans- The transition period for developing countries to forming its economic model, especially in substitut- implement the TRIMs agreement expired on ing away from illegal crops, which, it argued, would December 31, 1999. Although the agreement did require a domestic absorption or local content poli- not specify a deadline for requests for extension, by cy to ensure that farmers were able to sell their legal May 31, 2000, nine requests had been lodged with produce. Pakistan asserted that TRIMs conformity the WTO. In March 2001 Egypt formally filed a might be contrary to its development interests; request, bringing the total to 10. In general, there- opening the economy to import competition would fore, the record for implementation for the TRIMs prevent the country from exploiting domestic agreement is not too bad; approximately a third of resources optimally or promoting transfer of tech- the members that notified policies were not able to nology, employment, and domestic linkages. Pak- comply in time. This does not mean that serious istan also asked for a minimum period for implementation problems do not exist. There are extension, not a maximum. serious problems, but they differ substantially from Another reason cited for requesting an extension the type of implementation problems in the TRIPS was the interaction between preferential trade and the Customs Valuation agreements. In the agreements and multilateral obligations. Argentina, TRIMs case, the drafting of legislation to repeal in its request, specifically noted the importance of local content schemes is fairly simple and straight- negotiations within the context of the Southern forward, and there is no substantive technical need Common Market (MERCOSUR) Common Auto- in this regard. motive Policy. Mexico did not specifically mention There appear to be two issues related to transition the North Ame