Given the end of the Doha Round as we have known it, a major rethink of the WTO’s tariff-cutting approach is in order.
What might tariff liberalisation negotiations for emerging economies look like if economists, instead of actual trade policy negotiators, established the agenda and negotiating priorities?
The dominant terms-of-trade theory of trade agreements provides a compelling and simple insight that has shaped our understanding of the post-war trading system. In the absence of international cooperation, governments set import tariffs that impose economic costs on trading partners. The tariff drives down the price that the partners’ exporters receive for selling their goods in international markets; the costs arise because the importer has market power. This is referred to as the ‘terms-of-trade externality’.
In the absence of a trade agreement that imposes discipline over trade policy, the government of each individual country with market power would levy such a beggar-thy-neighbour tariff. The result is the classic, terms-of-trade driven prisoner’s dilemma.
The World Trade Organization (WTO) can potentially solve the prisoner’s dilemma by facilitating reciprocal policy actions. However, the solution may not result in trade that is completely free. An elegant design feature of the WTO is recognition that every country is not only an importer – and thus an imposer of externalities – but also an exporter – and thus a sufferer of such externalities. The WTO works by getting one country to cut a tariff on its imports just as its trading partner is reciprocally cutting a tariff that affects its exports.
A second and crucial implication of the theory, however, is that the continued existence of non-zero applied tariffs is not, by itself, evidence that the WTO’s reciprocal, match-making performance is incomplete. The WTO’s performance is only incomplete if tariffs remain high because the importing country is continuing to exert its market power.
Under this theoretical framework, identifying emerging economy tariffs for the WTO to cut, would require evidence linking high tariffs with the importing country’s own market power.
Increasingly evidence finds that the WTO has been able to remove much, but not all, of the terms-of-trade externalities from the tariffs that its members impose. And this can be seen by looking deeply into the specific areas where emerging economy tariffs are frequently alleged to be “too high”.
Latest evidence suggests that the WTO may be best positioned to address the high applied tariffs for countries with substantial “tariff overhang”, which is defined as the difference between a country’s WTO legally binding upper-limit for its tariff and its currently applied tariff rate. Empirical evidence also confirms that a strong positive correlation continues to link applied tariffs and market power for these countries.
Earlier negotiating proposals floated the idea that countries simply bind their tariffs at currently applied rates in order to eliminate the tariff overhang. It is worth noting that this proposal would not address the problems.
After all, currently applied tariffs are “too high” because they do not take into consideration the terms-of-trade externality. Even if negotiations eliminated all of the tariff overhang, the beggar-thy-neighbour component to the applied tariffs for these emerging economies would still remain.
Hence, while the WTO may still have substantial tariff liberalising “work” to do, identifying precisely where the work is to be done may make for a more fruitful set of negotiations the next time around. On average, the evidence from economic research suggests a strong positive correlation remains between a number of emerging economies’ applied tariffs and their import market power.
Given this result, one proposal is to allow these emerging economies the same basic framework for reciprocal tariff cutting negotiations amongst one another, with the tariff cuts then extended to the full WTO membership. This is what happened when the GATT system was established in 1947 and the high-income countries successfully relied upon this framework during the subsequent decades up until the establishment of the Doha Agenda in 2001.
There are other practical reasons to bring these emerging economies’ applied tariffs into the ambit of future WTO negotiations. Only very few emerging economies are involved in the mega-regional clubs and they are certainly not a part of upcoming supra-regional negotiations. The WTO may be their own best bet at finding a forum to extract themselves from their current terms-of-trade driven prisoner’s dilemmas.
Leave a Reply