DEPUTY DIRECTOR-GENERAL ALAN WM. WOLFF

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The past as prologue

There was a time of economic crisis when the United States was in serious balance of payments difficulties.   In a number of product sectors, imports were flooding in, destroying manufacturing jobs.  One Asian country was considered the main source of the problem.  Government policy was very supportive of its major industries.  There was little to no transparency of the depth of government involvement.  National champions were created.  Technology transfer from countries originating innovation was a major concern.  The competition was often deemed unfair by foreign competitors.  The country transformed itself from lagging in industrial development to become a manufacturing powerhouse.  It was widely seen as being on its way to indisputable economic dominance for the next century. 

For the U.S. President, this posed a political challenge, the harm to his political supporters and the concerns in Congress required a visible response. For the Treasury, the problems were more extensive, and a much greater worry.  While the United States had a trade surplus, that surplus was dwindling.  American outlays for defense and foreign aid were high. In short, the U.S. was facing a balance of payments crisis. 

The dollar was at the time backed by gold, at $35/ounce.  The French government was cashing in its dollars.  Cargo planes were secretly ferrying gold out of Fort Knox, Tennessee, where American gold was stored, to Europe.  The nation’s gold supply was shrinking. That situation was unsustainable. 

The American president invoked national emergency powers which had been given in entirely different circumstances two generations earlier to a prior president by Congress.  The measure the Administration chose to employ was a unilateral 10% additional tariff levied across-the-board against all imports. Nearly all of America’s trading partners condemned the U.S. action as inconsistent with U.S. international obligations under internationally agreed rules.  Nor did its three largest trading partners welcome American demands made for nonreciprocal nontariff concessions.  For its part, the United States government judged that circumstances fully justified its actions.   

This episode took place in 1971.

What eventually happened?  Agreement was reached at the Smithsonian Institution on December 18, 1971, four months and three days after the import surcharge had been imposed.  The dollar was devalued, other currencies were revalued, and the import surcharge was lifted.  The international monetary system evolved within fifteen months to floating exchange rates, with currency values no longer tied to gold.

As for trade, there were no nontariff concessions made at the time by America’s major trading partners.  Instead, it was agreed in September 1973 to start a major new round of multilateral trade negotiations.  This initiative, dubbed the GATT Tokyo Round, led six years later to the first multi-party agreements to eliminate nontariff barriers – in the form of three codes -- government procurement, customs valuation, and product standards.  The international trading system became more open, more rules-based, and subscribed to by more countries.

This episode in post-World War II international economic relationships has some faint echoes in present circumstances, but it was dissimilar in many if not most of its key particulars. I include this historical episode here for only one reason and one reason only:  A crisis properly managed can lead to a positive outcome. 

In the mid 1980s, the dollar was again overvalued, Congress threatened trade restrictions and the White House was employed unilateral trade measures. Again, change was needed.  Currency values were re-aligned via the Plaza Accord in September 1985, and major new multilateral trade negotiations were launched one year later, culminating in much broader coverage of world trade by rules, and almost incidentally, the creation of the WTO. 

Not every imposition of unilateral trade measures results in a better world for trade, but it did so in these two instances.  The lesson: a crisis provoked by trade measures can provide opportunities.

The WTO’s birth was not the result of a lot of planning.  There was no Bretton Woods style conference convened with the idea of creating a new institution for world trade.  The Uruguay Round, the last multilateral trade negotiation, was convened in 1986 to increase the scope of global trading rules, in particular for services and intellectual property, and to provide greater trade liberalization.  But as the U.S. was again at the time of the negotiations (the mid-1980s to early 1990s) resorting to unilateral trade measures, relatively late in the negotiations, Canada and then the European Communities (EC) began to focus on the governance of the multilateral trading system. This effort, acquiesced in and ultimately embraced by the United States, became the World Trade Organization.  The WTO brought with it a major new element -- rules would be enforced through decisions reached by means of international dispute settlement, through decisions that could not be blocked by the losing party.

The WTO proved to be durable.  Its most severe test was the international financial crisis in 2008, and the rules held. There was no repeat of competitive erection of tariff walls, which had deepened and lengthened the Great Depression of the 1930s. To the contrary, since the WTO was founded in 1995, world merchandise exports have increased in value terms from $5.6 trillion in 1995 to $17.7 trillion in 2017 (by 3.4 times) and in volume terms, merchandise trade rose by a multiple of 2.6 times. When the Trade Facilitation Agreement, designed to reduce the bureaucratic friction of moving goods across borders, which entered into force two years ago, is fully implemented, it is estimated that it could cut trade costs by an average of 14.3%. As of a few days ago, 141 Members of the 164 WTO Members had ratified the Agreement, and the remainder plan to do so.

The setting

Macro-economic conditions, the gross level of demand, far outweigh national trade policies in determining the level of global trade. But what is done in the trade arena can up-end the plans and projections of governments, international and private financial institutions and cause major disruptions.  If the WTO does not function fully as intended, the result can shave a significant edge off the growth of the world economy, first directly, and then with secondary effects -- with less investment taking place and ultimately a fall in business and consumer confidence. 

So far, the primary threats to trade lie in the future.  Despite current trade measures between the U.S. and China and those imposed with respect to steel and aluminium, world trade is growing, not shrinking.  According to the WTO’s World Trade Report, global merchandise trade volume growth of 4.4% was achieved in 2018 as measured by the average of exports and imports, roughly matching the 4.7% increase recorded for 2017. In the WTO Report for 2018, growth was expected to moderate to 4.0% in 2019, below the average rate of 4.8% since 1990 but still firmly above the post-crisis average of 3.0%.  However, there were signs that escalating trade tensions were already negatively affecting business confidence and investment decisions.(1) 

The WTO downgraded its trade forecast last September amid escalating trade disputes and tighter credit market conditions. Trade growth is currently forecast to slow to 3.7% in 2019 from an expected 3.9% in 2018, but these estimates could be revised downward if trade conditions continue to deteriorate.  Alternatively, greater certainty and improvement in the policy environment could bring about a swift rebound in trade growth.(2)

In terms of effects on world GDP, current additional tariffs (U.S. - China and steel and aluminum tariffs) are reducing total world economic activity by just over ½ of one percent by 2020.  Were China and the United States to escalate the level of tariffs as is now threatened, world economic activity would drop further.  Add additional car and truck tariffs, were they imposed, together with a loss of confidence, and market reactions, and the loss is estimated at 0.8 %.  That is the equivalent of a loss of some $800 billion for the world.(3)

The bottom line: macroeconomic factors swamp microeconomic until the latter begin to cause sufficient upset that both work in concert, exerting downward pressure on global growth.  This could happen. 

The current challenges to the multilateral trading system

There are a series of headline-grabbing challenges to the multilateral trading system.  They can easily be listed: increased tariffs as part of the U.S.-China trade conflict, the loss of an agreed appellate function in WTO dispute settlement as of mid-December this year, and the national security cases (increased tariffs on steel and aluminium, and the responsive retaliatory trade measures).  But the main challenge had been the inability of the WTO to evolve, to modify itself to meet current needs of world trade. 

Overcoming paralysis

A response to this larger challenge has begun. The Buenos Aires WTO Ministerial meeting in December 2017 provided two important breakthroughs, and the promise of a third.  One was the beginning of a recognition that the WTO required reform. The other was the launch by like-minded Members of Joint Initiatives (not subscribed to by all Members, but open to all).  In addition, all Members pledged to rein in fisheries subsidies, which are detrimental to many coastal developing countries’ fishermen. 

The reform movement was heralded by the United States, setting forth its initial agenda at the WTO Ministerial Meeting in December 2017.  It consisted of proposals that (1) the WTO Members’ live up to their commitments to provide transparency, (2) there be a more considered use by WTO Members of claims of developing country status, and (3) that rectification occur of what it saw as “judicial” overreach affecting the rights and obligations of Members as negotiated.  There followed a reform movement with multiple components, a trilateral (Japan, U.S. EU) initiative on a number of subjects that are largely unregulated by the WTO:  disciplines governing state-owned enterprises, industrial subsidies and the creation of overcapacity, and forced technology transfer; as well as an Ottawa initiative on the workings of the WTO, and an EU-China dialogue.  Suggestions were tabled by China and Honduras as well.  The reform movement crystalized in a G20 mandate, with a progress report due in June at the leaders’ meeting in Osaka, Japan. 

The second innovation of Buenos Aires was the creation of four Joint Initiatives.  Interested Members joined together to discuss and eventually negotiate in areas of common interest: E-commerce, investment facilitation, domestic regulation of services, micro and small and medium enterprises, and improving the participation of women in trade.  Countries accounting for three-quarters of global GDP signed up for the Initiatives which are open to any Member.  Others actively participate.  What these efforts will deliver and the degree of their general acceptability will only be determined in the future.

The first stage of reform, which is just getting underway, is to draft proposals. The second is to drive them through to adoption.(4)  It is imperative that the momentum which is building not slow, nor ambitions become diluted, if the promise of this WTO-spring is not to be lost.  Success or failure will not cause market turbulence, but it will affect longer term world economic growth.

Within the trading system, the risk of failing at reform is disaffection, which in term can lead to solutions that are far from second-best. 

Immediate challenges:

  • The U.S.-China Trade Conflict
    I hesitate to use the term “war”, because even if the current U.S.-China confrontation is confined to commerce, there is far more damage that can still be inflicted by each side on the other in a full-scale economic war.(5)  Current circumstances however are still serious.  The estimated economic costs in gross terms have been outlined above, and for the world is not intolerable – global trade is still growing.  The true costs are not yet reckoned -- in changes in investment patterns and supply chains -- as well as in lost profits and higher consumer costs.  There are some negative indicators – a lower rate of growth in China (from trade restrictions but also from a number of domestic causes) and reports of disruptions in supply chains and markets from increased tariffs.  For example, Harley Davidson, whose profits have disappeared, has announced transfer of sourcing of what had been U.S. exports to non-U.S. production sites. 
    The likelihood is that the current restrictive trade measures taken in the form of tariffs are aberrations and are unlikely to become permanent.  This is not to say that there will not be continuing friction, including measures and countermeasures, between the U.S. and China for years to come.  The differing economic systems and the various means used to attain goals may well provide fuel for continuing discord until a new balance or modus vivendi, however temporary, is established.  The lesson of the rise of Japan was that commercial relations between it and the United States were not completely stabilized from the 1960s until the close of the 1990s.(6)
    The WTO is not the primary forum in which the U.S.-China issues are being addressed.  The two countries are attempting to resolve their differences bilaterally.  This is their right as both as sovereign nations and as WTO Members.  There are various mechanisms that the WTO offers which can be used, including dispute settlement procedures.  Beyond this, part of any settlement, even on an interim basis can include agreed rules of conduct defined and added to the WTO rules as part of the efforts at systemic reform. Doing so would hold the prospect of greater stability in the relationship over time.  At this time, there is little evidence that either party is contemplating WTO reform as part of the resolution of their differences.  This could change.  There are ideas being floated by the U.S., the EU, and Japan that could be considered in this context, including limits on industrial subsidies and an understanding on the commercial conduct of state-owed enterprises, among others.    
  • National Security and Related Retaliatory Tariffs
    A second challenge is how the trading system is affected by national security measures and retaliation against them.  Single product tariffs (aluminium and steel), and responsive tariffs, disrupt sectors of the economy, supply chains, and investment decisions, but do not have a major impact on world economic growth.  The larger economic risk stems from possible expansion of current tariffs and the possibility that other countries might emulate the policies of the current antagonists.  There is little or no evidence of risk of contagion at present, however.  Most of world trade by far continues to be conducted in accordance with the WTO commitments its Members have made. 
    WTO dispute settlement is charged at present with examining the WTO consistency of the current measures.  There is great sensitivity, of course, for any Member to allow a dispute settlement panel to instruct it on where the limits might be on its right to invoke the national security exception to the WTO rules.  It is an issue that has to date, in seventy years of WTO and GATT jurisprudence, never been litigated to a conclusion.  The problem was recognized in the drafting of the original “essential security” provision of the International Trade Organization, and the tension between freedom of access to the exception and the potential for abuse was never resolved.

The Brexit GAP

The UK Treasury estimate for the United Kingdom of going to the WTO level of market access from being in the EU single market is a loss of 8.6% or higher of GDP by the year 2035.  When the number came out, I asked a senior economist to do a back-of-the-envelope calculation of what this implies for the world economy, that is: what is the difference between the world having a single market and keeping the WTO as is.  The answer was a loss of GDP for the world of about $90 trillion cumulatively by 2035.  For shorthand purposes, we can call this the “Brexit Gap”.

No WTO Member has indicated the slightest desire for the creation of a global single market, but the Brexit Gap indicates how much remains to be done to achieve greater freedom for trade through improvements in the multilateral trading system.  Covering E-commerce, expanding the coverage of commercial services, opening markets up further to agricultural and industrial products, reducing domestic support for agriculture, limiting industrial subsidies, and a host of other matters can be addressed in multilateral agreements without seeking to make the world economy a single market.  It is worth making progress toward closing the global Brexit Gap. 

WHO IS DRIVING THE BUS?  Longer term reform

Many senior officials, including White House officials, speaking earlier this month point to the need for WTO reform.  They criticize the WTO for a failure to adapt to current circumstances.  It is worth the WTO’s Members examining the extent of a failure of WTO governance, broadly considered.  The WTO is presumed incorrectly to be a form of supra-national organization.  It is not.  But it has a series of characteristics (perhaps faults) that are very rare in the annals of human organization.  These are: that it has no executive branch, that the legislative function has not functioned since the founding of the institution with some significant exceptions, and that the “judiciary” has lost legitimacy in the eyes of at least one major member.  There are few examples of successful governance worldwide under these circumstances.  To some degree, it is reminiscent of the US Continental Congress, made up of very sovereign states whose perceived interests differed from each other.  It was not an effective form of governance.

There is no doubt that some consideration of any WTO reform effort must eventually look into basic questions of governance.  It is clear that demands which are all too common to take care of a proponent’s interests before it will consider the interests of others, individually or as a whole, is a recipe for stasis.  Preservation of equality is not productive if it prevents any multilateral progress.  All aspects of the institution require review, including the role of the WTO Secretariat, which might serve the WTO Members more effectively by monitoring and reporting on trade conditions and making proposals.

For decades the US led, at times jointly with the EU, followed by other geometries, including a quad, a “green room” of a representative group of key Members.  The institution at present has not found a clear organizational path forward to achieve a comprehensive agenda. 

The danger of a failure of governance for the multilateral trading system, for the WTO, is desuetude, disuse, being by-passed increasingly, largely through bilateral and regional deals.  Some regional arrangements are exactly that – attempts to increase regional integration.  The largest of these efforts at present is the African Comprehensive Free Trade Agreement.  Intra-continental trade is very low, at about 10%.  The AfCFTA can be a building block contributing ultimately to a stronger international trading system.

Regional trade agreements can also be laboratories for innovations that can be brought back to Geneva to be part of the multilateral trading system.  They can be as Jacob Viner intended, trade creating to a greater extent than trade diverting. However, there is no current systematic WTO analysis as to whether this is the case.  Anecdotally, one can see that much of the consideration of issues within the WTO for the E-commerce Joint Initiative draws on provisions already agreed in bilateral and regional agreements.  That is potentially a very positive development. 

Conclusion

For a body consisting of 164 sovereign countries (including the EU), the overall record of accomplishment is strong, including the avoidance of a major resurgence of protectionist measures during the 2008 financial crisis.  This was a major stress test for the international trading system, and it passed.  The system held.  To be sure, we do not know what the next recession will bring – the future is unknowable -- therefore reinforcing the rules makes good sense now. 

I am fully convinced that the multilateral trading system will endure, that it will be improved and that it will in fact thrive.  This conviction does not justify complacency.  The tasks at hand are enormous, but so are the opportunities for positive change.  The system is being tested as never before in its 70-year history, but there are sound reasons for optimism.

Most of world trade by far continues to be conducted in accordance with the WTO commitments its members have made.  Not one of the 164 Member countries has opted to leave the WTO.  On the contrary, twenty-two countries are in the queue seeking to join it. 

The dominant theme among the WTO Members is to make it stronger not weaker, to reform the WTO to make it more responsive to longstanding as well as new issues generated by technologies driving a rapidly evolving world trading system. 

As noted by Japanese Prime Minister Abe stated on January 23 at Davos:
I would like Osaka G20 to be long remembered as the
summit that started world-wide data governance. . . under the roof of the WTO.  In Society 5.0, it is no longer capital but data that connects and drives everything, helping to fill the gap between the rich and the less privileged . . . . We have yet to catch up with the new reality, in which data drives everything, where the D.F.F.T., the Data Fee Flow with Trust, should top the agenda in our new economy.

As long as the WTO remains relevant, it will play the central role in the world trading system.

Notes:

  1. https://www.wto.org/english/news_e/pres18_e/pr820_e.htm back to text
  2. https://www.wto.org/english/news_e/news19_e/wtoi_19feb19_e.htm back to text
  3. em>Risks to global growth tilt to the downside. An escalation of trade tensions beyond those already incorporated in the forecast remains a key source of risk to the outlook. Financial conditions have already tightened since the fall. A range of triggers beyond escalating trade tensions could spark a further deterioration in risk sentiment with adverse growth implications, especially given the high levels of public and private debt. These potential triggers include a “no-deal” withdrawal of the United Kingdom from the European Union and a greater-than-envisaged slowdown in China.  World Economic Outlook, IMF, January 2019. back to text
  4. Andy Grove, co-founder of Intel Corporation, was fond of saying that “Inspiration without implementation is hallucination.” (This from recollection, so it may be paraphrasing the original.) back to text
  5. To put this in perspective, in December 1807, President Thomas Jefferson signed into law an Embargo Act prohibiting American commercial ships from entering any foreign port.  This was in retaliation for the French and British seizing American commercial ships. Even a full embargo, along with seizure of vessels is not remembered as a “war”.  That came later. back to text
  6. We can know what the bilateral U.S.-China trading relationship is for any given moment, but its direction, rate of change, and the timing of the next change are unknowable.  See for example the Heisenberg uncertainty principle or indeterminacy principle, articulated in 1927 by the German physicist Werner Heisenberg, that the position and the velocity of an object cannot both be measured exactly at the same time even in theory. The very concepts of exact position and exact velocity together, in fact, have no meaning in nature. https://www.britannica.com/science/uncertainty-principle. back to text

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