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Is there a future for the GATT in the new world economic order?

THE UP AND DOWN machinations of the Uruguay Round negotiations, and Lester Thurow's provocative declaration that "GATT is dead" have served to crystallize the opposing positions in the trade and industrial policy debate. Thurow, and others,(1) claim that the GATT multilateral approach is obsolete: it's time to throw in the towel on GATT, and concentrate instead on forging and/or reinforcing preferential trade blocs, and articulating strategies for managed sectoral trade. The era of trade blocs and managed trade is already upon us, and we would be better off starting from that premise. What is seldom made clear by such protagonists, however, is that a national industrial policy aimed at specific products and/or sectors is embedded in their recommendations. Either the national industrial policy defines the managed trade strategy, or vice versa.

On the other side of this debate are those that see clear advantages to reinforcing and expanding the GATT multilateral framework.(2) These advocates do not rule out regional and bilateral trade arrangements as long as these initiatives complement and reinforce the multilateral approach and do not substitute for it. To use the popular vernacular, this position endorses regional/bilateral free trade (or customs union) alternatives as long as they are "building blocks, rather than stumbling blocks, to GATT-wide free trade."(3)

The advocates of multilateral open trade do not, however, generally support managed sectoral trading arrangements: a national industrial policy is not in any way implicit in their reasoning. However, public policies that are directed to improving competitive advantage by focussing on upgrading fundamental factors of production (such as education, vocational skills, and infrastructure), or expanding the factor endowment by promoting savings and investment, are fully consistent with a multilateral free trade strategy. For instance, Reich (1990, 1991) makes a persuasive case for a public policy strategy to upgrade and expand the factors of production in the United States.

Consistent with this perspective, public policy should not discriminate against foreign capital investment. Investment, whatever the nationality, is desirable because it can expand the productive base and upgrade human capital through associated technology and skills training. The demonstrable increase in crossborder direct investment flows during the 1980s has radically changed economic realities: capital investment is highly mobile, and generally seeks access to markets with the highest possible after-tax return. In order to avert zero-sum competitive bidding for investment capital, Reich argues that the GATT multilateral framework should be expanded to include a code on direct investment. This is one of the critical new areas currently under examination at the Uruguay Round.

It is important, therefore, to distinguish between the Reich approach to trade and public policy, which is generally consistent with an open, multilateral trade regime, and the "industrial policy/managed trade" option advocated by Thurow and others. The Thurow approach is fundamentally inconsistent with open multilateral trade. Thus, it should not come as a surprise that he recommends jettisoning the GATT entirely.


It is ironic that the commitment of advanced industrial countries to the open, multilateral GATT trade order is in serious jeopardy at a time when the democracies emerging from Eastern Europe and the Commonwealth of Independent States are seeking access to world markets in order to smooth the process of restructuring and integrating their economies into Western trading areas. This could be effectively and efficiently accomplished by their adherence to a reinforced GATT agreement. GATT provides a stable, nonpartisan focal point for world trade issues during this period of adjustment and instability. But if the general commitment to GATT languishes, they would have no choice but to negotiate a series of bilateral trade agreements with major counterparties in the West, a potentially lengthy and arduous process.

The unexpectedly rapid denouement of the Cold War, together with the inexorable movement towards multilateral trade and financial interdependence, clearly show there is utility in having a multilateral GATT forum. In addition, a number of critical world trade issues, such as agriculture, textiles and intellectual property rights, can only be addressed satisfactorily in a multilateral format. GATT is the only organization that can perform these essential functions. The reality is that GATT will be with us, in one form or another.

The relevant question, therefore, is not whether GATT is dead or alive, but rather whether we want an effective GATT, suitably expanded with appropriate enforcement authority, or an increasingly marginalized international secretariat preoccupied with only diplomatic discussions. In order to create an effective GATT, the Uruguay package would have to be comprehensive and include, at a minimum, an agreement on agricultural subsidies, a phase-out of the Multifiber Agreement governing trade in textiles, an agreement on trade-related intellectual property rights, overhauled codes on antidumping, subsidies and countervailing duties, and substantially reinforced dispute settlement and enforcement mechanisms.


It is also an ironic twist of fate that the Uruguay Round hangs tenuously on a minimal agreement to reduce the distortions to agricultural trade caused by domestic price supports and exclusionary border controls. In 1955, GATT members granted a waiver to import quotas on farm products by the United States, and the Tokyo Round granted a conditional waiver on agricultural export subsidies. Over the intervening years some GATT agriculture producers used these waivers to erect elaborate systems of border protection and price subsidy supports. The cumulative effects of these policies created conditions of excess supply and depressed world prices in the 1980s: the 1955 waivers ultimately proved to be time bombs for relatively low-cost producers in the United States, Canada, Australia.

Ballooning farm subsidies in the early 1980s did moderate in 1988 and 1989, but the OECD Secretariat reported in 1991 that progress to reduce farm subsidies in the OECD took a step backwards in 1990. Similarly, the European Community, in its March 1991 recapitulation of the 1990 budget, disclosed that total farm support expenditures in the 1990 budget were likely to exceed the ceiling set out in the 1988 EC agricultural policy summit. Farm support expenditures moved up in other OECD countries as world agricultural raw material prices slumped by 4.1 percent (in U.S. dollar terms) in 1990, and roughly 2.8 percent in 1991.(4) Regrettably, several key OECD farm producers became engaged in a vicious circle of declining world prices and escalating farm subsidy payments, with surplus supplies periodically dumped into world markets. When seen in the light of this negative-sum game, few would dispute the necessity of finding a solution, both short- and long-term, to the agriculture subsidies: the GATT is the only multilateral forum available in which to do it.


GATT's critics have a dangerous tendency to highlight the obvious deficiencies in the world trading system, and then use this as a pretext for dismissing the entire GATT system as irrelevant to the modern global economy: "the GATT glass is half empty." But the reality is that GATT negotiators strived over the years to establish an effective framework for promoting open trade as a vehicle for economic recovery, growth and development. Initially, work concentrated on reducing tariffs and quotas, because these were the dominant modes of protection at that time. Over the seven successive rounds of negotiations, the average level of tariffs dropped from 40 percent to below 6 percent. This alone is a singularly significant achievement.

Real world trade growth expanded at near double digit rates during the 1960s and 1970s. Trade growth exceeded output growth during this period by a multiple of two. Admittedly, trade and output growth slowed during the 1980s as nontariff barriers multiplied. But there is no doubt that the GATT-inspired open trading system facilitated an exceptionally prosperous period of world growth.

Furthermore, it has become increasingly evident from recent empirical studies that developing countries who embraced the principles of GATT and fostered an open trading regime enjoyed the most successful economic development record.(5) This stands in stark contrast to the disappointing progress of developing countries that took the alternative route of systematically protecting domestic industries from the vagaries of import competition.

It is a fallacy to believe that the GATT system is inherently disadvantageous to the most liberal and open societies. Developing countries that embraced either the protectionist (or, in the case of Eastern Europe and the former USSR, industrial planning) alternatives are scrambling to restructure their trade regimes and pursue integration into the GATT system. The clear victory of the open trade option has generated a wave of interest in the GATT among developing countries and the former Comecon countries, and GATT membership has expanded from the original 23 signatories in 1947 to more than 100 in 1991.

Contrary to statements that the GATT is an elaborate and unworkable legal structure, the original trade contract was designed to be lean and efficient and is based on a compact core of principles and articles. As more countries embrace the open trading order and trade continues to diversify, the world trading system is becoming more multidimensional. Thus, a compact GATT framework for regulating trade is becoming more relevant in the 1990s, not less relevant.

The scope of GATT's application should inevitably expand to include the emerging democracies of Eastern Europe and the Commonwealth of Independent States, and into the critical new areas of agriculture, services, investment and intellectual property rights. This expansion is a sensible and natural evolution consistent with recent global developments, and it should not be equated with a process towards an unworkable framework for regulating trade.

Perhaps the most dangerous fallacy about the GATT trade principles is the "unfair trade fallacy;" countries that have relatively open trading systems are being unfairly exploited by countries that are relatively restrictive. This leads to demands for increased domestic protection in response to foreign protection, a perverse form of reciprocity. But a large body of available theoretical and empirical evidence exposes this fallacy. Early work on border taxes demonstrated that a border tax on imports, by raising the relative price of imports, is equivalent to a tax on exports.(6) Increasing domestic protection can therefore have a perverse impact on domestic resource allocation and export competitiveness.

On the empirical side, the experience of the newly industrializing countries in Latin America and South/Southeast Asia who have opted for an open trading regime provides extensive evidence to support the hypothesis that an open economy generates superior growth and productivity performance over time (it is no accident that this conclusion influenced the choice of trade regime during the initial phases of restructuring in Eastern Europe).(7) Rather than using the "unfair trade fallacy" as a pretext for domestic protectionism, energies should be redirected towards opening foreign markets on a nondiscriminatory basis through all possible channels.(8)

Finally, during the 1980s, large payments imbalances among the U.S., Japan, and the European Community emerged mainly as a consequence of major divergences in G7 macroeconomic policies, which led to a steep drop in the national saving rate in the United States and an overvalued U.S. dollar. The emergence of a gaping U.S. trade deficit led to an intensification of hostility towards the GATT framework because the basic principles were perceived to be unfair. Imports appeared to be flooding in from everywhere, while export penetration for producers based in the United States seemed, in certain instances, near impossible.

Certainly some of the stress points in the GATT system became more obvious during the 1980s as a result of these broad macroeconomic trends, but the GATT undoubtedly ended up shouldering a disproportionate share of the blame for the trade imbalances that emerged, and, to some extent, are still with us. Moreover, the intractable problems that emerged recently in agriculture trade cannot be attributed to an ineffective GATT. Therefore, while we should recognize the urgent need to reinforce, adapt and expand the GATT framework, we must at the same time avoid falling into the trap of using the GATT as a convenient scapegoat, and then marginalizing the multilateral framework for fundamentally the wrong reasons.


Lack of compliance and effective enforcement. As modern industrial economies increased their trade interdependence in the GATT-regulated postwar era, relatively mature domestic industries faced the inevitable competitive pressures from greater import penetration. But in many cases these industries looked for any means available to postpone necessary structural adjustment. Quite often this involved circumventing multilateral GATT obligations. In some cases, these actions constituted explicit contraventions of the letter of the GATT, leading to an increased frequency of trade disputes. More insidiously, though, there was an proliferation of restrictive trade practices that were not explicitly forbidden by GATT but clearly violated the spirit of a liberal trade order. This led to a high incidence of protectionist-inspired antidumping investigations, countervailing duties, and other unilateral, bilateral, and regional actions to curtail the flow of trade.

Insufficient adaptation. While the GATT was immensely successful at reducing tariff barriers, it was frequently unable to adapt and change to the new realities of the world trade order that emerged in the 1970s and 1980s. Specifically, the successful reduction in tariffs has been counteracted by increasing resort to various forms of nontariff barriers. Nontariff barriers include the use of global and bilateral import quotas, restrictive licensing, voluntary export restraints, import management agreements, domestic content legislation, subsidies, and restrictive technical standards.

Similarly, the GATT did not succeed in bringing increasingly prominent areas such as cross-border services, direct investment, and intellectual property rights under the rubric of multilateral trade law discipline. The omission of services is a major drawback for the industrial countries, because an increasing share of economic activity in advanced economies is accounted for by services.


It is outside the scope of this essay to assess the full ramifications of an inconclusive Uruguay round, because the impact would extend beyond the realm of international trade, to affect business confidence generally, the climate of international cooperation and investment, and other intangibles. Instead, we briefly review the most prominent risks of an erosion of the multilateral open trade system.

The fragmentation of the trading system would accelerate. If the Uruguay Round is inconclusive, a patchwork of bilateral, regional, and sectoral trade arrangements will emerge to dominate the trading system. While there is no denying that some of these initiatives have stimulated intraregional trade and increased the stakes for a successful Uruguay Round, an inconclusive round would definitely tilt the balance towards these second-best substitutes. In fact, the proliferation of regional and bilateral agreements has already eroded the credibility of the GATT framework and process, and has led to an alarming increase in noncompliance with GATT dispute settlement rulings since the Uruguay Round commenced in 1986.

Bilateral and regional free trade agreements and customs unions are admissable under GATT rules if they lead to rapid, and comprehensive, elimination of trade barriers for the participants, and no increase in barriers to nonparticipants. In practice, though, this is difficult to achieve and near impossible to enforce after the fact. For instance, the European Community was founded as a customs union in 1957, but twenty-eight years later the EC became engaged in a major exercise to remove the significant barriers to the internal market that still remained.

A fragmented trading system would also create powerful incentives for nonparticipating countries or regions to negotiate preferential, and potentially discriminatory, access agreements. This type of risk is abundantly evident in the European Community's multilayer system of trade preferences with nonmember groups of countries: the trade preferences with EFTA (the European Free Trade Association comprising Austria, Switzerland, Sweden, Norway and Finland), association arrangements with Turkey, Malta, Cyprus and the Lome Convention countries, and the Gulf Co-operation Council. Additional preference arrangements are currently being negotiated with countries in Eastern Europe, and the exercise is bound to repeated for the newly independent Baltic states and other former republics of the USSR if the current GATT round continues to falter.

Preferential bilateral, regional or sectoral trade agreements may be beneficial, on net, if the benefits from trade creation among the participants exceed the costs of trade diversion from nonparticipants. The debate over the pros of trade creation versus the cons of trade diversion is by no means resolved. Suffice to observe that the costs of trade diversion are probably the most significant if the product or service falls outside the GATT's direct area of competence.(10) Nevertheless, even a preferential trade agreement that carries net benefits is inferior to a multilateral GATT agreement, because the latter avoids the costs of trade diversion.

The current crisis in world agricultural markets would be exacerbated. The 1991 OECD review "Agricultural Policies, Markets and Trade: Monitoring and Outlook," paints a troubling picture of the growing financial burden of farm support in OECD countries. In 1990, direct government subsidies to farmers rose 17 percent to reach US$ 176 billion. At the same time, the implicit tax paid by consumers, which is embedded in the higher domestic price structure, rose 18 percent in 1990 to reach $133 billion. Overall farm support in the OECD area rose by 12 percent in 1990 to reach a staggering $299 billion. Ballooning subsidies have created excess supply and periodic dumping of farm products on world markets. For several years now world food and grain prices have experienced protracted weakness in both real and nominal terms. These problems could deteriorate further if international pressure to bring expanding farm subsidies under control dissipates. Moreover, fiscal deficits in the U.S., the European Community, and other agricultural countries would tend to expand as pressure to increase farm support mounts. Existing price and income distortions would persist, if not worsen, and countries dependent on agricultural exports would suffer further declines in relative wealth.

The fragmentation of the world trading system would inevitably be followed by an outbreak of regional, bilateral and unilateral trade protectionism, especially if a slow growth environment persists. Even though the GATT policeman walks softly and carries a small stick, a visible presence still serves as a deterrent to trade infractions. Remove and/or disarm the policeman, and there is a risk that domestic trade remedy measures would increase in frequency. In fact, a number of unilateral trade remedy actions have been postponed pending the outcome of the Uruguay Round.(10)

Rather than taking high profile, blanket protectionist measures, such as we saw with the Smoot-Hawley Tariff in 1930, we are likely to see a proliferation of industry or sectoral-specific market protection measures. In the United States, this would likely take the form of increased investigative activity under the "Super 301" clause of the 1986 Trade Bill. More ominously, the U.S. House of Representatives is currently debating the merits of expanding and reinforcing the powers of the U.S. Trade Representative, and Congress, to act under the "Super 301" clause.

World growth potential would be reduced. Potential growth would be reduced for the following two reasons. First, significant local investment presence would become increasingly indispensable for gaining effective access to fragmented trade blocs. But it is not at all clear that this would facilitate an appropriate distribution of the world's scarce capital resources. At a minimum a reduction would occur in the potential efficiencies from economies of scale. Secondly, regional trade blocs and managed trade arrangements would reduce prosperity as a result of the inevitable diversion of trade flows from third parties.

Provisional agreements would lapse. Provisional agreements on improved market access for tropical products, a streamlined and more effective dispute settlement procedure and the functioning of the GATT system, including regular GATT Secretariat surveillance of trade policies, would lapse if a broad Uruguay package does not materialize. Moreover, relatively advanced framework agreements in a number of areas, including subsidies, government procurement, trade in services, and intellectual property rights would be suspended indefinitely.


Failure to complete a broad and meaningful trade agreement under the Uruguay Round of negotiations would risk marginalization of the GATT postwar trade order: the fragile dike against multilateral trade protectionism, which has been diligently nurtured over the past forty years through eight GATT negotiating rounds, would start to crumble, with major repercussions for the direction of trade, relative prices, income distribution and cross-border investment flows.

The detour down the track towards regional block, which we have already seen in the past five years, would gain additional momentum. In this environment, the developing countries, Eastern Europe, and the members of the Commonwealth of Independent States would be left little choice but to forge strategic regional alliances, where feasible. In fact, the movement towards regional trade agreements is already evident with special trade agreements under negotiation between the EC and Eastern Europe, the EC and EFTA countries, the US-Canada-Mexico free trade negotiations and the 'Mercosul' common market pact recently signed by Brazil, Argentina, Paraguay, and Uruguay.

Finally, the potential increase in world growth and prosperity that would follow, from further multilateral trade liberalization, and GATT-mandated multilateral reductions in the levels of OECD farm subsidies, would be foregone for the foreseeable future.

Is this the kind of new world economic order we are striving to erect?

Brian Bethune is Senior Economist, Bank of Montreal, Toronto, Canada.


1 See Prestowitz, Tonelson, and Jerome (1991), inter alia.

2 See Bhagwati (1991), Ostry (1991), Schott (1990), inter alia.

3 Bhagwati (1991), p. 77.

4 International Monetary Fund, index of world agricultural raw materials prices.

5 World Bank (1991), pp. 96-108.

6 Lerner (1936).

7 Op. cit. pp. 96-108.

8 This was clearly the intent behind President Bush's January 1992 trip to Japan.

9 Examples include preferential sectoral agreements such as the European Coal and Steel Community, the EC Common Agricultural Policy, the U.S./Japanese Semiconductor Agreement, and the Canada/U.S. Automotive Pact.

10 One clear example is the "GATT trigger" contained in the 1990 U.S. Farm Act, which applies to the period 1991-95. If no Uruguay Round package is concluded by June 30, 1992, the U.S. Agriculture Secretary is instructed to increase spending on export promotion programs by $1 billion in 1994-95, and institute a marketing-loan program for wheat and grains beginning in the 1993 crop year (among other measures). Furthermore, if no trade pact is reached by June 1993, the Secretary would be in a position to amplify these measures, and may also waive all or part of the farm subsidy spending cuts mandated in the 1990 Farm Act.


Bhagwati, Jagdish, (1991), The World Trading System at Risk, (Princeton University Press: Princeton, New Jersey).

Congress of the United States, Congressional Budget Office, (1990) The GATT Negotiations and U.S. Trade Policy, (U.S. Government Printing Office: Washington, D.C.).

GATT Secretariat, (1990), International Trade 89-90, (GATT: Geneva). (1989), Activities, (GATT: Geneva).

Heldring, F., Gary C. Hufbauer and Irving B. Kravis, (1990) "Shaping the Tariff and Trade Regimes for the Next Decades," Papers from the Tenth International Monetary and Trade Conference, (The Global Interdependence Center, Philadelphia).

Jackson, John H., (1988), International Competition in Services, (American Enterprise Institute for Public Policy Research: Washington, D.C.).

Lerner, A.P., (1936), "The Symmetry between Import and Export Taxes," Economica, vol. 3, no. 11, (August).

Ostry, Sylvia, (1991), "The Uruguay Round: Unfinished Symphony," Finance and Development, (IMF/World Bank: Washington, D.C.), June.

(1990), Governments and Corporations in a Shrinking World: Trade and Innovation Policies in the United States, Europe, and Japan, (Council on Foreign Relations Press: New York, London).

Prestowitz, C.V. Jr., Alan Tonelson, and Robert W. Jerome, (1991), "The Last Gasp of GATTism," Harvard Business Review, (March-April).

Reich, Robert B., (1990), "Who is Us?" Harvard Business Review, (January-February). (1991), "Who is Them?" Harvard Business Review, (March-April).

Schott, Jeffrey J. (1990), Completing the Uruguay Round: A Results-Orientated Approach to the GATT Trade Negotiations, (The Institute for International Economics, Washington, D.C.).

Tobin, James, (1991), "The Adam Smith Address: On Living and Trading with Japan: United States Commercial and Macroeconomic Policies," Business Economics, Vol. XXVI, Number 1, pp. 5-16, (January).

Thurow, Lester, C., (1990), "GATT is dead," The Journal of Accountancy, (September).

Wonnacott, Ronald J., (1990), "U.S. Hub-and-Spoke Bilaterals and the Multilateral Trading System," C.D. Howe Policy Commentary No. 23, (Toronto: C.D. Howe Institute).

World Bank (1991), World Development Report, (Oxford University Press: New York).
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Title Annotation:General Agreement on Tariffs and Trade
Author:Bethune, Brian
Publication:Business Economics
Date:Oct 1, 1992
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