All free traders now?

In Singapore on December 9th, the two-year-old World Trade Organisation begins its first summit meeting. Although governments profess to be committed free traders, their actions still fall short of their words

"FREE trade", wrote Richard Cobden in 1857, "is God's diplomacy, and there is no other certain way of uniting people in the bonds of peace." Few politicians since Cobden have thought of themselves as missionaries for free trade. Yet now, an odd thing is happening: most of the world's governments claim to be exactly that. In Singapore from December 9th to 13th, trade ministers will attend the first ministerial conference of the World Trade Organisation (WTO)--and will surely take every opportunity to parade their free-trade credentials. How justified are their claims?
     On the credit side, in the past few years there have been four main achievements for free traders to cheer. First, the Uruguay round of the the WTO's predecessor, the GATT, went further than any previous global trade deal. Apart from promising to cut tariffs on manufactures-- which are now down to an average of just 3.8% in rich countries--governments agreed for the first time to some liberalisation of trade in agriculture and services. They also forged new agreements to get rid of some non-tariff barriers to trade, such as the spurious use of technical and health regulations to keep out imports. The round, which finished in 1993, also established the WTO itself, and set up a new mechanism for settling trade disputes.
     This mechanism is the second recent cause for celebration. Under the GATT, any member could veto the verdict of a panel set up to rule on a quarrel--even if it was a party to the dispute. WTO panels are stricter. They must report within nine months and their decisions can be overturned only by consensus. Countries found to have broken WTO rules must either mend their ways or offer compensation; if they do not, they may face trade sanctions. So far, the mechanism has worked well. More than 60 cases have been brought. About a quarter have been completed. Ten of these disputes were settled without going before a panel.
     The third encouraging sign is that more and more countries are joining the world trade club. During the Uruguay round, many developing countries realised that freer trade was not a confidence trick by rich countries, but would actually help their own economies. The membership of the GATT rose from 92 in 1986, when the round began, to 114 when negotiations ended (see chart). The WTO now boasts 126 members; another 30 countries, including China and Russia, want to join.
     Fourth, trade has been booming. The WTO estimates that world trade in goods grew by 8% in volume terms last year, four times the growth of world GDP. In fact, during the 1990s international trade has grown far faster than world output, showing that national economies are becoming ever more closely linked (chart). Foreign direct investment, another gauge of international economic integration, is also soaring: last year, estimates the United Nations Conference on Trade and Development, cross-border investment flows rose by 40%, to $315 billion.
     Against such a background, it may seem churlish to doubt governments' professions of free-trade faith. Unfortunately, there are good reasons for such doubt. Since the completion of the Uruguay round, governments have frequently acted much as they did under the old GATT: as downright protectionists on some occasions and as mercantilists almost as a matter of course. That is to say, the main purpose of their trade diplomacy has not been to open up their own markets to imports but to prise open other people's markets for exports. The opening of home markets is usually seen as a concession to others, not (as economic logic dictates) as a good thing in itself because it benefits local consumers and makes both national and global economies work more efficiently.

The sin bin
The clearest example of the mercantilist tendency is the conduct of the so-called "unfinished business" of the Uruguay round. When the round ended, agreement had not been reached on the following areas of service trade: financial services, shipping, "movement of natural persons" (trade-speak for letting in foreigners to supply services on a temporary basis) and telecommunications.
     In financial services the Americans, displeased by the slow pace of liberalisation promised by some Asian countries, walked away from an agreement just before a deadline in June 1995 (though several other negotiators, including the European Union, have kept their offers open and talks are due to restart next April). In shipping, America's highly protected and unionised maritime industry virtually sank the talks before they left port. The issue of letting in foreigners temporarily has become entangled by political reservations about immigration as a whole. Few governments anywhere are keen to welcome foreign workers.
     Only with the telecoms deal is there any sign of hope. After an earlier negotiation collapsed in April (with Europeans and Asians slow to commit themselves to liberalisation and with America demanding better access to satellite-communications markets in developing countries) a recent round of talks has found several groups, including the Americans and Europeans, making more liberal offers. Negotiators reckon a deal can be reached by the new deadline of next February.
     Telecoms, though, is an exception. For the most part, the grudging way in which some governments are keeping the promises they made during the Uruguay round smacks of bad faith. In textiles and clothing, for example, trade has been governed for over 30 years by a system of bilateral quotas. These quotas are supposed to be scrapped eventually and textile trade gradually brought into line with WTO disciplines; meanwhile, the size of quotas is being increased. But the process, which began in 1995, has been slow. Importing countries, which tend to be rich, are allowed to keep quotas covering almost half their trade until 2005. Moreover, they have started to bring under the WTO system only those products which are not subject to quotas--thus delaying the effect of the deal. Not surprisingly, exporters, most of them developing countries, are up in arms. Doing the bare minimum does not seem to be the behaviour of committed free traders.

Gauges of good faith
The problems left over from the past, however, are modest compared with those which are to come. In the next few years the free-trading commitment of the WTO's members will be tested by four daunting challenges, some familiar, others new. Each will give governments the opportunity either to make trade freer, or to hobble it.
     The first challenge is to continue liberalising trade in goods and services. The WTO is already committed to some negotiations as part of its "built-in agenda"--ie, matters begun during the Uruguay round. Negotiations on further liberalisation of agricultural trade are due to begin in 1999 and a fresh round of talks on services is due to start in 2000. Although both these talks are some years away, if history is any guide it is already a fair bet that they will be difficult. Agriculture provided one of the trickiest problems of the Uruguay-round talks-- indeed, the round nearly foundered on it.
     There may be progress, though, in an area of business that was not in those talks. American trade negotiators have been pushing hard for an "information-technology agreement" to reduce tariffs on computers, semiconductors, software and so forth. During last month's summit of the Asia-Pacific Economic Co-operation forum (APEC) in Manila, the Americans won the backing of other APEC countries for a WTO negotiation of the issue.
     The Americans have a chance of getting their way, but the hurdles remain high. The highest, say American negotiators, is disagreement with the EU both over how quickly the Europeans should reduce their tariffs and over the range of products any deal should cover. In addition, some Asian countries are hesitant; in Manila, the endorsement of some APEC members was lukewarm. So information-technology talks should provide a start for the WTO in tackling its expanding agenda. But it is likely to be a slow one.
     The WTO's second big challenge concerns China: on what terms should it be brought into the trading organisation? China is the world's eleventh-biggest exporter; without it, the WTO cannot claim to represent world trade.
     Incorporating China presents both technical and political problems. On the technical side, the difficulty is to bring a vast, semi-planned, semi-market economy into line with the WTO's more-or-less free-market principles. China has been freeing up its trade regime for the past decade, cutting tariffs and allowing foreign companies to invest through joint ventures with Chinese firms. But it still maintains a WTO-infringing array of controls, including export taxes, import quotas, trade licenses and import inspections. The Chinese are also determined to maintain a protective shroud around some "strategic" industries, such as cars.
     WTO members want China's government to set out a clear, and fairly short, timetable for the removal of all this. They also want an end to the county's habit of altering its trade regime arbitrarily. On this last point, China has at least promised to stop making matters worse. On November 1st, its trade minister, Long Yongtu, promised to impose no further trade restrictions inconsistent with WTO rules.
     The politics of admitting China is, if anything, trickier, especially in the United States. Chinese exports to America are subject to the same tariffs as most WTO members, but this privilege has to be renewed annually. Strictly speaking, renewal depends on China's meeting a relatively-narrow criterion of not restricting emigration. Politically, however, the annual renewal depends on China's broad human-rights record. The Chinese regime seems unlikely to alter that fundamentally, so the chances of WTO admission actually depend on both sides agreeing not to make a fuss about what is going on. Not making a fuss has recently got harder because China's trade surplus with America has climbed to become as big as Japan's. The result is that protectionists are finding common cause with human-rights activists in America to oppose the extension of WTO privileges to China. As an example of the potential for trade conflict, the Chinese and Americans are already in a fight over textiles. America cut the import quota for Chinese goods in September, claiming China had been sending extra clothes through third countries. The Chinese are threatening to retaliate.

Slippery ground
The third challenge facing the WTO is whether, or how, to extend its remit into the so-called "new issues" of trade policy: foreign investment, competition policy and labour standards. (These issues are not in fact new: they have been discussed since before the birth of the GATT in 1948.)
     None of the issues can be resolved quickly. They arouse deep disagreement-- and it is easy to see why. Consider rules on foreign investment first. These would take the world's trading body directly into tricky areas of national policy. It may be understandable if an international agreement prevents one country from slapping a big tariff on the goods exported by another. But it is less immediately apparent why one country should not offer some of its own taxpayers' money to a company from another in order to persuade it to build a spanking new factory in the first. Nor is it obvious why the host country should not, say, require foreign investors to employ a certain number of local managers. What's wrong with that?
     The answer is that such shackles and sweeteners act like tariffs or export subsidies, distorting the pattern of trade which would have prevailed had the measures not been in place. In theory, firms can sell in foreign markets either by sending their wares abroad, or by setting up a factory in a foreign land and serving the locals directly. In some industries, the second of these methods is far cheaper than the first. This is especially so of many services, such as banking, insurance and retailing. But it is increasingly common in manufacturing, too. A car, for instance, might contain an engine made in one country and axles from another, but be assembled in a third. According to one estimate, transactions within firms now account for about one-third of world trade.
     Yet despite close links between investment and trade, the WTO currently has little to say on the subject. Such rules as exist are patchy. Governments may not, for instance, limit foreign-owned factories' imports to the value of their exports or insist that foreign investors use local inputs. WTO copyright rules are supposed to protect foreign investors' intellectual property. But countries can and do protect local banks or stockbrokers, for example, by refusing to issue licences to foreigners. They can limit foreigners' stakes in broadcasting firms or airlines. Governments may also insist that foreign investors produce goods for export as well as for the domestic market.
     So it is not surprising that some people, led by the Europeans and Canadians, want to beef up the rules. America is prepared to support them, though it wants an agreement among OECD countries first. Some Latin American countries are also in favour, as is the WTO's secretariat, its civil service (this body, which usually stays neutral on such matters, issued a report in October backing the idea of a WTO investment accord).
     Equally unsurprisingly, many developing countries, led by India, Malaysia and Tanzania, are viscerally opposed. They say they are eager for foreign investment but want to keep the right to set the terms of entry for foreigners. They feel under no particular pressure to sign up. Even without a WTO agreement, they are not short of investment: developing countries attracted $100 billion-worth last year (see chart). China alone received $38 billion. So a deal hardly looks imminent.
     Prospects for an agreement covering competition policy look no rosier. This, too, is an apparently domestic economic matter with trade implications. The WTO is not out to ban all monopolies or create a universal competition policy. But some of its members do want to apply trade principles to the regulation of monopolies and mergers: those principles suggest monopoly policy should not discriminate against foreigners. Others think the WTO should have a role because firms could run international monopolies or cartels, yet be out of the reach of national competition watchdogs.
     But, as these differing ideas suggest, countries cannot yet agree even what facet of competition policy to discuss. The EU would like to start work on a common set of principles for national competition policies (it is always keen on harmonisation). America thinks this would be largely pointless; it reckons co-operation between national antitrust authorities will do for now.
     The argument for the third new issue, bringing labour standards into the WTO, is even weaker. The United States is keen that it should be discussed. Ultimately, it would like the WTO to enshrine five "core" labour standards in its rules. These include a ban on "exploitative" child labour and a guarantee of trade-union freedom. (Incidentally, world labour standards already exist, drawn up by the International Labour Organisation: America has ratified only one of the five in question.)
     Not surprisingly, developing countries want none of this. They fear that, if they promised to abolish child labour and then failed to keep their word, they would be vulnerable to retaliation under the WTO's dispute-settlement mechanism.
     So for the time being, the United States is unlikely to get its way. That may be just as well, for the intellectual case for a labour-standards agreement is weak. If forced to improve labour standards, developing countries would increase their costs and they would export less. That would make them poorer still, and would surely make labour standards even worse. Not by accident, however, it would help protect some firms and workers in rich countries.

The biggest test of all
The fourth big issue is the spread of regional trading agreements. Almost every member of the WTO is also a member of such a group, whose numbers are proliferating. The WTO lists no fewer than 76 free-trade areas or customs unions set up or modified since 1948. Of these, more than half have come in the 1990s (see chart).
     Evidence of zeal for freer trade? It would seem so, especially since regional deals sometimes cover aspects of trade that the WTO does not, such as investment and competition policy. For instance, the North American Free-Trade Agreement (NAFTA) has an investment code; APEC has some "non-binding principles". The EU and an agreement between Australia and New Zealand contain common regional competition policies.
     The truth, however, is more mixed. Yes, scrapping trade barriers within a region can encourage trade and investment among countries within the club. But it can also divert trade and investment away from other countries. Japanese car plants have been attracted to Britain, for example, by the thought that they can bypass the EU's restrictions on imports of Japanese cars. And while investment in Mexico has no doubt been boosted by the thought of tariff-free entry to the United States, some of this will have been at the expense of countries outside NAFTA.
     No less troubling is the danger that, just as regional deals can divert trade from one part of the world to another, so the agreements can have the same sort of impact on trade diplomats' energies, diverting them away from the more important business of continuing to liberalise world trade. There is still plenty to do: on conventional trade, on new issues and on the admission of China. God's diplomats? One day, maybe; but not yet.

The Economist Home Page - Search - Contents - Next article