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INTERNATIONAL ECONOMIC POLICY AND

DEVELOPMENTAA 2017-2018

PROF. PIERLUIGI MONTALBANOpierluigi.montalbano@uniroma1.it

Topic 1 – The efficacy of the GATT/WTO system and DCs

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Integration & interaction link

• There has been lively debate among economists, on the effectiveness of trade

liberalisation, for centuries.

• Dissemination of the free trade doctrine occurred in Europe in the nineteenth

century (i.e. A. Smith, 1776; D. Ricardo 1815)

• The 1860 Cobden-Chevalier Treaty, and introduction of the ‘most favoured

nation’ (MFN) clause, played a key role in trade history in the second half of

the nineteenth century (Bairoch, 1976, 1989)

• Most favoured nation (MFN) is a status or level treatment awarded by one

nation to another in international trade. Each member treats all the other

members equally as “most-favoured” trading partners. If a country improves

the benefits that it gives to one trading partner (i.e. a lower customs duty rate

for one of their products), it has to give the same “best” treatment to all the

other partners of the agreement

process of trade liberalisation

phenomenon of increased world trade linkages

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• Following this treaty, between 1863 and the 1866, most European countries, through treaties signed with France or the UK, became part of a dense network of spontaneous and informal free trade agreements, which became known as ‘the network of Cobden-Chevalier Treaties’.

• In a period of 15 years, this led to the conclusion of 56 similar PTAs in Europe, liberalising trade (mostly on manufactured goods) to a large extent.

• This guaranteed the development of free trade among the main trading powers for around 20 years.

• Economic depression and the economic and social consequences of World War I opened the way to a return of protectionism.

The Cobden-Chevalier Treaty

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The ‘Mother of all Spaghetti Bowls’: The Cobden-Chevalier Network in 1875

Source: Lampe (2011)Note: Lines represent unconditional MFN-PTAs signed between 1857 and 1875

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From a theoretical standpoint:

• Both the traditional (Lerner, 1936; Stolper, Samuelson, 1941; Metzler, 1949; Bhagwati, 1959; Graaf, 1949; Johnson, 1950, 1960) and modern theoretical approaches (Helpman and Krugman, 1985; Venables, 1990) substantially agree that tariffs produce distorting effects on the economy, leading to a suboptimal allocation of resources.

• Tariff liberalisation, in introducing changes to relative prices, leads to a better allocation of resources and, thus, increased production and consumption.

• Some exceptions: the ‘infant industry’ case; the so-called ‘secondbest’ approach (domestic market failures)

Tariff liberalisation effects:Theoretical evidence

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From an empirical standpoint:Divergent positions and not clearly defined relationship between trade policy and trade growth. Recent analyses have produced contrasting results, which at times contradict the theory.

• Positive effect of tariff liberalization on trade growth (Balassa, 1965; Krueger, 1978; World Bank, 1987; Thomas, Nash and Edwards, 1991; Papageorgoiu, Michaely and Choski, 1992; Weiss, 1992; Helleiner, 1994; Joshi and Little, 1996; Bleaney, 1999; Ahmed, 2000; Madsen, 2001; Santos- Paulino and Thirlwall, 2004; Pacheco-Lopez, 2005);

• Weak or nullus effect (Baldwin and Lewis, 1978; Bhagwati, 1988; Unctad, 1989; Agosín, 1991; Clarke and Kirkpatrick, 1992; Ostry and Rose, 1992; Greenaway and Sapsford, 1994; Shafaeddin 1994; Jenkins, 1996; Nenci and Pietrobelli, 2008).

Tariff liberalisation and trade growth:Empirical evidence

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Impact of multilateral trading system on trade

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Multilateral integration

Since 1944, much of the reduction in tariffs and other trade restrictions came about through international negotiations.

• The General Agreement of Tariffs and Trade was begun in 1947 (23 countries) as a provisional international agreement and was replaced by a more formal international institution called the World Trade Organization in 1995 (now 160 members).

• The WTO and GATT have reduced tariffs substantially in the last 50 years

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Average of regional tariffs after World War II

Legend: Asia: (Burma, Ceylon, China, Egypt, India, Indonesia, Japan, the Philippines, Siam, Turkey); Core: France, Germany, United

KingdomEuro periphery: Austria-Hungary, Denmark, Greece, Italy, Norway, Portugal, Russia, Serbia, Spain, Sweden; Latin America: Argentina, Brazil,Chile, Cuba, Colombia, Mexico, Peru, Uruguay; Offshoots: Australia, Canada, New Zealand

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Average unweighted tariff rates by region

0

20

40

60

South Asia

Latin America and the

Caribbean

East Asia and the Pacific

Sub-Saharan

Africa

Middle East and North

Africa

Europe and Central

Asia

Industrialized economies

Percent

1980-851986-901991-951996-98

Source: Martin (2001)

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Impact of multilateral trading systemon trade

• Distinguished scholars assert that the beginning of a liberal trading

order started before the GATT/WTO, with the creation of the

network of MFN bilateral treaties (Bairoch, 1989; Irwin,1993;

O’Rourke and Williamson, 1999).

• Other scholars debate the efficacy of GATT/WTO in liberalising

trade policy and increasing trade flows. They consider the role

played by the GATT/WTO system as not a determinant of world

trade promotion, arguing that the formalisation of the system did not

produce the expected results and did not lead to substantially

different results than those produced by the previous trading system.

• In this respect, we need to refer to the empirical contributions of

Rose (2004a, 2004b, 2005).

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Andrew K. Rose’s critique

Professor of Economic Analysis and Policy

University of California at Berkeley

http://faculty.haas.berkeley.edu/arose/

3 key papers:

1. Rose, Andrew K. (2004a) “Do We Really Know that the

WTO Increases Trade?” American Economic Review.

2. Rose, Andrew K. (2004b) “Do WTO Members have More

Liberal Trade Policy?” Journal of International Economics.

3. Rose, Andrew K. (2005c) “Which International Institutions

Promote International Trade?” Review of International

Economics.

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Rose AER 2004

Using a standard gravity model, Rose (2004 AER) estimates the effect of membership

in the GATT/WTO on trade

T is trade between countries i and j at year t

D is great-circle distance between the countries

Y is real GDP

X is a vector of other controls (population, dummies for common language, money,

and border, geographic characteristics, colonial characteristics, time dummies, etc.).

Coefficients of interest: γ1 and γ2, which measure the effects on trade of GATT/WTO

membership by both countries and one country respectively.

OLS estimates, panel of data covering over 50 years (1948-1999), 175 countries

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Rose JIE 2004

• Surprisingly, both coefficients, γ1 and γ2, were economically small and

statistically insignificant. He concludes that GATT/WTO had a limited role in the

promotion of world trade.

• Is it plausible?

• Second step of his research: testing if GATT/WTO membership had effect on trade

policy

• In Rose JIE 2004 , he used almost 70 measures of trade policy and liberalization to

see if membership in the GATT/WTO was actually associated with more liberal

trade policy.

• With one exception (the Heritage Foundation’s index of economic freedom) the

answer was a resounding no: GATT/WTO members just didn’t seem to have

measurably more liberal trade policy than outsiders.

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Rose RIE 2005

• Third step: In Rose RIE 2005 he compared the

GATT/WTO with two other significant international

institutions that are in the business of liberalizing trade,

the IMF and the OECD.

• He found that membership in the OECD had a

consistently large positive effect while accession to (but

not membership in) the GATT/WTO was also associated

with increased trade.

• Overall conclusions: no significant effects of

GATT/WTO membership on trade growth and trade

policy

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Rose’s critics

• Thanks to Roses’s works, there is now a growing body of

scholarly research that investigates the impact of the international

trade institutions on trade.

• Many scholars challenge his research (all of the critiques focus on

the AER 2004 paper).

• Key criticisms:

• inappropriate proxy for variable of interest;

• inappropriate data pooling;

• inappropriate handling of fixed effects;

• and selection bias.

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Rose’s critics: inappropriate proxy for variable of interest

• Low 2002 criticises Rose, challenging the quality of the trade flow

measurements, and claiming that the WTO’s mandate is broader than

simple trade liberalisation.

• Piermartini and Teh 2005 advance many reasons to explain Rose’s results:

- no request of significant reductions in trade barriers for DCs acceding

before the creation of the WTO in 1995;

- transition periods for tariff reductions are allowed;

- many countries already benefited from MFN treatment or preferential

tariffs before accession;

- many countries liberalized beforehand in order to facilitate accession;

- LDCs often export fuels and minerals which face little protectionism

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Rose’s critics: inappropriate data pooling

• Other scholars state that looking at all trade simultaneously masks the effects of the

GATT/WTO (no distinction of country and sector asymmetries in terms of de facto

liberalization).

• Subramanian and Wei (JIE 2007) - by introducing fixed effects and asymmetries between

countries and sectors in their gravity equation - find that GATT/WTO effectively promotes

trade but unevenly:

• a) GATT/WTO membership appears to have a significant effect on trade for

developed countries, but does not appear to have had a significant impact on the trade

of developing countries;

• b) GATT/WTO did not impact positively on trade in protected sectors, such as

agriculture and textile and clothing;

• c) WTO membership has a relatively stronger effect on new Members than on old

Members.

• Tomz et al. (AER 2007) show that Rose’s analysis overlooks a large group of countries to

which the trade agreement applies and classifies them incorrectly as nonparticipants

(colonies of formal Members, new sovereign states and provisional applicants to WTO) .

Rose ignored these informal GATT participants (de facto), and thus under-estimated its

impact. They argue that the GATT/WTO membership has had substantial positive effects

on trade.

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Rose’s critics: inappropriate handling of fixed effects

Most of Rose’s regressions do not include country-specific fixed

effects in the gravity equations

• Subramanian and Wei (2007) reveal the weakness of Rose in

not taking account of the results obtained by Anderson and

van Wincoop (2003), the “multilateral resistance effect” - on

the introduction of fixed effects by country within the

gravitational equation.

• Many of Rose’s critics include fixed effects for either

countries or country-pairs (see next table).

• They usually find significantly positive estimates of the effect

of membership on trade

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Rose’s critics: sample selection bias

• Selection bias due to omission of zero trade observations.

• He didn’t explicitly deal with the extensive margin of trade

(whether a pair of countries trades at all).

• Helpman et al. 2005, argue that disregarding zero trade

observations has important consequences for the empirical

analysis, as it generates biased estimates.

• Felbermayr and Kohler (2010) and Liu (2009) argue that members

of the GATT/WTO have systematically more trading relationships,

so that ignoring the effect of membership on the extensive trade

margin (i.e. losing information on those who start new trade

relationships) leads one to under-estimate the impact of the

GATT/WTO.

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The state of the art on this issue. Comparing recent results

The subsequent studies have provided mixed results not only about the overall impact

of the GATT/WTO on trade, but also on the channels through which the effect

operates, and the potential asymmetries that may exist across groups of countries and

periods.

Most recent estimates, effect of Gatt/WTO membership on bilateral trade

AuthorsSub-periods/rounds effect

Zero flows

negative positive intensive extensive industrialized developing

Liu (2009)

x x x

positive in pre-Kennedy year (1948-

1963) and post-Uruguay Round (1995-

2003) x

Felbermayr and Kohler (2010) x x no effect positive effect

negative during the Gatt, positive

during WTO x

Eicher and Henn (2011) no effect no effect negative effectno effect at all

Chang and Lee (2011) x

Herz and Wagner (2011)x

positive in all roundsx

Dutt et al (2013)moderatly

x (product

margin)

positive (product

extensive margin)

positive (product

extensive margin) x

Overall effectTrade margins (country

pairs) Countries effect

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Possible explanations of Rose’s results

Why membership in the GATT/WTO doesn’t deliver more trade?

• Developing Countries. GATT historically made few demands on most countries in

terms of trade liberalization, since most entrants were developing countries eligible

for “special and differential treatment”. If accession to the GATT/WTO doesn’t

force countries to liberalize, why should one expect accession to have a

measurable impact on trade? And if accession isn’t the time when the GATT/WTO

forced countries to liberalize, is the GATT/WTO really an effective agent of

liberalization?

• Sectors. The GATT/WTO has made almost no progress in liberalizing areas of

great protectionism, such as agriculture and textiles.

• MFN Status. MFN status is often given freely away

• NTBs. Non-tariff barriers have often been increased as substitute protectionism

• Ceteris Non Paribus. There are many other reasons why trade has grown, including

declining transportation/communication costs, higher productivity growth in

tradeables, and so forth.

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Rose’s critics 2

• Hufbauer, 2002 suggests that the correct test for the success of the

GATT/WTO would be to compare the expansion of trade in

historical periods when clubs with liberalisation mandates were

born, with those periods when such clubs did not exist, rather than

an analysis limited to examining the current system.

• Nenci 2011 tests the GATT/WTO results in terms of trade

liberalisation and trade growth with respect to previous periods

characterised by a ‘nonstructured=institutionalised’ (or even

absence of a) regime. The analysis is conducted at the aggregate

level for the period 1871–1986 (23 countries, historical

reconstruction of tariff data) and at panel level for the period

1961–2000 (same countries, standard data sources).

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Nenci 2011

Two research questions:

1. Has tariff liberalisation accelerated the growth of world

exports?

2. If so, has the GATT/WTO produced significant results

in terms of trade liberalisation and trade growth with

respect to previous periods?

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Nenci 2011 results

• Existence of a well defined and stable relationship between the reduction

in tariff barriers and growth in trade in different eras: results confirm the

existence of a long-run relationship at world level. This is relevant and

significant in the period pre-World War II, but gradually loses importance

and significance after 1950.

• Effectiveness of the current multilateral trading system in promoting

liberalisation and growing involvement of countries in world trade: by

testing different trade Rounds, the GATT/WTO international trading

system does not seem being particularly effective (partly in line with

Rose’s works).

• Greater tariff liberalisation does not appear to have been the main cause of

the extraordinary growth in trade flows that occurred in the post-World

War II period (but MTS important for ensuring rules and behaviours

among major players).