World Trade Organization: Time to Transform

World Trade Organization: Time to Transform

Delegates arrives for a special meeting of the General Council Preparatory Committee on Trade Facilitation at the World Trade Organization headquarters in Geneva, Switzerland in 2014. (Denis Balibouse/Reuters)

The international trading system as we know it is ending. Republicans can seize the opportunity to reimagine it.

Politicians and pundits never tire of saying that America is at a crossroads. But when it comes to the international trading system, it’s true. Since the creation of the World Trade Organization (WTO) in 1995, trade policy has operated under a consensus that nations should work together to reduce trade barriers to a bare minimum. But the growth of China’s state-led economy has demolished old assumptions about the gains from global free trade, leaving the WTO in disarray and slowing its work to a crawl. This new reality has left Republicans swinging between two extremes: defending a dying system, or blowing it up with no replacement.

For its part, the Biden administration recently unveiled a “strategic vision” that promised to remake U.S. trade policy, but offered little more than watered-down Trump-era policies. Meanwhile, the White House’s WTO strategy was relegated to a secondary statement that neglected to mention China and called only for piecemeal reform — even though the WTO’s rules continue to fundamentally shape global trade.

Republicans should answer with a more ambitious agenda that seeks transformation, not reform, at the WTO. Instead of alternating between unearned defense and blanket repudiation, Republicans can reshape the international trading system to the advantage of the U.S. and its allies.

The proximate cause of the WTO’s brokenness is the United States’ 2019 decision to block the appointment of new members to the Appellate Body, an exceptionally powerful court that issues binding judgments against nations held to have violated the various rules that make up the WTO system. Without new members, the Appellate Body can no longer operate, neutering the system’s key enforcement mechanism.

The death of the Appellate Body was well deserved. The Appellate Body had appropriated to itself the power to issue new interpretations of WTO treaty terms and regarded past rulings as binding precedent, resulting in a system run by a handful of international jurists instead of the nations that make up the WTO. Bureaucracy rewards mission creep, and so these jurists enacted powerful biases in favor of trade liberalization beyond what the text of WTO agreements actually permitted.

For example, the WTO permits member nations to place tariffs on imports that receive market-distorting subsidies from a “public body” in the exporting nation. One might imagine this would cover subsidies from state-owned enterprises or other entities controlled by the government. But the Appellate Body ruled that “public body” refers only to entities formally vested with governmental authority — leaving member nations no recourse to block Chinese exports subsidized by state-owned enterprises rather than an actual department of the Chinese government. It didn’t matter that this narrow definition of “public body” appeared nowhere in any WTO agreement and was never approved by any member nation. The opinion of three jurists was enough to bind member nations to this contrived definition.

The U.S. blocked new appointees to the Appellate Body to stop this unaccountable system from reordering our commercial relationships. But this institutional failure is only the latest in the WTO’s long-term decline in effectiveness and relevance. In short, the WTO was designed to solve a problem that no longer exists — high global tariffs. At the 1947 signing of the WTO’s precursor treaty, the Global Agreement on Tariffs and Trade (GATT), global tariffs averaged between 20 and 30 percent. Today, they’re in the single digits, and the United States’ weighted average tariff is 2 percent.

The modest liberalization of trade that accompanied the GATT yielded significant economic benefits, but with tariffs as low as they are, there is now little to be gained from further reductions. Gains from free trade are possible because trade redistributes income from less efficient activities to more efficient ones, but with smaller opportunities for gain, the redistributive effects of further liberalization swamp the efficiency benefits. One estimate from Harvard economist Dani Rodrik found that removing all remaining U.S. tariffs would redistribute $50 for every $1 of net gain from trade — effectively giving $51 to Peter, taking $50 away from Paul, and declaring that society is $1 better off. There is no appetite for that, as the WTO discovered when its most recent round of tariff-lowering negotiations, the Doha Round, collapsed in 2011.

Finding future victories in the war on tariffs impossible, the WTO instead turned its attention to “harmonizing” areas of domestic policy previously insulated from global governance, including rules on taxation, investment, environment, food safety, and industrial policy. The WTO saw variance in domestic laws as a transaction cost that impeded international commerce -— never mind the voters seeking different arrangements in the sovereign nations supposedly accountable to them.

The centerpiece of the WTO system is the requirement that all member nations afford one another’s goods equal treatment, or “most-favored nation” (MFN) treatment, in WTO parlance. MFN treatment is the counterintuitive term for non-discrimination between the imports of different countries. For instance, if the U.S. applies a tariff to the goods of one WTO member country, it cannot apply a higher tariff to the goods of another member country unless it can prove that country broke WTO rules. Because the WTO has effectively codified loopholes in its unfair-competition rules, the MFN requirement now serves to enforce equal treatment for rulebreakers, and the worst rulebreaker also happens to be the largest trading nation in the world.

China has used the WTO’s rules restricting state subsidies and other industrial policies to achieve an asymmetric advantage over its competitors. It remains free to subsidize its firms because WTO Appellate Body precedent exempts China’s powerful state-owned enterprises (SOEs) from subsidy restrictions by holding that SOEs were not actually “public bodies.” More problematically, the Chinese state is not a single entity. It is dispersed throughout its economy through both formal and informal Communist Party oversight of corporate boards, banks, and investment funds, whereby Beijing can dispense state resources to favored actors without tripping the WTO’s alarm. The result is that over 3 percent of China’s annual economic output is now made up of business subsidies, which are designed to help companies in key sectors such as renewable energy, autos, telecommunications, batteries, and semiconductors.

For example, China subsidizes its semiconductor industry not through direct cash transfers, but through below-market loans, reduced utility rates, tax breaks, discounted or free land, and investments from “government guided” private equity funds that accept subpar returns to meet state goals. Chinese state-controlled investment in the sector now totals $51 billion, and SMIC and Tsinghua Unigroup, two major semiconductor firms, now derive an estimated 30 percent of their annual revenue from government sources. Their market share is climbing steadily at the expense of embattled American firms.

Under WTO rules, the U.S. must simply accept these market distortions.  Because China creatively designs many of its subsidies to operate indirectly through non-state bodies, the U.S. can’t offset them through tariffs and must treat these subsidized imports the same way they do all other goods. Nor can the U.S. compete by subsidizing its own strategic sectors without running afoul of the WTO, because we (thankfully) lack the quasi-state institutions that make China’s industrial policy possible. WTO rules prohibiting discrimination were intended to have an equalizing effect. Instead, they force us to play a rigged game.

The “establishment” answer has been to call for heightened WTO governance over subsidies. In January 2020, the trade ministers of Japan, the EU, and the U.S. issued a joint statement calling for the WTO to prohibit or more tightly regulate additional categories of subsidies, including “excessively large” subsidies and subsidies directed at “uncompetitive” or “ailing” firms. The statement also called for requirements to report subsidies to the WTO. It’s a noble effort, unfortunately built on the false premise that heightened global governance can reach inside the Chinese system and change it. It cannot: China is fully committed to its state-led system, and will flout any new international rules designed to rein it in. But prim, law-abiding Western nations would likely follow such rules, entrenching the competitive asymmetries that got us here in the first place.

Instead of asking China to tie a hand behind its back, we will have better luck untying our own. Currently, the WTO’s most-favored-nation rule requires the U.S. to go through a costly, time-consuming process to prove that exports received improper government assistance from one of several narrowly construed buckets — and only after anticompetitive imports have inflicted sufficient levels of provable injury on American firms. China easily skirts those buckets, and after all, the point is to avoid being injured in the first place.

The heart of American trade strategy for this dangerous new era should be achieving the freedom to discriminate against adversaries. The WTO should be reimagined as a set of trading privileges for market economies, conferring policy space on states that share our system to opt out of free trade with states that do not. The WTO already permits opt-outs from MFN treatment to secure public goods such as national security and public health — why not also permit it against an economic system that creates massive threats to both? The most-favored-nation requirement to treat everyone’s goods equally is a bizarre principle in a world where some state-led economies are, for example, filling their supply chains with slave labor, converting exported goods into secret surveillance tools, and sponsoring massive cyberattacks on American industry. Why should anyone favor such a nation?

Dani Rodrik proposed the best opt-out mechanism in his 2011 book The Globalization Paradox. Rodrik suggests reforming the WTO’s Agreement on Safeguards — which permits temporary and MFN-compliant tariffs when an increase in imports injures domestic industry— to permit permanent, targeted, uncompensated, and preemptive tariffs when such imports originate from an authoritarian state. Unfortunately, the WTO is not set up to determine whether a given state is “authoritarian”— but it could instead measure state intervention in the economy, and permit members to use discriminatory tariffs against countries that do too much of it.

The WTO can do this by dusting off a concept it already uses: the “non-market economy” designation. Currently, this tool is relegated to the technocratic sidelines, allowing member states calculating anti-dumping duties to ignore domestic prices from countries that have a “complete or substantially complete monopoly of [their] trade and where all domestic prices are fixed by the State.” The test was originally designed for Soviet-style command economies, but today it should be broadened to include China-style state capitalism. The precise trigger could be worked out later: price distortion some amount beneath fair market value, SOEs above a certain market share, subsidy amounts above a certain level of GDP, or some combination thereof. The point is that the U.S. should demand that the WTO agree to permit what could be called “non-market safeguard tariffs” against exports from state-led economies.

Of course, the U.S. can already act unilaterally to raise tariffs on rulebreakers through Section 301, a domestic law that permits tariffs against countries found to be breaking trade agreements or unjustifiably burdening U.S. exports. Indeed, the Biden administration is reportedly considering a Section 301 investigation targeting Chinese subsidies. But overreliance on Section 301 disadvantages domestic exporters, who must face down retaliatory tariffs not imposed on foreign firms. Market economies must act against rulebreakers together, increasing the magnitude of the punishment and blunting the impact of any response.

Perhaps the ultimate unilateral measure would be leaving the WTO altogether, as Senator Josh Hawley (R., Mo.) has proposed. If we did this, the rest of the world would be free to apply whatever tariffs they want on U.S. exports, costing us far more in diminished market access than we would gain from freedom to retaliate against China. Further, leaving would allow China to reorder WTO rules to its own advantage, leaving a diminished U.S. to cobble together a new trading bloc from scratch. Any serious plan to leave the WTO would need to have that bloc of like-minded nations ready to go on Day 1 — yet that effort is nowhere in evidence. Instead, the optimal strategy is to preserve market access while gaining retaliatory strength inside the WTO — kicking out China instead of ourselves. Luckily, we have the Appellate Body as a hostage, affording us plenty of negotiating leverage. Republicans need only find a unified voice and start making demands.

Reimagining the WTO as a walled city rather than a henhouse with a fox inside it would require a large investment of time and effort. This could be spared by suspending our focus on signing new free-trade agreements. Many prominent free-trade agreements produce a rounding error’s worth of net economic gain for the U.S. in exchange for massive investments of state resources and political capital to negotiate them— to say nothing of their painful redistributive effects. For example, NAFTA is estimated to have increased U.S. economic welfare by less than one tenth of 1 percent, but workers in certain industries that lost tariff protection saw a wage penalty of up to 17 percent.

Rather than use free-trade agreements to protect cross-border capital flows and investor–state dispute settlement, Republicans would better serve their working-class voters by demanding that our trading partners raise their labor and environmental standards as a condition of access to our market, something Trump’s chief trade negotiator, Robert Lighthizer, has advocated. Republicans should start using the term “social dumping” — which refers to foreign competitors who gain an advantage for their exports by taking measures that would be unacceptable if taken by a domestic competitor, such as violating labor laws and despoiling the environment. American voters fought for labor and environmental protections through the democratic process in our own country only to see their jobs lost, and their social contract undone, because of the accident of a competitor’s country of origin. Republican voters would thrill to an announcement that if our foreign competitors want to export to our market, they will need to play by our rules. And if championing high global labor and environmental standards feels awkward to Republicans, they should get over it, because it would make our goods more competitive.

Cracking down on social dumping is also likely to violate our WTO obligation to treat all imports equally. It’s yet another reason why that institution is in dire need of transformation. Americans have done it before, when we built the institutions that shaped the global economy at Bretton Woods following World War II and more recently when we played a decisive role in framing the WTO itself. As the assumptions that built the previous era’s institutions collapse, Republicans can recapture this spirit of bold imagination on behalf of their middle- and working-class constituents. After decades of pain brought on by fealty to a fundamentally unfair system, they are owed that much.

These views are the author’s alone.

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[By: Nicholas Phillips

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