International Trade: Commercial Policy and Trade Negotiations

International Trade: Commercial Policy and Trade Negotiations

International Trade: Commercial Policy and Trade Negotiations Andreas Du¨r, University of Salzburg, Salzburg, Austria Ó 2015 Elsevier Ltd. All rights ...

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International Trade: Commercial Policy and Trade Negotiations Andreas Du¨r, University of Salzburg, Salzburg, Austria Ó 2015 Elsevier Ltd. All rights reserved.

Abstract Commercial policy has a strong negotiated component, with many international trade negotiations aiming at the liberalization of trade. Why do we see these trade negotiations, that is, why do countries even aim to liberalize trade? What explains whether countries engage in multilateral or bilateral and plurilateral negotiations? And how do countries negotiate over trade, that is, which role does power play and what explains the choice of bargaining strategy in commercial negotiations?

Commercial Policy Most countries today are more open to international trade than ever before in their history. While trade flows were severely curtailed in the interwar period, since the end of World War II trade has grown substantively faster than world output. In 2011, therefore, world merchandise trade amounted to no less than US$18 trillion (World Trade Organization, 2013: 5). International trade no longer only concerns trade in goods; services trade, for example, the cross-border provision of financial services, also plays a crucial role in the expansion of trade. Moreover, countries trade an increasing amount of intermediary goods, leading to the establishment of global value chains and global production networks (Elms and Low, 2013). As a consequence, the world economy has become highly dependent on world trade. The rapid growth in cross-border trade has been driven by technological innovations that have reduced the costs of trade. Not only have shipping and air travel become less expensive, but also the cross-border provision of services has become much easier as a result of the Digital Revolution. Next to technological changes, however, also the commercial policies adopted by countries across the globe have facilitated the growth in trade. Commercial policy is the part of government policy that directly aims at influencing the amount of trade that crosses borders. This can mean boosting trade, for example, by reducing barriers that hinder imports. Trade barriers include both tariffs and behind-the-border measures, such as discriminatory standards, that limit foreign imports. Boosting trade can also be achieved by facilitating or even subsidizing exports. Commercial policy can also be protectionist, that is, be aimed at reducing trade, by increasing trade barriers both at and behind the border. Commercial policy involves unilateral trade policy measures, such as unilateral increases or reductions in tariffs. In the United States, for example, the Smoot Hawley Act (1932) unilaterally increased tariffs across most imports, leading to a substantial decline in foreign imports. More recently, many emerging economies unilaterally reduced their tariffs, with Chile a particularly prominent example (Edwards and Lederman, 1998). Some trade policy measures are also inherently unilateral. This is the case for antidumping actions and countervailing measures. The former are duties imposed when a country suspects that another country sells a product


below the price of production. Countervailing measures are a response to subsidies given by another country. Because commercial policies do not only affect the own country but also trading partners, however, commercial policy also has a strong negotiated component. In fact, ever since countries engage in trade, they have signed agreements that facilitate or restrict trade between two or more countries. Commercial policy measures can be applied preferentially or nonpreferentially. A tariff cut, for example, can be extended to only a few countries (for example, in form of a preferential trade agreement (PTA)) or to all countries benefitting from ‘most-favored-nation’ treatment. Most-favored-nation treatment means that a country receives at least the same if not more trade advantages than any other country. In the words of Jackson (1997: 160–161), it establishes “an obligation to activities of a particular foreign country or its citizens at least as favorably as it treats the activities of any other country.” Antidumping duties or countervailing measures create preferential treatment, as they target specific suppliers or specific countries. Overall, then, commercial policy measures can liberalize or protect a market; can be imposed unilaterally or be the result of negotiations; and can be applied preferentially or in a nonpreferential manner. Table 1 summarizes these three dimensions that can be used to characterize commercial policy. It offers examples for seven of the eight possible types of commercial policy measures. The eighth – a negotiated, nonpreferential protectionist measure cannot be observed in practice.

Trade Negotiations as an Instrument of Commercial Policy Trade negotiations are a key instrument of commercial policy. Most trade negotiations aim at the liberalization of trade, that is, the removal of trade barriers that hinder the flow of goods or services across borders. After World War II, 23 countries signed the General Agreement on Tariffs and Trade (GATT), which foresaw the stepwise liberalization of trade following the principle of reciprocity. Reciprocity means that countries exchange tariff concessions; one country agrees to reduce the tariff on a product in exchange for another country reducing the tariff on the same or another product. Establishing reciprocity, especially among many countries, required trade negotiations.

International Encyclopedia of the Social & Behavioral Sciences, 2nd edition, Volume 12

International Trade: Commercial Policy and Trade Negotiations

Table 1

A typology of trade policy measures Unilateral









The unilateral removal of a specific trade barrier that only benefits one or a few countries The imposition of antidumping duties that only affect one or a few countries

A tariff cut that is applied to all countries enjoying mostfavored-nation treatment

A preferential trade agreement that liberalizes trade among two or a few countries

A trade agreement that leads to liberalization on a mostfavored-nation basis

A tariff increase that is applied to all countries

A voluntary export restraint agreement

Note: the cell entries provide examples for the various measures. They do not represent a comprehensive list of trade policy measures.

Such trade rounds in the framework of the GATT took place in 1947, 1949, 1950–51, 1956, 1960–61, 1964–67, 1973–79, and 1986–93 (see Table 2). The most important of these trade rounds, the Kennedy Round in the 1960s, the Tokyo Round in the 1970s, and the Uruguay Round in the 1980s and 1990s resulted in major tariff cuts and also the reduction of other barriers to trade (Cohn, 2002; Brown, 2003). The Uruguay Round also led to the creation of the World Trade Organization (WTO), which replaced the GATT in 1995. In the framework of the WTO, a major trade round – known as Doha Development Agenda – was started in 2001, with the negotiations still ongoing. Trade negotiations also take place outside the GATT/WTO. Especially, the last two decades have seen the rapid spread of PTAs that are the result of negotiations between two or among a few countries (Mansfield and Milner, 1999; Dür et al., 2014). Examples are the North American Free Trade Agreement (signed in 1992), the agreement between Japan and Switzerland (signed in 2009), and the Australia-New Zealand Closer Economic Relations Trade Agreement (signed in 1983). At the time of writing, Australia, Chile, Japan, Mexico, the United States, and a series of other countries engage in negotiations for a Trans Pacific Partnership agreement and the United States and the European Union envisage the conclusion of a Transatlantic Trade and Investment Partnership. Not all trade negotiations aim at liberalizing trade. Especially in the 1970s and 1980s, countries negotiated ‘voluntary’ export restraint agreements that restrict international trade (Bhagwati, 1988: 44). In these agreements, an exporting country agrees to reduce exports of a specific product to avoid Table 2

the imposition of trade barriers by the importing country. A prominent example for a voluntary export restraint is the 1981 agreement by Japan to reduce exports of cars to the United States.

Why Do Countries Engage in Trade Negotiations to Liberalize Trade? Trade negotiations thus mainly aim at the liberalization of international trade. But why are countries even interested in trade liberalization? It is generally agreed that free trade maximizes the welfare of all countries because it allows for goods and services to be produced in the most efficient locations. Free trade allows countries to specialize on producing the goods or providing the services for which they have a comparative advantage, meaning that they can produce or provide them at a lower opportunity cost than in another country. Countries thus do not need to have an absolute advantage in producing some goods or providing some services in order to benefit from trade; as long as countries differ in their relative efficiencies in producing different goods, all countries benefit from trade. Trade, however, also has distributional effects (Alt and Gilligan, 1994). An expansion in trade redistributes wealth in a society, that is, it benefits some and hurts others. Two theorems offer contradictory predictions about who will win and who will lose from an expansion in trade. The Stolper–Samuelson theorem predicts that the relative price of the factor that is used most intensively in the production of

Major multilateral trade negotiations




Geneva Annecy Torquay Geneva II Dillon Kennedy Tokyo Uruguay

1947 1949 1950–51 1956 1960–61 1964–67 1973–79 1986–93

Doha Development Agenda


Creation of the GATT and tariff reductions Tariff reductions Tariff reductions Tariff reductions Tariff reductions Tariff reductions and an antidumping code Tariff reductions and several codes for nontariff barriers Tariff reductions, nontariff barriers, service liberalization, foreign direct investment protection, intellectual property rights protection. Creation of the WTO The Bali package agreed upon in 2013 covers trade facilitation, food security, and preferential rules for least developed countries


International Trade: Commercial Policy and Trade Negotiations

a good will increase as production of the good expands. By contrast, the owners of the factor of production that is used less intensively in the production of this good will lose from an expansion of production. In a country exporting a labor-intensive good such as textiles, consequently, trade liberalization will result in an increase in wages. At the same time, the returns on capital will decline as the country increases its exports of textiles. This theorem builds on the assumption of perfect factor mobility, that is, it assumes that a factor of production can be moved without costs from one sector of production to another. The Ricardo–Viner model, by contrast, assumes that factors of production are specific to a sector. This may be because the capital used in one sector is different from the capital used in another sector. For example, a cotton spinning machine cannot be used in the production of cars. Following this model, an expansion in exports of a good will increase the price of capital and labor employed in the specific sector; and decrease the price of capital and labor in other sectors. The expectation then is for capital owners and labor in exporting industries to favor trade liberalization, and capital owners and labor in importcompeting industries to favor protectionist trade policies. Several studies have tried to find out which of these two models better accounts for trade preferences (Magee et al., 1989; Rogowski, 1989; Hiscox, 2002). Magee et al. (1989) found support for the Ricardo–Viner model. At the same time, the Stolper–Samuelson theorem has been used to show that increases or decreases in trade, for example, those resulting from cheaper transportation, can have major political consequences (Rogowski, 1989). Socialism may have been a response to the expansion of trade in a backward economy with a low land-labor ration. West European Fascism may have resulted from a decline in trade in an advanced economy with a low land-labor ratio. Hiscox (2002), finally, showed that factor mobility varies over time; sometimes, then, the Stolper–Samuelson theorem applies and at other times the Ricardo–Viner model. For many years, these distributional effects of trade have been used to explain countries’ choices between protectionism and trade liberalization (Alt et al., 1996). The expectation has been for the losers from trade to push for protectionist trade policies; and the winners to support trade liberalization. Both the losers and the winners may create pressure groups that push for their respective stances by donating to decision makers, providing information or mobilizing the public. The political economy of trade then expects a government to take into account the relative strength of the two sides when designing its commercial policy. If factor mobility is high, the demands for protection or trade liberalization may also be reflected in party programs. In either case, the expectation is that whenever the protectionist side is stronger, the country will implement a protectionist trade policy; whenever the free trade side is stronger, the country will opt for trade liberalization. Early on, however, scholars realized that the two sides in the trade policy debate may not be equally capable of getting organized and influencing government policy. In fact, traditionally the proponents of protectionist trade policies have been seen as having an advantage in mobilizing for political activity. The highly protectionist Smoot–Hawley Act that US Congress passed in 1932, for example, may have been the result

of the highly effective mobilization of protectionist interests, whereas the free trade interests were all but absent from the political scene (Schattschneider, 1935). In this view, the benefits of protection are concentrated on a few producers, while the costs of protection are distributed among many consumers. Collective action problems (Olson, 1965) hence are seen as benefitting protectionist interests. What then explains the move from protectionist trade policies to trade liberalization that we can observe just before and after World War II? Much research has focused on the passage of the Reciprocal Trade Agreements Act (RTAA, 1934) in the United States as the initial impetus for trade liberalization. The RTAA empowered the President to negotiate reciprocal trade agreements with trading partners. In a series of negotiations, the President used these powers to open foreign markets and bring down US trade barriers. For many, this piece of legislation, by shifting the responsibility for trade policy from Congress to the executive, allowed for the subsequent liberalization of trade (Lohmann and O’Halloran, 1994; Bailey et al., 1997; Gilligan, 1997). The institutional change may have been important because the President has a larger constituency than members of Congress and thus needs to take into account the negative externalities of protectionist policies for the welfare of the country as a whole (Lohmann and O’Halloran, 1994). The trade agreements that the president then negotiated with third countries locked in lower tariffs and made it more difficult for the at that time predominantly protectionist Republican Party to raise tariffs once back in control of Congress (Bailey et al., 1997). By concentrating the benefits of reciprocity on particular exporters, moreover, reciprocity created a powerful lobby for free trade (Gilligan, 1997). These arguments, however, have not gone unchallenged. Referring to the RTAA as a ‘magic bullet,’ Hiscox (1999) argued that this account may explain what happened after the RTAA was passed, but cannot account for the passage of this piece of legislation. He argues that the act only passed because the back then free trade oriented Democratic Party controlled Congress at that time. The RTAA also did not lead to a stark reversal in the strength of protectionist and free trade interests in the United States in the following decades. Rather, for exogenous reasons, namely a shift in the geographic distribution of production in the United States, the Republican Party became increasingly divided with respect to trade policy. This allowed the RTAA to survive in the 1940s and 1950s even after the Republicans regained a majority in Congress. The explanation provided in Dür (2010) also runs counter the institutionalist explanation. Here the argument is that twentieth-century trade liberalization was a response to the discrimination created first by the system of imperial preferences implemented by the United Kingdom and its dominions and then the process of European integration. Congress passed the RTAA only 2 years after the Ottawa agreements established the system of imperial preferences. Both societal interests and decision-makers supportive of the RTAA clearly alluded to the negative consequences of the Ottawa agreements for American exporters in making their case for the RTAA. Later, the creation of the European Economic Community in the late 1950s reinvigorated the American interest in trade liberalization, leading to the far-reaching trade liberalization agreed upon in the Kennedy Round. Most recently, following this account, the

International Trade: Commercial Policy and Trade Negotiations

discrimination created by the spread of PTAs propelled further trade liberalization. Trade liberalization may also result from a change of ideas (Goldstein, 1993; Schonhardt-Bailey, 2006). In the nineteenth century, economic ideas may have played a major role in the British unilateral shift from protectionism to free trade, as exemplified by the repeal of the highly protectionist Corn Laws (Schonhardt-Bailey, 2006). More recently, the perception that the protectionist policies of the interwar period contributed to the Great Depression may have made decision-makers favor free trade policies. What is not completely clear from this explanation, however, is why most trade liberalization was achieved in international trade negotiations, rather than implemented unilaterally.

When Do Countries Engage in Multilateral and When in Bilateral or Plurilateral Trade Negotiations? Commercial negotiations comprise only either two or a few countries (bilateral or plurilateral negotiations) or many countries (multilateral negotiations). The results achieved in trade negotiations, moreover, can be applied preferentially or on a most-favored nation basis. For many years, countries have been granting most-favored nation status to other countries (Horn and Mavroidis, 2001). Most-favored nation treatment also became a key element of the trading system that emerged after World War II. A key principle of the multilateral trade rounds taking place in the framework of the GATT/WTO is that any concessions offered by a country to another are extended to all members of the GATT/WTO. At the same time, many bilateral or plurilateral trade negotiations aim at the establishment of PTAs that liberalize trade between two or among a few countries without extending these concessions to third countries. From a welfare perspective, under many circumstances PTAs are inefficient, as they may lead to the substitution of more efficient imports by less efficient production within the preferential trading zone. This effect is known as trade diversion (Viner, 1950). PTAs also create trade if inefficient domestic production is substituted by more efficient production from within the preferential trading area. Despite their ambiguous welfare effects, PTAs have been mushrooming since around 1990. In the period from 1945 to 1990, countries around the world signed 208 PTAs (Dür et al., 2014). After 1991, this number substantially increased, with countries signing 525 new agreements between 1991 and 2009. Many of these new agreements not only reduce tariffs on goods, but also contain provisions regarding the liberalization of services trade, the protection of foreign direct investments, the harmonization of standards, and many other behind-the-border trade barriers. Several explanations exist for why countries pursue preferential rather than multilateral trade agreements. For one, countries may find it easier to negotiate far-reaching agreements between two or among a few countries (Krugman, 1993). As of 2014, the WTO has 159 members. Agreeing on a multilateral agreement among so many countries has proven difficult. The Doha Development Agenda has been ongoing since 2001, with only limited results. In this view, PTAs simply


satisfy countries’ needs for negotiated trade liberalization in the absence of a multilateral agreement. PTAs may not only be a second-best policy, however. Producers of goods that benefit from economies of scale may favor PTA because they allow them to increase their production and hence reduce unit costs without facing world-wide competition. A PTA then can serve as a springboard for these producers to achieve global competitiveness. Realizing this, these producers may lobby governments to sign preferential rather than or in advance of multilateral trade agreements (Chase, 2005). Countries may also pursue PTAs for geopolitical reasons. A PTA may allow a dominant country to increase other countries’ dependence on the own market, which in turn should increase the dominant country’s power over these other countries (Hirschman, 1945). Similarly, a PTA may be an instrument to increase the military power of a set of countries. PTAs increase trade among the member countries; this trade creation enhances the national income of the participating countries, allowing them to invest more in defense (Gowa, 1994). A PTA may also be a response to the PTAs signed by other countries. By liberalizing trade only among a few countries, PTAs discriminate against third countries. Exporters from these third countries suddenly find themselves in a situation in which they are no longer competitive in the PTA market, because they face higher trade barriers than firms inside the PTA. Third country exporters may then lobby their governments to also sign a PTA with the members of a PTA or to form a competitive PTA, leading to a domino effect that makes more and more countries sign PTAs (Baldwin, 1993; Dür, 2010; Baccini and Dür, 2012). PTAs may also be a signal to voters in democracies that the government is pursuing efficient economic policies (Mansfield and Milner, 2012). The argument here is that voters often do not know whether an economic downturn is a result of the economic policies pursued by the government or exogenous circumstances. In doubt, they use elections to oust the government. Knowing this, the government can sign PTAs that signal to voters that it is pursuing an efficient economic policy, allowing it to stay in power even during economic downturns. Finally, especially for governments in developing countries, PTAs may also serve to lock in domestic economic reforms (Whalley, 1998). Economic reforms can be painful; once implemented, they may not survive a change in government. By linking these reforms to better foreign market access in PTAs, governments can ensure the durability of these reforms.

How Do Countries Negotiate over Trade? Early trade negotiations in the GATT were dominated by a few countries. Developing countries mainly were passive recipients of the concessions exchanged by the key trading nations. It was not before the Uruguay Round that developing countries became increasingly vocal. The increasing number of active players in multilateral negotiations has made the analysis of these negotiations substantially more demanding. Both multilateral and preferential trade negotiations have also become increasingly complex because of the growing number of topics covered in trade negotiations. Whereas originally the


International Trade: Commercial Policy and Trade Negotiations

negotiations mainly tackled tariff cuts, contemporary trade negotiations have a scope that goes far beyond tariffs and encompasses behind-the-border barriers to trade. One important consequence of the increasing complexity of multilateral trade negotiations has been the emergence of coalitions that explicitly coordinate their position. In the Uruguay Round, for example, several coalitions of developing countries played an important role (Drahos, 2003; Narlikar, 2003). Bargaining together allowed them partly to balance the superior power of the developed countries. As preferential trade negotiations mainly do not allow for such coalition building, weaker countries may be more open to exploitation in these negotiations than in the GATT/WTO system. An analysis of international trade negotiations thus always begs the question of who has power in these negotiations. There are several sources of power in trade negotiations (Drahos, 2003; Dür, 2010). A country’s market size is key, as countries are more eager to get access to larger than to smaller markets. Access to the own market, then, can be ‘sold’ in exchange for concessions from the other countries. A country’s domestic political institutions may also matter for the country’s bargaining power in international trade negotiations. The literature on international negotiations shows that countries with high ratification requirements tend to be more powerful in international negotiations (Putnam, 1988). Finally, negotiation strategies may matter for a country’s bargaining power. Choosing the right tactics at the right moment (for example, building a coalition) can give a country an advantage in the negotiations. Existing research on the power of countries in international trade negotiations indeed provides evidence for power imbalances. Gruber (2000) showed that countries that are able to conclude trade negotiations without waiting for more protectionist countries possess what he calls ‘go-it-alone-power.’ This go-it-alone power allows them to impose certain trade policy choices on excluded countries. Kim (2010) argues that developed countries used their power to shape the multilateral trade institutions following their preferences. By doing so, they managed to affect trade flows in a way that benefit them to the detriment of developing countries. Dür (2010) argues that countries that discriminate against other countries manage to gain power in international trade negotiations. The creation of the European Economic Community, for example, enabled the European countries to extract concessions from the United States. Some research has also looked at the strategies that countries use in international trade negotiations. Strategies are sets of tactics that countries adopt in pursuit of their objectives (Odell, 2006: 15). They vary between distributive and integrative bargaining (Walton and McKersie, 1965) or between hard and soft bargaining (Dür and Mateo, 2010). Distributive bargaining refers to a strategy that is aimed at claiming value from others. Integrative bargaining, by contrast, aims at creating value, that is, increasing the size of the pie that can be distributed in a negotiation. Hard bargaining refers to the use of conflictual or aggressive tactics; and soft bargaining to the use of cooperative or friendly ones. A few studies report empirical evidence on the choice of strategies in international trade negotiations. Davis (2003) analyzed how countries use issue linkages to reach compromises in agricultural trade negotiations. Elms (2006) studied US strategies in negotiations with Japan and South Korea in the

1990s. She shows that countries adopt a distributive or valueclaiming strategy when they face losses in trade negotiations. They do so even though a distributive strategy is likely to result in a suboptimal outcome.

Outlook The increasing scope of international trade negotiations has made them increasingly salient to the public. The Seattle WTO Ministerial Meeting of 1999, which was supposed to start the multilateral trade negotiations later known as Doha Development Agenda, witnessed violent protests (Smith, 2001). The Anti-Counterfeiting Trade Agreement signed in 2011 and 2012 was not ratified by the European Union because of a massive mobilization of citizens opposing the transnational protection of intellectual property rights (Dür and Mateo, 2014). The negotiations for a Transatlantic Trade and Investment Partnership have also experienced a bumpy start after the plans for investor-state dispute settlement – namely the ability for private investors to sue states before an international tribunal – were publicly debated. While earlier trade negotiations were nearly exclusively decided by a few negotiators, this greater public salience will have a major effect on current and future trade negotiations. It will influence the speed of liberalization; countries’ choice of multilateral or bilateral negotiations; and power and strategies in negotiations.

See also: Area and International Studies: Political Economy; Globalization: Geographical Aspects; International Trade: Economic Integration; Trade Policy.

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Relevant Websites – Design of Trade Agreements (DESTA) Database – European Commission, Trade. – SICE. The Organization of American States Foreign Trade Information System. – United Nations, International Trade.