Deep Dive

System Upgrade

System Upgrade

The international trading system has been a cornerstone of the global economy for more than 60 years and has made an important contribution to harmony in the community of nations. Now, however, the system risks losing pace with a fast-changing world. It’s past time to give international trade a much-needed revamp by reaching agreement to modernize the system. Concluding the Doha round of trade talks is the most obvious way to do that, but now this vitally important negotiation is imperiled by discord among key players and risks being sidelined for some time to come.

Any doubts about the stability and importance of the global trade architecture should have been dispelled by the remarkable manner in which the system has endured the devastating economic crisis that shook the world from 2008 to 2009. That durability stands in stark contrast with many other elements in the international architecture, which proved too brittle to withstand this shock. For example, governments have yet to devise an international system for managing climate change or currency volatility. Other issues heavily tinged by domestic politics, such as migration, are not even on the international agenda and face fire even at the regional level, as we have seen with the influx of immigrants to Europe following recent events in North Africa. By now, it should be clear that the failure to establish a system of global governance in the area of international finance unquestionably blunted governments’ ability to respond effectively to the crisis.

Yet even while a great many things went wrong in the crisis, the trading system responded precisely as it was intended to. Compare that with the 1930s, when the last great global economic calamity unfolded. No such system was in place, and the global economy paid a heavy price. The United States passed the Smoot-Hawley Tariff Act in 1930, quadrupling tariffs and raising duties to at least 60 percent on more than 3,000 types of imported products. Faced with this provocation, America’s trading partners did not sit idly by; tit-for-tat retaliation rapidly ensued, closing markets and throttling trade. Between 1929 and 1934, world trade contracted 66 percent. The bulk of this collapse was due to disintegrating demand and the drying-up of credit. But the imposition of prohibitive duties not only pushed the economy further into depression — it also fostered a profound sense of ill will between governments and contributed to the international tensions that led to World War II.

To prevent this from happening again, leaders of great vision and wisdom agreed to create a rules-based, transparent, and nondiscriminatory trading system. Men like James Meade and Cordell Hull succeeded in encouraging 23 countries to accept a compact known as the General Agreement on Tariffs and Trade (GATT). Since the GATT came into force in 1948 and since the World Trade Organization (WTO) opened its doors in 1995, the world has not seen protectionist outbreaks like those of the early 1930s.

This is not to say that the trading system has not been tested. Protectionist pressures surged in 1971, for example, when the gold standard for currency conversion was abandoned, and during the 1997-1998 Asian economic crisis, when Pacific Rim countries saw their economies contract by double-digit margins. In each case, markets stayed open to the flow of goods and services from the affected countries, enabling them to trade their way back to stability and prosperity.

The bigger test came with the 2008-2009 Great Recession, the first truly global recession since World War II. When the international economy went into free fall, trade went right along with it. Production and supply are today thoroughly global in nature, with most manufactured products made from parts and materials imported from many other countries. These global value chains have a multiplier effect on trade statistics, which explains why, as the global economy contracted by 2 percent in 2009, trade volume shrank by more than 12 percent. This multiplier effect works the other way around as well: Growth returned to 4.6 percent and trade volume grew by a record 14.5 percent over the course of 2010. Projections for trade in 2011 are also strong, with WTO economists predicting that trade volume will rise 6.5 percent during the current year.

This sharp rebound in trade has proved two essential things: Markets stayed open despite ever-stronger pressures to close them, and trade is an indispensable tool for economic recovery, particularly for developing countries, which are more dependent on trade.

Shortly after the crisis broke out, we in the WTO began to closely monitor the trade policy response of our member governments. Many were fearful that pressures to impose trade restrictions would prove too powerful for governments to resist. But this is not what happened. Instead, the system of rules and disciplines, agreed to over 60 years of negotiations, held firm. In a series of reports prepared for WTO members and the G-20, we found that governments acted with great restraint. At no time did the trade-restrictive measures imposed cover more than 2 percent of world imports. Moreover, the measures used — anti-dumping duties, safeguards, and countervailing duties to offset export or production subsidies — were those which, in the right circumstances, are permissible under WTO rules. I am not suggesting that every safeguard measure or countervailing duty imposed during those difficult days was in compliance with WTO rules, but responses to trade pressures were generally undertaken within an internationally agreed-upon framework. Countries by and large resisted overtly noncompliant measures, such as breaking legally binding tariff ceilings or imposing import bans or quotas.

As markets stayed open, trade flows began to shift, and countries that shrugged off the impact of the crisis and continued to grow — notably China, India, and Brazil — became ever-more attractive markets for countries that were struggling, including those in Europe and North America. Trade has been a powerful engine for growth in the developing world, a fact reflected in the far greater trade-to-GDP ratios we see there. In 2010, developing countries’ share of world trade expanded to a record 45 percent, and this trend looks set to continue. Decisions made in Brasilia, Beijing, and New Delhi to open their respective economies to trade have been instrumental in enabling these countries to lift hundreds of millions of people out of poverty.

It’s a sound system to be sure, but in a rapidly changing world, standing pat is not an option. Governments historically have understood this well, and in the latter part of the 20th century, they concluded eight global trade accords, known as rounds, that further opened trade and strengthened trade rules. The last of these trade rounds, the Uruguay round in 1986, transformed the GATT into the WTO and extended the coverage of international agreements far beyond tariffs to include trade in agriculture, textiles, and services; the protection of trade-related intellectual property; and a binding dispute settlement system.

This was an important upgrade, but in the years since the Uruguay round was concluded, the world has changed enormously and the trading system has not kept pace. In an age of global sourcing of supply and production, this multilateral system is more important than ever. Over the years, tariffs have been gradually reduced, whether multilaterally, bilaterally, or unilaterally. Still, the rules governing the movement of goods through customs procedures were written in 1948, long before people had even dreamed of containerization, bar codes, or laptops.

The need to make our system both more development friendly and more relevant in the 21st century was the principal motivation that compelled governments to launch the Doha round in 2001. Ten years later, much progress has been made toward the stated goals of modernizing the system and making it more equitable. But we have now reached an impasse — an impasse that threatens to bring these negotiations to a complete standstill.

Concluding a Doha agreement will not be easy. The WTO operates on the principle of consensus, and gaining a consensus among 153 countries on 20 different topics, each with 10 subtopics, is an outcome on which few statisticians would bet. Given this degree of complexity and difficulty, many governments seem to prefer easier-to-attain, but less fruitful regional and bilateral agreements. Yet given the nature of trade today, there is no combination of bilateral or regional trade agreements that can deliver the kind of environment that enables firms to plan sourcing effectively. Businesses operate globally today, and they want rules for customs clearance and more efficient border crossing to be harmonized globally. They want greater competition among the providers of essential services in the key countries in which they operate. In essence, they want the rules of tomorrow to be in place today.

In some ways, the WTO is like a mule: It is reliable, it is dependable, and it is sturdy. Much like the multilateral trading system, mules do not go backward. The difficulty is that sometimes they are also reluctant to move forward. But there’s no better way to get ahead.