GLOBAL ECONOMICS


Patrick Grady and Kathleen Macmillan
Opening Markets More
from Seattle and Beyond: the WTO Millenium Round (1999), Chapter 2.

Tariffs

Improved market access for goods including in particular reduced tariffs have been the main objectives of the General Agreement on Tariffs and Trade ever since it was concluded in 1947. Over eight rounds of multilateral trade negotiations, great progress has been made in lowering average tariff rates on manufactured goods levied by industrialized countries from 40 per cent before GATT to around 4 per cent today. Progress was also made in eliminating other barriers to trade such as exchange controls, import licensing and quotas that were even more damaging to trade than tariffs.

The GATT applied an easy three-step recipe to reduce the overall level of protectionism in the world economy. First, less visible non-tariff trade barriers were, wherever possible, replaced with tariffs or, better still, eliminated. Second, maximum (or "bound") tariff rates were negotiated. Third, the bound rates were lowered further over time in subsequent rounds of negotiations.

For most industrialized countries, bound tariff rates are the same as MFN tariff rates. But for developing countries, bound tariff rates are often much higher than applied rates and serve as a ceiling. This gives these countries the flexibility to raise tariffs arbitrarily and unexpectedly if they so choose. In contrast, countries that bind their tariffs at applied levels must compensate their trading partners if for any reason they raise their tariffs.

By far the thickest pile of paper produced by the Uruguay Round contains the detailed schedules of bound tariffs by Harmonized System classification for each individual country participating in the negotiations. The Uruguay Round tariff cuts, which will be fully phased in by the year 2000, will average almost 40 per cent and will lower the average tariff on industrial products levied by developed countries from 6.3 per cent to 3.8 per cent. The proportion of the value of these products that will be duty free will rise from 20 per cent to 44 per cent. The proportion facing high tariffs above 15 per cent will fall from 7 per cent to 5 per cent. And the proportion of these tariff lines that are bound has increased from 78 per cent to 99 per cent.

Tariffs paid on most of the 84 per cent of Canadian exports with its most important trading partner, the United States, are set at zero under NAFTA. Tariffs negotiated under the GATT apply to the rest of Canada's trade, more than half of which is with the European Union (5.5 per cent) and Japan (3 per cent), Canada's next most important trading partners.

According to an OECD study, average tariffs will have been reduced substantially when the Uruguay Round cuts are fully phased in, but they will still have some way to go (Chart 1). Among the four Quad countries, tariffs will average in the 4 to 7 per cent range and be higher in the European Union and Canada than in Japan and the United States. Except for Switzerland and Sweden though, bound tariff rates will be significantly higher in other advanced OECD countries averaging from 9 to 25 per cent. And bound tariffs will be even higher still in the developing countries of Mexico and Turkey averaging 35 to 45 per cent. This is representative of bound tariff rates in the developing world. Bound tariff rates are usually much higher than applied rates in developing countries. Applied tariff rates only averaged 14 per cent in Mexico and 10 per cent in Turkey.

Simple Average of Bound Tariff Rates on Completion of Uruguay Round

It's not only the level of the tariffs that cause intersectoral distortions in production. A high dispersion of tariff rates combined especially with tariff "spikes" can also lead to a misallocation of resources. The same OECD study presents standard deviations for tariff rates as an indicator of dispersion (Chart 2). They are sufficiently high in the OECD's view to be a potential source of distortions. (The extraordinarily high standard deviation of tariff rates in Norway results from the tariffication of agricultural tariff rates.) Tariff "spikes," which are defined as exceeding three times the simple of MFN tariff rates, are also prevalent in most countries (Chart 3).

Overall Standard Deviation for All Tariff Rates in 1996 as Measured by Import Coverage Ratio

Tariff Spikes in 1996

A good example of a tariff "spike" occurs in truck tariffs, which are 22 per cent in the European Union and 25 per cent in the United States. The United States has relatively high tariffs for textiles, ceramics and glass, but this doesn't affect Canada because of the NAFTA. Some high tariffs facing Canadian producers include European Union tariffs on fish products (7 to 22 per cent), plywood (6 to 10 per cent), and non-ferrous metals including especially aluminum (7.5 per cent).

Even seemingly low tariffs can provide important protection. The OECD tariff study found a significant degree of tariff "escalation" in some countries. When this occurs, effective tariff protection increases as goods undergo further processing. For example, the Japanese tariff on lumber is only 4.8 per cent, but that's high enough to make it hard for Canadian lumber exporters to compete with Japanese lumber manufacturers who can import raw logs duty free.

In its recent report, the Standing Committee on Foreign Affairs and International trade found that tariffs are still very high in many developing countries not covered by the OECD study. By region, tariffs are highest in South Asia, where they averaged around 45 per cent in the early 1990s. Next comes Africa, where tariffs average in the 25 to 30 per cent range. Tariffs in East Asia (excluding China) and Latin America average in the 10 to 20 per cent range.

A discussion of the extraordinarily high tariffs on many agricultural goods following tariffication is reserved for the next chapter on agriculture.

There is clearly lots of room to cut tariffs further in the Millennium Round, even taking into account that they remain an important source of government revenue in many developing and transition economies. An ambitious objective for developed industrialized countries would be to try to reduce tariffs to zero or as close thereto as possible. For developing countries, another round of 30 to 40 per cent reductions would be a reasonable objective.

Non-Tariff Barriers

While much progress has been made in eliminating or lowering non-tariff barriers, they still exist and are important. The OECD study referred to above examined the prevalence of NTBs among OECD countries. The NTBs considered fell under two rubrics: price controls, and quantitative restrictions (QRs). Price controls covered Voluntary Export Restrictions like those used for automobiles and textiles, variable charges, and antidumping and countervailing duties. QRs included non-automatic licensing, export restraints, and other quotas and import prohibitions. The OECD study showed that QRs have not yet been confined to the dustbin of history (Chart 4). Ignoring Austria, QRs were most prevalent among the Quad countries, particularly the European Union and the United States. This suggest that the more advanced the economy the more subtle a form that protectionism assumes.

Importance of Non-Tariff Barriers in 1996 as Measured by Import Coverage Ratio

Trade Facilitation

Work has been underway at the WTO since the 1996 Singapore Ministerial looking at the practical problems faced by traders in moving goods across borders. This is to see whether existing WTO trade facilitation obligations such as the Customs Valuation and Rules of Origin Agreements are working and what more needs to be done. At a symposium held in 1998, which was attended by business representatives as well as government, there was an abundance of complaints about the way excessive red tape, inadequate computerization, lack of transparency, and failure to cooperate between customs and other government agencies made trading needlessly difficult. With just-in-time inventories and manufacturing, businesses are becoming increasingly dissatisfied with bureaucratic delays in getting goods through customs. Proposals have been advanced by some countries, including the United States and Canada, to improve existing trade facilitation provisions. This work will continue in the Millennium Round, perhaps even resulting in an Agreement on Trade Facilitation as well as modifications to existing agreements. More transparent procedures for trade and more efficient customs administration are badly needed and would be welcomed by traders throughout the world.

Automobiles

The Auto Pact, Canada's preferential trade agreement with the United States for its largest and most important industry accounting for $86-billion in output, has been challenged recently by Japan and the European Union before a WTO panel. They claim that Canada's 6.1-per-cent MFN tariff on vehicle imports from overseas is unfair and discriminatory because it does not apply to North America's Big Three Auto Companies. These three firms are able to import cars from their subsidiaries or affiliates duty free Ford from Jaguar and Volvo, Daimler-Chrysler from Mercedes Benz, and GM from Saab. So is Suzuki, which acquired Auto Pact status through its investment in the Cami Automotive assembly plant, a joint venture with GM. This preferential treatment contrasts with that of Honda and Toyota, which also produce cars in Canada, but which must pay duties on any cars they import. Japan and Europe in their complaint also challenged the Auto Pact more generally, including its performance requirements for the value of vehicles assembled in Canada and Canadian content, which are tied to the duty waver.

The panel's preliminary ruling, which became known in mid-October and will probably be approved by the WTO in January, found that the Auto Pact was inconsistent with many WTO articles and recommended that it, in effect, be abolished. In particular, it found that waver granted Auto Pact members of the 6.1-per-cent MFN tariff on motor vehicles was discriminatory and constituted a prohibited export subsidy. To comply, the Canadian Government will have to get rid of the Auto Pact, which can be done by order-in-council. The Canadian Government will also have to either eliminate the 6.1-per-cent MFN tariff, or apply it to all imports at the existing rate.

There are arguments on both sides of the issue. On the one hand, the Big Three will lobby the Government to retain the tariff and apply it to all non-North American imports. They will argue that, since the benefit of continued protection on the cars they produce in North America would outweigh the loss of having to pay the tariff on the relatively few cars they import from outside North America, they would be able to provide more economic activity and employment in Canada if the tariff were retained. This protection would, of course, be mitigated by any reduction in the tariff resulting from the Millennium Round and subsequent trade negotiations. But the tariff would be a chip in these negotiations and could be useful in negotiating tariff cuts by other countries.

On the other hand, the Japanese producers, who obviously want to see the tariff eliminated as soon as possible, will argue that the lower car prices that would result would be in the interest of Canadian consumers. Regardless of which side wins the day, however, it shouldn't have a very big affect on the Canadian automobile industry. Cars are produced in Canada today because of the strong competitiveness of the Canadian automobile industry and not because of the tariff and the Auto Pact. And most of the cars are made for export not for the domestic market.

Agreement on Textiles and Clothing

The sector that provides the initial impetus in the industrial development of many developing countries is textiles and clothing. It is labour intensive and makes good use of the low-wage, unskilled labour that they have in abundance. The competitiveness of the textiles and clothing industries in developing countries has long been considered a threat to the established industries of the industrialized countries which necessarily must pay wages and benefits many times higher.

The fear of lost jobs and depressed economies in producing regions if textiles and clothing imports were allowed to replace domestic production gave rise to powerful political pressures for protectionist measures. The Multifibre Arrangement (MFA), which was created in 1974 to manage trade in textiles and clothing with the developing countries, was the institutional response of the developed world to the prospect of soaring Third World textile and clothing imports. It established rules that enabled the importing developed countries to impose quotas based on historical shares in bilateral negotiations with the producing developing countries. It also legitimized the use of quantitative restrictions to deal with import surges. This approach was obviously discriminatory and violated basic GATT principles. However, the developing countries that wanted access to the developed world's textiles and clothing market had little choice but to go along, like it or not. But, it, at least, reduced the uncertainty they faced over market access and gave them a share in the quota rents, rather than leaving all the rents to the importing countries.

Given their visceral opposition to the patent unfairness of the MFA, the most important achievement of the Uruguay Round for many developing countries was the new Agreement on Textiles and Clothing (ATC), which embodied a plan to phase out the quantitative restraints of the MFA. At that time four WTO members Canada, the European Union, the United States and Norway still maintained import restrictions.

Under the ATC, the textile and clothing sector is being returned to normal GATT disciplines over a ten-year transition period ending in 2005. The products covered are yarns, fabrics, made-up textile products, and clothing. The process of integration into the rules of GATT is to be carried out progressively in three stages: in the first stage started on January 1, 1995 at least 16 per cent of products were integrated; in the second stage on January 1, 1998 an additional 17 per cent was integrated; in the third stage on January 1, 2002 another 18 per cent will be integrated; on January 1, 2005 the remaining products will be integrated. The ATC also contains a programme for liberalizing existing restrictions by increasing existing quota growth rates by a specified percentage. In addition, it provides a special transitional safeguard mechanism to protect against import surges of products that are not under quota but are not yet integrated. A Textiles Monitoring Body has been set up to oversee the implementation of the ATC and make sure that any measures taken respect the rules of the agreement.

While quantitative restrictions are already well on their way to being phased out under the ATC, developing country textile and clothing producing countries won't be completely out of the woods until all the products are integrated and the agreement terminated. There is always a risk that the phase out could be extended or additional restrictions could be imposed. Textile and clothing industry lobbyists in the developed world may be down but they're not out yet. The United States Administration demonstrated this when it gave in to pressure from the American Textile Manufacturers Institute, and sought to extend the application of textile quotas to China for an additional five years in its bilateral accession negotiations with China last April.

Forestry and Fisheries

There's been an ongoing controversy between the United States and Japan in particular over the forestry and fisheries sectors that could spill over into the Millennium Round. The United States, supported by Canada, became the champion of APEC's Early Voluntary Sectoral Liberalization (EVSL) initiative. Fifteen sectors were identified at the 1997 Leaders' meeting in Vancouver in 1997 for liberalization. Forestry and fisheries were among the nine fast-track sectors for which trade liberalization agreements were to be finalized for the 1998 Leaders' meeting in Kuala Lumpur. When it proved impossible to reach agreements, APEC passed the buck to the WTO.

The Japanese are still strongly opposed to any American efforts to achieve an agreement for early liberalization in forestry or fisheries because of the political sensitivity of these sectors, which are characterized by traditional lifestyles and account for much employment. If the Japanese had their druthers, these sectors would get special treatment like agriculture does under the WTO rules. Barring that, they want them to be part of the overall negotiations. The Americans, on the other hand, are adamant on the need for quick progress.

Forestry and fisheries are special in that they both involve renewable resources. Fisheries are difficult because the widespread mismanagement of fish stock has lead to their depletion. This mismanagement has been compounded by enormous sectoral subsidies that encourage over-fishing. A World Bank study by Milazzo estimates that global fisheries subsidies are in the US$15 to $20 billion range. Other estimates put the subsidies as high as US$50 billion. To promote conservation of fish stocks, these subsidies need to be curtailed by WTO disciplines.

Information Technology Agreement

After the conclusion of the Uruguay Round, there was a major breakthrough at the 1996 Singapore Ministerial. An Information Technology Agreement was reached to scrap customs duties on telecommunications equipment, software and semiconductors by the year 2000. This agreement is important because it will make the benefits of the revolution in information technology and infrastructure available to users around the world more rapidly and cheaply. It will thus help to narrow the wide international gaps in the access to information technology, and will raise global productivity. But it was not only altruism that motivated the American trade negotiators that were the main force pushing for the agreement. The United States is the home of the world's leading edge information technology sector that is best placed to take advantage of the increased demand for information products.

The ITA took effect on April 1, 1997 after participants accounting for 90 per cent of the $500 billion world trade in information technology products had signed on to agreement (including some like Chinese Tapei that were not yet WTO members). The first of four equal agreed reductions in tariffs was implemented on July 1, 1997 and the last will be implemented on January 1, 2000. There are now 48 participants in the agreement including the fifteen EU countries. But all WTO members benefits from the tariff cuts as they are made on a MFN basis.

Countries Participating in the Information Technology Agreement
AustraliaIcelandMacauSingapore
CanadaIndiaMalaysiaSlovak Republic
Chinese TapeiIndonesiaMauritiusSwitzerland (incl.
Czech RepublicIsraelNew ZealandLiechtenstein)
Costa RicaJapanNorwayThailand
El SalvadorKoreaPanamaTurkey
European UnionKyrgyz RepublicPhillipinesUnited States
EstoniaLatviaPoland
Hong Kong, ChinaLithuaniaRomania

Already one WTO case has involved the ITA indirectly. In 1997, the United States challenged the EUs reclassification of networking equipment from the category of computers to telecommunications equipment, which had tariffs nearly twice as high. The panel supported the United States' claim, but the decision was overturned on appeal. The EU defused the controversy by agreeing to have the disputed equipment covered by the ITA agreement, which means that the offending tariff will be eliminated by January 1, 2000.

Efforts have been underway to expand the scope of the ITA. The first review of the ITA produced a long list of additional information technology products that could be added. Discussions went on through 1998 but no agreement could be reached on expanded coverage for a so called ITA-II. Resistance to further liberalization has been strongest from India and Malaysia. But with the ITA expiring next year, the US Trade Representative Charlene Barshefshy is hopeful that it will be possible to reach agreement on an ITA-II with coverage extended to some 200 new products, accounting for an additional $13 billion in sales and including radar and navigational equipment. This could be one of the early harvests of the Millennium Round.

Regional Integration Agreements

Members of the WTO are allowed to enter into preferential customs unions and free trade areas with other countries under certain specified conditions set out in Article XXIVof the GATT. They are also allowed to liberalize trade in services preferentially with specific countries under GATS Article V. The main difference between a customs union and a free trade area is that a customs union has a common external tariff against third countries. It also usually involves a higher level of integration.

Regional Integration Agreements (RIAs) have been proliferating and radically altering the trade landscape. Over the last fifty years, GATT or the WTO were informed of more than 150 such arrangements. Most of these are still around in one form or another. RIAs have multiplied to such an extent that only a handful of WTO members aren't members of some regional trade pact or other. Half of international trade now takes place within the framework of RIAs.

The reigning heavyweight RIAs are the European Union and NAFTA. Other major agreements include the Mercosur, the European Free Trade Area (EFTA), the Australia-New Zealand CRTA, South African Customs Union, and the ASEAN free trade area. Canada has free trade agreements with Chile and Israel and is currently negotiating with the EFTA. The European Union has free trade agreements with Central European countries and trade deals with North Africa and Mercosur. New Zealand just signed a trade pact with Singapore at the APEC meeting in Auckland. The EU has concluded a free trade arrangement with South Africa that takes effect next year. Negotiations are underway for a Free Trade Agreement of the Americas (FTAA). And everyday more talks get underway New Zealand-Chile, Japan-South Korea, South Korea-Mexico the list goes on. These RIAs run the course from a regional economic union (the EU) to bilateral free trade agreements.

RIAs can be a step down the path to multilateral free trade if they are a manifestation of a general willingness to open up markets and bring down trade barriers. But they can just as easily go the other way if they're really disguised efforts to discriminate against others.

Concern about the contrasting tendencies for and against freer trade inherent in RIAs has led the WTO to establish some basic conditions that a customs union or free trade agreement must meet to qualify under the GATT. First, the agreement must eliminate all the duties and other restrictive regulations of commerce on "substantially all the trade between the constituent territories in products originating in such territories." Second, the proposed implementation of the customs union or free trade area must be in a reasonable period of time. Third, the agreements can't raise barriers to trade. This means that, as a general rule, the duties and other regulations can't be made higher or more restrictive. The WTO must be notified of the details of any agreement and has the right to approve or reject it, or to recommend changes.

The process of vetting RIAs was sufficiently controversial in the Uruguay Round that an Understanding on the Interpretation of Article XXIV of the GATT was negotiated to clarify the rules. It is in the interest of all non-members of an RIA that the agreement be trade creating and not diverting. But this is probably too much to ask given that almost all WTO members benefit from some trade diversion in their favour as a result of their membership in an RIA. The rules consequently are limited to preventing the worst forms of discrimination, namely raising barriers against non-RIA members. And since everyone is doing it, of course, nobody really wants the WTO to adopt too tough a line.

The agreements that have the greatest potential to divert trade and merit the closest scrutiny are those between developed countries and high tariff developing countries. The worst example of this is the free trade agreements between the European Union and North African countries. Given the high external tariffs of these North African countries, it will be difficult for non-EU countries to be competitive in their markets. A similar criticism could be made by the Europeans of the FTAA if it comes to pass.

If everyone is so keen on negotiating more and more bilateral free trade agreements, an obvious question is why not go for a multilateral free trade agreement. Clearly, bilateral free trade agreements are a poor substitute for multilateral free trade. It would be much more efficient to have a single non-discriminatory agreement for everyone rather than a plethora of discriminatory bilateral agreements. But the politics and a perverse prisoner's dilemma dynamics works in favour of bilateral agreements, hence their popularity.

One of the big achievements of a successful Millennium Round would be to get tariffs down as close to zero as possible. This would make the RIAs divert less trade and help to improve the efficiency of the global economy. For Canada, it would reduce the benefits of NAFTA, but would create opportunities to diversify trade. That wouldn't be a such bad thing given the concentration of Canadian trade with the United States.

The Millennium Round could also, perhaps, as part of its institutional review of the WTO, strengthen the provisions of Article XXIV. One possibility would be to be more specific about how long the RIA participants would have to eliminate all tariff barriers among themselves. This would require the participants to go all the way to a customs union or a free trade area and not to enter into a discriminatory trade agreements of indefinite duration.

Trade blocks themselves, other than the European Union, will not play a big role as participants in the Millennium Round. Only the European Union and South African Customs Union negotiated jointly in the Uruguay Round. Mercosur should negotiate jointly if it is going to become a real customs union, but the trade conflict between Argentina and Brazil after last year's devaluation of the Brazilian real make joint participation problematic. Once again, except for the EU, it will again be countries around the table.

There is also the question of the role of the Asia Pacific Economic Cooperation (APEC) in the Millennium Round. APEC, while not a real RIA, includes the United States, Japan, Canada, and eighteen other Pacific economies (the word "countries" is a not used because of the membership of Hong Kong and Taiwan). It's APEC's sheer size, accounting for over half of world output as well as more than half of the world's population, and its potential to introduce discriminatory measures that has worried outsiders, including most notably the Europeans, rather than anything APEC has actually done. So far except for launching the Information Technology agreement, which became multilateral, and an aborted effort to achieve sectoral trade liberalization, APEC has limited itself to enunciating grandiose targets for regional free trade by 2010 for developed countries and 2020 for developing countries. In the declaration emanating from the APEC's leaders' meeting in Auckland in September, the leaders passed the ball for trade liberalization to the WTO calling for a comprehensive three-year round of multilateral negotiations. APEC will not be a force in the Millennium Round. So the Europeans can stop worrying.