Wither the Trade Regime? Purchased

Abstract

Democratic governance, liberal values, and the open trading regime are facing interconnected existential challenges. For most of the post-WWII period, they were “legs to the same stool.” Today, the connections among the three have frayed, and this has implications for the future of the liberal international economic order. While the trade regime successfully incorporated smaller autocratic states, the rise of China and increasing tension among signatories to the WTO has challenged the rule-based trading system. This essay argues that even with these divisions among the memberships, all trading nations, including China, need the General Agreement on Tariffs and Trade (GATT)/WTO. Trade requires market predictability; exporters and their home governments require some means to adjudicate conflict. The GATT/WTO remains the best, and perhaps the only, organization that can facilitate such coordination and finesse the changing nature of the international system to assure an open world economy.

La gobernanza democrática, los valores liberales y el régimen comercial abierto se enfrentan a retos existenciales interconectados. Durante la mayor parte del periodo posterior a la Segundam Guerra Mundial, fueron "patas del mismo taburete". Hoy en día, las conexiones entre los tres se han desgastado y esto tiene implicaciones para el futuro del orden económico internacional liberal. Aunque el régimen comercial se incorporó con éxito a los Estados autocráticos más pequeños, el ascenso de China y la creciente tensión entre los signatarios de la Organización Mundial de Comercio (OMC) han desafiado el sistema comercial basado en normas. En este ensayo se sostiene que, incluso con estas divisiones entre los miembros, todas las naciones comerciales, incluida China, necesitan el Acuerdo General sobre Aranceles Aduaneros y Comercio (General Agreement on Tariffs and Trade, GATT) y la OMC. El comercio requiere previsibilidad en el mercado; los exportadores y sus gobiernos de origen necesitan algún medio para resolver los conflictos. El GATT/ OMC sigue siendo la mejor, y quizás las única, organización que puede facilitar esa coordinación y suavizar la naturaleza cambiante del sistema internacional para garantizar una economía mundial abierta.

La gouvernance dámocratique, les valeurs libérales et le régime commercial ouvert sont confrontés à des défis existentiels interconnectés. Pour la majeure partie de la période postseconde guerre mondiale, ces aspects ont été « les pierres d'un même édifice ». Aujourd'hui, les Page 1 of 20 International Studies Review For Review Only relations entre ces trois composantes se sont effilochées, ce qui a des implications pour l'avenir de l'ordre économique international libéral. Bien que le régime commercial soit parvenu à intégrer de plus petits àtats autocratiques, l'ascension de la Chine et les tensions croissantes entre les signataires de l'OMC ont remis en question le systàme commercial fondé sur des ràgles. Cet essai soutient que, malgré ces divisions entre les membres, toutes les nations commeràantes, y compris la Chine, ont besoin du GATT/de l'OMC. Le commerce exige une prédictibilité du marché, et les exportateurs et leurs gouvernements nationaux ont besoin de moyens pour arbitrer les conflits. Le GATT/l'OMC reste la meilleure, et peut-àtre la seule, organisation capable de faciliter cette coordination et de gérer avec finesse la nature changeante du systàme international pour assurer une économie mondiale ouverte.

The Nature of the Problem

Democratic governance, liberal values, and the open trading order are facing interconnected existential challenges.¹ While for most of the post-WWII period, they were “legs to the same stool,” the connections among the three have frayed, and this shift has implications for the future of the liberal international economic order (LIEO). What has changed? When the United States invited nations to participate in what became the inaugural Round of the General Agreement on Tariffs and Trade (GATT) trading regime, participants sought to solve a particular set of problems. In 1947, negotiators worried about market instability, economic growth, and how best to get governments out of the market. In response, members created rules, assuming this joint view of the world. Those rules were relatively “thin” and focused on coordinating export markets. Those at the table understood that overly constraining rules would create problems for the membership and instead, relied on a shared set of values on the importance of stable markets to coordinate their external relationships.

Whether or not the vast increase in trade that occurred post-WWII was due to the GATT is open to debate.² Along with GATT discipline came a US led Western Alliance system, the creation of long and productive supply chains and most important, lowered costs of transportation and communication. Still, by the time the GATT was revamped into the WTO, the organization had taken on stature. The GATT had been a club; the WTO was a diverse and almost universal organization. The GATT had minimal goals; the creators of the reformed GATT used the Uruguay Round to fill in gaps in the GATT system, and now the WTO reflected a larger vision for the trading regime. Membership in the new regime was more binding, in that nations could no longer skirt dispute settlement and more extensive; that is, it was a “single undertaking” and included “behind the border” activities. However, while there were increased obligations, the organization remained limited in its ability to assure compliance. With a small secretariat and an even more limited budget, the system worked because nations found it in their interest to follow the rules. The WTO, like the GATT before it, worked essentially because it was self enforcing.

The first decades of the 21st century were difficult for the WTO. Market instability made the WTO appear weak and even outdated, unable to legislate, unable to respond to market disruptions, and as the decade went on, unable to retain legitimacy for its judicial function.³ China’s accession in 2001 had created a set of unanticipated problems. Along with the economic dislocation known as the “China Shock” came a set of organizational problems within the WTO itself.⁴ China was an outlier among the membership from the start. By 2001, most of the members of the WTO had privatized their economies and, more or less, accepted neo-liberal market principles. While smaller autocratic states had successfully integrated into the GATT/WTO system, China was a unique challenge.⁵ China was not only an economic powerhouse in world markets, but its leadership was also unwilling to endorse market principles and was far less constrained by organized producer groups.⁶

To be sure, crafting a cohesive and collective response to trade issues had become increasingly difficult even before 2001. But the absence of a concerted and centralized response to the “China shock” increased the pressures on elected leaders to act unilaterally, and this further weakened the organization.⁷ The problem with the organization was less the absence of adherence to WTO rules—the members for the most part acted consistent with their commitments. Rather, what Chinese entrance had made apparent was that the trading order itself was less about specific rules and more about shared values on the role of governments in the market. While the WTO should be given credit for keeping protectionism at bay after the 2008 financial crisis, the fundamental question of how to stabilize a trading regime with an ascendant China remains a festering problem.

This essay makes two observations about the future of the LIEO’s trading regime. First, China is the Achilles heel of the regime. The reason is that the GATT/WTO regime assumes its members value free markets and are constrained by organized interests. China has neither a commitment to market independence nor a need to respond to social pressures. Instead, China represents an alternative model of political economy, best labeled authoritarian capitalism.⁸ Second, and more optimistically, instead of assuming that China is the “fox in the chicken coop” perpetually undermining the WTO, the WTO may be the best, and perhaps the only, organization able to respond to the expanding Chinese footprint. China’s leadership is constrained; domestic and global markets have become increasingly interdependent. Like the other members of the WTO regime, China values the WTO’s “insurance” role suggesting that China, like the other members of the regime, share a need for a revitalized WTO.

Can the WTO Keep Markets Open?

Today, trade barriers are at historic lows. If we look at tariffs, for example, nations retain specific product protections but they are far less of a deterrent to trade than they were a generation ago. Of course, even within the WTO’s membership, rates are far from uniform. High income nations have low rates; the United States, for example, has an average tariff of about 3 percent. In emerging markets such as India, there is still an external tariff barrier, currently at about 14 percent. Rates in the developing world are also higher than in the West but vary, from about a low of 6 percent for the Philippines to about 17 percent for Egypt. This acquiescence to variation is consequential: It allows leaders who agree with regime norms to self declare when they are ready to open up to competition. The willingness of the organization to allow governments this latitude is part product of history, part realization that competitiveness varies and, finally, part recognition that the organization is a “shell” in which each party chooses the degree to which it is politically feasible for them to participate in the process of market liberalization.⁹ In short, the trade regime was based on the combination of thin rules and shared norms. The problem with the regime today is that economic and cultural forces have undermined collective norms, making flexibility a liability and not a virtue.

Attention to Societal Interests

The GATT began as a club of leaders in democratic or quasi democratic nations who shared a set of concerns about economic growth. The membership was mindful of domestic constraints and were wary of too much international delegation.¹⁰ Indicative of these concerns, decision-making was by consensus, and obligations were riddled with exceptions. The weakness of the central regime was viewed positively by then current and potential members, and in part, the weak commitment encouraged expansion. As Gowa and Kim (2005) explain, however, while the expansion of membership may have increased trade, it undermined the fundamental nature of the regime by bringing in new types of regimes.

As international trade moved from manufacturing items to services and from commercial transactions to foreign direct investment, the thinness of the rules became problematic, both in their lack of clarity on how to deal with new issues and also on how to accommodate market variation among the membership. As interests diverged, it became increasingly difficult to craft a consensus among the voting nations. In particular, the growth of value chains created a rift along North-South lines, especially with regulatory harmonization after 1995 and increasing expectations that nations who signed onto the treaty would, in fact, comply. In the first decades of the 21st century, the organization appeared increasingly moribund, with rules and behavior drifting apart.

This drift among the members reflected what we can now see as a fundamental misunderstanding about the role of the trade regime. In the wake of the breakup of the USSR, those who crafted the WTO believed that a new era had begun. Capitalism had triumphed and as a result, the WTO could, and should, expand its reach. This burst of enthusiasm for free markets helped to spur support for more centralized market centered trade rules.¹¹

This shift toward harmonization in rules and behavioral expectations now appears to have been premature and not consonant with the interests of all members. The “single undertaking” was itself at odds with the central insight of the GATT’s founders. The early GATT, itself an alternative to the Havana Charter, which would have created a far deeper regime, valued imprecision because it created space for countries to placate powerful domestic groups without endangering a general commitment to the regime.¹² Unsurprisingly, the GATT had tolerated grey area border measures as a necessary compromise between market discipline and political necessity. However, while the GATT founders understood such deviations, economists and lawyers saw this as reflective of imprecise law. To assure compliance, the organization felt it needed to fill in the legal holes and create a stronger and more centralized regime. Writing down new rules came with a price: specificity and mandatory dispute settlement further exacerbated underlying differences among the membership. The result was that just as China became a problematic member, there was no interest in, nor consensus for, further legalization.

Chinese entrance into the WTO revealed a fundamental blind spot in the regime. The early members all worried about organized groups; the regime was thought to serve the purpose of helping to craft domestic coalitions, allowing leaders to act in the collective and shared interest of opening up markets. The Chinese did not fit this model; they were far less constrained by organized interests than the Western democracies. Their ideal was not a market unfettered from politics but rather, they assumed leaders had a central role in directing the economy. China did not share the underlying norms of governance and markets, and so the thinness of the rules, and the dependence on shared norms, was now undermining the regime itself.

Underlying Norms

The GATT had been a group of like minded nations who believed that protectionism and other beggar-thy-neighbor policies had contributed to the Great Depression and ultimately to WWII. As such, they wanted to restore the stability of the trading system and free up markets. The founders believed that the balance between market independence and government intervention had moved in the wrong direction in the interwar years and as a result, trade had subsided and nations had pursued nationalist goals. Most of those who rebuilt the world economy in the post-war years believed that economic interdependence encouraged peace, and that mercantilism was at odd with a shared goal of encouraging growth. The method chosen to reach the goal of “peace through trade” was to facilitate reciprocal trade deals based on the principle of most favored nation (MFN), so that all members of the GATT would receive benefits and have a stake in the trading regime (Barton et al. 2006).

Early on, however, the fragility of these shared norms became evident. By the 1960s, the use of specific reciprocity in trade rounds, that is, tariff swaps, was rejected by the developing world. At the request of the emerging market nations, Part IV of the GATT was legislated, stipulating that a set of member nations were no longer expected to give equal access to other GATT members’ imports, or what was known as special and differential treatment. A second core norm, that of “diffuse reciprocity” or MFN started to erode as more nations signed preferential agreements only nominally consistent with Article 24. Article 24 opened Pandora’s box and created a “spaghetti bowl” of overlapping and preferential agreements that looked a lot like the world in which the GATT was created to fix. And most strikingly, the Article III inscribed norm of national treatment was contested in favor of environmental and labor standards; for most of the history of the GATT, product regulation ended at the border. In the new WTO, standards harmonization, especially for issues of production, triumphed over domestic autonomy (Barton et al. 2006).

By the time China became a voting member of the regime, they were able to argue that their behavior was not inconsistent with that of other new members, especially those in the developing world. Preferential access to markets, differential adherence to specific rules, and the right to claim the need for exceptional developing nation status allowed them to abide by the rules and ignore norms. However, while these exceptions were unproblematic when applied to small and non-competitive nations, they were now being weaponized by a big competitive state. Still, the response by the membership was muted, reflecting that even post-WTO, the dispute system was not set up to police norm violators. In the absence of coordination among the membership to collectively “name and shame” norm deviants, there was little to be done to reign in a renegade nation. In the post-Chinese accession years, it became increasingly evident that the system had never worked because of rule specificity; but rather, the system depended on the larger nations cooperating out of the belief that the rules, and the norms, were in their collectives self-interest.

What Does China Want from the WTO?

Today, China is the second largest economy in the WTO, set to surpass the United States in the next decades. The Chinese strategy for economic growth was, and remains, dependent on world markets. China has an intrinsic interest in market stability and in protecting the liberal trading order, and their entree into the trading world was via the WTO. Still, while careful to not explicitly break rules, their behavior has been at odds with the underlying expectations for regime members, instead using the open trading system as a way to pursue often predatory policies (Bown 2015). What have the Chinese done?

Chinese policies on economic growth are less a frontal attack on the trading order and more a sharp departure from underlying norms. For example, “Made in China 2025” is a national strategic plan to increase the breadth of Chinese manufacturing. The program was announced in 2015, and its goal, according to leadership is to have China move away from being the “world’s cheap low tech factory,” and instead to upgrade into technology-intensive production. Through an industrial strategy of loans and huge subsidies, the nation is re-revamping its productive capacity.¹³ While some degree of industrial policy exists among all GATT/WTO members, the Chinese version of policy is more direct, discriminatory, and uses all the tools of government.¹⁴ When married to a policy of forced technology transfer and the absence of organized labor rights, the Chinese growth model is overt nationalism.

While Made in China 2025 is at odds with the WTO norms of state–market relations, the greater challenge to the multilateral system may be the Belt and Road Initiative (BRI). The Chinese have used loans, infrastructure assistances, and trade agreements to create a hub and spoke world with China at the center. The BRI is a substantial expansion of Chinese economic relationships beyond the traditional Silk Road and into Africa and South America.¹⁵ The logic behind the BRI is that it enables the government to export excess manufacturing capacity and put accumulated savings into new markets. China then uses these relationships to both secure preferential and cheap inputs for its manufacturing sector and to set technical standards in foreign countries so as to give home companies a leg up in markets. The Chinese call this Tianxia; the West decries it as norm breaking mercantilism.¹⁶

The liberal trading regime must face a reality. Its second-largest member does not subscribe to its founding norms. It offers an alternative model of authoritarian capitalism. The government’s relationship with its economy is direct, and economic output is used to maximize more general Chinese goals. Can the regime accommodate such an actor? Since the late 1980s, the theory was that China would change and become more Western, as it privatized and its producers became independent. This has not occurred. This does not suggest that China will not evolve. But rather, the direction of that evolution is likely not in the neo-liberal direction. Today, the issue is not to change China but how, and if, the Chinese government can be convinced that growth is not a zero-sum.

The Multilateral Option

How have nations responded to Chinese growth? Initially, there was a flurry of unilateral responses, some more restrained than others. The Europeans tried to negotiate and threatened sanctions. Not so for the United States, choosing instead the cudgel approach, threatening to close the American market if the Chinese did not change their behavior. Then President Trump, manipulating nationalism and anti-Chinese sentiment, raised tariffs at the border, opened a number of investigations into Chinese companies, and then negotiated an explicit promise from Beijing that they would buy more US goods. His focus was not the WTO regime but rather the American bilateral trade account.

Looking back at the results, the buy American Phase One promises were never realized. China did not increase purchases of US goods to the level promised, and the trade balance was worse when Trump exited office than when he began (Bown 2021, 2022). Likewise, the tariff hikes he promoted did little to change Chinese policy and merely raised prices in the United States. While Biden’s strategy has been less aggressive, for example, he revoked Trump’s targeting of TikTok and WeChat, and he has attempted to garner European assent for a joint strategy, he has retained most of the Trump tariffs.

Trump lacked confidence in the WTO, suggesting that the WTO had allowed the Chinese to cheat. But the Chinese rarely break formal rules. While the protocol to the Chinese accession agreement had made promises about future issues, the agreement itself was quite limited.¹⁷ Take, for example, two policy areas for which the Chinese have been criticized: the subsidization of state-owned enterprises (SOEs) and the forced transfer of intellectual property (IP) as a condition for investment. As Mavroidis and Sapir (2021) explain, the rules around SOEs are under-defined in the multilateral framework, and even when brought before the dispute body, the decisions have done little to create explicit and transparent rules by which to judge the Chinese government. Similarly, Trade-Related Aspects of Intellectual Property Rights (TRIPs), which were agreed to by the Chinese, say little about the use of state power to shape contracts. The government can mandate a range of behaviors vis-a-vis firms who seek to produce in China and remain within the bounds, albeit often on the edges, of their formal commitments. It is more helpful to think about Chinese behavior as less a reflection of cheating on promises and more a result of an under-specified contract. And while for most of the GATT/WTO history, under-specification was viewed as a positive, the Chinese case suggests that in the absence of norms, rules need to be more explicit. What is the multilateral option?

First, the community should abandon the idea that, over time, the Chinese will look more “Western.” The Chinese regime has never made that promise, and it is a pipe dream reminiscent of Fukuyama’s “End of History” (1992). Members need to adjust to having a wide array of types of regimes in the organization. These regimes will differ in their relationship with their own markets, and no one should assume that the liberal approach of the West will be the model of the future. The WTO can not fundamentally change the relationship between governments and markets and, instead, should focus on particular behaviors that undermine the LIEO. This will require a new narrative about China itself. The view of China as an economic enemy or as a rule breaker needs to be replaced by a narrative that stresses instability as a shared problem and the WTO as the place where differences are adjudicated.¹⁸ The expectation, often unsaid but generally believed, that the end goal of membership is a textbook version of market independence must be relinquished.

Second, the WTO needs to clarify for the membership just what policies are out of sync with regime norms. For example, in the two areas of friction mentioned above, there are collective responses that could shift Beijing’s policies. One idea suggested by Mavroidis and Sapir (2021) is to have the WTO specify that SOEs are public entities and then have them constrained by existing subsidy rules. This would provide an avenue within the formal rules with which to respond to what is perceived to be an unfair advantage in production and pricing of exports. In terms of IP, while the Chinese did sign onto TRIPs, that agreement needs to be modernized. The original authors were not thinking about the forced transfers of IP but rather more general issues of patents and licensing between firms. The WTO needs to re-write and update the agreement so as to clarify, not only for China but for other nations that have also used market power to force IP transfers and expectations for behavior. One way to get the Chinese to agree to a new TRIP, also suggested by Mavroidis and Sapir, would be to have WTO signatories agree that they are under no obligation to enforce any contracts between domestic and foreign firms if they were subject to forced IP transfers.

Third, new agreements need to be crafted that take advantage of Chinese long-term interests. How would this occur? The Chinese have two needs: they are dependent on continued market access for their exports, and they seek acknowledgment of their international stature. Given both, there are sticks and carrots to offer that could convince the Beijing leadership to sit at the table. On the more coercive side, the Biden administration has already begun to create a coalition of importers to have a unified position on Chinese actions. Regional arrangements can include language on SOEs and IP that creates alternative legal structures to those supported by Beijing. And within the WTO, there is the third option of pluralilateral agreements, which would effectively squeeze and sideline Beijing.

There are carrots as well. The strategy of conciliation may appear to Beijing the better route than going it alone. They are facing a number of the same production problems faced by the West, such as labor shortages and, perhaps due to the SOEs, low levels of productivity. They have status and supporters in the WTO, and they have an interest in having a say in rule setting, whether in disputes or in crafting new plurilaterals. A Chinese diplomat has been elevated to Associate Director General. Being at the table in Geneva, the Chinese will want to succeed and be viewed well in the economic world, even as they are criticized in other domains.

Final Thoughts

From the perspective of the Chinese government, the WTO is an insurance policy; they pay the price of admission in order to stop their trading partners from pursuing protectionist policies. China’s economic health is dependent on the LIEO and more like other members, they need the WTO to be efficacious. However, the WTO itself is having a “mid-life” crisis, attempting to finesse growing skepticism among its membership about the benefits of liberal trade policies. Populism, on the left and the right, has bred nationalism, often scapegoating outsiders. Given this rising nationalism, will the WTO be able to continue to protect the world economy?

For optimists, the response is positive and functional: The organization has served the important purpose of stabilizing the world economy. Membership was always a commitment mechanism, undercutting potential shifts in politics at home; governments adhere to organizational rules and norms out of self-interest. In theory, it should not matter whether those governments are democracies or autocracies as long as they adhere, more or less, to liberal market principles.

For pessimists, the future is far more contentious. The Chinese government will not be constrained by a set of trading rules established by its economic adversary, the United States. Rather, critics such as John Mearsheimer (2021) countered that it was a fantasy to believe that China would ever internalize the values of the LIEO. Rather than embracing liberal values, he argues that “China grew more repressive and ambitious...” (p. 48). By this reckoning, economic engagement was a failed experiment that fueled great power conflict.

These are two starkly different visions of the role of the WTO. In the first, while the WTO is seen as flawed, it remains an essential treaty that restrains members from overt manipulation of domestic markets. Instead of abandoning the WTO, the policy prescription is to have regime members focus on internal reforms, both normative and procedural. In the second, the WTO is impotent and can do little to constrain the policies of an ascendant China. Attempts to integrate China into the organization will not only fail to change domestic policy but will also hasten an inevitable cold war between China and the United States. Here, the policy prescription is to isolate China, both in and out of the organization, in order to slow down growth.

There is a middle road between these two positions. Both of these perspectives point to the importance of the world economy to the future aspirations of the Chinese leadership. There is an agreement that the Chinese economy cannot be easily un-tethered from economic events outside its borders. As such, even if we assume with the pessimists that the Chinese leadership has hegemonic goals, then they are constrained to a strategy indelibly linked to a growing world economy. China may prefer a trading order more to her liking but the leadership cannot weather steep economic decline. In this sense, the liberal world economy is a shared interest, even as the Chinese and other authoritarian-leaning governments undercut the free market within their own borders. A shared interest in stable world markets is the root of the more optimistic view of the future. While gaining assent from increasingly divergent governments for deeper liberalization may be impossible, the membership agrees on the basic need to allow the international flow of goods and services. This makes the WTO the best, and perhaps the only, means to assure a future of world-wide market access.

Acknowledgments

This essay benefited from comments from the chairs of ISA, 2021, Nita Rudra, and Carew Elizabeth Boulding, as well as the outgoing president, Helen Milner. I also received helpful comments from Robert Gulotty, Sung Mi Kim, and Elizabeth van Lieshout as well as the participants in the ISA Sapphire Panel: A New Global Economic Order? In particular, I want to thank Duncan Snidal whose comments were especially helpful.

Footnotes

References