Talking Trade blog
Managing disputes over trade: Part I
Published 27 January 2023
Trade policy, like many other arenas, has developed a complicated language that can be impenetrable or, at best, opaque to outsiders. Some aspects, especially those touching on law, have extra layers of jargon.
While trade dispute settlement systems can be quite important and have been frequently in the news over the past few years, it can be hard to follow the arguments. Talking Trade will be running a multi-part set of blog posts to help unravel the situation and make it easier for you to follow evolving developments. Let’s dive in with some background to help set the context…
The international trading system has had to overcome multiple challenges to function and remain effective. Governments have strong incentives to cheat or, as they would put it, to strongly prioritize their own economy and companies over the affairs of others. But if everyone is busy protecting their own, the net result is much worse for everyone.
This basic tension between keeping markets open despite individual incentives for closure has been a key element of the system for decades. Now, the long-standing the consensus in favor of freer trade has started to fray with far more serious trade disputes ahead.
The global trading system is built on the idea of comparative advantage. Put simply, no one country or geography will ever have all the resources, capital and labor needed to provide all the possible things or experiences that citizens might require or want. Even the largest will struggle to deliver everything purely on their own. And, even if they managed this task, the net costs of doing so would be so high as to be unmanageable. Autarky, or going it alone, has never delivered strong economic results.
The solution to this problem is to specialize and then trade with the neighbors. Countries do not need to be the very best at a specific economic task, only slightly more productive than others. This allows scarce resources to be more efficiently allocated, particularly by using price signals.
In short, open markets deliver better results for everyone in the aggregate and across the long run than alternatives.
So far, so good. But governments do not always care much about the aggregate or the long run. Many want to remain in office tomorrow and are not very fussed about what might happen two decades from now. Individuals and firms that are harmed by shifts in open markets will always protest more vigorously than a broad swath of citizens what might get very small individual gains from a particular transaction or pattern of trade. Benefits arriving in the long run could be quite far off indeed. The short run could be quite painful, especially for those facing quick adjustments.
Thus, one seriously inherent tension in the global trading system is that while open markets deliver the greatest benefits to the broader community, individual members have strong incentives to keep their own market sheltered from competition. The best result could be to have a protected domestic market but remain able to compete in open markets elsewhere.
This is not just a theoretical or hypothetical problem. To help sort out the mess created by protectionism of the 1930s and support recovery from Second World War, a handful of governments banded together to create a new trading regime. The General Agreement on Tariffs and Trade (GATT) opened its doors on 1 January 1948 with 23 members.
The early years of the GATT focused on collectively lowering tariffs to support freer trade, as tariffs were the primary means of protecting goods markets. Over time, the mission, mandate, and membership all expanded in 1995 to become what is now called the World Trade Organization (WTO) with 164 members.
The point here is not to review the history of the GATT/WTO, but to reflect on how members tried to address inevitable strains between members.
Institutions are hard to design well. Creating a trade regime to appropriately manage built-in stresses has been difficult. Grappling with the tensions between a collective result and individual incentives is even harder when each member has different resource and historical backgrounds.
The GATT itself was not the original institution. Officials actually created a much larger, more comprehensive organization which was to be called the International Trade Organization (ITO). The ITO was torpedoed by member objections, most notably from the United States.
What emerged from the remains was a portion of the institution—the chapter on tariffs. This section was quickly supplemented with a set of rules and institutional practices to get the GATT off the ground and running.
Two elements of the GATT package, however, are causing particular challenges today. First, the GATT (and now the WTO) have operated by consensus. In the global trade regime, all members need to agree (or at least not object) on changes. As the organization has grown larger and more diverse, the difficulties of getting consensus have continued to increase. Now, any attempt to dramatically restructure the operations, mission, or mandate of the organization, including adjustments to the dispute settlement process, has become nearly impossible.
Second, the GATT system created a mechanism or process for resolving disputes. Again, to simplify greatly (and with a real risk of getting many, many comments from trade lawyers and professors), the GATT system set up two parts to the system—a “panel” with external experts to review any legal disputes about whether members were following the rules and commitments and a second system of selected individuals to review decisions of the panel in cases of appeal.
GATT panels ruled on whether or member’s measure (like a specific tariff, law, or regulation) violated existing GATT commitments. If the panel agreed, the member was supposed to remove or adjust the measure to bring it into conformity with the GATT. The appellate body could review the panel processes upon appeal.
The member found to be out of compliance was supposed to adjust the offending measure. If they did not, or did not want to do so, the enforcement mechanism called for them to pay an equivalent amount of damages rendered from the ongoing use of the measure, which could mean payment of higher tariffs on other products to the complaining party.
Note that the system has never required members to provide compensation for past damages—just the possible adjustment of measures that violate GATT commitments to avoid further harm. The point of the dispute system was not to punish members but to encourage them to faithfully follow and implement existing commitments and continue to allow trade to flow without discrimination between members. In fact, the best outcome would have been adjustments to the measure without the need for any case at all—a solution found through consultations prior to any panel.
The GATT system of managing disputes had an important problem—although the “guilty” party was supposed to adjust the problematic measure, the party could simply block the court from acting by vetoing the outcome.
This was adjusted in the transition from the GATT to the WTO in 1995. Under the WTO, parties could no longer reject the decision of the panel and appellate body. Adjustments made to the dispute mechanism led to a dramatic increase in the usage of the system. But it has also led to a growing list of complaints and, as of this moment, the complete collapse of the appellate body.
The dispute system, in other words, is currently broken. Part II of this Talking Trade series will look at recent developments, including options on the table for reform. Stay tuned!
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