Revoking normal trade status

The idea of removing normal trade status was floated last year with regard to Russia.  It is now being discussed again in the context of trade between the United States and China.  Our original post on the topic from last year is shown below to help explain some of what PTNR (or what the rest of the world calls Most Favored Nation or MFN) means for trade and tariffs. 

In short, there are at least three ominous implications of revoking PNTR.  First, the United States would be reversing a bedrock principle of the global trading system—to avoid discrimination.  While regular readers certainly know that the system has been under tremendous pressure, it has continued to function as a brake on all kinds of otherwise possible unilateral actions by all World Trade Organization (WTO) members.  This brake will be gone if the US explicitly opts for discrimination.

Second, while some supporters of revoking PNTR seem to suggest that this action will be limited to China, once the brake is gone, it is gone for all.  There is little reason to think that others will not opt to do something similar, including against the United States.  Hence, businesses should be extremely concerned that their “foreign” products and services in markets around the world will suddenly be targets for all sorts of actions, starting with unilateral adjustments in tariff levels and moving towards outright discrimination in treatment over foreign products in markets. 

Some could argue that firms already face a range of discriminatory actions in different markets, particularly with inconsistent application of non-tariff measures, unequal licensing requirements, or generally unfair trade treatment.  However, these measures are actually quite restrained compared to what will happen in the total absence of MFN.

Third, as always, the worst damage is likely to be felt by firms and communities that are already at the margins.  Poor developing countries and small firms are going to be badly hit by adjustments to the global trading rules.  Without a strong network of trade agreements in place to help cushion the blows, sudden adjustments in tariff rates, differentiated customs treatment, denied access to services markets, rejections of licenses or qualifications, removal of protections for intellectual property rights, or restrictions on the movement of business people will make trade increasingly difficult or even impossible across borders. 

The US Congress, of course, has a responsibility to act in the interests of their constituents.  But they should remember that revoking PNTR is not just a symbolic gesture.  It will have real and serious consequences for governments, businesses, and consumers all around the globe. 

***Reprint from Talking Trade, March 16, 2022:

Russia’s invasion of Ukraine has been met, so far, with wide-ranging economic sanctions.  Many of the tools being used, such as bans on specific banks from using the SWIFT network, are completely new. 

One such tool, revoking Russia’s Normal Trade Status (as it is called under US law) or Most Favored Nation (MFN) status (for everyone else), is also being tested in a novel manner with potentially important trade implications. 

Russia is currently a member of the World Trade Organization (WTO), having joined in August 2012 as the 156th member.  Negotiations on entry took 18 years.

As a WTO member, Russian exports are granted what is called Most Favored Nation (MFN) status and granted national treatment.  To greatly simplify often complex arguments, the WTO asks all members to treat members in the same manner and to not discriminate against them. 

To see how this might work in practice, imagine a rule on eyeglasses.  It cannot be drafted in such a way to only apply to eyeglasses from one WTO member market.  The rule cannot apply to only foreign eyeglasses, while exempting local eyeglasses. 

The situation is especially important at the border.  Many products are subject to tariff payments at customs.  Under the WTO, governments may not apply one set of tariff rates to eyeglasses from one member and another tariff to all other imported eyeglasses.   

The reason for crafting the MFN rule that ensures consistent tariff application rests partly on the bedrock non-discrimination principle of the WTO and its predecessor organization the General Agreement on Tariffs and Trade (GATT) and partly on the practical reason that negotiating and then applying different tariff levels for the 164 WTO members gets extremely complicated.

However, as many can quickly attest, not every product does pay the same tariff rate at the border.  In particular, firms that can take advantage of free trade agreements can have lower tariffs than others.  This is a large (and growing) loophole in MFN. 

Nevertheless, the basic point still stands—products from the WTO are meant to be given consistent tariff rates at the border.  Thus, a member with an MFN rate of 10% on eyeglasses can collect 10% in tariffs from every incoming WTO member firm at the border for each pair of glasses.

If the eyeglasses are coming from a non-WTO member, then there are no MFN or national treatment obligations.  Members can apply whatever tariffs they want to glasses from non-WTO members.  The pool of non-members is steadily shrinking with most remaining outside the WTO currently involved in accession negotiations. 

Belarus is not yet a WTO member, meaning that members can quite easily apply whatever tariffs or measures they want against Belarusian eyeglasses or any other product.

Governments can be quite particular about products that come in from across borders.  Thus, although they have agreed to non-discrimination and MFN treatment in the WTO, they do not give such consent in all circumstances.  There are a number of exceptions clauses within the WTO that can be triggered, such as in times of crisis. 

The WTO has an explicit set of national security exceptions.  The original GATT was formed in the aftermath of World War II and officials were extremely conscious of trade concerns in times of direct conflict or war.  They put into place Article XXI on security exceptions that includes a provision to suspend application of the rules “taken in time of war or other emergency in international relations.”

For a long time, the use of national security exceptions remained limited.  They were assumed to be for use by direct combatants in war situations. But the norm against invoking these exceptions has sharply weakened in recent years.

Some WTO members have now declared that they will apply national security exceptions to revoke Russia’s MFN treatment.  In other words, they have reserved the right to make unilateral changes in their treatment of Russian imports such as imposing an across-the-board 35% tariff on all products.  The removal of MFN thus far has largely been focused on tariff changes, but discriminatory practices could be taken across a range of possible trade commitments.

Russia’s MFN status within the WTO remains unchanged.  What is new is that a growing number of countries have declared their intention to unilaterally suspend MFN and apply tariffs to Russian products.  American law requires Congress to do so by revoking what is called “Normal Trade Relations.”

These actions can be taken without the need for specific approval by the WTO.  As MFN is being revoked by non-combatants, it certainly opens up the possibility for future non-application of MFN and national treatment by other members against one another in the future.  Such actions may not just be limited to national security in times of war or direct conflict.

There is also growing interest in suspending Russia’s membership from the WTO as well.  This is much more difficult.  There is no clear provision that allows membership suspension. 

As the WTO operates by consensus, it would require all members to agree to allow such a suspension.  As Russia is a WTO member, if it rejected the decision of the grouping (even if all other WTO members wanted it to happen), it could be blocked by Russia. 

WTO scholars can create a range of scenarios under which it might be possible to evict Russia or create a new institution immediately following the dissolution of the WTO that does not include Russia.  However, these are highly unlikely scenarios.

In particular, while members have been growing more comfortable with taking unilateral actions outside the WTO, it is not yet clear whether the institution itself is prepared to make big changes.  What is certainly happening now is a growing paralysis in the system, as members refuse to take up issues when Russia is present.

Global trade has been under enormous pressures over the past few years with, as regular readers are certainly familiar, a wide range of specific causes from the pandemic to geopolitics.  The use of new and novel economic tools, including the removal of MFN, adds another element of stress to a fracturing system.