Emerging economies and WTO tariff liberalisation after Doha

Chad Bown 23 December 2015

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Given the end of the Doha Round as we have known it (Froman 2015, Hufbauer 2015), a major rethink of the WTO’s tariff-cutting approach is in order. What might tariff liberalisation negotiations for emerging economies look like if economists, instead of actual trade policy negotiators, established the agenda and negotiating priorities?

Applying the economists’ classic beggar-thy-neighbour approach

The dominant terms-of-trade theory of trade agreements (Bagwell and Staiger 1999, 2002) provides a compelling and simple insight that has shaped our understanding of the post-war trading system.

In the absence of international cooperation, governments set import tariffs that impose economic costs on trading partners. The tariff drives down the price that the partners’ exporters receive for selling their goods in international markets; the costs arise because the importer has market power (Johnson 1953-54).

This is referred to as the ‘terms-of-trade externality’.

In the absence of a trade agreement that imposes discipline over trade policy, the government of each individual country with market power would levy such a beggar-thy-neighbour tariff. The result is the classic, terms-of-trade driven prisoner’s dilemma.

The WTO can potentially solve the prisoner’s dilemma problem by facilitating reciprocal policy actions; however, the solution may not result in trade that is completely free.

First, an elegant design feature of the GATT/WTO is recognition that every country is not only an importer – and thus an imposer of externalities – but also an exporter – and thus a sufferer of such externalities. The WTO works by getting one country to cut a tariff on its imports just as its trading partner is reciprocally cutting a tariff that affects its exports.

However, a second and crucial implication of the Bagwell and Staiger (1999) theory is that the continued existence of non-zero applied tariffs is not, by itself, evidence that the WTO’s reciprocal, match-making performance is incomplete. The WTO’s performance is only incomplete if the tariffs that remain high are because the importing country is continuing to exert its market power.

Under this theoretical framework, identifying emerging economy tariffs for the WTO to cut would require evidence linking high tariffs with the importing country’s own market power.

The growing evidence of the WTO’s impact and implications for emerging economy tariffs

Increasingly evidence finds that the WTO has been able to remove much, but not all, of the terms-of-trade externalities from the tariffs that its members impose.

However, one initial limitation of this literature was that the early papers focused on a relatively small sample of WTO members – either recent WTO accession countries (Bagwell and Staiger 2011) or members with relatively higher incomes (Broda et al. 2008; Ludema and Mayda 2013).1 

To show the relevance of this WTO theory for reducing currently applied tariffs, new evidence is needed that would link emerging economy tariffs to their market power.

In a recent paper (Bown 2015), I provide some of this evidence by extending the recent insights of Nicita et al. (2013). The new research investigates three specific areas where emerging economy tariffs are frequently alleged to be “too high,” including the applied tariffs for countries

  1. where tariff binding legal commitments are so high, they are essentially meaningless;
  2. whose products remain legally unbound under the WTO; and
  3. who are not yet members of the WTO.

Figure 1 illustrates the geographic distribution of countries with each of these three potential policy concerns.

Figure 1 WTO Members with Substantial Tariff Overhang, Members with Substantial Unbound Products, and WTO Non-members in 2013

Source: Bown (2015, Figure 1). WTO members with substantial tariff overhang defined as having more than one third of non-agricultural products with tariff bindings but with average tariff overhang of 15 percentage points or more. (For list, see Table 1.) WTO members with substantial unbound products defined as having fewer than one third of non-agricultural products with tariff bindings.​

WTO members with tariff overhang and the resulting problem of applied tariffs

The evidence in my paper suggests the WTO may be best positioned to address the high applied tariffs for countries with substantial “tariff overhang,” which is defined as the difference between a country’s WTO legally binding upper-limit for its tariff and its currently applied MFN tariff rate.

My econometric approach is to use the product-level inverse foreign export supply elasticities provided in Nicita et al. (2013) in order to assess whether there is empirical evidence linking currently applied tariffs for 45 emerging economies with these measures of their import market power.

The results confirm that a strong positive correlation continues to link applied tariffs and market power for these countries. Furthermore, the evidence is primarily found in non-agricultural products, and thus would seemingly be most relevant for new non-agricultural market access (NAMA) negotiations.

Reducing legal binding commitments to currently applied tariff levels is not enough

Earlier negotiating proposals floated the idea that countries simply bind their tariffs at currently applied rates in order to eliminate the tariff overhang. It is worth noting that this proposal would not address the problem identified by the results described here.2

The evidence here is that currently applied tariffs are “too high” because they do not take into consideration the terms-of-trade externality. Even if negotiations eliminated all of the tariff overhang, the beggar-thy-neighbour component to the applied tariffs for these emerging economies would still remain.

Who are the countries?

Table 1 reveals the 45 emerging economies that currently average more than 15 percentage points of tariff overhang and that form the sample for the regression exercise.

Table 1 WTO members with substantial tariff overhang in 2013

Sources: Bown (2015, Table 7). WTO members with average tariff overhang greater than 15 percentage points, ranked from lowest to highest. GNI=Gross national income, NA=not available.​

  • First, the list includes many members of the Group of 20 (G20) – e.g. Argentina, Brazil, India, Indonesia, Mexico, and Turkey – and thus countries with leadership potential to influence the future of the multilateral system.
  • Second, collectively these countries matter, as 2.4 billion people live in WTO member countries with substantial tariff overhang.
  • Third, it is important to reiterate that this result does not imply that each of these countries’ non-zero tariffs is imposed with market-power motives in mind. This is an average result; more work is needed to identify specific products as well as potential reciprocal trading partner matches.
  • Fourth, in retrospect, of course, the tariff overhang problem came into being via the manner through which these countries joined the WTO. Most all joined during the first wave of entrants in 1995; countries that have acceded since 1998 were not permitted such tariff overhang (Bown 2015, Table 3) and thus could not continue to impose beggar-thy-neighbour tariffs via their applied MFN rates.
  • Fifth, worth highlighting are the countries notably absent from this list. In particular, available evidence for recent accession countries, including China and Russia, suggests that WTO accession neutralised the terms-of-trade component of their tariffs.3 Because exporting firms in trading partners are therefore not worried about the terms-of-trade impacts of their applied tariffs, such countries would not be priority negotiating invitees when seeking to identify reciprocal tariff cuts.

Negotiating implications

While the WTO may still have substantial tariff liberalising “work” to do, identifying precisely where the work is to be done may make for a more fruitful set of negotiations the next time around.

On average, the evidence from economic research (Bown 2015; Nicita et al. 2013) suggests a strong positive correlation remains between a number of emerging economies’ applied tariffs and their import market power.

Given this result, one proposal is to allow these emerging economies the same basic framework for reciprocal tariff cutting negotiations amongst one another – with the tariff cuts then extended to the full WTO membership on an MFN basis – just as the GATT system established in 1947 and that the high-income countries successfully relied upon during the subsequent decades up until the establishment of the Doha Agenda in 2001.[iv]

Finally, there are other practical reasons to bring these emerging economies’ applied tariffs into the ambit of future WTO negotiations.  Very few (see again Table 1) are involved in the mega-regional clubs of the Trans-Pacific Partnership (TPP) Agreement, the RCEP or FTAAP negotiations, and they are certainly not a part of the T-TIP negotiations between the US and EU. The WTO may be their own best bet at finding a forum to extract themselves from their current terms-of-trade driven prisoner’s dilemmas.

References

Bagwell, Kyle, Chad P. Bown and Robert W. Staiger (forthcoming) “Is the WTO Passé?” Journal of Economic Literature.

Bagwell, Kyle and Robert W. Staiger (1999) “An Economic Theory of GATT,” American Economic Review 89(1): 215-48.

Bagwell, Kyle and Robert W. Staiger (2002) The Economics of the World Trading System. Cambridge, MA: The MIT Press.

Bagwell, Kyle and Robert W. Staiger (2011) “What do trade negotiators negotiate about? Empirical evidence from the World Trade Organisation,” American Economic Review 101(4): 1238-73.

Bagwell, Kyle, Robert W. Staiger, and Ali Yurukoglu (2015) “Multilateral Trade Bargaining: A First Look at the GATT Bargaining Records,” NBER Working Paper No. 21488, August.

Beshkar, Mostafa, Eric W. Bond, and Youngwoo Rho (2015) “Tariff binding and overhang: theory and evidence,” Journal of International Economics 97(1): 1-13.

Bown, Chad P. (2015) “What’s Left for the WTO?” CEPR Discussion Paper No. 11003, December.

Bown, Chad P. and Meredith A. Crowley (2013) “Self-Enforcing Trade Agreements: Evidence from Time-Varying Trade Policy,” American Economic Review 103(2): 1071-1090.

Broda, Christian, Nuno Limão, and David E. Weinstein (2008) “Optimal tariffs and market power: the evidence,” American Economic Review 98(5): 2032-65.

Froman, Michael (2015) “We are at the end of the line on the Doha Round of trade talks,” Financial Times, 13 December. Available at 

Handley, Kyle (2014) “Exporting under trade policy uncertainty: Theory and evidence,” Journal of International Economics 94(1): 50-66.

Handley, Kyle and Nuno Limão (2014) “Policy Uncertainty, Trade and Welfare: Theory and Evidence for China and the US,” Mimeogr., University of Maryland

Handley, Kyle and Nuno Limão (2015) “Trade and Investment under Policy Uncertainty: Theory and Firm Evidence,” American Economic Journal: Economic Policy 7(4): 189-222.

Hufbauer, Gary C. (2015) “The WTO lives on, the Doha Round does not,” VoxEU.org, 22 December.

Johnson, Harry G. (1953-54) “Optimum Tariffs and Retaliation,” Review of Economic Studies 21(2): 142-153.

Ludema, Rodney D. and Anna Maria Mayda (2013) “Do Terms-of Trade Effects Matter for Trade Agreements? Theory and Evidence from WTO Countries,” Quarterly Journal of Economics 128(4): 1837-93.

Nicita, Alessandro, Marcelo Olarreaga, and Peri Silva (2013) “Cooperation in WTO’s Tariff Waters,” CEPR Discussion Paper No. 9529.

Endnotes

[i] In addition to their examination of GATT/WTO non-members, Broda, Limao and Weinstein (2008) also examine the MFN tariffs for the United States and find no statistically significant evidence for their measures of foreign export supply elasticities.  Also see Nicita, Olarreaga and Silva (2013), Bown and Crowley (2013), and Beshkar, Bond and Rho (2015). Bagwell, Bown, and Staiger (forthcoming) provide a recent survey of the theory and empirical evidence on the WTO.

[ii] Reducing tariff bindings and eliminating tariff binding overhang may have other benefits, however, such as reducing trade policy uncertainty (Handley 2014, Handley and Limão 2014, 2015). Nevertheless, this will not address the negative terms-of-trade externality.

[iii] See in particular the regression estimates in Bown (2015), Table 8, column (7).

[iv] For a micro-level empirical analysis of the negotiations taking place under the Torquay Round of GATT negotiations in 1950-51, see Bagwell, Staiger and Yurukoglu (2015).

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Topics:  International trade

Tags:  GATT,  WTO,  tariffs, Doha Round

Senior Fellow, Peterson Institute for International Economics; CEPR Research Fellow

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