The cross-border flows of goods, investment, services, know-how and people associated with international production networks – call it ‘supply-chain trade’ for short – has transformed the world (Gereffi and Lee 2012). The WTO has not kept pace. It is time to change that, as I argue in CEPR Policy Insight No 64, posted today (Baldwin 2012). Before turning to the governance issue, consider the changes.
The world of trade has changed
Since the 1990s, globalisation has been associated with a sharp drop in rich nations’ share of world income, world manufacturing and world exports (Figure 1). The big winners are developing nations that industrialised by joining, rather than by building, supply chains (Figure 2). The big share winners are all part of the supply chains of the US, Germany (Poland and Turkey), and Japan (China, Korea, Indonesia and Thailand). India is the exception. This rapid industrialisation also pulled up a wide range of developing nation commodity exporters like Brazil, Russia, Australia and South Africa.
Figure 1 G7 share of world exports, manufacturing and GDP
Figure 2 Manufacturing shares: Seven gainers and the G7 losers
The world of trade politics and trade governance also changed. If a high-tech firm is to locate production stages in a developing nation, the nation’s government must ensure the necessary free movement of goods, services, information and the protection of tangible and intangible property rights. Old fashioned protection, anti-FDI policies, or lax property rights almost guarantee that the offshored stages will go somewhere else. Developing nations that got the offshored factories became hyper-competitive and wiped out the exports of developing nations that clung to import-substitution industrialisation. In the world of supply-chain industrialisation, protectionism has become destructionism.
Having learned this lesson, developing nations unilaterally lowered tariffs and eagerly signed up for deep disciplines in regional trade agreements and bilateral investment treaties (Figure 3). It happened regionally, rather than multilaterally since most supply chains are regional (Baldwin and Lopez-Gonzales 2012). The fact that the WTO has been locked in a decade-long preoccupation with twentieth century trade issues (tariffs and agriculture) in the Doha Round has merely exacerbated the regionalisation of supply-chain disciplines.
Figure 3 Trade politics changed: Protectionism became destructionism
The latest erosion of WTO centricity comes with the mega-regionals – like the Trans-Pacific Partnership – that are being negotiated. On current trajectory, rules for supply chain trade will have been harmonised in thess mega-regionals within a few years entirely outside the WTO’s ambit.
Looking ahead on global trade governance: WTO 2.0 needed
The new rules and disciplines underpinning the rise of supply-chain trade have been and continue to be written outside the WTO – primarily in deep RTAs, BITs, and autonomous reforms by emerging economies. Efforts to harmonise these new disciplines are taking place in mega-regionals (Trans-Pacific Partnership, Trans-Atlantic Partnership, etc.) and mega-bilaterals (e.g. EU-Japan) that are under negotiation or discussion. As the Doha Round is unlikely to conclude before 2020 and WTO engagement in supply-chain issues is unlikely before it does, world trade governance is headed for fragmentation. Specifically, supply-chain disciplines will be harmonised by mega-regionals and mega-bilaterals that will, on current trajectory, exclude China and other large emerging economies.
Repairing the fragmentation and exclusion will require supply-chain disciplines to be multilateralised into a new organisation – call it WTO 2.0. A new organisation is needed since today’s WTO is not suited to the task.
The GATT/WTO’s success was based on win-win cooperation whose nature followed from the nature of traditional trade – i.e. goods crossing borders. With traditional trade, tariffs help the protecting nation while harming others, so the end result of individually rational protection is collective folly. The GATT/WTO flourished by solving this coordination problem – by disciplining selfish-but-harmful-to-others policies. The basic GATT/WTO bargain that underpinned the discipline was ‘my market for your market’. Negative third-nation effects were global, so universal membership was the natural outcome. Given vast market-size and income differences, ‘Special and Differential Treatment’ for developing nations was a natural part of the package.
Supply-chain trade poses radically different coordination problems, so it is natural that the structure of the organisation that solves it would be radically different. The cross-border flows that trigger supply-chain trade tend to be one-way. Advanced-technology firms offshore tangible and intangible assets, combining them with low-wage labour in developing nations. The firms get higher returns on their firm-specific assets; the developing nations get fast-track industrialisation.
As such, the basic deal in supply-chain cooperation is not ‘I’ll keep my market open if you keep yours open’, as in WTO 1.0. It is ‘I’ll offshore my factories and technologies if you assure my tangible and intangible assets are protected’. The negative third-nation effects are limited, so the logic of universal membership in WTO 2.0 is weak. The justification for SDT also disappears. The cooperation helps developing nations credibly commit to policies that are good for them. Allowing a poor nation to not assure protection of the assets that trigger supply-chain trade would harm rather than help. In the world of supply-chain trade, protectionism is destructionism as far as developing nations are concerned. Given that WTO 1.0 has universal membership and Special and Differential Treatment in its DNA, multilateralising supply-chain disciplines will require a new organisation – WTO 2.0 as it were.
Much of my Policy Insight is based on judgements and conjectures that are debateable. One point that is not debatable, however. WTO centricity in global trade governance is eroding and will continue to erode. On current trajectory, multilateralism will continue to reign for traditional trade, but fragmentation and exclusion are the most likely outcomes when it comes to the most dynamic segment of international commerce – supply-chain trade.
This may well end up as the new normal. China and other large emerging markets may be big enough to counter the exclusion. They may continue to attract offshored factories with a ‘my internal market for your factories and technology’ deal instead of the ‘your factories for my reform’ deal that most developing nations must make.
This new normal, however, would hardly be the best the world can do. Worse yet, a fragmented world dominated by Great-Power struggles could lead to the steady erosion of the WTO’s centricity that sooner or later brings the world to a tipping point – a point beyond which expectations become unmoored and nations feel justified in ignoring WTO 1.0 norms since everyone else does.
I am not sure that the solutions proposed in my Policy Insight are the right ones, but I am sure that solutions must be found if the world trade system is to avoid fragmentation and exclusion. It’s time to start thinking ahead on global trade governance.
Baldwin, R (2012). “WTO 2.0: Global governance of supply-chain trade”, CEPR Policy Insight No.64, December.
Baldwin, R and J Lopez-Gonzalez (2013). “Supply-chain trade: A portrait of global patterns and several testable hypotheses”, NBER WP 18957.
Gereffi, G and J Lee (2012). “Why the World Suddenly Cares About Global Supply Chains”, Journal of Supply Chain Management (48, 3): 24-32.