EU trade policy and the future of global trade governance

Posted by Richard Baldwin on 15 September 2010

As the Vox column & Lead Commentary by Lucian Cernat shows, the EU is in a reflective mood when it comes to the Union’s future trade policy. I will soon post a longer column elaborating my points, but here I wanted to weigh in with a slightly different approach to think about future EU trade policy than the one taken by my friend Lucian.

  • The EU’s trade strategy is focused on how it can serve the EU’s goals and boost its economy. Fair enough; that’s what Commission officials are paid to do.
  • But I wonder if it wouldn’t be useful to take a broader view of the role of EU trade policy in governance of the global trade system.
  • I believe that the world trade system and world trade governance are out of balance, and my main comment is that I believe the EU should think a bit harder about this and how its trade policy might make things better, or, if designed wrongly, might make things worse.

Here is my reasoning:

21st century trade but 20th century trade governance

Let me start with a sequence of assertions about the world (I’m currently working on documenting these better in a couple of projects, and in fact there is already a lot of work showing various aspects of it, but for the moment I’ll stick with assertion of stylised facts).

  1. A good deal of the world’s trade – and in particular its most dynamic element in the past 20 years – is a much more complex phenomenon than trade was in the 1980s and earlier. Moreover there has been a significant acceleration of this 21st century trade since the early to mid 1990s.
    • The key is ‘production unbundling’ or what I like to call the ‘second unbundling’ (the 1st is the geographical separation of factories from consumers, the 2nd is the geographical separation of the factories themselves as various stages of production are offshored); see Baldwin (2006, 2009) for more detailed discussion of this.
    • Spatially separating manufacturing stages goes against the forces that had led firms to spatial concentrate the stages in a single factory or within a single city (think of Detroit, Nagoya or Stuttgart).
      • There are many names for these, but I think “coordination costs” sums them up well.
      • It is the same sort of forces that lead to the spatial concentration of academics in a university department or Commission officials in a single building.
      • For reasons that are easy to list but hard to document, it is just easier, faster, surer, and cheaper to undertake complex activities that involve many people when those people are physically close to each other.
    • ICT developments made it feasible to separate some stages of production and once it became feasible, comparative advantage made it inevitable. Internationalisation of the supply chain, i.e. production unbundling, was the result.
    • However the need to coordinate was not eliminated; all that happened was the nature of the coordination changed to facilitate offshoring.
    • The result is that production facilities located in different nations must interact in ways that were not common before offshoring. This involves sharing intellectual property, training workers, managers & technicians. It involves investment and long-term relationships. It involves more time-sensitive shipping.
    • In short, international commerce is much more than putting goods made in a factory in one nation on a boat to sell to customers in another nation. There is much more back and forth that requires excellent communication services, short-term (but guaranteed) movement of managers and technicians, overnight delivery services, exchange of tacit and explicit know-how, etc.
    • The empirical footprints left by this sort of trade between the nations engaged in it include: a great deal of imports and exports of parts and components; a great deal of business travel; a great deal of telecommunications; a great deal of services trade (especially so-called infrastructure services, or pro-export services like trade finance, insurance, overnight mail, air cargo, port services, etc.); a great deal of intellectual property trade (much of it of the tacit type that is embedded in long-term business relationship if not actual ownership); and a great deal of FDI and other forms of corporate ties (indeed practical people working in this field often use ‘trade’ and ‘investment’ in the same breath when discussing this sort of international commerce).
  2. This more complex international commerce requires a different type of governance. Things such as intellectual property right assurances, rights of establishment, assurances to investors on several aspects, assurances that short-term visas will be issued promptly, assurances that world-class infrastructure services will be available continuously and at reasonable prices, etc.
  3. The national laws of rich nations are typically sufficient to give corporations the confidence to engage in this sort of commerce, but in emerging economies, the corporations often seek or demand some sort of formal international governance.
    • In East Asia, such assurances were often provided in discussions between corporations from rich nations and the governments of the host nations – what used to be called the ‘Asian approach’ to trade and investment. The increased pace of product cycles and the growing complexity of the necessary assurances needed to underpin multi-nation supply chains tended to make this deal-making approach less feasible.
  4. The WTO – whose structure was last revised based on an agenda set in 1986 when the Uruguay Round was launched – does not provide such disciplines to the necessary extent.
  5. There is, in short, a governance gap between the sort of rules and disciplines necessary to foster 21st century trade (production unbundling and all it entails) and the 20th century world trade governance we have at the WTO.
  6. Rich nations and emerging nations have found it mutually beneficial to fill this gap by signing ‘deep’ free trade agreements. There are three sets of these in existence – those signed the US (NAFTA-type agreements), those signed by Japan (EPA-like agreements), and those signed by the EU.
    • Some emerging economies have filled some of the gap by engaging in unilateral reforms that are often called ‘pro-business’ or ‘pro-market’ reforms. These are efforts to move themselves into a situation where corporations feel more comfortable relying on local laws even without formal ‘deep’ trade agreements. One step in this direction is WTO membership, which is one reason joining the WTO is popular even in an era of bilateralism; here China and Russia come to mind.
  7. This, in short, is my picture of the imbalance between 21st century trade and 20th century trade governance; RTAs are filling the gap, but the power asymmetries involved hark back to 19th century trade governance structures.
  8.  This picture is not a disaster. The complex commerce I described is growing rapidly and seems robust. For example, it seems to have survived the “Great Trade Collapse” with hardly a shudder.
    • But is this the optimal path for global trade governance?
      • Is it enough to rely on bilateral agreements between middle sized emerging economies and industrial and technological mammoths like the US, EU and Japan?
    • Where do the big emerging economies fit in?
      • Will China, India and Brazil develop their own parallel set of disciplines?
      • Will they simply be forced to copy one or the other templates established by the North-South RTAs? 
  9. Absent some pretty determined efforts by the largest trading nations, the gap between trade and trade governance will continue to be filled by bilateralism. WTO centricity will continue to erode (Baldwin 2008). While I don’t think “the end is nigh”, continued erosion of the WTO’s central role in global trade governance is not a comfortable trend. At some point, nations may start to feel good about ignoring WTO disciplines since everyone else is doing so, particularly when their most important trade and investment relations are underpinned by bilateral or regional deals. This would not be a good outcome for the EU or any other nation.
  10. This is the sort of thing I believe the EU needs to think more about in crafting its trade strategy for the coming decade.
  11. Here are a few ideas: Why not try to see how far the deeper disciplines diverge already? Is it true that US, EU and Japanese deeper agreements are inconsistent? Could they be merged or at least be made to be more compatible with each other using things like ‘codes of conduct’ or discussing various deeper disciplines in a multilateral or plurilateral setting?
  12. A reasonably good analogy here is what happened with investment assurances. The failure of the Multilateral Investment Agreement (which wasn’t negotiated in a multilateral way!) meant that a serious gap emerged between the need for assurances to investors and the ability of world trade governance to provide it. Bilateralism filled the gap and what we have is an ad hoc ‘system’ of thousands of Bilateral Investment Treaties and an ad hoc ‘court’, the International Centre for Settlement of Investment Disputes.
    • Few think that this is the optimal way to handle the problem, but with over 2500 BITs already signed, it is pretty hard to think of a way to improve the situation.
  13. To put it differently, I believe that multilateralising regionalism should be one of the goals of the EU’s trade policy. There are many ways to get started. A number are discussed in Baldwin and Low (2009).