VII Issues for the 1990s

International Monetary Fund
Published Date:
January 1992
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In some respects the issues for the 1990s remain those of the past two and even three decades—agriculture, steel, textiles and clothing, subsidies, nontariff barriers, etc. Progress in these areas depends on the outcome of the Uruguay Round, which is expected to have an important bearing on the full integration into the multilateral trade system of the developing and Eastern European countries. Meanwhile, new problems have emerged in response to changes in the world trading environment, which relate to the increased integration of the world economy through the globalization of investment and production and the effects of this on the relative importance of trade in the economy, the geographic organization of production, and the way countries compete in world markets. These forces were behind the inclusion of new issues (services, investment, and intellectual property) in the Uruguay Round and, to some extent, they explain the increased resort to regional arrangements, in the absence of relevant multilateral rules in the new areas.132

The complex interrelations among transnational firms, which invest and produce globally, have broadened the scope of policies that affect trade, foreign investment, and international competition and raised issues concerning the relevance of traditional trade policies and the appropriateness of GATT rules. The use of trade policies to pursue environmental objectives has also created new challenges for GATT and the global economy. These issues are on the trade policy agenda for the 1990s.

Integration of Developing and Eastern European Countries into the Multilateral Trade System

The experience of the past decade has amply demonstrated the linkages between openness, technological advance, and economic growth, and this has encouraged many developing and the Eastern European countries to deregulate their economies, liberalize their exchange and trade systems, and promote foreign investment. To bear fruit, these efforts will depend on two interrelated elements: the ability of the countries themselves to persist with their reform efforts and greater access to foreign markets, particularly those of the industrial countries. Security of access to foreign markets for developing and Eastern European countries is also linked to their fuller participation in the GATT system. For the Eastern European countries this involves renegotiating the conditions of their membership to reflect the greater market orientation of their economies.133

The review of trade reforms programs indicated that many developing countries need to move beyond the initial stages of trade reform toward completing trade regimes that rely mainly on price-based measures and that yield a basically neutral incentive structure. For them and for Eastern European countries, the effectiveness of the substantial exchange and trade reforms already in place will depend on further domestic reforms to develop product and factor markets that foster competition and the allocation of resources based on a realistic relative price structure. In this process greater openness to foreign investment would facilitate privatization, the transfer of technology and know-how, and the development of competitive industrial and agricultural sectors.

Improved access to world markets is essential for the success of policies aimed at increasing efficient resource allocation. This will depend importantly on a comprehensive agreement in the Uruguay Round, where the major impediments to the exports of developing and Eastern European countries are under negotiation. Liberalization in these areas is likely to be slow, however, considering the long transition periods contemplated in any agreements on sensitive sectors.134 Industrial countries, from their side, look for concessions by developing countries in specific areas of interest to them, namely, services, trade-related investment measures, and intellectual property rights. In contrast to previous GATT rounds, they also seek more secure access to developing country markets, particularly those of the dynamic Asian economies. Although the immediate tangible benefits of a Uruguay Round agreement to developing and Eastern European countries may be small, the strengthening of the multilateral trade rules and their enforcement would be crucial for the outward-oriented adjustment strategy these countries are pursuing.

For Eastern European countries, access to industrial country markets has become more critical because of the collapse of trade among former CMEA countries. As discussed in Section VI, industrial countries have accommodated this to some extent by dismantling restrictions on Eastern European exports and extending MFN treatment and GSP privileges in most cases. The EC is also negotiating Association Agreements with the Czech and Slovak Federal Republic, Hungary, and Poland that would provide for free trade in most industrial products and somewhat more limited access in sensitive areas: agriculture, textiles, clothing, steel, and coal. At the same time, the collapse of Eastern European exports to the former U.S.S.R. has been aggravated by the extension of tied aid and export credits by industrial countries to the former U.S.S.R., including to finance agricultural exports from the former German Democratic Republic.

The longer-term challenge of integrating the Eastern European countries into the world trade system is expected to involve substantial structural adjustment for Western Europe in particular, given its close geographic and cultural ties to Eastern Europe. This could have adverse consequences for other countries depending on the policy responses of Western European countries, especially those of the EC.135 Adjustment pressures will increase in those sectors that are already heavily protected, but offsetting this is the opportunity to expand exports of goods (particularly capital goods) and services to Eastern Europe. Resisting these structural changes through protectionist policies would reduce the potential benefits the world economy could derive from the opening up of Eastern Europe. Even more, it would jeopardize the effectiveness of financial resources channelled to these countries and their own efforts to create competitive market economies. Such resistance could take the form of preferential access to Western European markets for Eastern European countries at the expense of competing suppliers (both developing and industrial countries), or access could continue to be denied in trade-sensitive areas. While Western Europe may be most directly affected by the opening of Eastern Europe, the same considerations apply to other industrial countries, which need to accompany financial aid to Eastern European and developing countries with improved access to their markets. In this connection, it has been estimated that if industrial countries eliminated all their tariff and nontariff barriers the level of real national income of the developing countries would rise by 3 percent of GDP, equivalent to approximately twice the amount of official development aid extended annually by the industrial countries.136

Regional Arrangements and the Multilateral Trade System

The increased resort to regional trade arrangements is viewed by many as a cause for concern; others view it as a natural consequence of the regional integration that has already taken place both formally and informally. In any event, it is widely believed that regional trade groups—de facto or de jure—are here to stay. These developments raise the question of whether regional trade arrangements are likely to hinder or support the open, multilateral trade system.

The GATT permits preferential trading arrangements provided that substantially all trade between members is liberalized within a reasonable length of time and that barriers to trade with nonmembers are not raised. These provisions aim to avoid the proliferation of discriminatory arrangements, but in practice they have been weakly enforced and have not prevented the formation of numerous regional trade arrangements during the past forty years that do not fully conform to Article XXIV. A review of the experience with regional arrangements among industrial countries suggests that up until now they have not hindered the process of multilateral liberalization. The compatibility of regional trade arrangements among industrial countries with the multilateral trade system can be attributed to their outward orientation. These arrangements have generally been characterized by high levels of integration and relatively low levels of protection against third countries in most areas of trade. Under such conditions, countries gained from greater competition within the region as well as exposure to foreign competition.137 The obvious exception is the EC’s adoption of the CAP, which has sheltered the agricultural sector and built up resistance to multilateral liberalization. In other sensitive areas, the need for consensus within the EC may also slow the speed at which nontariff measures can be phased out.

The more recent regional initiatives have been defended by those involved on the grounds that they permit greater liberalization among like-minded countries than would be possible in a multilateral forum, and that they address the need for stronger or new disciplines in areas of interest to participants. Nevertheless, countries are well aware of the limitations and risks in this approach, especially the potential for trade diversion to outweigh trade creation; the loss of bargaining power and the security provided by the multilateral trade system for countries outside free trade areas; trade warfare among regional blocs; and the diversion of effort away from multilateral trade negotiations. The greatest risk seen in the trend toward regional blocs is the potential for fragmentation and interregional conflicts if the Uruguay Round failed, again underlining the importance of the Round for the stability of the world trade system.

Regionalism is not a substitute for the multilateral trade system. In particular, there are limits to the regional approach to liberalization in the most difficult, heavily protected sectors: agriculture, textiles and clothing, and steel. It is widely believed that the problems in these areas can only be adequately addressed within a multilateral framework, in part because of the greater scope for a reciprocal exchange of concessions but also because disciplines on subsidies and other practices that distort trade and investment would be less effective if implemented only at the regional level.

Whether regional trade arrangements hinder or support the multilateral trade system will depend on how closely they conform to Article XXIV and whether remaining trade barriers to exports of non-member countries can be kept low. To minimize the adverse effects on third countries, it has been suggested that members of regional trade arrangements (free trade areas or customs unions) go beyond the requirements of Article XXIV by reducing their trade barriers. In this context, one advantage of a free trade arrangement over a customs union is that members of the former can liberalize trade without reaching a consensus among member countries. Australia, New Zealand, and Sweden provide recent examples of countries in free trade arrangements that have continued to lower tariff and non-tariff barriers against third countries, thereby reducing the potential for trade diversion.

Globalization of Investment and Production

Growing economic interdependence among countries and the globalization of business strategies has increasingly blurred the distinction between national and foreign firms and shifted the focus of trade policy away from traditional trade policy instruments toward domestic policies that affect competition, investment, and innovation. With mobile factors of production, it is now more difficult for countries to maintain restrictive business practices without impairing their ability to compete in world markets. At the same time, there is increased concern that countries’ domestic laws and regulations may unduly limit the ability of foreign firms to compete on the same basis as national firms. Thus, the globalization process is increasingly confronting governments with the need to harmonize trade and trade-related competition, investment, and innovation policies.

Interrelation Between Trade and Competition Policies

Recognition of the interaction between trade and competition policies is not new. Indeed, these issues were covered in the Havana Charter for the International Trade Organization, and attempts have been made subsequently, in the OECD and elsewhere, to achieve greater harmonization of competition laws among countries and to reduce inconsistencies between trade laws and the principles of competition policy. The current focus on these issues, which is reflected in the communiqué of the OECD ministerial meeting of June 1991 and in extensive work programs under way in the OECD and elsewhere, stems primarily from the increased globalization of investment and production, which has raised questions about the relevance of traditional trade policy instruments that assume “nonnational” firms supply domestic markets primarily through trade. From the perspective of competition policy, it raises fundamental issues concerning the appropriateness of competition laws, which have been developed with domestic transactions primarily in mind, and on the role of governments in fostering competition.

Competition policy defines the rules that regulate competition among domestic firms. Trade policy, in a broad sense, regulates competition among firms across national boundaries. These policies have similar objectives, in that they aim to promote competition and provide remedies for dealing with anticompetitive behavior. Conflicts between these policies and among nations arise for two main reasons. First, not all countries have well-developed competition laws and, where they do exist, there are differences in approach (jurisdiction, investigatory powers, and procedural rules and remedies) and enforcement. The effect of these differences may limit access of foreign firms to domestic markets directly or indirectly via their effects on inward direct investment, or may enable domestic firms to unfairly target foreign markets. Second, both GATT and national trade laws permit trade-limiting actions in certain circumstances, which tend to weaken competition in both international and domestic markets. In addition, the trade-promoting policies of one country may be in conflict with the competition laws of other countries.

Many of the issues discussed under the U.S. Japan Structural Impediments Initiative (SII) fall in the area of competition policy. These include issues related to enforcement of antimonopoly laws that could have allowed restrictive business practices, and restrictions on foreign direct investment. Problems associated with the use of antidumping duties (ADDs) and VERs are examples of issues that fall in the area of trade policy. These trade policy instruments tend to foster noncompetitive behavior by encouraging the formation of cartels and oligopolistic market structures, and the use of restrictive business practices.138

Inconsistencies between trade and competition policies, together with the increased potential for these inconsistencies to cause conflict in an interdependent world, call for (1) a re-examination of GATT and national trade rules in terms of the principles of competition policy; and (2) an examination of how competition laws affect international trade.

Trade rules in particular need of review include remedies to deal with anticompetitive trade practices (e.g., antidumping and countervailing laws, and laws to protect intellectual property rights), remedies to deal with injury to domestic industries from imports traded competitively (e.g., Article XIX of GATT, VERs, and other gray-area measures), export promotion policies (subsidies), instruments used to pry open foreign markets (e.g., Section 301 of the U.S. 1974 Trade Law), rules of origin, and local content rules. The extent to which deficiencies in trade rules are remedied as a result of the Uruguay Round will need to be assessed at the end of the Round.

In the area of competition policy, issues that need to be re-examined from a trade angle include the appropriate economic and geographic definition of the “market”; the criteria applied in assessing the impact on market structures of mergers and acquisitions (both nationally and across borders); and the impact on international trade of restrictive business practices including intrafirm agreements (e.g., transfer pricing) of multinational enterprises. In addition, the exemption from most competition laws of import and “pure” export cartels needs to be re-examined.139

One approach to achieve greater harmonization of competition laws, which is being used in EC 1992, involves the prior harmonization of a minimum number of essential regulations; mutual recognition by member countries of regulations that are not harmonized; and factor mobility.140 As factors of production will likely move to locations with preferred regulatory systems, this will put pressure on national authorities to adopt preferred systems and thus result in a convergence of such policies among EC member states. Despite its appeal, this approach is not considered feasible at a global level or even among all OECD countries at this stage because the necessary conditions, including, in particular, free labor mobility, are not in place.

Competition and trade authorities in a number of countries suggest that the first order of business should be the establishment of competition laws in all countries based on agreed principles, and greater uniformity in enforcement of competition laws across countries. This would provide a better basis than currently exists for a greater convergence of these laws. In their view, the stepped up efforts in this area in the OECD could facilitate this process.

Issues Related to Trade and Investment Policies

In an open world economy, the trade and investment decisions of firms are closely integrated. The decisions of firms to invest overseas are either factor-driven (access to materials, technology, lower-cost labor) or policy-driven (investments directly influenced by national policies). For firms, investments that are policy-driven rather than factor-driven represent a second-best response to impediments or incentives that lead to an inefficient allocation of resources.141 This was recognized by the inclusion of trade-related investment measures and investment incentives (under the Subsidies Code) in the Uruguay Round. It is also evident in the efforts of countries to establish more neutral and transparent investment rules through bilateral trade and investment treaties and bilateral and regional trade and investment agreements.

The growing importance of foreign direct investment (FDI) in achieving and maintaining international competitiveness in world markets and in the diffusion of technology has brought into sharper focus a wider range of policies that can distort trade and investment flows and inhibit competition. Such measures affect access to foreign markets, for either goods or investment, and the conditions under which foreign-owned firms compete with national firms. For example, concerns and disputes have grown over trade measures that distort the form and extent of investment and trade flows. These include VERs, antidumping and countervailing measures, local content rules, rules of origin, and regional trade arrangements. Investment to circumvent actual or potential instruments of protection or to ensure future market access distorts the allocation of resources and decreases the share of output that is traded compared with what would be traded in the absence of protection;142 such investment has become a major source of trade friction (anticircumvention laws and transplants). Ideally, protection should be reduced; meanwhile fewer restrictions on factor mobility can reduce the welfare losses owing to the immobility of goods.

Domestic policies affecting investment flows and the way firms compete have also taken on greater importance. These include policies that inhibit foreign investment and competition indirectly through structural impediments, such as cross-corporate ownership relations or differences among countries in merger and acquisition laws and their implementation; prohibitions on investments in sensitive sectors; restrictions on the right of establishment that effectively limit investments in service sectors; and “strategic” policies that raise barriers to entry in research consortia, or otherwise limit the transfer of technology. All these measures are perceived to tilt the playing field and have become a growing source of friction among trade partners. This is increasing pressure on governments to seek regulatory convergence in areas affecting trade and investment decisions.

The ongoing work in the OECD to strengthen the provisions and enforcement mechanisms of the National Treatment Instrument and the Liberalization Codes for capital flows and invisibles could form the basis for multilateral negotiations on an investment accord in a wider forum that would aim to establish clear rules governing the right of establishment (market access) and national treatment and include effective mechanisms for dispute settlement and enforcement. The aim would be to develop more neutral and transparent trade and investment rules to ensure that investment and trade decisions are unaffected by the existence of national borders, thereby maximizing the efficiency gains from an open trade and investment regime.

Issues Related to Innovation and “Strategic” Trade Policies

Innovation (or technology) policies cover a range of government interventions that aim to assist firms in developing and adapting new technologies for commercial uses. These policies are based on the view that the ability to develop and adapt new technology, that is, to innovate, is a key determinant of national competitiveness in manufacturing. The “new” trade theories have provided the intellectual justification for pro-active innovation policies. In contrast to traditional trade theories, which explain the pattern of trade based on countries’ relative factor endowments (comparative advantage), the new theories rely on imperfect competition and economies of scale to explain the fact that most trade occurs among countries with similar factor endowments and is dominated by intra-industry trade; in this kind of world, it is argued that countries can create “competitive advantage” through innovation policies. For example, in industries where there are dynamic returns to scale (learning-by-doing), being there first and having access to foreign markets matter. Table 17 compares some of the familiar concepts from traditional trade theories with those associated with the new trade theories.

Table 17.Old Arguments in New Cloth?
Comparative advantage: countries gain by specializing in the production and export of goods in which they have a comparative advantage based on their relative factor endowments or relative costs. Trade is mostly interindustry.Competitive advantage: with rapid technical change, economies of scale and scope, and learning-by-doing, countries can gain by producing and exporting goods in which they have a competitive advantage that is created not endowed. Trade is mostly intra-industry.
Optimal tariff: a large country can improve its terms of trade by imposing a tariff, which induces foreign suppliers to lower their prices.Profit-shifting: in highly concentrated oligopolistic industries, a subsidy to entry can deter production by foreign competitors and shift excess profits to the home country.
Perfect competition: entry unlimited because start-up costs are low.

Constant returns to scale.
Imperfect competition: entry limited by large fixed startup costs and scale economies that limit the number of firms that can profitably be active in an industry.

Dynamic scale economies arise from learning-by-doing, which reduces unit costs within the firm as output accumulates over time.
Infant industry: market failures prevent development along lines of potential comparative advantage.

Imperfect capital markets lack the foresight or depth to finance investments with positive discounted present values.

Externalities cannot be appropriated by pioneer firms that create intangible benefits.
High technology industry: market failures and imperfect competition limit the ability of the private sector to profitably develop high technology applications.

Imperfect capital markets: the private costs of funds exceed their social benefit because asymmetries of information result in adverse selection.

Externalities in the creation of knowledge that spillover beyond the firm cannot be appropriated.

Two basic justifications for government intervention are derived from these theories. One is that in oligopolistic industries that enjoy monopoly profits, government support can deter production by foreign competitors and shift excess profits to national firms.143 The other is based on the existence of market failures (i.e., capital market imperfections or externalities). As a practical matter, it is not possible for governments to determine ex ante if the conditions exist to shift profits through intervention or how trade partners will respond to such beggar-thy-neighbor policies; capital market imperfections are also difficult to identify and correct.144 With regard to externalities, there is ample evidence that research and development and high-technology industries generate positive externalities that cannot be fully appropriated by firms. Under these conditions, private markets unaided will underinvest in precompetitive research and development, as well as basic research. The best policy response would be a tax or subsidy directed at the source of the externality if it could be identified and measured, and an effective instrument designed—all difficult tasks. Whether a country could raise its national income from such policies would depend on whether the externalities were national or global in scope and whether the resources drawn from other sectors would be more effectively used.145

Government policies to support innovation include provisions for research consortia, subsidies for research and development and sunrise industries, access to intellectual property, government procurement, the weakening of competition rules to support national champions or strategic alliances, restrictions on foreign investment in strategic sectors, and restrictions on the foreign sales of goods embodying new technologies. In each of these areas, there is scope for conflict between innovation, trade, and competition policies. The Tokyo Round Codes cover some of these policies, such as subsidies and government procurement, and the Uruguay Round is dealing with others (intellectual property and investment measures), but awareness of the need to agree on rules of the game is growing. In the case of subsidies, for example, there is no agreement among countries on when the subsidization of basic and precompetitive research ends and direct industrial subsidization begins.146

International rules governing innovation policies based on free market competition would imply, inter alia, research consortia open to foreign as well as domestic firms, support for generic research and development that is widely diffused, and competition rules that balance considerations of market power against the need for alliances to pool resources and share the risks of research and development. With regard to trade policies, in industries characterized by imperfect competition and economies of scale, the benefits of trade liberalization have been shown to be even greater than under perfect competition.147 Thus, the presence of imperfect competition further strengthens the case for maintaining a multilateral effort toward greater trade liberalization.

Trade and the Environment

In recent years, environmental concerns have taken on transnational and global dimensions and increased the scope for conflicts between environment policies and trade policies. This is apparent in the number of trade disputes related to the impact of environmental regulations on trade and in environmental concerns over the prospects of trade liberalization at the regional and multilateral levels. The environmental issues raised in connection with the proposed NAFTA are the most recent examples of the latter. Environmentalists are concerned that trade liberalization contributes to the degradation of the environment by reducing standards to the lowest common denominator and thereby encouraging the exploitation of resources at an unsustainable rate and the migration of “dirty” industries to countries with lower environmental standards. On the other hand, trade officials are concerned about environmental policies that are motivated by protection and about the use of trade policies to pursue environmental goals at national and international levels.148

In principle, the goals of an open, world trade system, which aim to promote the efficiency of resource use through specialization in areas of comparative advantage, need not conflict with those of environmental policy, which focus on the sustainable use of resources and pollution control. A host of practical problems emerge, however, when environmental externalities are transnational or global in character and countries differ in their environmental preferences. These relate to the design of policies to achieve environmental goals, including the proper role of trade policy.

Many of the problems involved in reconciling trade and environmental objectives arise because the prices of internationally traded goods and services do not fully reflect the environmental costs of their production and consumption or disposal. Environmental policies aim to internalize these costs through various forms of intervention including the assignment of property rights, environmental regulations and standards, subsidies and taxes, trade measures, and the use of marketable permits and emission charges. While price-based measures can achieve environmental goals at lower cost and provide incentives for innovation, governments rely primarily on less efficient direct regulation, including trade measures. Poorly designed environmental policies can lead to trade distortions that are not justified in terms of the environmental benefits achieved. Similarly, trade policies are seldom the best instruments to achieve environmental goals.149

Environmental issues were not explicitly included in the Uruguay Round agenda; however, several provisions of the GATT and the Tokyo Round Codes and proposals related to these provisions under consideration in the Round could come into play in relation to the effects of environmental measures on trade and the use of trade measures for environmental purposes. These include the Subsidies Code, which defines countervailable subsidies; the Standards Code, which deals with technical barriers to trade; proposed sanitary and phytosanitary regulations; and Article XX, which provides for exceptions to GATT rules for measures “(b) necessary to protect human, animal or plant life or health … (g) relating to the conservation of exhaustible natural resources …” The proposed improvements to the Tokyo Round Codes, which aim to clarify underlying principles and procedures, will not fully address possible conflicts between environmental policies and trade policies, and it is expected that these issues will be taken up in a comprehensive way after the Uruguay Round.

The challenge is to develop a policy framework that fosters environmentally sustainable growth and development while maximizing the welfare gains derived from free international trade. This will require a multidisciplinary approach to ensure that environmental objectives are scientifically based and that policies achieve environmental goals in an efficient manner and with the least distortion to international trade. Apart from GATT, work on these issues is under way at the OECD, UNCTAD, and other forums. In particular, at the June 1991 ministerial meeting, the OECD ministers called for the further analysis of the links between trade and the environment and the development of policy guidelines to protect the environment and preserve the open multilateral trade system.

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