GATT and the Alternative of Unilateral Free Trade; P. Lemieux

238 GATIandthe Alternative of Unilateral Free Trade by Pierre Lemieux F rom December 5 to December 9 of last year, representatives of more than 100 na tional governments met in Montreal for the mid-term ministerial review of the Uruguay Round of multilateral trade negotiations under the General Agreement on Tariffs and Trade (GATT). What Is GATT? GATT is a commercial treaty, whose aim, as stated in its preamble, is "the substantial reduc tion of tariffs and other barriers to trade and. . . the elimination of discriminatory treatment in in ternational commerce." Its main principles in clude: the most-favored-nation clause, according to which any advantage granted to one signatory nation has to be extended to all others (Article I); equal treatment of goods from signatory coun tries in terms of internal taxation and regulation (Article II); fair trade against dumping and ex port subsidization (Article VI); the elimination of quantitative restrictions and the exclusive use of tariffs for protection of domestic industry (Arti cle XI); and negotiated settlement of commercial disputes (Articles XXII and XXIII).

The name "GATT" also refers to the some what informal association of signatory nations~ called "Contracting Parties." All Western Euro pean countries, the United States, Canada, Aus tralia, New Zealand, Japan, as well as some 70 underdeveloped countries, plus a few Commu nist-bloc nations (Czechoslovakia, Hungary, Mr. Lemieux is an economistand author who has been widelypublishedin Canadaand France. Poland, Rumania, and Yugoslavia)are members. TJ1e supreme governing body of GAlT is the an nual Session of the Contracting Parties but, in practice, the organization is ruled by the Council of Representatives of member states. The secre tariat, employing some 400 persons and headed by a Director-General, is located in Geneva. After World War II, protectionism was widespread. Prewar tariffs and import quotas had been supplemented by wartime measures such as foreign exchange controls. Tariffs on manufac tured goods averaged 40 percent in the industrial ized world; in the U.S. they averaged 18 percent with peaks of 50 percent or more.

In 1945, the U.S. government started two ini tiatives to liberalize international trade. First, an international trade treaty, to become known as the Havana Charter, was proposed. Second, trade talks were started among 15 nations-Australia, Belgium, Brazil, Canada, China, Cuba, Czechoslovakia, France, India, Luxembourg, the Netherlands, New Zealand, South Africa, the United Kingdom, and the United States-with the purpose of immediately reducing tariffs. The Havana Charter was finally rejected as it aimed more at managed trade and economic planning than at free trade. The second initiative, the trade negotiations, was more successful. On October 30, 1947, 23 countries-the original 15 plus Burma, Ceylon, Chile, Lebanon, Norway, Pakistan, South Rhodesia, and Syria-agreed on tariff reductions covering a significantproportion of world trade. They also rescued the commercial section of the stillborn Havana Charter and signed it under the name of the General Agreement on Tariffs and Trade, to come into effect on January 1, 1948.

GATT has remained a provisional agreement without a formal organization to supersede it. As of June 1988, the Agreement has been officially signed by 96 nations, which represent more than four-fifths of international trade. It is also unoffi cially applied by some 30 other nations. TariffReductionsUnderGATT Before the actual "round" of multilateral trade negotiations initiated in Uruguay in 1986, seven general negotiations had been held under GATT. These negotiations have presided over significant tariff reductions. At Torquay, England, in 1951, tariffs were reduced by one-fourth on average from 1948 levels. The 1964-1967Kennedy Round and the 1973-1979 Tokyo Round, both held in Geneva, brought more general tariff reductions: in each of these rounds, tariffs on manufactured goods were reduced by an average of 35 percent. Following the Tokyo Round, whose decisions came in full effect in 1986 and 1987, average (weighted) tariffs are 4.4 percent in the U.S., 4.7 percent in the European Community, and 2.8 percent in Japan. Average tariffs on industrial goods have thus decreased from 40 percent after World War II to around 5 percent today.

A voluntary dispute settlement mechanism was established under the Agreement. A trade complaint brought by one state against another is discussed between them. If it cannot be settled by consultation, it may be referred to the GATT Council of Representatives (or, more rarely, to the Session of the Contracting Parties) who will normally establish a special panel of three inde pendent experts. After holding hearings and studying the contentious matter, the panel sub mits a report which typicallyincludes a ruling and suggested remedies. Panel reports are generally adopted by the GATT Council. In the 40 years of GATT, there have been about 100 complaints put before the GATT Council, only a small number of which were not finally settled one way or another. More than half of these issues could not be immediately resolved and were the object of a panel study and report. Complaints to the GAlT have increased in the past few years: in the 22 months from the begin ning of 1986alone, 20 panels were established.

239 As with most GATT matters, decisions are reached unanimously.GATT decisions are gener ally obeyed, although they often require further negotiations and compromise. The only penalty provided in the Agreement against a member that does not abide by a Council ruling is autho rization for other countries to suspend advan tages to the offending party, but this has been done only once. Indeed, in many instances, GATT has effec tively, albeit slowly, enforced free trade. Results of its decisions over the years include: cancella tion in 1961 of a British tariff increase on ba nanas; the 1985 liberalization by the Canadian government of a foreign investment regulation forcing foreign buyers of Canadian companies to engage in a buy-Canadian policy; abolition in 1986 of book printing protection through copy right restrictions in the U.S., following a Euro pean Community complaint. The New Protectionism Yet, GATT's performance has been mixed.

High tariff peaks remain: the International Mon etary Fund reports that on textiles and clothing, "More than half the tariff lines in Austria, Cana da, Finland, Norway and the United States carry duties in excess of 15 percent" (Issues and De velopments in International Trade Policy, Decem ber 1988). More important, and despite some Tokyo Round efforts, GATT has been quite pow erless·in the face of a new protectionism based on non-tariff barriers, which not only have resisted the trend to generally decreasing tariffs, but have been on the rise since the 1970s.Also, the Agree ment itself has been used to legalize new tariff and non-tariff barriers. Subsidies, countervailing duties,and anti-dumping duties have increased. Nontariff barriers are very diversified and in clude import licensing, foreign exchange autho rizations, minimum import prices, and a number of bureaucratic obstacles at customs points. In in dustrialized countries, the major barriers are technical standards, government procurement policies, and quantitative restrictions.

Technicalstandardsand regulations.These are health, environmental, or consumer protection regulations that are often used to close the do mestic market to foreign products. Recent exam240 THE FREEMAN • JUNE 1989 pIes include a Canadian government agency's standards barring some American plywood from being used in Canadian construction, or the Eu ropean Community forbidding imports of Ameri can meat treated with growth hormones. Government procurement policies. Govern ment purchases often involve preferences for na tional suppliers. The Tokyo Round has slightly opened up this market, but many contracts by state, provincial, and local governments remain closed to foreign bidders. Quantitative restrictions. This category in cludes import quotas and export restraints, and is the most important and disruptive type of non tariff barrier. Import quotas apply on many agri cultural products (sugar in the United States is one example among many). In May 1988,261 ex port restraints were in effect, most of the so called "voluntary" variety. Many nations have skirted GATT regulations by blackmailing other countries into "voluntary" export restraint agree ments in such industries as steel (more than 30 agreements), electronics, and automobiles. In cluding textiles and clothing, voluntary export re straint agreements cover some 10 percent of world trade.

In a December 6 statement to the Ministerial Meeting of the Trade Negotiations Committee in Montreal, World Bank President Barber Conable noted that trade affected by non-tariff barriers al most doubled in the last 20 years. For example: 56 percent of iron and steel imports are hit by non-tariff barriers, nearly 90 percent of food im ports by industrialized countries face such barri ers, as do 21 percent of undeveloped countries' exports of manufactures to developed countries. In fact, many forms of the new protectionism have relied on exceptions duly recognized and thus legalized by GAIT, such as anti-dumping or countervailing duties, safeguards, and the Multifi bre Arrangements. Anti-dumping and countervailing duties. These measures are meant to counter so-called unfair trade. Anti-dumping duties (such as the 6 to 47 percent duties just imposed by the Euro pean Community against Japanese dot matrix printers) are recognized by Article VI of GAIT as a means of protecting domestic producers against products sold in their markets at lower prices than in the exporters' own markets. If the underselling is caused by a foreign government's subsidies, Article VI legalizes countervailing du ties as a retaliatory measure. One recent example is the countervailing duties imposed by the U.S.

government against Canadian soft-wood produc ers. Safeguards. Even when no unfair trade prac tices are alleged, and notwithstanding other GATT articles, a country is empowered by Arti cle XIX to enact emergency actions or "safe guards" against any imported products that "cause or threaten serious injury to domestic pro ducers." Safeguards may be tariffs, quantitative restrictions, or any other measure. From 1950 to the end of 1988, 134 Article XIX actions had been taken; at mid-1987, 26 of these measures were still in force. Multitibre Arrangements. Despite lip service about the desirability of opening up developed markets to producers from poorer nations, less developed countries have been badly hurt by the new protectionism, often with GATT's seal of ap proval. Protectionism in agricultural and espe cially tropical products is one example. But per haps the worst case is the Multifibre Arrangements, renegotiated many times since 1974 under GATT. Under the Multifibre Ar rangements and the 60 or so bilateral agreements signed under its authority, textile and clothing im ports from underdeveloped countries into indus trialized countries are severely restricted. This has led to a 20 to 50 percent increase in clothing prices for consumers in industrialized countries.

Other exceptions. Many other exceptions to free trade are legal under GATT, such as restric tions to safeguard the balance of payments (Arti cle XIII), or to favor underdeveloped countries and their policies (Article XVIII and the new Part IV of the Agreement). Subsidies. Government subsidies are often classified as non-tariff barriers but should be treated differently. On the rise mainly in agricul ture but also important in other sectors (e.g., aeronautics and shipbuilding in Europe, automo biles in France), they have provided good excuses for a host of new tariff and non-tariff barriers. Two periods may be distinguished in the post war history of international trade. From GATT's formation until around 1970, tariff and, to a certain extent, non-tariff barriers were on the wane. Starting around 1970, a phenomenon began to parallel the decline of tariffs: the growth of non tariff measures. According to some estimates, the percentage of U.S. imports covered by protection increased from 8 percent in 1975 to 21 percent ten years later (The Wall StreetJournal, Novem ber 1, 1985). All over the world, this new protec tionism has now cancelled much of the liberaliza tion of the past decades.

The Tokyo Round had tried to deal with non tariff barriers, subsidies, agriculture, services, safeguards, and so forth, but with little success. Many of the unresolved issues, which are also main contributors to the new protectionism, stood in the forefront of debates and disagree ments in the recent negotiations in Montreal. Agricultural subsidies were the main contentious issue;the U.S. proposal to eliminate them by year 2000 was rejected by the European Community. Final adoption of frameworks of agreement on matters such as tariffs, services,tropical products, and better enforcement of GAIT decisions were made conditional upon resolution of this issue. Moreover, no agreement could be reached on textiles and clothing, safeguards, and protection of intellectual property. The Uruguay Round ne gotiations are to last until 1990. GATT's multilateral trade negotiations are based on the idea that trade liberalization re quires a global approach by all sides. Bilateral agreements, as were used before (including in GATT's early history), were found to be too clumsy, slow, and inefficient. Multilateralism is now threatened again by the rise of bilateral trade actions, on the one hand, and by regional free trade areas, on the other hand. Bilateral agreements such as the Canada-U.S. Free Trade Agreement, the U.S.-Israel Free Trade Agree ment, and the Australia-New Zealand Closer Economic Relations Trade Agreement were partly designed to counter the threat of the new protectionism, but they may have added fuel to it. Bilateral or regional free trade agreements do not necessarily lead to freer trade at the world level, and fears that protectionism may be actual ly strengthened by "Fortress Europe" and "Fortress America" are not without foundations.

But, as we shall see, multilateralism, bilateral ism, and regional free trade areas are not the only alternatives. GATT AND FREE TRADE 241 The roots of the difficulties in achieving free trade lie in philosophical problems that are not unique to GAIT, but which help to explain the recent underachievements of this organization. In GATT's language and culture, individuals are identified with their countries which, in tum, are equated to their respective governments. This statist approach leads to a related problem. One often wonders whether what GATT tries to en force is free trade or managed trade, i.e., its very opposite. In GATT, everything is done by or through national governments, everything is thought of in terms of state action. One GAIT brochure (Aider la croissancemondiale)stresses that the General Agreement is "not a 'free trade charter' " but provides means for controlling pro tection of domestic industry. The necessity of some protection is unquestioned and, as we have seen, permitted or even encouraged under GATT. The requirements of domestic policies and planning have precedence over the principles of free trade. Has the Havana Charter made an anonymous comeback?

Another aspect of this fundamental misunder standing is the philosophy of intergovernmental negotiations, on which the whole GAIT system is based. It conveys the false idea that the less one government gives up and the more the other "contracting party" concedes, the better off peo ple are. This approach is reminiscent of 17th-cen tury mercantilism whichviewed exports as wealth and imports as costs. In a very real sense, freer trade does not need agreements between nations. Trade can be freed by declaring free trade unilaterally,which is basi cally what the British government did in the mid dle of the 19th century. British Prime Minister William Gladstone went so far as saying that "a commercial treaty would be an abandonment of the principles of Free Trade. . . if it were found ed on what I may call haggling exchanges." The basic philosophical failure of GAIT is that it may have distracted us from the advantages of unilat eral, one-way free trade.

UnilateralFree Trade Although the idea of unilateral free trade has not yet passed into popular culture, it has been generally accepted by economists since the time of Adam Smith (1723-1790), John Stuart Mill 242 THE FREEMAN • JUNE 1989 (1806-1873), and the Physiocrats in 17th-and 18th-century France. The desirability and feasi bility of unilateral free trade can be demonstrat ed in three steps. First, it must be realized that advantages from international trade stem·more from imports than from exports. Individuals, not countries, are the real trading partners and the ones who benefit from trade. Now, the advantages from trade come more from what one buys than from what one sells. Advan tages from trade with your butcher lie more in the meat you buy from him than from the work you do to earn the money to pay him. We trade because we think that what we get is worth more than what we give up. Similarly, we work and produce in order to consume.

This applies also to international trade, which is only inter-individual trade over a political bor der. As individuals produce in order to consume, and sell in order to buy, so they export in order to import. From the point of view of individual traders, importation is the goal; exports are just a way to finance their consumption. Advantages of international trade come more from the freedom to import than from the capacity to export. GAIT is plagued by the same problem as gov ernments: it is more a producers' club than a con sumers' association because, as shown by the Public Choice school, the interests of the latter are less concentrated and, thus, less vocal. Maxi mum prosperity requires that we let consumers (and firms as intermediaries) import freely as they wish. Would not freedom to import lead to chronic balance of payment problems? No, for the simple reason that in order to import, residents of a country must export an equivalent value. Exports necessarily equal imports. This is the second step in demonstrating the advantages of unilateral free trade.

The basic reasoning is quite straightforward. As John Stuart Mill showed 200 years ago, "an imported commodity is always paid for directly or indirectly with the produce of our own indus try." An American company pays for its imports in U.S. dollars, which are nothing but titles to American production. The foreign firm receiving the dollars can sell them in exchange for domes tic funds. The final foreign acquirer of these U.S. dollars will use them to import from the U.S., or will save them to exercise later his claim to American production. Alternatively, imports into the United States can be financed by foreign loans, but these eventually will have to be repaid and thus represent titles against future U.S. pro duction. If we look beyond the veil of money and financial transactions, then, products are ex changed only against products. Increasing im ports will automatically promote exports.

This is just another way of saying that, since each trading company or individual takes care of his own balance of payments (i.e., revenues and expenditures), there can be no overall bal ance of payments disequilibrium. A current ac count balance deficit (higher imports than ex ports of goods and services) is financed and exactly compensated by a capital account sur plus (net inflow of capital). Conversely, a capital account deficit (net capital outflow) serves to fi nance our partner's current account deficit, i.e., to compensate our own surplus. The correspon dence need not be exact between any two coun tries, but the equality of all exports and imports must hold between anyone country and the rest of the world. The third step in our demonstration will be to show that domestic protectionism compounds problems. It is true that foreign protectionism will reduce America's capacity to export. But as imports can not exceed exports over time, foreign protection ism will also reduce American imports. Now, sup pose the U.S. government retaliates with domestic protectionism. This will directly re~uce the American consumers' liberty to import, adding further to the disadvantage of foreign pro tectionism. If Americans import less, they will not be able to export as much since their imports are somebody else's exports and revenues. It can thus be seen that domestic protectionism reduces both domestic imports and exports; it further lim its two-way trade and compounds the problems of foreign protectionism.

It follows that if your neighbor is protectionist, you can limit damages to yourself by buYingfrom him as much as it is in your interest and capacity to do. These purchases will automatically finance themselves since, by permitting foreign vendors to sell here, we also oblige them to buy from us, one day or another, a corresponding value. As a consequence, unilateral free trade represents the best strategy for the victim of protectionism. The argument for unilateral free trade was well-known to French economists of the Physio cratic School. Pierre Mercier de la Riviere (1720 1793) wrote about free trade: "It is obvious that a nation can implement it by itself, independently of other nations; the right of property can be come a sacred right for its subjects without be coming so in all foreign countries." Another Physiocat, Pierre Dupont de Nemours (1739 1817) added, talking about protectionism: "If some foreign power becomes guilty of one of the offenses we just talked about, let us never be led into retaliatory actions because these would be all against our nation's interest."

These theoretical considerations can be brought to bear on GAIT. Let us suppose that the Uruguay Round turns out to be a failure in 1990. International markets could still be signifi cantly opened up by any large country or any number of countries unilaterally freeing their cit izens from their own import restrictions. Through unilateral elimination of trade barriers, we could obtain many of the advantages of GATT. Higher imports would result, but they would have to be paid for by increased exports, or by capital inflows which mean increased ex ports in the future. Any absolute advantage poor countries have in labor costs would be counterbalanced by our advantages in capital-intensive production and/or by exchange rate adjustments. Trade would in crease and flow according to comparative advan tages. The economic distortions and moral dis grace of trade barriers against underdeveloped countries would be eliminated. Indeed, the best way of fostering development in these countries (besides a liberalization of their own internal policies) is to allow them to export in order to fi nance their imports from us.

As far as agricultural subsidies are concerned, the U.S. government is right in arguing that they must be abolished. But again, this problem could, and should, be solved unilaterally.Let's just an nounce (in Canada and/or in the United States) that we will abolish our own subsidies. Even if agricultural subsidies were not abolished else where, unilateral liberalization would produce as high benefits for the economy as a whole as mul tilateralliberalization, as the International Mone tary Fund correctly argues (Issues and DevelopGATT AND FREE TRADE 243 ments in International Trade Policy, December 1988). It is quite probable that European taxpayers could not continue for long to subsidize agricul tural production, at the rate of two-thirds the Eu ropean Community budget. Liberalizing our agri culture would rapidly force them to follow. In the meantime, any disruptive effect of their temporar ily higher subsidies would be compensated by the increase in other exports from us which would be necessary to finance our higher imports of agricul tural products. Moreover, it is by no means cer tain that free and productive producers can never undersell subsidized and lazy ones. Boeing still sells airplanes and often wins sales against subsi dized Airbus. The adjustment potential of a free market economy has been shown in the petroleum markets for the last 15 years.

The Real World, Todayand Tomorrow But the real world is what it is and, until un derstanding of the advantages of unilateral free trade has progressed, we may need institutions like GATT. For the collapse of multilateral trade negotiations under GATT probably would lead to all-around protectionism instead of declara tions of unilateral free trade. First best is multilateral free trade. Second best is unilateral free trade. Third best is institu tions such as GAIT. Worst is unchecked protec tionism. Provided it does not yield to managed trade, then, GATT serves a useful purpose for now. One advantage of such international organiza tions is to impose some discipline on national governments, to prevent them from complying too easily. with demands of domestic pressure groups. Paradoxically, a club of producers' clubs can dampen local protectionist pressures. But this short-run strategy shouldn't deter us from limiting more directly the powers and trade interventionsof our own governments.No one would advocate that Western governments nego tiate individual liberty with Communist coun tries: "If you do not free your subjects, we will enslave ours equally.... " But isn't this exactly what negotiating free trade amounts to in the economic realm? Let's consider the alternative of unilateral free trade. D 244 A REVIEWER1S NOTEBOOK The Other Path by John Chamberlain I n two trips to post-Allende Chile I skipped over Peru without a decent sight of Lima.