Development of the World Trading System
Strong economic arguments support unrestricted free trade. While many governments have recognized the value of these arguments, they have been unwilling to unilaterally lower their trade barriers for fear that other nations might not follow suit. Consider the problem that two neighboring countries, say, Brazil and Argentina, face when deciding whether to lower trade barriers between them. In principle, the government of Brazil might favor lowering trade barriers, but it might be unwilling to do so for fear that Argentina will not do the same. Instead, the government might fear that the Argentineans will take advantage of Brazil’s low barriers to enter the Brazilian market, while at the same time continuing to shut Brazilian products out of their market through high trade barriers. The Argentinean government might believe that it faces the same dilemma. The essence of the problem is a lack of trust. Both governments recognize that their respective nations will benefit from lower trade barriers between them, but neither government is willing to lower barriers for fear that the other might not follow.18
Such a deadlock can be resolved if both countries negotiate a set of rules to govern cross-border trade and lower trade barriers. But who is to monitor the governments to make sure they are playing by the trade rules? And who is to impose sanctions on a government that cheats? Both governments could set up an independent body to act as a referee. This referee could monitor trade between the countries, make sure that no side cheats, and impose sanctions on a country if it does cheat in the trade game.
While it might sound unlikely that any government would compromise its national sovereignty by submitting to such an arrangement, since World War II an international trading framework has evolved that has exactly these features. For its first 50 years, this framework was known as the General Agreement on Tariffs and Trade (GATT). Since 1995, it has been known as the World Trade Organization. Here, we look at the evolution and workings of the GATT and WTO.
FROM SMITH TO THE GREAT DEPRESSION
As noted in Chapter 5, the theoretical case for free trade dates to the late eighteenth century and the work of Adam Smith and David Ricardo. Free trade as a government policy was first officially embraced by Great Britain in 1846, when the British Parliament repealed the Corn Laws. The Corn Laws placed a high tariff on imports of foreign corn. The objectives of the Corn Laws tariff were to raise government revenues and to protect British corn producers. There had been annual motions in Parliament in favor of free trade since the 1820s when David Ricardo was a member. However, agricultural protection was withdrawn only as a result of a protracted debate when the effects of a harvest failure in Great Britain were compounded by the imminent threat of famine in Ireland. Faced with considerable hardship and suffering among the populace, Parliament narrowly reversed its long-held position.
During the next 80 years or so, Great Britain, as one of the world’s dominant trading powers, pushed the case for trade liberalization, but the British government was a voice in the wilderness. Its major trading partners did not reciprocate the British policy of unilateral free trade. The only reason Britain kept this policy for so long was that as the world’s largest exporting nation, it had far more to lose from a trade war than did any other country.
By the 1930s, the British attempt to stimulate free trade was buried under the economic rubble of the Great Depression. The Great Depression had roots in the failure of the world economy to mount a sustained economic recovery after the end of World War I in 1918. Things got worse in 1929 with the U.S. stock market collapse and the subsequent run on the U.S. banking system. Economic problems were compounded in 1930 when the U.S. Congress passed the Smoot-Hawley tariff. Aimed at avoiding rising unemployment by protecting domestic industries and diverting consumer demand away from foreign products, the Smoot-Hawley Act erected an enormous wall of tariff barriers. Almost every industry was rewarded with its “made-to-order” tariff. A particularly odd aspect of the Smoot-Hawley tariff-raising binge was that the United States was running a balance-of-payment surplus at the time and it was the world’s largest creditor nation. The Smoot-Hawley Act had a damaging effect on employment abroad. Other countries reacted to the U.S. action by raising their own tariff barriers. U.S. exports tumbled in response, and the world slid further into the Great Depression.19
Enacted in 1930 by the U.S. Congress, this act erected a wall of tariff barriers against imports into the United States.