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Trade: The Unwinnable War

Author: Jagdish N. Bhagwati
January 29, 2002
Financial Times

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The World Trade Organisation's decisive ruling this month against the US came as no surprise to informed observers. The US had, according to the WTO, breached international rules by providing subsidies to exporters operating through offshore subsidiaries.

What has come as a shock is the reaction in the US to the decision. Nothwithstanding the pledge by Robert Zoellick, US trade representative, to abide by the ruling, the general reaction has been unwittingly nationalistic, framed entirely in the context of European Union-US trade spats and dominated by incoherent arguments. That is why the decision requires some clarification and invites careful commentary.

That an export subsidy cannot be permitted should be clear enough. On economic grounds, such subsidies distort trade flows. Arguing in their favour is as bad as defending trade-restricting tariffs and other barriers to free trade.

More fundamentally, perhaps, it is a question of keeping your word: the export subsidy in question is simply incompatible with the agreement on permissible and proscribed subsidies, which the US signed along with other members of the WTO.

Yet, in the US, nearly all commentators have denied both of these compelling arguments. Many have argued that the matter is more about taxes than about trade and is no business of the WTO.

What these voices fail to understand is that, yes, a reduction of tariffs is about taxes; so, symmetrically, is the granting of export subsidies. But both issues belong par excellence to the remit of the WTO.

Then others argue that the EU does it too. Here, they are wrong again on the economics. Citing value-added taxes, they object to the rebates on exports therefrom as a parallel offence. But as my former student Gene Grossman, now of Princeton, has shown, this tax system does not distort comparative advantage.

The presumption that the EU is violating the WTO subsidies agreement is something else again. If the EU were indeed in breach of the WTO, you can be sure that Washington would have slapped on a counter-suit long ago. Nor is it anything more than justified chagrin to note that the EU has agricultural export subsidies. A move towards their elimination has finally been put on to the Doha agenda but as of today there is no legal bar to their existence.

In fact, the reaction of the US media should have been an acknowledgment of two beneficial aspects of the case and the decision. First, the WTO and the EU deserve a "thank you" note from Mr Zoellick and the American public. The export subsidy was little more than what Ralph Nader calls "corporate welfare". The decision illustrates well how the WTO dispute settlement mechanism often helps to crowd out harmful policies that otherwise would creep like cancer into the body politic.

More important, since it paves the way for massive trade retaliation by the EU, the WTO decision throws into sharp relief the absurdity of "trade wars", particularly when huge sums are involved. The US Congress remains wedded to this conventional response to adverse decisions, freely using both retaliation and sanctions. It has even risked a nuclear winter in trade by threatening to use a "carousel" approach - targeting innocent foreign exporters on a rotating basis, thus maximising disruption and distress - in the hormone-fed beef case that the EU lost against the US.

I have long noted that, with the world moving towards trade disputes of huge dimensions - with the hormone-fed beef running into trade retaliation of a few hundred million dollars, the subsidy case into Dollars 4bn and future cases on genetically modified products running into possibly hundreds of billions - it is nonsensical to allow full-scale retaliation. This has to be stopped through caps such as those we contemplate now for tort settlements.

We also need to open up other forms of remedy when an offending legislation or practice cannot be vacated. Thus, we should permit and encourage the payment of monetary damages that reflect not the value of trade affected but the gains from trade lost (which is only a small fraction of the sales). Damages could be directed, in the spirit of torts claims, in carefully limited cases to the industry whose market access has been disrupted by the inability to implement the WTO decision.

Now that the US itself faces mega-retaliation thanks to the present WTO decision, we may be able to propel the system in the direction of such reforms. That would be a good example of the uses of adversity.


Jagdish Bhagwati is Andre Meyer senior fellow at the Council on Foreign Relations and a professor at Columbia University

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