The foundations of the world trading system

If you wish to get more information about World Trade Organization, just click WTO. Its URL is: As WTO updates its site periodically, some of these documents are not readily accessible. To assist students, however, some items are copied below. These documents originated in the WTO websites, and Kwan Choi is NOT the author.

What is the WTO?

The principles of the trading system

The case for open trade

What is the World Trade Organization?

The World Trade Organization (WTO) is the legal and institutional foundation of the multilateral trading system. It provides the principal contractual obligations determining how governments frame and implement domestic trade legislation and regulations. And it is the platform on which trade relations among countries evolve through collective debate, negotiation and adjudication.

The WTO was established on 1 January 1995. Governments had concluded the Uruguay Round negotiations on December 15, 1993 and Ministers had given their political backing to the results by signing the Final Act at a meeting in Marrakesh, Morocco in April 1994. The 'Marrakesh Declaration' of 15 April 1994, affirmed that the results of the Uruguay Round would "strengthen the world economy and lead to more trade, investment, employment and income growth throughout the world". The WTO is the embodiment of the Uruguay Round results and the successor to the General Agreement on Tariffs and Trade (GATT).

Out of a potential membership of 152 countries and territories, 76 governments became members of the WTO on its first day, with some 50 other governments at various stages of completing their domestic ratification procedures, and the remainder engaged in negotiating their terms of entry.

Not only does the WTO have a potentially larger membership than GATT (128 by the end of 1994), it also has a much broader scope in terms of the commercial activity and trade policies to which it applies. The GATT applied only to trade in merchandise goods; the WTO covers trade in goods, services and "trade in ideas" or intellectual property.

The WTO is based in Geneva, Switzerland. Its essential functions are:

- administering and implementing the multilateral and plurilateral trade agreements which together make up the WTO;

- acting as a forum for multilateral trade negotiations;

- seeking to resolve trade disputes;

- overseeing national trade policies (this means giving up some portion of national sovereignty); and

- cooperating with other international institutions involved in global economic policy-making.

The Principles of the Trading System

The WTO agreement contains some 29 individual legal texts - covering everything from agriculture to textiles and clothing, and from services to government procurement, rules of origin and intellectual property. Added to these are more than 25 additional Ministerial declarations, decisions and understandings which spell out further obligations and commitments for WTO members. However, a number of simple and fundamental principles run throughout all of these instruments which, together, make up the multilateral trading system.

Trade without discrimination

For almost fifty years, key provisions of GATT outlawed discrimination among members and between imported and domestically-produced merchandise. According to Article I, the famous "most-favoured-nation" (MFN) clause, members are bound to grant to the products of other members treatment no less favourable than that accorded to the products of any other country. Thus, no country is to give special trading advantages to another or to discriminate against it: all are on an equal basis and all share the benefits of any moves towards lower trade barriers.

There are a number of exceptions to Article I - notably that covering customs unions and free-trade areas. However, most-favoured-nation treatment generally ensures that developing countries and others with little economic leverage are able to benefit freely from the best trading conditions wherever and whenever they are negotiated.

A second form of non-discrimination known as "national treatment", requires that once goods have entered a market, they must be treated no less favourably than the equivalent domestically-produced goods. This is Article III of the GATT.

Apart from the revised GATT (known as "GATT 1994"), several other WTO agreements contain important provisions relating to MFN and national treatment. That on Trade-Related Aspects of Intellectual Property (TRIPS) contains, with some exceptions, MFN and national treatment requirements relating to the provision of intellectual property protection by WTO members. The General Agreement on Trade in Services (GATS) requires members to offer MFN treatment to services and service suppliers of other members. However, it permits listed exemptions to the MFN obligation covering specific measures for which WTO members are unable to offer such treatment initially. Where such exemptions are taken, they are to be reviewed after five years and should not be maintained for more than ten years. On the other hand, national treatment is only an obligation in the GATS where members explicitly undertake to accord it for particular services or service activities. This means that national treatment is often the result of negotiations among members.

Other WTO agreements with non-discrimination provisions include those on rules of origin; preshipment inspection; trade-related investment measures ; and the application of sanitary and phytosanitary measures.

Predictable and growing access to markets

The multilateral trading system is an attempt by governments to provide investors, employers, employees and consumers with a business environment which encourages trade, investment and job creation as well as choice and low prices in the market place. Such an environment needs to be stable and predictable, particularly if businesses are to invest and thrive.

The existence of secure and predictable market access is largely determined by the use of tariffs, or customs duties. While quotas are generally outlawed, tariffs are legal in the WTO and are commonly used by governments to protect domestic industries and to raise revenues. However, they are subject to disciplines - for instance, that they are not discriminatory among imports - and are increasingly "bound". Binding means that a tariff level for a particular product becomes a commitment by a WTO member and cannot be increased without compensation negotiations with its main trading partners (Article XXVIII of GATT 1994). Thus it is frequently the case that the extension of a customs union can lead to higher tariffs in some areas for which compensation negotiations are necessary.

Following the establishment of the GATT in 1948, average tariff levels fell progressively and dramatically through a series of seven trade rounds. The Uruguay Round added to that success, cutting tariffs substantially, sometimes to zero, while raising the overall level of bound tariffs significantly. The commitments on market access through tariff reductions made by over 120 countries in the Uruguay Round are contained in some 22,500 pages of national tariff schedules.

Tariff reductions, for the most part phased in over five years, will result in a 40 per cent cut in developed countries' tariffs on industrial products, from an average of 6.3 per cent to 3.8 per cent, and a jump from 20 to 44 per cent in the value of imported industrial products that receive duty-free treatment in developed countries. At the higher end of the tariff structure, the proportion of imports into developed countries from all sources that encounter tariffs above 15 per cent will decline from 7 to 5 per cent and from 9 to 5 per cent for imports from developing countries.

The Uruguay Round increased the percentage of bound product lines from 78 to 99 per cent for developed countries, 21 to 73 per cent for developing economies and from 73 to 98 per cent for economies in transition - results which are providing a substantially higher degree of market security for traders and investors.

The "tariffication" of all non-tariff import restrictions for agricultural products provided a substantial increase in the level of market predictability for agricultural products. More than 30% of agricultural produce had been subject to quotas or import restrictions. Virtually all such measures have now been converted to tariffs which, while initially providing substantially the same level of protection as previous non-tariff measures, are being reduced during the six years of implementation of the Uruguay Round agricultural agreement. The market access commitments on agriculture will also eliminate previous import bans on certain products.

While tariffs at the border do not exist for trade in services, there is no less a need for predictable conditions. To meet that need, governments undertook an initial set of commitments covering national regulations affecting various service activities. These commitments are, like those for tariffs, contained in binding national schedules and will be extended through further rounds of services negotiations in the future.

Many other WTO agreements seek to ensure conditions of investment and trade are more predictable by making it very difficult for member governments to change the rules of the game at whim. In almost every policy area which impinges on trading conditions, the scope of members to pursue capricious, discriminatory and protectionist policies is constrained by WTO commitments.

The key to predictable trading conditions is often the transparency of domestic laws, regulations and practices. Many WTO agreements contain transparency provisions which require disclosure at the national level - for instance, through publication in official journals or through enquiry points - or at the multilateral level through formal notifications to the WTO. Much of the work of WTO bodies is concerned with reviewing such notifications. The regular surveillance of national trade policies through the Trade Policy Review Mechanism provides a further means of encouraging transparency both domestically and at the multilateral level.

Promoting fair competition

The WTO is not the "free-trade" institution it is sometimes described as - if only because it permits tariffs and, in limited circumstances, other forms of protection. It is more accurate to say it is a system of rules dedicated to open, fair and undistorted competition.

Rules on non-discrimination are designed to secure fair conditions of trade and so too are those on dumping and subsidies. Existing GATT rules, which laid down the basis on which governments could impose compensating duties on these two forms of "unfair" competition, were extended and clarified in WTO agreements.

The WTO agreement on agriculture is designed to provide fairness in farm trade. That on intellectual property will improve conditions of competition where ideas and inventions are involved, and the GATS will do the same thing for trade in services. The plurilateral agreement on government procurement will extend competition rules to purchases by thousands of "government" entities in many countries. There are plenty of other examples of WTO provisions which are designed to promote fair and undistorted competition.

Encouraging development and economic reform

Over three-quarters of WTO members are developing countries and countries in the process of economic reform from non-market systems. During the seven-year course of the Uruguay Round - between 1986 and 1993 - over 60 such countries implemented trade liberalization programmes. Some did so as part of their accession negotiations to GATT while others acted on an autonomous basis. At the same time, developing countries and transition economies took a much more active and influential role in the Uruguay Round negotiations than in any previous round.

This trend effectively killed the notion that the trading system existed only for industrialized countries. It also changed the previous emphasis on exempting developing countries from certain GATT provisions and agreements. With the end of the Uruguay Round, developing countries showed themselves prepared to take on most of the obligations that are required of developed countries. They were, however, given transition periods to adjust to the more unfamiliar and, perhaps, difficult WTO provisions - particularly so for the poorest, "least-developed" countries. In addition, a Ministerial decision on measures in favour of least-developed countries gives extra flexibility to those countries in implementing WTO agreements; calls for an acceleration in the implementation of market access concessions affecting goods of export interest to those countries; and seeks increased technical assistance for them. Thus, the value to development of pursuing, as far as is reasonable, open market-oriented policies, based on WTO principles, is widely recognized. But so is the need for some flexibility with respect to the speed at which those policies are pursued.

Nevertheless, the provisions of the GATT intended to favour developing countries remain in place in the WTO. In particular, Part IV of GATT 1994 contains three articles, introduced in 1965, encouraging industrial countries to assist developing nation members "as a matter of conscious and purposeful effort" in their trading conditions and not to expect reciprocity for concessions made to developing countries in negotiations. A second measure, agreed at the end of the Tokyo Round in 1979 and normally referred to as the "enabling clause", provides a permanent legal basis for the market access concessions made by developed to developing countries under the generalized system of preferences (GSP).

The case for open trade

The economic case for an open trading system based upon multilaterally agreed rules is simple enough and rests largely on commercial common sense.

All countries, including the poorest, have assets - human, industrial, natural, financial - which they can employ to produce goods and services for their domestic markets or to compete overseas. "Comparative advantage" means that countries prosper by taking advantage of their assets in order to concentrate on what they can produce best. This happens naturally for firms in the domestic market, but that is only half the story. The other half involves the world market. Most firms recognize that the bigger the market the greater their potential - in terms of achieving efficient scales of operation and having access to large numbers of customers. In other words, liberal trade policies which allow the unrestricted flow of goods, services and productive inputs multiply the rewards that come with producing the best products,with the best design, at the best price.

But trading success is not a static thing. Competitiveness in particular products can move from company to company when the market changes or new technologies make cheaper and better products possible. History and experience show that whole countries which have enjoyed an advantage, say, in the cost of labour or natural resources, can also become uncompetitive in some goods or services as their economies develop. However, with the stimulus of an open economy, they move on to become competitive elsewhere. This is, in general, a gradual process. For as much as the trading system is allowed to operate without the constraints of protectionism, firms are encouraged to adapt in an orderly and relatively painless way to focus on new products, finding either a new "niche" in their current area or expanding into new product areas.

The alternative of import protection and perpetual government subsidies leads to bloated, inefficient companies supplying consumers with outdated, unattractive products. Ultimately, factories close and jobs are lost despite protection and subsidies. If other governments pursue such policies overseas, markets contract and world economic activity is reduced. One of the objectives of the WTO is to prevent such a self-defeating and destructive drift into protectionism.