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25 years of the WTO—Causes of Decay and Reform Proposals for the Future

Kiel Focus

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The World Trade Organisation (WTO) has brought very significant rewards to the international community. In small, open economies like the Netherlands, about a quarter of the wealth per capita depends on the WTO's trading system, while in Germany it is about five percent. But the multilateral trade order is in a deep, existential crisis, because the WTO is not designed for geostrategic rivalry between its members. There is no simple solution. The WTO must reinvent itself, only in this way can the world community be spared to fall back into poorer times.

When, on 15 April 1994, GATT members agreed on the Marrakesh Declaration which led to the creation of the WTO, there was a shared vision of the geopolitical landscape of the future. After the end of Soviet-style communism, it was generally assumed that all countries would gradually develop into a broadly similar model of democratic market economies. The only remaining superpower, the United States, was to provide the world with a liberal world order modelled on its own.

System competition between East and West, as it has been known until now, would then be a thing of the past and the international economic order would not suffer from fundamental geopolitical disagreements, since the economic and humanitarian value systems of the political actors would have converged. However, this hope has not materialized, as demonstrated by the current system-competition between the democratic, market-oriented capitalism of the "West" and the autocratic state capitalism of some emerging countries such as China.

This is where the fundamental problem of the WTO originates. Today the organization has 164 members, ranging from extremely poor to extremely rich countries, from some of the world's most terrible autocracies to model democracies, from illiberal closed economies like Venezuela to very liberal ones like Singapore. And even countries with very similar institutional structures can pursue very different interests within the WTO.

Since the WTO is a member-based institution, each of its members has an equal right of veto. The enormous heterogeneity and the systems-competition among large members such as the United States and China renders agreement on a uniform set of rules extremely complicated. Economically, fundamentally different approaches compete within the WTO, for example with regard to the legitimacy of subsidies or the question of monopoly power.

In addition, the political divergence within the WTO was accompanied by a convergence of economic power. The GDP of the G7 countries has fallen in relation to global GDP from almost 65 percent in the early 1990s to less than 40 percent today. The economic rise of the "non-G7" countries was driven by the integration of former low-wage countries into the global value-added system. Contrary to hopes, however, economic convergence did not also lead to political convergence.

The motivation for the liberalization of world trade has always been to promote economic convergence. This has been achieved. Small, often relatively poor countries are among the biggest beneficiaries of the WTO's multilateral system. What is particularly explosive is that China in particular has succeeded in making this ascent without copying the democratic market economy system of the "West".

The USA and probably also European states would never have agreed to China's accession if they had known at the time that the country could overtake them in terms of overall economic power within a quarter of a century, relying on a completely different, rival societal model. Since the global economic and financial crisis of 2009 at the latest, China has stopped aligning its economic system with the Western model. This has increasingly revealed incompatibilities between Chinese state capitalism and the Western economic model. The situation keeps worsening as the Middle Kingdom has been preparing to export its model with the help of the Belt-and-Road Initiative for several years. It is therefore not too surprising that the USA, the decisive force for a liberal world trade system in the 1990s, has been gradually withdrawing itself from its original role.

Political differences and an alignment of economic strength are not a problem per se, but become an obstacle when central actors do not trust each other and fear opportunistic behavior by their trading partners. When China was admitted to the WTO in November 2001, mutual trust was apparently still high enough, but has since declined significantly.

This World Trade Organization was developed for a world where there are no substantial geostrategic rivalries. The basic premise of the WTO (and its predecessor, the GATT) was that the only objective of economic policy is to increase the per capita income of citizens. Such a universal focus leads to a simple logic: whenever the liberalization of international trade leads to a higher per capita income, this is welcome. In such a model, all countries benefit from an increasing division of labor, even if a trading partner might gain substantially more. For this positive-sum logic to work, however, a great deal of trust is needed. Every trading partner must be able to trust that its dependence on foreign procurement and export markets will not be exploited to its detriment. The larger the trading partner is relative to its own economy, the greater the threat.

The more the actors trust each other, in multilateral negotiations, the easier it will be for them to consider per capita income as their main or even only political objective. The smaller the amount of trust available, the more will actors focus on weakening the relative economic strength of their opponents, even if their own economy will suffer somewhat.

However, when policy-makers no longer focus solely on per capita income, but also and perhaps even primarily on the size of their own economies compared to their systemic competitors, the world is no longer in a positive-sum game, but in a zero-sum game. The actors are concerned with the distribution of existing economic and political power, no longer with the creation of new, shared prosperity. In such a world, the textbook model of the WTO collapses: the principles of reciprocity and non-discrimination that have been so successful up to now are no longer sufficient to achieve cooperative results. In competing for economic power, countries weaponize tariffs, exchange rates, or international investment.

Many current economic policy tensions and decisions can be explained by the return of systemic competition. Thus, trading partners often act according to mercantilist thinking again, i.e. with a view to the bilateral balance of trade vis-à-vis a rival. John Maynard Keynes, the intellectual godfather of the failed International Trade Organization after the Second World War, was aware of this problem and pleaded for mechanisms to ensure balanced bilateral trade balances. However, the WTO (rightly) has no rules at all for bilateral balances, since they are completely irrelevant to the welfare-enhancing effects of international trade in the sense of a positive-sum game.

In a world of systems-competition, it also makes sense for policy makers to concentrate on the manufacturing industry. According to the original cooperative logic of the WTO, it would not matter to countries which sector they specialize in. If the loss of industrial production is overcompensated by an advantage in the service sector, each country would recognize this as a boost to its prosperity and accept this development. However, if countries do not trust their trading partners to behave cooperatively, self-sufficiency in critical sectors suddenly becomes important.

Another consequence of the WTO crisis is the increasing popularity of bilateral preferential agreements. It is probably no coincidence that their number has gone up most rapidly at the turn of the millennium, when it became clear that the WTO's multilateral system was based on untenable assumptions. In the zero-sum logic, where it is only a question of increasing one's own relative strength, bilateral agreements are even more attractive, especially for countries with large domestic markets such as the USA, the EU, or China.

The crisis of the multilateral system is therefore not only a consequence of the new economic nationalism embodied by politicians such as Donald Trump, Xi Jinping, Vladimir Putin or Narendra Modi. It was the dysfunctionality of the WTO that ultimately made the rise of the new national right possible. But it is also clear that aggressive economic nationalism is further undermining confidence in multilateral agreements and reinforcing the paralysis of the WTO. As a result, the international community is deprived of a forum for discussion and dispute settlement.

The multilateral system has brought great economic rewards to almost every country in the world. Turning away from it would impoverish the world and make concerns about the distribution of existing wealth a pressing issue. The challenge, therefore, is to adapt the WTO's rules to reflect the complex political and economic situation.

In order to get out of the current impasse, one has to realize that the conceptual underpinnings of the WTO are based on a brief historical exception in which nationalism was believed to have been overcome. Today, it must be assumed that the international competition of political systems for economic supremacy will continue.

Assuming that the economies of key players such as China and the US will not grow together in the near future and that lost confidence cannot be restored easily, the WTO should implement the following measures to save itself from insignificance.

An immediate threat to the credibility of the WTO is the US blockade of the appointment of judges to the WTO Appellate Body. It must therefore reorganize its arbitration proceedings with the highest priority in order to remain able to act and should in future simply dispense with an appeal body. It is not unusual for dispute resolution systems not to provide for such an appeal body, as has been the case for many years in investor-state dispute settlement. Countries that want to resort to an appeals mechanism must then find solutions outside the WTO. The EU has already set up a model panel with Canada, and other country pairs could do the same or adopt the systems of other countries.

Moreover, the WTO-members willing to secure the core of the multilateral system should take active precautions for its collapse and develop a plan B—a legal system to replace the WTO in the worst-case scenario. Former WTO Director General and EU Trade Commissioner Pascal Lamy has suggested such a move. It would put pressure on the US to be more constructive in seeking solutions and accepting reforms rather than paralyzing the whole system. But it will probably not be enough to win back US support, as there is too much concern about the rise of China. That is why the WTO must at the same time address the systemic differences between its members.

This could be organized through a club system. A core of democratic market economies with mutually consistent value systems further deepens economic integration, renounces degrees of freedom in trade policy and transfers sovereignty to joint dispute settlement bodies. In trade with countries whose economic systems are not compatible, the applied rules ressemble more to those of the GATT of 1994 than to those of a more advanced WTO.

In some ways, the WTO is already operating in this way today, as its members are already organizing themselves within like-minded plurilateral groupings, leaving out system competitors. Such a two-pronged approach has its shortcomings, of course. It is only the second best solution for a world in which trading partners distrust each other. But it is about avoiding the risk of a complete system failure, which would lead to much higher costs. The European Union should take the lead here.

Finally, the WTO should support the implementation of bilateral trade agreements. These cannot replace a multilateral system, but they offer certainty at a time when the world trade order is being renegotiated. An important requirement of these agreements must be that they are open to a multilateral solution as soon as a new global order has been found.

The WTO turns 25 at the turn of the year. If the international community also wants to celebrate its 30th birthday, it must now face the realities of the times and act. It is about the prosperity of the world and perhaps even more.

(The contribution appeared in German in a shortened and slightly changed version on 12.12.2019 as guest comment under the title “Ein Plan B für die WTO” in the magazine Die Zeit.)


Coverfoto: © Dilok Klaisataporn – iStockphoto

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