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SCRC Article Library: Trade Agreements: Tariff and Tax in International Trade

Trade Agreements: Tariff and Tax in International Trade

Published on: Jan, 15, 2011

by: Winston Cockburn, MBA ‘05 Michael Johnston , MBA ‘05 Steven Edwards, Co-Director SCRC North Carolina State University

Trade Agreements (1)

MFN

The most-favored-nation (MFN) clause binds a country to apply to its partner country any lower rate of import duties that it may later grant to imports from some other country. The clause may cover a list of specified products only, or specific concessions yielded to certain foreign countries. Alternatively, it may cover all advantages, privileges, immunities, or other favorable treatment granted to any third country whatever. The clause is intended to provide each signatory with the assurance that the advantages obtained will not be attenuated or wiped out by a subsequent agreement concluded between one of the partners and a third country. It guarantees the parties against discriminatory treatment in favor of a competitor.

The effect of the MFN clause on customs duties is to amalgamate the successive trade agreements concluded by a state. If the rates in different agreements are fixed at varying levels, the clause reduces them to the lowest rate specified in any agreement. Thus, goods imported from a country benefiting from MFN treatment are charged the rate of duty applicable to imports from another country which, in a subsequent trade agreement, has negotiated a lower rate of duty.

The coverage of the MFN clause can be considerably reduced by a minute definition of a particular item so that a concession, while general in form, applies in practice to only one country.

The advantages granted under the MFN clause may be conditional or unconditional. If unconditional, the clause operates automatically whenever appropriate circumstances arise. The country drawing benefit from it is not called on to make any fresh concession. By contrast, the partner invoking a conditional MFN clause must make concessions equivalent to those extended by the third country. A typical wording was that of the 1911 treaty between the United States and Japan, which stated that in all that concerns commerce and navigation, any privilege, favor or immunity, to the citizens or subjects of any other State shall be extended to the citizens or subjects of the other Contracting Party gratuitously, if the concession in favor of that other State shall have been gratuitous, and on the same or equivalent conditions, if the concession shall have been conditional.

The conditional form of the clause may at first sight seem more equitable. But it has the major drawback of being liable to raise a dispute each time it is invoked, for it is by no means easy for a country to evaluate the compensation it is being offered as in fact being equivalent to the concession made by the third country.

The effect of the unconditional form of the MFN clause is; finally, to wipe out any relevance that the principle of reciprocity may have had to the purely bilateral preoccupations of the negotiating parties, since the results of the bargaining process, instead of being limited to the participants, influence their relationships with other states. In practice, therefore, a country negotiating a trade agreement must measure the advantages it is willing to concede in terms of the benefits these concessions will provide collaterally to that third country which is the most competitive. In other words, the concessions that may be granted are determined by the minimum protection that the negotiating state deems indispensable to protect its home producers. This sets a major limitation on the scope of bilateral negotiations.

Proponents of free trade consider that the unconditional MFN clause is the only practical way by which to obtain the progressive reduction of customs duties. Those who favor protectionism are resolutely against it, preferring the conditional form of the clause or some equivalent mechanism.

The conditional MFN clause was generally in use in Europe until 1860, when the so-called Cobden-Chevalier Treaty between Great Britain and France established the unconditional form as the pattern for most European treaties The United States used the conditional MFN clause from its first trade agreement, signed with France in 1778, until the passage of the Tariff Act of 1922, which terminated the practice. (The Trade Reform Bill of 1974, however, in effect restored to the U.S. president the authority to designate preferential tariff treatment, subject to approval by Congress.)

The Conference of Genoa, Italy, in May 1922 and the World Economic Conference in May 1927 both recommended that trade agreements include the MFN clause whenever possible. But the Great Depression of the 1930s led instead to a rise of restrictions in world trade. Imperial or regional systems of preference came into being: the Ottawa Agreements of 1932 for the British Commonwealth, similar arrangements for the French empire, and a series of tariff and preference agreements negotiated in eastern and central Europe from 1931 on.
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FTA

Any contractual arrangement between states concerning their trade relationships is referred to as a Trade Agreement or a Free Trade Agreement. Trade agreements may be bilateral or multilateral, that is, between two states or more than two states.

For most countries international trade is regulated by unilateral barriers of several types, including tariffs, non-tariff barriers, and outright prohibitions. Trade agreements are one way to reduce these barriers, thereby opening all parties to the benefits of increased trade.

In most modern economies the possible coalitions of interested groups are extremely numerous. Additionally, the variety of possible unilateral barriers is great. Further, there are other, non-economic reasons for some observed trade barriers, such as national security or the desire to preserve or insulate local culture from foreign influences. Thus, it is not surprising that successful trade agreements are very complicated. Some common features of trade agreements are: (1) reciprocity, (2) a most-favored-nation clause, and (3) national treatment of non-tariff barriers.

Reciprocity is a necessary feature of any agreement. If each required party does not gain by the agreement as a whole, it has no incentive to agree to it. If agreement takes place, it may be assumed that each party to the agreement expects to gain at least as much as it loses. Thus, for example, Country A, in exchange for reducing barriers to Country B’s products, thereby benefiting A’s consumers and B’s producers, will insist that Country B reduce barriers to Country A’s products, benefiting Country A’s producers and perhaps B’s consumers.

The most-favored-nation clause protects against the possibility that one of the parties to the current agreement will subsequently selectively lower barriers further to another country. For example, Country A might agree to reduce tariffs on some goods from Country B in exchange for reciprocal concessions and then further reduce tariffs for the same goods from Country C in exchange for other concessions. But if A’s consumers can get the goods in question more cheaply from C because of the tariff difference, B gets nothing for its concessions. Most-favored-nation status means that A is required to extend the lowest existing tariff on specified goods to all its trading partners having such status. Thus, if A agrees to a lower tariff later with C, B automatically gets the same lower tariff.

A “national treatment of non-tariff restrictions” clause is necessary because most of the properties of tariffs can be easily duplicated with an appropriately designed set of non-tariff restrictions. These can include discriminatory regulations, selective excise or sales taxes, special “health” requirements, quotas, “voluntary” restraints on importing, special licensing requirements, etc., not to mention outright prohibitions. Instead of trying to list and disallow all of the possible types of non-tariff restrictions, signatories to an agreement insist on similar treatment to that given to domestically produced goods of the same type.

Even without the constraints imposed by most-favored-nation and national treatment clauses, sometimes general multilateral agreements are easier to reach than separate bilateral agreements. In many cases the possible loss from a concession to one country is almost as great as that which would result from a similar concession to all or many countries. The gains to efficient producers from worldwide tariff reductions are large enough to warrant substantial concessions. The most successful and important multilateral trade agreement in modern times is the General Agreement on Tariffs and Trade (GATT). It includes provisions for reciprocity, most-favored-nation status, and national treatment of non-tariff restrictions. Since GATT took effect in 1948, world tariff levels have dropped substantially and world trade has rapidly expanded.

For more information, see the project appendices:

List of International Trade Agreements

List of Trade Unions
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Other applications of FTAs

GATT (General Agreement on Tariff and Trade) was concluded by 23 countries at Geneva, in 1947 (to take effect on Jan. 1, 1948), it was considered an interim arrangement pending the formation of a United Nations agency to supersede it. When such an agency failed to emerge, GATT was amplified and further enlarged at several succeeding negotiations. It subsequently proved to be the most effective instrument of world trade liberalization, playing a major role in the massive expansion of world trade in the second half of the 20th century. By the time GATT was replaced by the World Trade Organization (WTO) in 1995, 125 nations were signatories to its agreements, which had become a code of conduct governing 90 percent of world trade.

GATT’s most important principle was that of trade without discrimination, in which each member nation opened its markets equally to every other. As embodied in unconditional most-favored nation clauses, this meant that once a country and its largest trading partners had agreed to reduce a tariff, that tariff cut was automatically extended to every other GATT member. GATT included a long schedule of specific tariff concessions for each contracting nation, representing tariff rates that each country had agreed to extend to others. Another fundamental principle was that of protection through tariffs rather than through import quotas or other quantitative trade restrictions; GATT systematically sought to eliminate the latter. Other general rules included uniform customs regulations and the obligation of each contracting nation to negotiate for tariff cuts upon the request of another. An escape clause allowed contracting countries to alter agreements if their domestic producers suffered excessive losses as a result of trade concessions.

GATT’s normal business involved negotiations on specific trade problems affecting particular commodities or trading nations, but major multilateral trade conferences were held periodically to work out tariff reductions and other issues. Seven such “rounds” were held from 1947 to 1993, starting with those held at Geneva in 1947 (concurrent with the signing of the general agreement); at Annecy, France, in 1949; at Torquay, Eng., in 1951; and at Geneva in 1956 and again in 1960–62. The most important rounds were the so-called Kennedy Round (1964–67), the Tokyo Round (1973–79), and the Uruguay Round (1986–94), all held at Geneva. These agreements succeeded in reducing average tariffs on the world’s industrial goods from 40 percent of their market value in 1947 to less than 5 percent in 1993.

The Uruguay Round negotiated the most ambitious set of trade-liberalization agreements in GATT’s history. The worldwide trade treaty adopted at the round’s end slashed tariffs on industrial goods by an average of 40 percent, reduced agricultural subsidies, and included groundbreaking new agreements on trade in services. The treaty also created a new and stronger global organization, the WTO, to monitor and regulate international trade. GATT went out of existence with the formal conclusion of the Uruguay Round on April 15, 1994. Its principles and the many trade agreements reached under its auspices were adopted by the WTO.
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Reference:

(1) “trade agreement.” Encyclopædia Britannica from Encyclopædia Britannica Premium Service.
http://www.britannica.com/eb/article?tocId=9073135

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