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Issue 34/17 March 2011

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Today’s Issue Includes:

1) The Role, Functions and Powers of the World Trade Organisation in the Regulation of International Trade by Maziar Homayounnejad, Queen Elizabeth’s School, Barnet.

Introduction: The Role of the WTO

The World Trade Organisation (WTO) is an international organisation based in Geneva, Switzerland. It consists of 153 member states representing 97% of total world trade, and has two main roles:

Firstly, the WTO acts as a forum to negotiate trade agreements between countries, similar to a law-making institution like Parliament. The aim is to dismantle tariffs, quotas and other non-tariff barriers in order to promote free trade on the basis of comparative advantage. Negotiations are conducted in ‘rounds’ of trade talks. The most recent of these is the Doha Round, which was launched in 2001 to promote a fairer participation of the developing countries in world trade, agriculture, services and intellectual property rights.

Secondly, the WTO has a dispute settlement role, similar to a court, where it resolves trade disputes between countries and enforces the trade agreements. It does this through the Dispute Settlement Panel and, in case of any appeals, the Appellate Body. The WTO has various ways of enforcing its decisions, such as when it authorises retaliation and cross-retaliation (see below). There have been some well-known cases brought to the WTO, including the EU-US steel tariffs case, the US/Ecuador-EU banana protectionism case, the China-EU shoe tariffs case and, more recently, the China-US tyre tariffs case.

WTO Principles

When negotiating trade agreements and resolving disputes between its member states, the WTO follows certain general principles. The three most important of these are:

  • Most Favoured Nation (MFN) Rule – this principle states that a tariff reduction granted to one country (i.e. the ‘most favoured nation’) should be extended to all other members of the WTO. So if country X reduces wine tariffs on country Y to only 5%, it should not impose wine tariffs of 10% on country Z. In such a case, country Z’s wine should also be subject to a tariff of 5%.
  • National Treatment Rule – according to this principle, once foreign goods have entered the domestic economy they must be treated on a par with domestically produced goods. So countries cannot have a higher rate of VAT on imported wine and a lower rate for domestic wine. Likewise, countries should not insist that foreign cars be subject to an MOT every six months, while domestically produced cars only go for an MOT once a year.
  • Tariff reductions should be mutual. So in the example given above, both countries Y and Z benefit from a reduction on wine tariffs to only 5%. In return, they should both lower their own tariffs on country X’s wine to 5%.
    Safety valves
  • Protectionism is allowed when it can be objectively justified. For example, tariffs to offset illegal subsidies or to protect infant industries; quotas to correct a balance of payments crisis, etc.

The WTO Agreements

There is a large number of trade agreements currently enforced by the WTO. Six of the most common ones are:

  • General Agreement on Tariffs and Trade (GATT) – prevents any further tariffs and quotas on goods only.
  • General Agreement on Trade in Services (GATS) – widens access to foreign markets for services like banking, insurance and telecoms.
  • Trade-Related Aspects of Intellectual Property Rights (TRIPS) – member states have an obligation to create a system of intellectual property rights to protect the copyrights, trademarks and patents of foreign firms.
  • Subsidies and Countervailing Measures (SCM) Agreement – outlaws trade- distorting subsidies and lays down the circumstances in which a countervailing tariff (also known as an ‘anti-dumping duty’) may be imposed.
  • Sanitary and Phyto-Sanitary (SPS) Agreement – this regulates the use of non-tariff barriers – in particular, health and safety requirements imposed on food, animal and plant imports. Such health and safety requirements and inspections have to be objectively justified and backed by proper scientific evidence to ensure that there are no unnecessary obstacles to trade.
  • Technical Barriers to Trade (TBT) Agreement – this also regulates the use of non-tariff barriers – in particular, technical standards and quality inspections on imports of manufactured goods. The essence of the TBT agreement is that these should be objectively justified and should not create unnecessary obstacles to trade.

Enforcement of WTO Rulings

It is important to note that the WTO follows a system of international law. In a domestic system like English law, anyone who ignores court rulings will be found in ‘contempt of court’. This is a criminal offence, which can lead to fines and even jail sentences.

However, the same situation cannot hold true in international law. It would be impractical to impose criminal sanctions against sovereign governments who fail to comply with WTO rulings. Hence the WTO has other, more practical ways of enforcing its decisions when recalcitrant member states ignore them.


Firstly, the WTO may authorise retaliation. This is where the country which has been hit by illegal tariffs / quotas is allowed to impose its own protectionist measures against the offending country. The aim is to encourage the government of the offending country to abolish its illegal measures and to continue trading on the basis of comparative advantage.

Two important points need to be made here, both linked to the principle of reciprocity. Firstly, retaliatory measures can only be imposed up to the value of the original protectionist measure. So if country X’s illegal tariffs have reduced export demand in country Y by $10 million, then country Y’s retaliatory tariffs can only reduce X’s export demand by no more than $10 million.

Secondly, retaliation must be kept within the same WTO agreement. For example, if country X’s illegal tariffs are on manufactured goods (i.e. breaking the GATT agreement), then country Y’s retaliatory tariffs must also be on manufactured goods. Y cannot impose tariffs on services, as this is covered by the GATS agreement. By insisting on these two conditions, the WTO ensures that retaliation remains ‘fair and proportional’, and is therefore seen by the international community as a legitimate response to protectionism.

A good example of retaliation can be seen in the steel tariffs case. Here, the US government failed to remove its illegal tariffs on imports of steel from the European Union, despite losing its case at the WTO. The WTO then authorised the EU to impose $2.2 billion worth of retaliatory tariffs against a range of goods imported from the US. Consequently, the US government agreed to abolish its steel tariffs.

In this case, retaliation was seen as a powerful enforcement mechanism. Indeed if there was no risk of retaliation, the US may have felt confident enough to impose even more illegal tariffs, to see what it could get away with.

However, there is a major downside. If the original country decides to retaliate even further by stepping up its illegal tariffs, this may spark a trade war and mass protectionism. Admittedly, the likelihood of this happening is quite rare, so long as retaliatory measures remain ‘fair and proportional’, as above. However, if it does happen comparative advantage will no longer form the basis for trade, thus resources will be used inefficiently. And the consequence will be a fall in total world output, which undermines global living standards.


When the two countries involved in a trade dispute are of equal bargaining power (e.g. the US and the EU), retaliation can be very effective. However, when retaliatory measures are taken by economically weak countries against stronger ones, they can often be ineffective and therefore ignored.

In such a case, the WTO may authorise cross-retaliation. This is where a small country, which has been hit by illegal tariffs / quotas from a large country, is allowed to impose protectionist measures and to suspend its obligations under more than one WTO agreement. The aim is to threaten to inflict enough economic damage on the offending country that it will have an incentive to remove its illegal measures, despite the unequal bargaining power.

A good example of cross-retaliation can be seen in the US/Ecuador-EU banana case. Here, the European Union imposed tariffs and quotas on banana imports from Ecuador, to allow more bananas to be imported from its former colonies in Africa and the Caribbean. The WTO ruled that these tariffs and quotas against Latin American bananas were illegal, yet the EU failed to remove them.

For Ecuador to impose retaliatory tariffs on European goods would be pointless, as it is a very small and insignificant export destination for EU goods. Hence the WTO allowed Ecuador to cross-retaliate and to suspend its obligations under the TRIPS Agreement too. In other words, Ecuador was no longer required to protect the copyrights, trademarks or patents of EU firms.

The impact could have been catastrophic, with counterfeit goods produced legally in Ecuador, finding their way into other world markets, particularly the highly lucrative US market. Not surprisingly, the EU agreed to bring its illegal banana tariffs and quotas to an end, hence no suspension of the TRIPS Agreement was necessary.

Voluntary Compliance

However, despite such legal wrangling in these very few instances, it must be noted that in the vast majority of cases member states do voluntarily comply with WTO rulings. Indeed losing parties realise that their failure to recognise the organisation’s legitimacy may result in a weakened system that is unable to effectively regulate trade – much to their own and everyone else’s detriment.

One good, though by no means unique example of voluntary compliance can be seen in the Costa Rica-US underwear quotas case. Here, the world’s most powerful economy willingly complied with a WTO ruling to remove import restrictions on underwear from one of its small neighbours, despite the huge disparity in economic power between the two countries. As with the majority of trade disputes, there was no question of the US ignoring the WTO decision. Accordingly, we see voluntary compliance as the norm and cases of retaliation / cross-retaliation as the rare exception, though of course it remains vital for the continued viability of the world trading system that such exceptional measures stay on the list of possible remedies, and that the WTO is willing and able to use them when needed.


Crisis Economics

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2) Can we believe the statistics?: A look at the measurements of inflation and youth unemployment by Nigel Tree.

Consumer Prices Index and Retail Prices Index

The ‘shopping baskets’ of items which are used to compile the CPI and the RPI have just been revised, as they are every year. The ‘shopping basket’ is an imaginary one which is made up of the goods and services which UK consumers typically spend their money on, and this basket will change over time.

A sample of prices of representative goods and services is made on a monthly basis. In fact, around 180,000 separate price quotations are used every month in compiling the indices, which cover a ‘basket’ of over 650 representative goods and services, with prices being collected in about 150 areas of the UK.

Thus each year the two main measurements of inflation are calculated to represent the changing cost of a basket of goods and services of “fixed composition, quantity and quality”, according to the Office for National Statistics. This is done by firstly, keeping the sample of representative goods and services constant. Secondly, applying a fixed set of weights to price changes of the items selected such that their influence on the index reflects their importance “in the typical household budget”. And, finally, ensuring that replacements for brands which are no longer stocked in an individual shop are of comparable quality. This ensures that any changes in the inflation indices only measure changes in prices and not variations in consumer purchasing patterns.

Representative items

The items in the ‘baskets’ and their weights are updated annually, so that any bias that might develop over time can be avoided, as customers move from one type of good or service to another. So, for example, the proportion of household expenditure devoted to household services has risen over the past couple of decades, and thus the baskets have been changed to include items such as internet subscriptions, playgroup and nanny fees.

The prices collected for each product group are combined to produce the overall CPI and RPI, after being given weights which are proportional to total expenditure on the entire product group. So for example, there are about 20 products which are included as representative items in the ‘furniture and furnishings’ classification, but these are then weighted to reflect average household spending on all furniture products as opposed to just those items chosen for the basket. Recent weightings for the most important groups, can be seen in the figure below.


Source: ONS

Although the vast majority of the 650+ items in the basket remain unchanged for 2011 there were a number of significant changes made in February this year. For example, craft kits have been included to represent a sector not previously covered in the games, toys and hobbies class. Also, oven-ready joints of meat have been introduced in an attempt to reflect the move towards buying more prepared food by shoppers.

Other changes included ‘apps’ for smart phones, which are replacing mobile phone downloads, such as ringtones and wallpaper. Also, dating agency fees are introduced for the first time, to reflect the spread of internet dating sites. On top of this, sparkling wines are being added as they are becoming more popular, and vending machine cigarettes have been removed to reflect new legislation restricting the sale of cigarettes.

Can we believe the figures?

What we can probably say is that the inflation figures do reflect the “typical household budget” which is what the ONS is trying to achieve. But, as students of economics, we need to realise that there is no such thing as a ‘typical household’.

This means that while the inflation figures may be broadly accurate for the generality of households, there will be sections of society, particularly at the extremes of the spectrum, for which these figures do not hold true.

For example, the poorest households in the UK might be suffering higher levels of inflation because a greater proportion of their income is spent on food. With soaring worldwide food prices in recent months, the inflation which this group is experiencing may be relatively greater than for middle-class families. In other words, they would need a greater weighting for their food expenditure than the figure of 118 which is given in the 2011 RPI weights, to accurately reflect their level of inflation.

This would also be true for many pensioners who would fall into this group, as they are far from being a typical household. Other areas of difference, may be that price inflation for rural households is greater due to their greater need to travel by car, given the recent huge surge in petrol prices.

So we could conclude that although inflation figures may reflect the typical household, there may be few ‘typical’ households in the country, and we should take notice of the possible extreme inflationary effects on certain groups of people in the country.

Are the youth unemployment figures exaggerated?

Iain Duncan-Smith, the Work and Pensions Secretary, obviously thinks so, as he has reportedly written to the ONS to complain about the ‘misleading’ picture which is currently being portrayed.

Also, the Chartered Institute of Personnel and Development (CIPD) thinks so, according to a report published this week, entitled “Getting the measure of youth unemployment”. The CIPD claims that: “The widespread perception that 1 in 5 16-24 year olds are unemployed is based on a narrow and somewhat misleading interpretation of official statistics while talk of a ‘lost generation’ of young people is simplistic.”

The report finds that the current scale of youth unemployment is only properly understood in the context of greatly increased participation in post-16 education in recent decades. This, plus the fact that almost 30% of young people classified as unemployed by the ONS are in full time education, distorts public perception of both the level and rate of youth unemployment.

As the Daily Telegraph put it: “As the labour force excludes students, the jobless constitute a larger proportion of a smaller total – skewing the percentage rate.” The CIPD analysis shows that only 13.1% of the total youth population are unemployed, against 12% in 1992, but 3.8 percentage points of this total count young people who are in education, so that the real jobless figure is only 9.4%. In other words, only about 1 in 11 16-24 year olds are unemployed, compared to the official figures of 1 in 5.

There is, of course, still a severe structural problem with youth unemployment which needs to be addressed, but again the official figures are almost certainly distorting the real situation.


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