international trade

international trade

Introduction

      economic transactions that are made between countries. Among the items commonly traded are consumer goods, such as television sets and clothing; capital goods, such as machinery; and raw materials and food. Other transactions involve services, such as travel services and payments for foreign patents (see service industry). International trade transactions are facilitated by international financial payments, in which the private banking system and the central banks of the trading nations play important roles.

      International trade and the accompanying financial transactions are generally conducted for the purpose of providing a nation with commodities it lacks in exchange for those that it produces in abundance; such transactions, functioning with other economic policies, tend to improve a nation's standard of living. Much of the modern history of international relations concerns efforts to promote freer trade among nations. This article provides a historical overview of the structure of international trade and of the leading institutions that were developed to promote such trade.

Historical overview
      The barter of goods or services among different peoples is an age-old practice, probably as old as human history. International trade, however, refers specifically to an exchange between members of different nations, and accounts and explanations of such trade begin (despite fragmentary earlier discussion) only with the rise of the modern nation-state at the close of the European Middle Ages. As political thinkers and philosophers began to examine the nature and function of the nation, trade with other countries became a particular topic of their inquiry. It is, accordingly, no surprise to find one of the earliest attempts to describe the function of international trade within that highly nationalistic body of thought now known as mercantilism.

      Mercantilist analysis, which reached the peak of its influence upon European thought in the 16th and 17th centuries, focused directly upon the welfare of the nation. It insisted that the acquisition of wealth, particularly wealth in the form of gold, was of paramount importance for national policy. Mercantilists took the virtues of gold almost as an article of faith; consequently, they never sought to explain adequately why the pursuit of gold deserved such a high priority in their economic plans.

      Mercantilism was based on the conviction that national interests are inevitably in conflict—that one nation can increase its trade only at the expense of other nations. Thus, governments were led to impose price and wage controls, foster national industries, promote exports of finished goods and imports of raw materials, while at the same time limiting the exports of raw materials and the imports of finished goods. The state endeavoured to provide its citizens with a monopoly of the resources and trade outlets of its colonies.

      The trade policy dictated by mercantilist philosophy was accordingly simple: encourage exports, discourage imports, and take the proceeds of the resulting export surplus in gold. Mercantilists' ideas often were intellectually shallow, and indeed their trade policy may have been little more than a rationalization of the interests of a rising merchant class that wanted wider markets—hence the emphasis on expanding exports—coupled with protection against competition in the form of imported goods.

      A typical illustration of the mercantilist spirit is the English Navigation Act (Navigation Acts) of 1651 (see Navigation Acts), which reserved for the home country the right to trade with its colonies and prohibited the import of goods of non-European origin unless transported in ships flying the English flag. This law lingered until 1849. A similar policy was followed in France.

      A strong reaction against mercantilist attitudes began to take shape toward the middle of the 18th century. In France, the economists known as Physiocrats (physiocrat) demanded liberty of production and trade (free trade). In England, economist Adam Smith (Smith, Adam) demonstrated in his book The Wealth of Nations (1776) the advantages of removing trade restrictions. Economists and businessmen voiced their opposition to excessively high and often prohibitive customs duties and urged the negotiation of trade agreements (trade agreement) with foreign powers. This change in attitudes led to the signing of a number of agreements embodying the new liberal ideas about trade, among them the Anglo-French Treaty of 1786, which ended what had been an economic war between the two countries.

      After Adam Smith, the basic tenets of mercantilism were no longer considered defensible. This did not, however, mean that nations abandoned all mercantilist policies. Restrictive economic policies were now justified by the claim that, up to a certain point, the government should keep foreign merchandise off the domestic market in order to shelter national production from outside competition. To this end, customs levies were introduced in increasing number, replacing outright bans on imports, which became less and less frequent.

      In the middle of the 19th century, a protective customs policy effectively sheltered many national economies from outside competition. The French tariff of 1860, for example, charged extremely high rates on British products: 60 percent on pig iron; 40 to 50 percent on machinery; and 600 to 800 percent on woolen blankets. Transport costs between the two countries provided further protection.

      A triumph for liberal ideas was the Anglo-French trade agreement of 1860, which provided that French protective duties were to be reduced to a maximum of 25 percent within five years, with free entry of all French products except wines into Britain. This agreement was followed by other European trade pacts.

Resurgence of protectionism
      A reaction in favour of protection spread throughout the Western world in the latter part of the 19th century. Germany adopted a systematically protectionist policy and was soon followed by most other nations. Shortly after 1860, during the Civil War, the United States raised its duties sharply; the McKinley Tariff Act of 1890 was ultraprotectionist. The United Kingdom was the only country to remain faithful to the principles of free trade.

      But the protectionism of the last quarter of the 19th century was mild by comparison with the mercantilist policies that had been common in the 17th century and were to be revived between the two world wars. Extensive economic liberty prevailed by 1913. Quantitative restrictions were unheard of, and customs duties were low and stable. Currencies were freely convertible into gold, which in effect was a common international money. Balance-of-payments problems were few. People who wished to settle and work in a country could go where they wished with few restrictions; they could open businesses, enter trade, or export capital freely. Equal opportunity to compete was the general rule, the sole exception being the existence of limited customs preferences between certain countries, most usually between a home country and its colonies. Trade was freer throughout the Western world in 1913 than it was in Europe in 1970.

The “new” mercantilism
  World War I wrought havoc on these orderly trading conditions. By the end of the hostilities, world trade had been disrupted to a degree that made recovery very difficult. The first five years of the postwar period were marked by the dismantling of wartime controls. An economic downturn in 1920, followed by the commercial advantages that accrued to countries whose currencies had depreciated (as had Germany's), prompted many countries to impose new trade restrictions. The resulting protectionist tide engulfed the world economy, not because policy makers consciously adhered to any specific theory but because of nationalist ideologies and the pressure of economic conditions. In an attempt to end the continual raising of customs barriers, the League of Nations (Nations, League of) organized the first World Economic Conference in May 1927. Twenty-nine states, including the main industrial countries, subscribed to an international convention that was the most minutely detailed and balanced multilateral trade agreement approved to date. It was a precursor of the arrangements made under the General Agreement on Tariffs and Trade (GATT) of 1947.

      However, the 1927 agreement remained practically without effect. During the Great Depression of the 1930s, unemployment in major countries reached unprecedented levels and engendered an epidemic of protectionist measures. Countries attempted to shore up their balance of payments by raising their customs duties and introducing a range of import quotas or even import prohibitions, accompanied by exchange controls (exchange control).

      From 1933 onward, the recommendations of all the postwar economic conferences based on the fundamental postulates of economic liberalism were ignored. The planning of foreign trade came to be considered a normal function of the state. Mercantilist policies dominated the world scene until after World War II, when trade agreements and supranational organizations became the chief means of managing and promoting international trade.

The theory of international trade

Comparative-advantage analysis
      The British school of classical economics began in no small measure as a reaction against the inconsistencies of mercantilist thought. Adam Smith (Smith, Adam) was the 18th-century founder of this school; as mentioned above, his famous work, The Wealth of Nations (1776), is in part an antimercantilist tract. In the book, Smith emphasized the importance of specialization as a source of increased output, and he treated international trade as a particular instance of specialization: in a world where productive resources are scarce and human wants cannot be completely satisfied, each nation should specialize in the production of goods it is particularly well equipped to produce; it should export part of this production, taking in exchange other goods that it cannot so readily turn out. Smith did not expand these ideas at much length, but another classical economist, David Ricardo (Ricardo, David), developed them into the principle of comparative advantage, a principle still to be found, much as Ricardo spelled it out, in contemporary textbooks on international trade.

Simplified theory of comparative advantage
      For clarity of exposition, the theory of comparative advantage is usually first outlined as though only two countries and only two commodities (commodity trade) were involved, although the principles are by no means limited to such cases. Again for clarity, the cost of production is usually measured only in terms of labour time and effort; the cost of a unit of cloth, for example, might be given as two hours of work. The two countries will be called A and B; and the two commodities produced, wine and cloth. The labour time required to produce a unit of either commodity in either country is as follows:

cost of production (labour time)
country A country B
wine (1 unit) 1 hour 2 hours
cloth (1 unit) 2 hours 6 hours
See as table:
      As compared with country A, country B is productively inefficient. Its workers need more time to turn out a unit of wine or a unit of cloth. This relative inefficiency may result from differences in climate, in worker training or skill, in the amount of available tools and equipment, or from numerous other reasons. Ricardo took it for granted that such differences do exist, and he was not concerned with their origins.

      Country A is said to have an absolute advantage in the production of both wine and cloth because it is more efficient in the production of both goods. Accordingly, A's absolute advantage seemingly invites the conclusion that country B could not possibly compete with country A, and indeed that if trade were to be opened up between them, country B would be competitively overwhelmed. Ricardo, who focused chiefly on labour costs, insisted that this conclusion is false. The critical factor is that country B's disadvantage is less pronounced in wine production, in which its workers require only twice as much time for a single unit as do the workers in A, than it is in cloth production, in which the required time is three times as great. This means, Ricardo pointed out, that country B will have a comparative advantage in wine production. Both countries will profit, in terms of the real income they enjoy, if country B specializes in wine production, exporting part of its output to country A, and if country A specializes in cloth production, exporting part of its output to country B. Paradoxical though it may seem, it is preferable for country A to leave wine production to country B, despite the fact that A's workers can produce wine of equal quality in half the time that B's workers can do so.

      The incentive to export and to import can be explained in price (price system) terms. In country A (before international trade), the price of cloth ought to be twice that of wine, since a unit of cloth requires twice as much labour effort. If this price ratio is not satisfied, one of the two commodities will be overpriced and the other underpriced. Labour will then move out of the underpriced occupation and into the other, until the resulting shortage of the underpriced commodity drives up its price. In country B (again, before trade), a cloth unit should cost three times as much as a wine unit, since a unit of cloth requires three times as much labour effort. Hence, a typical before-trade price relationship, matching the underlying real cost ratio in each country, might be as follows:

country A country B
Price of wine per unit $ 5 £1
Price of cloth per unit $10 £3
See as table:
      The absolute levels of price do not matter. All that is necessary is that in each country the ratio of the two prices should match the labour–cost ratio.

      As soon as the opportunity for exchange between the two countries is opened up, the difference between the wine–cloth price ratio in country A (namely, 5:10, or 1:2) and that in country B (which is 1:3) provides the opportunity of a trading profit. Cloth will begin to move from A to B, and wine from B to A. As an illustration, a trader in A, starting with an initial investment of $10, would buy a unit of cloth, sell it in B for £3, buy 3 units of B's wine with the proceeds, and sell this in A for $15. (This example assumes, for simplicity, that costs of transporting goods are negligible or zero. The introduction of transport costs complicates the analysis somewhat, but it does not change the conclusions, unless these costs are so high as to make trade impossible.)

      So long as the ratio of prices in country A differs from that in country B, the flow of goods between the two countries will steadily increase as traders become increasingly aware of the profit to be obtained by moving goods between the two countries. Prices, however, will be affected by these changing flows of goods. The wine price in country A, for example, can be expected to fall as larger and larger supplies of imported wine become available. Thus A's wine–cloth price ratio of 1:2 will fall. For comparable reasons, B's price ratio of 1:3 will rise. When the two ratios meet, at some intermediate level (in the example earlier, at 1:21/2), the flow of goods will stabilize.

Amplification of the theory
      At a later stage in the history of comparative-advantage theory, English philosopher and political economist John Stuart Mill (Mill, John Stuart) showed that the determination of the exact after-trade price ratio was a supply-and-demand (supply and demand) problem. At each possible intermediate ratio (within the range of 1:2 and 1:3), country A would want to import a particular quantity of wine and export a particular quantity of cloth. At that same possible ratio, country B would also wish to import and export particular amounts of cloth and of wine. For any intermediate ratio taken at random, however, A's export-import quantities are unlikely to match those of B. Ordinarily, there will be just one intermediate ratio at which the quantities correspond; that is the final trading ratio at which quantities exchanged will stabilize. Indeed, once they have stabilized, there is no further profit in exchanging goods. Even with such profits eliminated, however, there is no reason why A producers should want to stop selling part of their cloth in B, since the return there is as good as that obtained from domestic sales. Furthermore, any falloff in the amounts exported and imported would reintroduce profit opportunities.

      In this simple example, based on labour costs, the result is complete (and unrealistic) specialization: country A's entire labour force will move to cloth production and country B's to wine production. More elaborate comparative-advantage models recognize production costs other than labour (that is, the costs of land and of capital). In such models, part of country A's wine industry may survive and compete effectively against imports, as may also part of B's cloth industry. The models can be expanded in other ways—for example, by involving more than two countries or products, by adding transport costs, or by accommodating a number of other variables such as labour conditions and product quality. The essential conclusions, however, come from the elementary model used above, so that this model, despite its simplicity, still provides a workable outline of the theory. (It should be noted that even the most elaborate comparative-advantage models continue to rely on certain simplifying assumptions without which the basic conclusions do not necessarily hold. These assumptions are discussed below.)

      As noted earlier, the effect of this analysis is to correct any false first impression that low-productivity countries are at a hopeless disadvantage in trading with high-productivity ones. The impression is false, that is, if one assumes, as comparative-advantage theory does, that international trade is an exchange of goods between countries. It is pointless for country A to sell goods to country B, whatever its labour-cost advantages, if there is nothing that it can profitably take back in exchange for its sales. With one exception, there will always be at least one commodity that a low-productivity country such as B can successfully export. Country B must of course pay a price for its low productivity, as compared with A; but that price is a lower per capita domestic income and not a disadvantage in international trading. For trading purposes, absolute productivity levels are unimportant; country B will always find one or more commodities in which it enjoys a comparative advantage (that is, a commodity in the production of which its absolute disadvantage is least). The one exception is that case in which productivity ratios, and consequently pretrade price ratios, happen to match one another in two countries. This would have been the case had country B required four labour hours (instead of six) to produce a unit of cloth. In such a circumstance, there would be no incentive for either country to engage in trade, nor would there be any gain from trading. In a two-commodity example such as that employed, it might not be unusual to find matching productivity and price ratios. But as soon as one moves on to cases of three and more commodities, the statistical probability of encountering precisely equal ratios becomes very small indeed.

      The major purpose of the theory of comparative advantage is to illustrate the gains from international trade. Each country benefits by specializing in those occupations in which it is relatively efficient; each should export part of that production and take, in exchange, those goods in whose production it is, for whatever reason, at a comparative disadvantage. The theory of comparative advantage thus provides a strong argument for free trade—and indeed for more of a laissez-faire attitude with respect to trade. Based on this uncomplicated example, the supporting argument is simple: specialization and free exchange among nations yield higher real income for the participants.

      The fact that a country will enjoy higher real income as a consequence of the opening up of trade does not mean, of course, that every family or individual within the country will share in that benefit. Producer groups affected by import competition obviously will suffer, to at least some degree. Individuals are at risk of losing their jobs if the items they make can be produced more cheaply elsewhere. Comparative-advantage theorists concede that free trade would affect the relative income position of such groups—and perhaps even their absolute income level. But they insist that the special interests of these groups clash with the total national interest, and the most that comparative-advantage proponents are usually willing to concede is the possible need for temporary protection against import competition (i.e., to allow those who lose their jobs to international competition to find new occupations).

      Nations do, of course, maintain tariffs (tariff) and other barriers to imports. For discussion of the reasons for this seeming clash between actual policies and the lessons of the theory of comparative advantage, see State interference in international trade (international trade).

Sources of comparative advantage
      As already noted, British classical economists simply accepted the fact that productivity differences exist between countries; they made no concerted attempt to explain which commodities a country would export or import. During the 20th century, international economists offered a number of theories in an effort to explain why countries have differences in productivity, the factor that determines comparative advantage and the pattern of international trade.

      First, countries can have an advantage because they are richly endowed with a particular natural resource. For example, countries with plentiful oil resources can generally produce oil inexpensively. Because Saudi Arabia produces oil very cheaply, it holds a comparative advantage in oil, and it exports oil in order to finance its purchases of imports. Similarly, countries with large forests generally are the major exporters of wood, paper, and paper products. The supply available for export also depends on domestic demand. Canada has large quantities of lumber available for export to the United States, not only because of its large areas of forest but also because its small population consumes little of the supply, leaving much of the lumber available for export. Climate is another natural resource that provides an export advantage. Thus, for example, bananas are exported by Central American countries—not Iceland or Finland.

Factor endowments: the Heckscher-Ohlin theory
      Simply put, countries with plentiful natural resources will generally have a comparative advantage in products using those resources. A related, but much more subtle, assertion was put forward by two Swedish economists, Eli Heckscher (Heckscher, Eli Filip) and Bertil Ohlin (Ohlin, Bertil). Ohlin's work was built upon that of Heckscher. In recognition of his ideas as described in his path-breaking book, Interregional and International Trade (1933), Ohlin was a recipient of the Nobel Prize for Economics in 1977.

      The Heckscher-Ohlin theory focuses on the two most important factors of production, labour and capital (capital and interest). Some countries are relatively well-endowed with capital; the typical worker has plenty of machinery and equipment to assist with the work. In such countries, wage rates generally are high; as a result, the costs of producing labour-intensive goods—such as textiles, sporting goods, and simple consumer electronics—tend to be more expensive than in countries with plentiful labour and low wage rates. On the other hand, goods requiring much capital and only a little labour (automobiles and chemicals, for example) tend to be relatively inexpensive in countries with plentiful and cheap capital. Thus, countries with abundant capital should generally be able to produce capital-intensive goods relatively inexpensively, exporting them in order to pay for imports of labour-intensive goods.

      In the Heckscher-Ohlin theory it is not the absolute amount of capital that is important; rather, it is the amount of capital per worker. A small country like Luxembourg has much less capital in total than India, but Luxembourg has more capital per worker. Accordingly, the Heckscher-Ohlin theory predicts that Luxembourg will export capital-intensive products to India and import labour-intensive products in return.

      Despite its plausibility the Heckscher-Ohlin theory is frequently at variance with the actual patterns of international trade. As an explanation of what countries actually export and import, it is much less accurate than the more obvious and straightforward natural resource theory.

      One early study of the Heckscher-Ohlin theory was carried out by Wassily Leontief (Leontief, Wassily), a Russian-born U.S. economist. Leontief observed that the United States was relatively well-endowed with capital. According to the theory, therefore, the United States should export capital-intensive goods and import labour-intensive ones. He found that the opposite was in fact the case: U.S. exports are generally more labour intensive than the type of products that the United States imports. Because his findings were the opposite of those predicted by the theory, they are known as the Leontief Paradox.

Economies of large-scale production
      Even if countries have quite similar climates and factor endowments, they may still find it advantageous to trade. Indeed, economically similar countries often carry on a large and thriving trade. The prosperous industrialized countries have become one another's best customers. A main reason for this situation lies in what is called the economies of large-scale production (see economy of scale).

      For many products, there are advantages in producing on a large scale; costs become lower as more is produced. Thus, for example, automobiles can be made more cheaply in a factory producing 100,000 units than in a small factory producing only 1,000 units. This means that countries have an incentive to specialize in order to reduce costs. To sell a large volume of output, they may have to look to export markets.

      The smaller the country, and the more limited its domestic market, the more incentive it has to look to international trade as a way of gaining the advantages of large-scale production. Thus, Luxembourg or Belgium has much more to gain, relatively, than the United States. Indeed, the advantages of large-scale production were one of the major sources of gain from the establishment of the European Economic Community (EEC; renamed the European Community in 1993), which was formed for the purpose of providing free trade between most western European countries.

      Even a large country such as the United States, however, can gain in some cases by exporting in order to exploit the economies of production lines. For example, the Boeing Company has been able to produce airplanes more efficiently and cheaply because it is able to sell large numbers of aircraft to other countries. The importing countries also gain because they can buy aircraft abroad at prices far lower than they would pay for domestically produced equivalents.

      Technological development can also provide a distinctive trade advantage. The relatively advanced countries—particularly the United States, Japan, and those of western Europe—have been the principal exporters of high-technology products such as computers and precision machinery.

      One important aspect of technology is that it can change rapidly. This is perhaps most obvious in the computer field, where productivity has increased and costs have fallen sharply since the early 1960s (see Moore's law (Moore, Gordon E.)). Such rapid changes present several challenges. For countries that are not in the front rank, it raises the question of whether they should import high-technology products or attempt to enter the circle of the most advanced nations. For the countries that have held the technological lead in the past, there is always the possibility that they will be overtaken by newcomers. This occurred in the second half of the 20th century when Japan advanced technologically in its automobile production to the point where it could challenge the automobile leadership of North America and Europe. Japan quickly became the world's foremost producer of automobiles, and by the end of the 20th century, Korean automakers were attempting to follow the Japanese example with the aggressive export of automobiles.

      Technological advances also strengthen global trade in a general sense: e-commerce (electronic commerce), for example, reduced the impact of geographic distance by facilitating fast, efficient, real-time ties between businesses and individuals around the world. Indeed, at the end of the 20th century, information technology, an industry that scarcely existed 20 years earlier, exceeded the combined world trade in agriculture, automobiles, and textiles.

The product cycle
      The spread of technology across national boundaries means that comparative advantage can change. The most technologically advanced countries generally have the advantage in making new products, but as time passes other countries may gain the advantage. For example, many television sets were produced in the United States during the 1950s. As time passed, however, and technological change in the television industry became less rapid, there was less advantage in producing sets in the United States. Producers of television sets had an incentive to look to other locations, with lower wage rates. In time, the manufacturers established overseas operations in Taiwan, Hong Kong, and elsewhere. Concurrently, the United States turned to new activities, such as the manufacture of supercomputers (supercomputer), the development of computer software, and new applications of satellite (satellite communication) technology.

Romney Robinson Paul Wonnacott Ed.

State interference in international trade

Methods of interference
      Regardless of what comparative-advantage theory may say about the virtues of unrestricted trade, all nations interfere with international transactions to some degree. Tariffs (tariff) may be imposed on imports—in some instances making them so costly as to bar completely the entry of the good involved. Quotas (quota) may limit the permissible volume of imports. State subsidies (subsidy) may be offered to encourage exports. Money-capital exports may be restricted or prohibited. Investment by foreigners in domestic plant and equipment may be similarly restrained.

      These interferences may be simply the result of special-interest pleading, because particular groups suffer as a consequence of import competition. Or a government may impose restrictions because it feels impelled to take account of factors that comparative advantage sets aside. It is of interest to note that insofar as goods and services are concerned, the general pattern of interference follows the old mercantilist (mercantilism) dictum of discouraging imports and encouraging exports.

      A company that finds itself barred from an attractive foreign market by tariffs or quotas may be able to sidestep the barrier simply by establishing a manufacturing plant within that foreign country. This policy of foreign plant investment expanded enormously after World War II, with U.S. companies taking the lead by investing particularly in western Europe, Canada, Asia, and South America. Industry in other developed countries followed a similar pattern, with many foreign companies establishing plants within the United States as well as in other areas of the world.

      The governments of countries subject to this new investment find themselves in an ambivalent position. The establishment of new foreign-owned plants may mean more than simply the creation of new employment opportunities and new productive capacity; it may also mean the introduction of new technologies and superior business-control methods. But the government that welcomes such benefits must also expect complaints of “foreign control,” an argument that will inevitably be pressed by domestic owners of older plants who fear a new competition that cannot be blocked by tariffs. This has been a pressing problem for many governments, particularly insofar as investment by U.S. firms is involved, and it is a chief complaint of critics who view globalization (globalization, cultural) as a form of economic exploitation. Some countries, such as the United Kingdom and Canada, have been liberal in their admissions policy; others, notably Japan, have imposed tight restrictions on foreign-owned plants.

Romney Robinson

Tariffs (tariff)
      A tariff, or duty, is a tax levied on products when they cross the boundary of a customs area. The boundary may be that of a nation or a group of nations that has agreed to impose a common tax on goods entering its territory. Tariffs are often classified as either protective or revenue-producing. Protective tariffs are designed to shield domestic production from foreign competition by raising the price of the imported commodity. Revenue tariffs are designed to obtain revenue rather than to restrict imports. The two sets of objectives are, of course, not mutually exclusive. Protective tariffs—unless they are so high as to keep out imports—yield revenue, while revenue tariffs give some protection (protectionism) to any domestic producer of the duty-bearing goods. A transit duty, or transit tax, is a tax levied on commodities passing through a customs area en route to another country. Similarly, an export duty, or export tax, is a tax imposed on commodities leaving a customs area. Finally, some countries provide export subsidies; import subsidies are rarely used.

How tariffs work
      Tariffs on imports may be applied in several ways. If they are imposed according to the physical quantity of an import (so much per ton, per yard, per item, etc.), they are called specific tariffs. If they are levied according to the value of the import, they are known as ad valorem tariffs (ad valorem tax).

      Tariffs may differentiate among the countries from which the imports are obtained. They may, for instance, be lower between countries that have previously entered into special arrangements, such as the trade preferences accorded to each other by members of the European Community (EC; formerly the EEC) in the European Union.

      Tariffs may be imposed in different ways, each of which will have a different effect on the economy of the country imposing them. By raising the prices of imported goods, tariffs may encourage domestic production. As expenditures on domestic products rise, domestic employment tends to do likewise. This is why tariffs are favoured by industries that find themselves pressed by foreign competitors. The tariff may also encourage tendencies toward a monopolistic market structure to the extent that it lessens foreign competition, with a resulting decrease in the incentive to modernize or innovate. Because tariffs increase the price of an imported commodity, they may also reduce its consumption. The decrease in demand could be large enough in relation to the world market to force the price of the import down.

Measuring the effects of tariffs
      It is difficult to gauge the effect of tariff barriers among countries. Clearly, the way in which import demand responds to changes in tariffs will depend on a variety of factors. These include the reaction of producers and consumers to price changes, the share of imports in domestic production and consumption, the substitutability of imports for domestic products, and so on. The reaction to tariff levels will differ from country to country as well as from commodity to commodity. Thus, the amount of a tariff does not necessarily determine its restrictive effect. Typically, such comparisons apply only to products for which tariffs are the major protective device. This is generally true for nonagricultural products in developed countries (other strategies, such as import quotas, are a common means of protecting agricultural commodities). Although tariffs on imported raw materials will protect domestic producers of those commodities, such tariffs will also increase the costs to domestic manufacturers who use those raw materials. These conditions necessitate a distinction between nominal and effective rates of protection.

      The nominal rate of protection is the percentage tariff imposed on a product as it enters the country. For example, if a tariff of 20 percent of value is collected on clothing as it enters the country, then the nominal rate of protection is that same 20 percent.

      The effective rate of protection is a more complex concept: consider that the same product—clothing—costs $100 on international markets. The material that is imported to make the clothing (material inputs) sells for $60. In a free trade situation, a firm can charge no more than $100 for a similar piece of clothing (ignoring transportation costs). Importing the fabric for $60, the clothing manufacturer can add a maximum of $40 for labour, profit markup, rents, and the like. This $40 difference between the $60 cost of material inputs and the price of the product is called the value added.

      The same situation may be considered with tariffs—say, 20 percent on clothing and 10 percent on fabric. The 20 percent tariff on clothing would raise the domestic price by $20 to $120, while a 10 percent tariff on fabrics would increase material costs to the domestic producer by $6 to $66. Protection would thus enable the firm to operate with a value-added margin of $54—the difference between the domestic price of $120 and the material cost of $66. The difference between the value added of $40 without tariff protection and that of $54 with it provides a margin of $14. This means that the effective rate of protection of the domestic processing activity—the ratio of $14 to $40—would be 35 percent. The effective rate of protection derived—35 percent—is greater than the nominal rate of only 20 percent. This will be the case whenever the tariff rate on the final product is greater than the tariff on inputs. Because countries generally do levy higher tariffs on final products than on inputs, effective rates of protection are usually higher than nominal rates—often much higher.

      The effective rate of protection also depends on the share of value added in the product price. Effective rates can be very high if value added to the imported commodity is a small percentage or very low if value added is a large percentage of the total price. Thus, effective protection in one country may be much higher than that in another even though its nominal tariffs are lower, if it tends to import commodities of a high level of fabrication with correspondingly low ratios of value added to product price.

Nontariff barriers
      Other government regulations and practices may also act as barriers to trade. Quotas (quota) or quantitative restrictions may prohibit the importation of certain commodities or limit the amounts imported. Such quotas are usually administered by requiring importers to have licenses to import particular products. Quotas raise prices just as tariffs do, but, being set in physical terms, their impact on imports is direct, with an absolute ceiling set on quantity. Increased prices will not bring more goods in. There is also a difference between tariffs and quotas in their effect on revenues. With tariffs, the government receives the revenue: under quotas, the import license holders obtain a windfall in the form of the difference between the high domestic price and the low international price of the import.

      Another barrier is the voluntary export restraint (VER), noted for having a less-damaging effect on the political relations between countries. It is also relatively easy to remove. This approach was applied in the early 1980s when Japanese (Japan) automakers, under pressure from U.S. competitors, “voluntarily” limited their exports of automobiles to the U.S. market. Like quotas, VERs limit the quantity of trade and therefore tend to raise the prices of imported goods. In this case, the VER made Japanese automobiles less available in the United States and raised the prices that U.S. consumers had to pay for them, thereby making domestically produced cars more attractive. This approach also allowed Japanese exporters to charge higher prices. As a result, the Japanese exporters, rather than U.S. importers, reaped much of the windfall from the VER. VERs are usually not voluntary in any meaningful sense. In this example, the Japanese automakers agreed to a VER in order to avoid a U.S. import quota.

      Still other barriers include state trading organizations and government procurement practices that may be used preferentially. In the United States, “buy American” legislation requires government procurement agencies to favour domestic goods. Customs classification and valuation procedures, health regulations, and marking requirements may also have a restrictive effect on trade. Japan, for example, has restricted imports of U.S. apples on the grounds that the apples could be contaminated with the fire blight disease. Finally, excise taxes may act as a barrier to trade if they are levied at higher rates on imports than on domestic goods.

Protectionism in the less-developed countries
      Much of the industrialization that took place in the late 20th century in some less-developed countries was characterized by the expansion of import-competing industries protected by high tariff walls. In many of those countries, tariffs and various quantitative restrictions on manufactured goods were high, but the effective rates of protection (protectionism) were often even higher, because the goods tended to be highly fabricated and the proportion of value added in production after importation was low. While countries such as Taiwan, Hong Kong, and South Korea oriented their manufacturing industries mainly toward export trade, they tended to be exceptional cases. More commonly, developing nations have mistakenly sought to compete with foreign-made goods for the domestic market. High protection in these countries has often contributed to a slowdown in production, while the export of primary commodities has discouraged expansion of exports of the more valuable manufactured goods. Although domestic production of nondurable consumer goods fosters rapid economic growth at an early stage, less-developed countries have encountered considerable difficulties in producing more-sophisticated, value-added commodities. They suffer all the disadvantages of small domestic markets, in addition to a lack of incentives for technological improvement.

Bela Balassa Trent J. Bertrand Paul Wonnacott

Arguments for and against interference
      Developing nations in particular often lack the institutional machinery needed for effective imposition of income or corporation taxes (see income tax). The governments of such nations may then finance their activity by resorting to tariffs on imported goods, since such levies are relatively easy to administer. The amount of tax revenue obtainable through tariffs, however, is always limited. If the government tries to increase its tariff income by imposing higher duty rates, this may choke off the flow of imports and so reduce tariff revenue instead of increasing it.

Protection of domestic industry
      Probably the most common argument for tariff imposition is that particular domestic industries need tariff protection for survival. Comparative-advantage theorists will naturally argue that the industry in need of such protection (protectionism) ought not to survive and that the resources so employed ought to be transferred to occupations having greater comparative efficiency. The welfare gain of citizens taken as a whole would more than offset the welfare loss of those groups affected by import competition; that is, total real national income would increase. An opposing argument would be, however, that this welfare gain would be widely diffused, so that the individual beneficiaries might not be conscious of any great improvement. The welfare loss, in contrast, would be narrowly and acutely felt. Although resources can be transferred to other occupations, just as comparative-advantage theory says, the transfer process is sometimes slow and painful for those being transferred. For such reasons, comparative-advantage theorists rarely advocate the immediate removal of all existing tariffs. They argue instead against further tariff increases—since increases, if effective, attract still more resources into the wrong occupation—and they press for gradual reduction of import barriers.

Romney Robinson

The infant-industry argument
      Advocates of protection often argue that new and growing industries, particularly in less-developed countries, need to be shielded from foreign competition. They contend that costs decline with growth and that some industries must reach a minimum size before they are able to compete with well-established industries abroad. Tariffs can protect the domestic market until the industry becomes internationally competitive and, it is often argued, the costs of protection can be recouped after the industry has reached maturity. In short, the infant-industry argument is based principally on the idea that there are economies of large-scale production in many industries and that developing countries have difficulty in establishing such industries.

      Advocates of such protection, however, can have their arguments turned against them. While an individual country can, in some circumstances, gain from protecting its infant industries, this protection is particularly costly for the international community as a whole. Where there are major advantages in large-scale production, there are also large advantages in relatively free international trade. By closing off markets, protection reduces the ability of firms to gain economies of large-scale by exporting. If a group of countries imposes infant-industry protection, it will split up the market; each country may end up with small-scale, localized, inefficient production, thus reducing the prosperity of all of the countries. One way in which less-developed nations have tried to deal with this problem has been through the establishment of customs unions or other regional groupings (see International trade arrangements (international trade)).

      Infant-industry tariffs have been disappointing in other ways; the infant-industry argument is often abused in practice. In many developing countries, industries have failed to attain international competitiveness even after 15 or 20 years of operation and might not survive if protective tariffs were removed. The infant industry is probably better aided by production subsidies (subsidy) than by tariffs. Production subsidies do not raise prices and therefore do not curtail domestic demand, and the cost of the protection is not concealed in higher prices to consumers. Production subsidies, however, have the disadvantage of drawing upon government revenue rather than adding to it, which may be a serious consideration in countries at lower levels of development. (See also economic development.)

Bela Balassa Trent J. Bertrand Paul Wonnacott

      Tariffs or quotas are also sometimes proposed as a way to maintain domestic employment—particularly in times of recession. There is, however, near-unanimity among modern-day economists that proposals to remedy unemployment by means of tariff increases are misguided. Insofar as a higher tariff is effective for this purpose, it simply “exports unemployment”; that is, the rise in domestic employment is matched by a drop in production in some foreign country. That other country, moreover, is likely to impose a retaliatory tariff increase. Finally, the tariff remedy for unemployment is a poor one because it is usually ineffective and because more suitable remedies are available. It has come to be generally recognized that unemployment is far more efficiently dealt with by the implementation of proper fiscal and monetary policies.

National defense
      A common appeal made by an industry seeking tariff or quota protection is that its survival is essential for the national interest: its product would be needed in wartime, when the supply of imports might well be cut off. The verdict of economists on this argument is fairly clear: the national-defense argument is frequently a red herring, an attempt to “wrap oneself in the flag,” and insofar as an industry is essential, the tariff is a dubious means of ensuring its survival. Economists say instead that essential industries ought to be given a direct subsidy to enable them to meet foreign competition, with explicit recognition of the fact that the subsidy is a price paid by the nation in order to maintain the industry for defense purposes.

      Many demands for protection, whatever their surface argument may be, are really appeals to the autarkic feelings that prompted mercantilist reasoning. (Autarky is defined as the state of being self-sufficient at the level of the nation.) A proposal for the restriction of free international trade can be described as autarkic if it appeals to those half-submerged feelings that the citizens of the nation share a common welfare and common interests, whereas foreigners have no regard for such welfare and interests and might even be actively opposed to them. And it is quite true that a country that has become heavily involved in international trade has given hostages to fortune: a part of its industry has become dependent upon export markets for income and for employment. Any cutoff of these foreign markets (brought about by recession abroad, by the imposition of new tariffs by some foreign country, or by numerous other possible changes, such as the outbreak of war) would be acutely serious; and yet it would be a situation largely beyond the power of the domestic government involved to alter. Similarly, another part of domestic industry may rely on an inflow of imported raw materials, such as oil for fuel and power. Any restriction of these imports could have the most serious consequences. The vague threat implicit in such possibilities often results in a yearning for autarky, for national self-sufficiency, for a life free of dependence on the hazards of the outside world.

      There is general agreement that no modern nation, regardless of how rich and varied its resources, could really practice self-sufficiency, and attempts in that direction could produce sharp drops in real income. Nevertheless, protectionist arguments—particularly those made “in the interests of national defense”—often draw heavily on the strength of such autarkic sentiments.

The terms-of-trade (terms of trade) argument
      When a country imposes a tariff, foreign exporters have greater difficulty in selling their products. As their exports decline, they may cut prices in order to keep their sales from falling drastically. Thus, for example, when a tariff of $10.00 is imposed, foreign exporters may cut their price by, say, $6.00. The foreign exporter is being “taxed” when the tariff is imposed; the other $4.00 is reflected in a higher price to the consumer. The use of tariffs to tax foreign exporters in this way is known as the terms-of-trade argument for protection. The terms of trade represent the relative price of what a nation is exporting, compared with the price paid to foreigners for imported goods. When the price of what is being exported rises, or when the price paid to foreigners for imported goods falls (as it may when a nation imposes a tariff), terms of trade improve.

Balance-of-payments (balance of payments) difficulties
      Governments may interfere with the processes of foreign trade for a reason quite different from those thus far discussed: shortage of foreign exchange (see international payment and exchange). Under the international monetary system established after World War II and in effect until the 1970s, most governments tried to maintain fixed exchange rates between their own currencies and those of other countries. Even if not absolutely fixed, the exchange rate was ordinarily allowed to fluctuate only within a narrow range of values.

      If balance-of-payments (balance of payments) difficulties arise and persist, a nation's foreign exchange reserve runs low. In a crisis, the government may be forced to devalue the nation's currency. But before being driven to this, it may try to redress the balance by restricting imports or encouraging exports, in much the old mercantilist fashion.

      The problem of reserve shortages became acute for many countries during the 1960s. Although the total volume of international transactions had risen steadily, there was not a corresponding increase in the supply of international reserves. By 1973 payment imbalances led to an end of the system of fixed, or pegged, exchange rates and to a “floating” of most currencies. (See also gold standard; gold-exchange standard.)

Romney Robinson Paul Wonnacott

Contemporary trade policies
      There are many ways of controlling and promoting international trade today. The methods range from agreements among governments—whether bilateral or multilateral—to more ambitious attempts at economic integration through supranational organizations, such as the European Union (EU).

Trade agreements
      The term trade agreement or commercial agreement can be used to describe any contractual arrangement between states concerning their trade relationships. Trade agreements may be bilateral or multilateral—that is, between two states or between more than two states.

Bilateral trade agreements
      A bilateral trade agreement usually includes a broad range of provisions regulating the conditions of trade between the contracting parties. These include stipulations governing customs duties and other levies (tariff) on imports and exports, commercial and fiscal regulations, transit arrangements for merchandise, customs valuation bases, administrative formalities, quotas, and various legal provisions. Most bilateral trade agreements, either explicitly or implicitly, provide for (1) reciprocity, (2) most-favoured-nation treatment, and (3) “national treatment” of nontariff restrictions on trade.

      In a trade agreement, the parties make reciprocal concessions to put their trade relationships on a basis deemed equitable by each. The principle of reciprocity is extremely old, and in one form or another it is to be found, implicitly at least, in all trade agreements. The concessions may, however, be in different areas. In the Anglo-French Agreement of 1860, for example, France pledged itself to reduce its duties to 20 percent by 1864. In return, Britain (United Kingdom) granted duty-free imports of all French products except wines and spirits. The principle of reciprocity implies only that the gains arising out of foreign trade are distributed fairly.

The most-favoured-nation clause
      The most-favoured-nation (most-favoured-nation treatment) (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 favourable 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 favour 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. A historical illustration of this technique can be found in the German Tariff of 1902, which admitted at a special rate

large dappled mountain cattle, reared at a spot at least 300 metres above sea level, and which have at least one month's grazing each year at a spot at least 800 metres above sea level.

      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, favour 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 favour 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 favour 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 (see Richard Cobden (Cobden, Richard)). 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 (Genoa, Conference of), 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.

The “national treatment” clause
      The “national treatment” clause in trade agreements was designed to ensure that internal fiscal or administrative regulations would not introduce discrimination of a nontariff nature. It forbids discriminatory use of the following: taxes or other internal levies; laws, regulations, and decrees affecting the sale, offer for sale, purchase, transport, distribution, or use of products on the domestic market; valuation of products for purposes of assessment of duty; legislation on prices of imported goods; warehousing and transit regulations; and the organization and operation of state trading corporations.

Multilateral agreements after World War II
      The conclusion of World War II spurred efforts to correct the problems stemming from protectionism, which had increased since 1871, and trade restrictions, which had been imposed between World Wars I and II. The resulting multilateral trade agreements and other forms of international economic cooperation led to the General Agreement on Tariffs and Trade (GATT) and laid the foundation for the World Trade Organization (WTO).

      The General Agreement on Tariffs and Trade was signed in Geneva on October 30, 1947, by 23 countries, which accounted for four-fifths of world trade. On the same day 10 of these countries, including the United States, the United Kingdom, France, Belgium, and The Netherlands, signed a protocol bringing the agreement into force on January 1, 1948.

      GATT took the form of a multilateral trade agreement that set forth the principles under which the signatories, on a basis of “reciprocity and mutual advantage,” would negotiate “a substantial reduction in customs tariffs and other impediments to trade, and the elimination of discriminatory practices in international trade.” As more countries joined, GATT became a charter governing almost all world trade except for that of the communist countries.

      The agreement also contained a variety of clauses providing exceptions to the rules in special situations. These included balance-of-payments disequilibrium; serious and unexpected damage to domestic production; the requirements of economic development or, subject to very broad reservations, of agricultural policy; the need to protect domestic raw material production; and the interests of national security. In addition, GATT rules permitted various departures from the MFN principle. For example, within the former EEC, France could permit duty-free entry of goods from its fellow members—such as Germany and Italy—without extending such duty-free treatment to the products of non-EEC nations.

      Prior to the creation of GATT's successor organization, the WTO, multilateral trade conferences, called rounds, were held periodically by GATT countries to resolve trade problems. Most of these took place in Geneva, former site of GATT headquarters and current site of the WTO. At the time, the formula for multilateral tariff bargaining under GATT represented a major innovation in intergovernmental cooperation. In appraising the concessions that they could afford to make, this approach to GATT negotiations permitted governments to account for the indirect advantages that they could expect from the full set of bilateral negotiations. GATT made positive contributions to the growth of world trade, with three GATT sessions seen as having particular historic importance—the so-called Kennedy, Tokyo, and Uruguay Rounds.

      As the economic integration of western Europe progressed, some Americans became concerned at the prospect of being excluded from these advances in trade policy. President John F. Kennedy (Kennedy, John F.) pursued the goal of an Atlantic partnership and secured special negotiating powers under the Trade Expansion Act of 1962. The act authorized tariff reductions of up to 50 percent, subject to reciprocal concessions from the European partners. This marked a fundamental shift away from the traditional protectionist posture of the United States and led to the Kennedy Round negotiations in GATT, held in Geneva from May 1964 to June 1967.

      The Kennedy Round continued the process of tariff reduction begun two decades earlier by the industrial countries. While developing countries drew little immediate advantage from the Kennedy Round negotiations, they were able to obtain the addition of a new part titled “Trade and Development” to the GATT charter, calling for stabilization, as far as possible, of raw material prices; reduction or abolition of customs duties or other restrictions that differentiate unreasonably between products in their primary state and the same products in finished form; and renunciation by the advanced countries of the principle of reciprocity in their relations with less-developed countries.

Maurice Allais Paul Wonnacott
      The next ministerial meeting of GATT opened in Tokyo on September 12, 1973, and was attended by representatives of ministerial or comparable level from 102 countries. On September 14 the meeting closed with the adoption of what came to be called the Tokyo Declaration.

      The declaration differed markedly from previous GATT documents in the inordinately large portion of its language devoted to strengthening the negotiating position of the less-developed countries. Specifically, the trade negotiations would aim at improving the conditions of access for products of interest to such countries while ensuring stable, equitable, and remunerative prices for primary products. Tropical products would be given special and priority treatment. The principle of nonreciprocity in negotiations between developed and less-developed countries, an established principle in GATT, was reaffirmed: the importance of maintaining and improving the Generalized System of Preferences (a provision for lower tariff rates) granted by developed countries to less-developed countries, as well as the need for special measures and the importance of providing special, differential, and more favourable treatment for less-developed countries, were recognized. Special attention was to be given to the trade interests of the least-developed countries.

      The Tokyo Declaration was followed by several years of multinational trade negotiations that came to be called the Tokyo Round, concluding in 1979 with the adoption of a series of tariff reductions to be implemented generally over an eight-year period beginning in 1980. Further progress was also made in dealing with nontariff issues. Most notably, a Code on Subsidies and Countervailing Duties was negotiated. This code had two main features: it listed a number of unacceptable subsidy practices, and it introduced a requirement that formal procedures be followed before the imposition of countervailing duties on imports subsidized by foreign nations. Specifically, before the imposition of a countervailing duty, an investigation had to establish that competing domestic firms were being injured. The code was not signed by all of the members, however, and the signing nations agreed only to follow the prescribed rules before applying countervailing duties to the exports of other signatories. Thus, while the code represented progress in dealing with a new topic, it also represented a departure from the MFN principle: signatories were not required to extend the benefits of the code to GATT members who did not sign the code.

      A new set of negotiations was initiated at a conference in Uruguay in 1986. Because traditional tariffs were becoming much less important, most of the attention was focused on other impediments to international transactions, such as those affecting trade in services or intellectual property. The Uruguay Round led to the replacement of GATT by the WTO in 1995. Whereas GATT focused almost exclusively on goods (though much of agriculture and textiles were excluded), the WTO encompassed all goods, services, and intellectual property, as well as some investment policies. The combined share of international trade of WTO members came to exceed 90 percent of the global total.

Paul Wonnacott Ed.

The World Trade Organization (World Trade Organization)
      As the successor to the General Agreement on Tariffs and Trade (GATT), the World Trade Organization (WTO) was established to supervise and liberalize world trade.

      During negotiations ending in 1994, the original GATT and all changes to it introduced prior to the Uruguay Round of trade negotiations were renamed GATT 1947. This earlier set of agreements was distinguished from GATT 1994, which comprises the modifications and clarifications negotiated during the Uruguay Round (referred to as “Understandings”) plus a dozen other multilateral agreements on merchandise trade. GATT 1994 became an integral part of the agreement that established the WTO. Other core components include the General Agreement on Trade in Services (GATS), which attempted to supervise and liberalize trade; the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), which sought to improve protection of intellectual property across borders; the Understanding on Rules and Procedures Governing the Settlement of Disputes, which established rules for resolving conflicts between members; the Trade Policy Review Mechanism, which documented national trade policies and assessed their conformity with WTO rules; and four plurilateral agreements, signed by only a subset of the WTO membership, on civil aircraft, government procurement, dairy products, and bovine meat (though the last two were terminated at the end of 1997 with the creation of related WTO committees). These agreements were signed in Marrakech, Morocco, in April 1994, and, following their ratification, the contracting parties to the GATT treaty became charter members of the WTO. By the early 21st century, the WTO had more than 145 members.

      Critics of the WTO, including many opponents of economic globalization, have charged that the organization undermines national sovereignty by promoting the interests of large multinational corporations and that the trade liberalization it encourages leads to environmental damage and declining living standards for low-skilled workers in developing countries. Some WTO members, especially developing countries, resisted attempts to adopt rules that would allow for sanctions against countries that failed to meet strict environmental and labour standards, arguing that the sanctions would amount to veiled protectionism. Despite these criticisms, however, WTO admission remained attractive for nonmembers, as evidenced by the increase in membership after 1995. Most significantly, China entered the WTO in 2001, after years of accession negotiations, and many other countries were slated to join through accession in succeeding years.

The Organisation for Economic Co-operation and Development
      On April 16, 1948, 16 European countries responded to a U.S. offer of economic aid under the European Recovery Program by setting up the Organisation for European Economic Co-operation (European Economic Co-operation, Organisation for) (OEEC). Although the immediate aim was to coordinate the distribution of U.S. credits, the OEEC convention was also designed to foster free trade between the members and allow their participation in customs unions or similar institutions. The members by 1955 consisted of Britain, France, West Germany, Italy, Spain, the Benelux countries, Austria, Denmark, Sweden, Norway, Switzerland, Portugal, Greece, Ireland, Turkey, and Iceland.

      The Organisation for European Economic Co-operation did much to facilitate the recovery of intra-European trade and particularly to abolish most of the quantitative restrictions on imports within the area. On September 30, 1961, the OEEC was converted into a new institution, the Organisation for Economic Co-operation and Development (Economic Co-operation and Development, Organisation for) (OECD), and membership was extended to the United States and Canada. Japan joined in 1964, followed by Finland (1969), Australia (1971), New Zealand (1973), and others to total 30 OECD member nations by the beginning of the 21st century.

      The three fundamental aims of the OECD are to promote the economic growth of member countries, to contribute to the economic growth of less-developed countries, and to foster the growth of world trade on a multilateral, nondiscriminatory basis. Having little power to enforce its decisions, the OECD at the start of the 21st century served mostly as a consultative body, influencing trade through its studies of such matters as the impact of social policies, globalization (globalization, cultural), and protectionism.

Economic integration
Forms of integration
      The economic integration of several countries or states may take a variety of forms. The term covers preferential tariffs, free trade associations, customs unions, common markets, economic unions, and full economic integration. The parties to a system of preferential (imperial preference) tariffs levy lower rates of duty on imports from one another than they do on imports from third countries. For example, Great Britain and its Commonwealth countries operated a system of reciprocal tariff preferences after 1919. In free trade associations no duty is levied on imports from other member states, but different rates of duty may be charged by each member on its imports from the rest of the world. A further stage is the customs union, in which free trade among the members is sheltered behind a unified schedule of customs duties charged on imports from the rest of the world. The 19th-century German Zollverein was a customs union. A common market is an extension of the customs union concept, with the additional feature that it provides for the free movement of labour and capital among the members; an example was the Benelux common market until it was converted into an economic union in 1959. The term economic union denotes a common market in which the members agree to harmonize their economic policies generally, as is the case with the European Union. Finally, total economic integration implies the pursuit of a common economic policy by the political units involved; examples are the states of the United States or the cantons of the Swiss Confederation.

      Economic integration may be brought about by the political will of a state powerful enough to impose it, as under the Roman Empire or the European colonial systems of the 19th century, or it may result from freely negotiated agreement between sovereign states, as was more common in the 20th century.

      The attempts at economic integration made after World War II can be appraised only by reviewing them against the background of the long process through which, over the centuries, the nations of the world have progressively achieved economic integration. Thus, for instance, the world's greatest power in the 17th century, France, was divided into a number of provinces separated from one another by various customs barriers involving a multitude of duties, tolls, and prohibitions. Trade regulations and fiscal charges differed from one region to the next; there was not even a single system of weights and measures. Not until after the Revolution did the economic integration of France really get under way.

Intranational integration

      The economic integration of the United States was not achieved all at once, but as the result of a long process during which the powers of the federal authorities were constantly reinforced. The Constitution (Constitution of the United States of America) empowered the federal government to regulate the conditions of trade with other countries and to set up a single system of duties. It also abolished the right of individual states to maintain separate customs legislation and to issue their own currencies. It authorized the federal government alone to issue currency and established the principle of free movement of persons, merchandise, and capital between the federated states. But the conflict of interest between North and South was settled only by the American Civil War, and although the economies of the states can be considered as integrated for practical purposes, there remain many economic and fiscal disparities among them.

      The difficulties faced by the 13 original states should not be underestimated. During the years prior to the adoption of the Constitution there were bitter trade disputes among the states, which imposed tariffs against each other and refused to accept each other's currencies. Everything seemed to justify the words of a contemporary liberal philosopher, Josiah Tucker, Dean of Gloucester (England):

As to the future grandeur of America, and its being a rising empire under one head, whether republican or monarchical, it is one of the idlest and most visionary notions that ever was conceived even by writers of romance. The mutual antipathies and clashing interests of the Americans, their differences of governments, habitudes, and manners, indicate that they will have no centre of union and no common interest. They never can be united into one compact empire under any species of government whatever; a disunited people till the end of time, suspicious and distrustful of each other, they will be divided and sub-divided into little commonwealths or principalities, according to natural boundaries, by great bays of the sea, and by vast rivers, lakes, and ridges of mountains.

      The Swiss example is no less instructive. Although the Helvetic Confederation emerged as a political entity in the 14th century, its economic integration was achieved, only after many vicissitudes, with the constitution of 1848. The terms of this document established a common currency, set forth the principle of a common protective system for the cantons, and provided for free movement of goods and Swiss citizens throughout the national territory. Swiss economic integration is all the more remarkable in that it comprises peoples who speak four different languages.

Integration of colonial empires
      When the colonial powers (colonialism, Western) of Europe founded their empires from the 16th century onward, they attempted to monopolize trade with the colonies and to turn it to their own profit. This policy involved four main restrictions: (1) The colonies were to trade exclusively with the mother country. (2) They were not to undertake manufacturing; transformation of raw materials into finished goods remained a monopoly right of the mother country. (3) Imports and exports of the colonies were to be carried only in ships flying the mother country's flag. (4) The mother country exempted colonial products from duty, or imposed lower rates.

      This system, although progressively attenuated, applied in various forms from the 16th to the 19th century. Based on force, it was to the benefit of the home countries and detrimental to the economic growth of their colonies. (See colonialism (colonialism, Western).)

      The best-known example of the early customs unions is the German Zollverein (literally, “customs union”). Even though Napoleon had reduced the number of German (Germany) states from 300 to 40 at the beginning of the 19th century, those that remained were isolated from each other by their own customs systems. In addition, numerous internal customs barriers hampered trade within each state. At the same time there was no single external tariff, and the German industries that had sprung up during the Napoleonic Wars were being crushed by English competition. These difficulties were at the root of the creation of the Zollverein.

      The starting point was Prussia's (Prussia) abolition of all internal duties and its adoption of an external tariff in 1818. In the next few years a number of other German states followed the Prussian example. Bavaria and Württemberg set up a customs union in 1828, and by 1830 four separate customs unions were in existence. Prussia then sought to break up the local customs unions and attach them to a general customs union, the Zollverein. The coverage of the Zollverein increased until, by 1871, it included all the German states.

      In its first phase, from 1834 to 1867, the Zollverein was administered by a central authority, the Customs Congress, in which each state had a single vote. A common tariff, the Prussian Tariff of 1818, shielded the member states from foreign competition, but free trade was the rule internally.

      During a second phase, from 1867 to 1871 (following Prussia's victory over Austria at Sadowa), executive power was wielded by a federal council ( Bundesrat) composed of governmental delegates, in which decisions were taken by an absolute majority. Prussia was entitled to 17 of the 58 votes and held the chair of the council. Legislative power lay with a “customs parliament” (Zollparlament) composed of deputies directly elected by popular vote, and, like the council, taking decisions by a majority vote. This arrangement transformed what had been a confederation into a federal state.

      After the victory over France and the proclamation of the German empire in 1871, the customs parliament and the federal council were replaced by the parliament and the executive council of the empire. The federal state had become a nation.

      The progressive destruction of a tangled maze of regulations, prohibitions, and controls set the stage for the subsequent rapid development of the German economy. Although economic integration occurred before political unification, it would not have been possible had not many difficulties been swept away by irresistible pressure from Prussia with its military victories.

      In 1921 Luxembourg, a former member of the Zollverein, signed the Convention of Brussels with Belgium, creating the Belgium–Luxembourg Economic Union. Belgium and Luxembourg thereby had the same customs tariff and a single balance of payments since 1921.

      The union was expanded after World War II to include The Netherlands (Netherlands, The). At the beginning of 1948 most import duties within the Benelux area were abolished, and a common external tariff was put into operation. Exceptions were made, nevertheless, for a few agricultural products, and it was also felt necessary to introduce a system of quotas.

      It was rapidly perceived that a simple customs union was inadequate, and a treaty on October 15, 1949, set as its target the progressive and complete liberalization of trade between the partners, systematic coordination of their international commercial and monetary policies, and the adoption of a joint bargaining position in negotiations with other countries. Though the experiment was optimistically viewed everywhere as the precursor of a wider European economic integration, it faced difficulties arising from the very different postwar situations of Belgium and The Netherlands. The two economies were competitive rather than complementary. Other problems arose in connection with the free access of Dutch agricultural products to the Belgian market. Moreover, the Belgian economic system was more liberal than the Dutch, where rigorous price control had long been a standard practice.

      The development of Benelux received strong impetus from the formation of the European Economic Community in the 1950s. When the Treaty of Rome in 1957 created the EEC, or Common Market, it spurred the members of Benelux to confirm and strengthen their own integration in the Benelux Treaty of Economic Union signed at The Hague on February 3, 1958. The Hague treaty, however, contained little that was new, and in outline form it was no more than the codification of results already achieved.

      The Benelux Economic Union made all of its decisions unanimously, and all members of the union became founding members of the EU.

      An important step in European integration was taken in May 1950 when the French foreign minister, Robert Schuman (Schuman, Robert), proposed that a common market for coal and steel be set up by countries willing to delegate powers over these sectors of their economies to an independent authority. The motive behind the plan was the belief that a new economic and political framework was needed if European unity was to be achieved and if the threat of a future Franco-German conflict was to be avoided. In April 1951 France, West Germany, Italy, and the three Benelux countries signed a treaty in Paris setting up the European Coal and Steel Community (ECSC).

      The signatories bound themselves to abolish all customs barriers and other restrictions on the movement of coal and steel between their countries; to renounce all discriminatory practices among producers, purchasers, or users (with respect to price and delivery conditions, transport charges, selection of suppliers, etc.); to end government subsidies or grants-in-aid; and to eliminate all practices interfering with the operation of markets.

The constitution of the community
      When first promulgated, the constitution of the Coal and Steel Community allowed that it be governed by a High Authority, assisted by a Consultative Committee, a Common Assembly, a Special Council of Ministers, and a Court of Justice.

      There was, however, a basic incompatibility between the community's provenance, limited to the coal and steel industries, and the sovereignty of the member countries, each of which was responsible for its own general economic policy. As a practical matter, during the first 17 years of the community's existence, authority on all substantive issues remained vested in the national governments. The High Authority was autonomous only in matters of secondary importance. Thus, the coal crisis (coal mining) of 1958—when West German, Belgian, and French stocks of unsold coal rose to unmanageable proportions—was resolved at the national level. All the High Authority could do was to confirm the measures taken, even when they were contrary to the provision of the treaty. Similarly, the reduction of the labour force in coal mining from 650,000 persons at the end of 1957 to 300,000 10 years later was effected by individual countries; there was no community-wide action.

      The treaty reserved for member countries responsibility for their own trade policies toward third countries. This hindered the establishment of an effective common market since a common market requires a unified system of protection from foreign competition. At the height of the coal crisis, for example, when stocks of coal rose in Belgium, West Germany, and France, Italy nonetheless continued to buy cheap supplies from the United States.

Later developments
      Despite such difficulties much was accomplished by the community. The markets for steel and coal were liberalized to a considerable degree; the community served as a useful forum in which questions of common interest could be examined; and it fostered the growth of an international spirit, which did much to facilitate the negotiation of the Treaty of Rome and the creation of the EEC and the European Atomic Energy Community (Euratom). These advances contributed to the formation of the EU.

The European Economic Community (European Community)
      The European Coal and Steel Community represented only an initial step in the movement for European integration. On March 25, 1957, its six member governments signed the Treaty of Rome (Rome, Treaties of), under which they agreed to establish the European Economic Community, or Common Market, which came into being on January 18, 1958. It expanded with the entry of the United Kingdom, Ireland, and Denmark in 1973, Greece in 1981, Spain and Portugal in 1986, and the former East Germany as part of reunified Germany in 1990. In the process, it represented the most far-reaching attempt at economic integration among sovereign countries. Its founding treaty stands as the model, in whole or part, for all subsequent attempts at economic integration.

      The Treaty of Rome aimed to “establish a common market” and “progressively bring the economic policies of members into alignment” so as to

promote the harmonious growth of economic activity in the Community as a whole, regular and balanced expansion, augmented stability, a more rapidly rising standard of living, and closer relations between the participating states.

      The treaty pledged the signatories to

abolish customs duties and quantitative restrictions on the entry and outflow of merchandise, to abrogate all other measures having an equivalent effect, and to fix a common customs tariff for imports from non-member states.

      They also agreed to “abolish, as between members, all barriers to the free movement of persons, services and capital.”

Formation of a customs union
      The Treaty of Rome had set a timetable for the abolition of customs duties between member states. On balance, this timetable was met and in some areas exceeded so that, by the middle of 1968, tariff barriers had been abolished for agricultural as well as industrial products. By that date also, most quota restrictions had been lifted. The customs posts had not disappeared, however; they were still needed for such tasks as assessing and collecting the compensatory taxes that equalized the differences in taxes between member countries.

      Tariffs on imports from outside the community were gradually brought closer, and on July 1, 1970, a common community tariff was put into effect.

Development of a common agricultural (agricultural economics) policy
      When the Treaty of Rome took effect at the beginning of 1958, agriculture was subsidized in all six member countries. The various price-support mechanisms differed substantially, as did foreign-trade policies and tariff levels. The cumulative impact of governmental intervention of various kinds over the years had led to major differences in agricultural price levels among the member nations. With the average price of wheat in the six countries in 1959 indexed at 100, the relative price levels in individual countries were as follows: Germany, 108; France, 78; Italy, 108; Belgium, 101; Luxembourg, 119; and The Netherlands, 86. The achievement of common policies in agriculture appeared to be so difficult that the treaty limited itself to setting forth a number of general provisions on which agreement seemed feasible. Despite this, a common agricultural policy was achieved: all tariff and quota restrictions on trade in farm products among member countries were abolished; a common set of tariffs on agricultural imports from non-EEC countries was established; and a common system of price supports took the place of the former national systems.

      The price supports required difficult compromises among the member governments because of the differences in their domestic price levels for farm products. The EEC wheat price, for example, was set roughly halfway between the prices of the lowest-cost suppliers in the community, France and The Netherlands, and those of West Germany, which was the highest. France exerted considerable political pressure to persuade West Germany to accept a substantial lowering of the returns to its wheat producers.

      Since its inception, the common agricultural policy experienced several fundamental problems, especially recurrent surpluses and conflicts of interest between large- and small-scale producers. Surpluses originated as a result of the price support system, and while this system helped marginal farmers stay in business, it often encouraged more-productive farmers to overproduce, creating surpluses that had to be purchased with EEC funds. It also caused conflicts of interest between net food exporters that received greater relative support and countries that were net food importers (e.g., the United Kingdom); those that imported more than they exported made large contributions to the common policy but received little return in export subsidies and price supports.

Toward a harmonization of policies
      Another fundamental aim of the Treaty of Rome was to achieve a general harmonization of national economic policies. The treaty envisaged the working out of common rules covering such matters as competition, taxation, and other economic legislation. It also called for the development of common policies in such areas as foreign trade and transportation. Members were asked to concert their economic policies in the fields of fiscal and monetary policy, balance-of-payments policy, and social welfare.

The European Union

The European Community (European Community)
      The EEC remained a leading proponent of economic integration until 1993, when, renamed the European Community (EC), it became the principal component of the European Union (EU), a broader entity seeking economic and political cooperation. The EC was formed by the Maastricht Treaty (formally known as the Treaty on European Union; 1991), which went into force on November 1, 1993. The treaty also provided the foundation for an economic and monetary union, which included the creation of a single currency. The Amsterdam Treaty, which entered into force in 1999, gave the EC jurisdiction over immigration and asylum policies.

EU institutions
      Governance and representation within the EU occur through a number of institutions, many of which were formed as part of the EEC. Chief among these are the EC, which advances the economic interests of the EU; the Council of the European Union, a legislative organization that represents member states; and the European Parliament, which has legislative and supervisory roles. The Parliament is the only EU institution whose members are elected by the votes of individual citizens of EU nations. Other EU institutions are the Court of Justice, the Court of Auditors, the European Central Bank (which oversees monetary policy and introduced the euro), the Economic and Social Committee, the Committee of the Regions, the European Investment Bank, and the European Ombudsman. In addition to the institutions, the agencies of the European Union are charged with overseeing particular interests, such as occupational safety, training, or social and environmental concerns.

New members
      As was true for the EEC, any European state can request membership in the EU. Candidate countries must demonstrate an adherence to the principles of democracy, market economy, and human rights. Acceptance is granted through a unanimous decision by member countries. The EU's founding members were the 12 original countries comprising the EEC. In 1995, they were joined by Austria, Finland, and Sweden. A significant step toward enlargement took place on April 16, 2003, when the 15 EU member nations signed the Treaty of Accession with 10 candidate countries: Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lituania, Malta, Poland, the Slovak Republic, and Slovenia. The enlargement, scheduled for May 2004, was expected to be followed by the addition of yet more new member countries.

      The efforts that led to the creation of the EU were paralleled by another attempt to foster trade in the region. At the same time that the EEC was being organized in the 1950s, Great Britain (United Kingdom) sought to organize a free trade area that would include 17 member countries of the Organization for European Economic Co-operation (European Economic Co-operation, Organisation for). Had it succeeded, this would have given Britain access to the benefits of the industrial common market on the Continent while avoiding possible infringements of British sovereignty. The effort failed, however, mainly because of French opposition. Britain then undertook the formation of a free trade area in association with Austria, Denmark, Norway, Portugal, Sweden, and Switzerland. Together they made up the European Free Trade Association (EFTA).

      The convention setting up EFTA was signed in Stockholm on January 4, 1960. The preamble stated that one of the main purposes of the organization was to “facilitate the future establishment of a wider multilateral association for abolition of customs barriers.” More specifically, EFTA was meant to liberalize trade with the six Common Market countries without subscribing to the commitments of political character embodied in the Treaty of Rome. In the meantime, EFTA gave its seven members a stronger bargaining position vis-à-vis the other six, as well as the means of creating a large market of their own.

Operation of the EFTA
      The EFTA treaty, like that of the EEC, provided for a transitional period, set forth rules governing competition, and called for the abolition of all indirect protection and trade discrimination. The Association chose to be governed by the EFTA Council, composed of one member from each participating state. Over time the council set up a joint consultative committee comprising representatives of industry, business, and labour; a set of six permanent technical committees (on customs, trade, economic development, agriculture, economics, and budget); and working parties dealing with special topics.

      EFTA had one special problem arising from its nature as a free trade area. Since the duties charged on imports from outside countries were likely to differ from one member to another, traders could take advantage of the differences by channeling imports through the country levying the lowest rates and delivering them to customers in another member country. Rules were established to prevent this by classifying merchandise according to whether it was produced or fabricated in one of the member countries. In the case of goods made from imported raw materials, the rules required that the import content not exceed 50 percent of the export price of the finished product.

EFTA's record
      Although a 10-year transitional period was originally envisaged, internal customs barriers on industrial goods were eliminated on January 1, 1967, three years ahead of schedule. Bilateral trade agreements were also negotiated to increase trade in agricultural products.

      EFTA passed through two grave crises in the 1960s. The first was in 1961 when Britain (United Kingdom), acting unilaterally, informed its partners that it had applied for membership in the EEC. The upshot was a joint declaration in which EFTA members committed themselves to “coordinate their action and remain united throughout the negotiations.” The second crisis occurred in October 1964, when, to shore up the pound sterling, Britain suddenly introduced a surcharge of 15 percent on all its industrial imports—an act that was in violation of the treaty.

      Finland became an associate member of EFTA in July 1961, and Iceland was admitted to full membership in March 1970. In 1973 Britain and Denmark left the association when they were accepted as members in the EEC—Britain, after two previous unsuccessful tries. At the beginning of the 21st century, the remaining EFTA member countries were Iceland, Norway, Liechtenstein, and Switzerland. The group continued to advance global trade; for example, in 2003 EFTA signed separate free trade agreements with Singapore and Chile.

      Since the Russian Revolution of 1917, Soviet (Union of Soviet Socialist Republics) policy had clearly been influenced by the desire for self-sufficiency, further reinforced by Soviet suspicions of the capitalist world and by a strong desire for centrally directed planning. In response to the Marshall Plan, a Soviet-sponsored effort to integrate the economies of eastern Europe began as early as January 25, 1949. (It was disbanded on June 28, 1991.) Bulgaria, Hungary, Poland, Romania, Czechoslovakia, and the Soviet Union were the founding members of the resultant organization, Comecon (Council for Mutual Economic Assistance). Albania joined in 1949, and the German Democratic Republic in 1950, though Albania ceased to participate after 1961. In its early years the activities of Comecon were limited mainly to the registration of bilateral trade and credit agreements among the member countries. After Joseph Stalin's death in 1953, it made efforts to promote industrial specialization and to reduce “parallelism” in the economies of its members. In 1956 and 1957, when most of its standing commissions began to operate, attempts were made to harmonize the long-term plans of the members. The establishment of the EEC in 1958, together with pressures from the eastern European countries for a greater degree of independence, induced the Soviet leadership to rethink the organization. A new charter was signed by the members in Sofia, Bulgaria, on December 14, 1959.

      Comecon sought to coordinate the development of technology and industrialization, growth of labour productivity, and industrial specialization in member countries. Its objectives, however, were hindered by certain political and economic constraints. One of the most serious was the absence of flexible and realistic price systems in the member countries. This made it impossible to base trade on relative prices; instead it was conducted mainly on a barter basis through bilateral agreements between governments. In negotiating such agreements, the parties were led to use “world prices”—i.e., prices prevailing in the trade of countries outside Comecon. Another hindrance to economic integration was the highly centralized economic planning in the member countries, which had only limited success in coordinating their plans. There were also serious nationalistic tensions within the council. The Romanian (Romania) government, for example, announced its intention to pursue all-around industrialization, including the development of its heavy industries, in opposition to the policy of specialization in raw materials and agricultural products that was said to have been Comecon's plan for Romania.

      Among the practical achievements of Comecon, however, were the organization of railroad coordination (1956); construction of a high-voltage electricity grid (1962); creation of the International Bank for Economic Cooperation (1963); the pooling of 93,000 railway freight cars (1964); and construction of the “Friendship” oil pipeline from Russia's Volga region to the eastern European countries. Comecon initially was composed of the old Soviet Union's eastern European satellites, but in 1962 the Mongolian People's Republic became a member, followed by Cuba in 1972 and Vietnam in 1978.

      Comecon was often called the eastern European counterpart of western Europe's EEC. Although their general aims were indeed the same, the two organizations differed radically in their approach to the problems involved. While Comecon sought to achieve cooperation among nations with centrally planned economies, the EEC aimed to achieve decentralized integration by means of an economic market in which goods, services, capital, and persons could have full freedom of movement—a market regulated by uniform economic legislation.

      The collapse of communist governments across eastern Europe in 1989–90 was followed by a shift to private enterprise and market-type systems of pricing, all of which undermined Comecon's system of trade and by 1991 left the organization defunct. Under agreements made early in 1991, Comecon was replaced by the Organization for International Economic Cooperation, a group intended to assist with the move from centralized to market economies. Each nation was deemed free to seek its own trade outlets, and the obligation of membership was reduced to a weak pledge to “coordinate” policies on quotas, tariffs, international payments, and relations with other international bodies. Over time, the former Comecon countries moved away from the Soviet-era trade restrictions and developed trade relationships with other nations—particularly those of the EU.

Maurice Allais Ed.

Economic integration in Latin America (Latin America, history of)
      Progress toward economic integration in Europe encouraged the Latin American republics to make similar attempts. By the late 20th century several organizations had been established to work toward such integration; they included the Central American Common Market; the Latin American Free Trade Association; the Andean Community of Nations; and the Caribbean Community and Common Market.

The Central American Common Market
      On June 10, 1958, El Salvador, Guatemala, Honduras, Nicaragua, and Costa Rica signed a multilateral treaty aiming at free trade and economic integration. The Central American Common Market (CACM) provided for the establishment of a free trade area within 10 years. The participating countries also agreed to the industrial integration of the region. These arrangements were completed by the signing on December 13, 1960, of the Treaty of Managua. Its aims were similar to those of the EEC, namely, the establishment of a common market within five years and the organization of integrated industrial development. Most barriers on the region's internal trade were then removed or reduced.

      Economic integration in Central America has been hampered by disagreements and military conflicts in the area. Following a dispute with El Salvador in 1970, Honduras in effect withdrew from common market membership by implementing tariffs on imports from other member countries. In 1980, however, Honduras signed a treaty with El Salvador, settling their dispute and restoring Honduran participation in the common market trade agreements in 1981. During the 1980s, tensions between the revolutionary government of Nicaragua and its neighbours, as well as other disorders, disrupted trade between the nations of Central America. In an effort to promote freer trade in the larger region, the group began working on trade agreements with the Caribbean Community and Common Market (Caricom (international trade), see below) in 1991, and CACM negotiated an agreement with the Dominican Republic in 1998. Throughout this time, CACM also took steps to protect its interests against Mexico's increasing economic dominance in the region, especially after Mexico, Canada, and the United States signed the North American Free Trade Agreement.

The Latin American Free Trade Association and the Latin American Integration Association
      On February 18, 1960, Argentina, Brazil, Chile, Mexico, Paraguay, Peru, and Uruguay signed a treaty setting up the Latin American Free Trade Association (LAFTA), predecessor to the Latin American Integration Association. By 1970 the seven signatories had been joined by Ecuador, Colombia, Venezuela, and Bolivia. The treaty provided for a 12-year transition period during which all obstacles to trade were to be eliminated. It was based on the principle of reciprocity and most-favoured-nation (MFN) treatment. Member states also committed themselves to progressive coordination of their industrialization policies. Special treatment was provided for agriculture and for the relatively least-developed member countries.

      Liberalization of trade between the member countries was carried out initially through negotiation of product-by-product concessions. In 1967, however, the negotiations failed; they were postponed to 1968, when agreement was reached on a system of across-the-board automatic tariff reductions similar to those of the EEC. The eventual aim was that LAFTA be the first step in a process that would lead to a common Latin American market; but during the 1970s it became apparent that the geographic diversity and varying levels of economic development exhibited by the member countries were handicapping the formation of a true common market within the association's existing framework. In the late 1970s negotiations were begun to establish a new framework for economic integration, and in 1980, 20 years after the creation of LAFTA, the Latin American Integration Association (LAIA; Asociación Latino-Americana de Integración) was formed. Unlike its predecessor, LAIA adopted an alternative to the concept of a free trade area in that it opted for the establishment of bilateral preference agreements that would take into account the varying stages of economic development of the member countries. Cuba was admitted to LAIA in 1986 with observer status and became a member in 1999. In order to best negotiate bilateral preference agreements the member nations were divided into three categories. Although some countries were shifted to different categories over time, by the beginning of the 21st century the three tiers were: most-developed countries (Argentina, Brazil, and Mexico); intermediate-developed countries (Chile, Colombia, Peru, Uruguay, and Venezuela); and least-developed countries (Bolivia, Cuba, Ecuador, and Paraguay).

The Andean Group and the Andean Community of Nations (Andean Community)
      In 1966 Bolivia, Chile, Colombia, Ecuador, Peru, and Venezuela—all members of the Latin American Free Trade Association—agreed to form a regional subgroup. The Andean Group began its official existence in June 1969 without Venezuela, which had withdrawn. By 1973 Venezuela had decided to join, but Chile withdrew in 1976. The Andean Group began negotiating free trade agreements with the Mercado Commún del Sur (also known as the Southern Market, or Mercosur; a trade community comprising Argentina, Brazil, Paraguay, and Uruguay) in 1996, and in 1997 the group became known as the Andean Community of Nations (CAN). Among the Andean Community's aims are the acceleration of economic integration between member countries, the coordination of regional industrial development, the regulation of foreign investment in member countries, and the standardization of some agricultural and economic policies.

The Caribbean Community and Common Market
      Established in 1973 by 12 Caribbean countries, the Caribbean Community and Common Market (Caricom) is the successor to the Caribbean Free Trade Association (Carifta), which was founded in 1968 by five former British colonies (Antigua, Barbados, Guyana, Jamaica, and Trinidad and Tobago), all of which joined the new organization. The organization attempts to encourage economic integration in the Caribbean (West Indies) region and achieved partial agreement to a common external tariff and protective policy for the community in 1978.

      Caribbean economic integration had been curtailed between 1976 and 1978, partly because of import restrictions imposed by Jamaica and Guyana, and partly because of dissatisfaction among the less-developed countries, which claimed that they were not receiving their fair share of trading revenues. By 1980 Jamaica and Guyana had removed their import restrictions, and the Caricom Council had endorsed several measures to improve the status of the less-developed countries within Caricom. These countries, however, remained dissatisfied, and in 1981 the seven former members of the West Indies Associated States (Antigua and Barbuda, Dominica, Grenada, Montserrat, Saint Kitts-Nevis, Saint Lucia, and Saint Vincent and the Grenadines) formed a subregional economic integration organization, the Organization of Eastern Caribbean States, though they retained their Caricom membership.

      In succeeding years Caricom added new member countries, with the Bahamas joining in 1983 and Suriname joining in 1995. Joining as associate members were the Turks and Caicos and the British Virgin Islands (1991), Anguilla (1998), and the Cayman Islands (2002). Haiti was asked to join Caricom as a provisional member in 1997, with full membership to be based on conditions such as trade liberalization.

Ed.

The Association of South East Asia and the Association of Southeast Asian Nations
      The Association of Southeast Asian Nations (ASEAN) (ASEAN) originated in 1961 as the Association of South East Asia (ASA), which had been founded by the Philippines, Thailand, and the Federation of Malaya (now part of Malaysia). In 1967 ASEAN was established by the governments of Indonesia, Malaysia, the Philippines, Singapore, and Thailand to accelerate economic growth and social development in Southeast Asia. The end of hostilities in Vietnam brought dynamic economic growth to the region in the 1970s, and resulting strengths within the organization enabled ASEAN to adopt a unified response to Vietnam's invasion of Cambodia in 1979. Brunei joined the association in 1984, followed by Vietnam in 1995, Laos and Myanmar in 1997, and Cambodia in 1999. ASEAN's chief projects have centred on economic cooperation and the promotion of trade, both among ASEAN countries and between ASEAN members and the rest of the world. The end of the Cold War between the United States and the Soviet Union at the end of the 1980s allowed ASEAN countries to exercise greater political independence in the region, and in the 1990s ASEAN emerged as a leading voice for regional trade and security issues. In 1992 members reduced intraregional tariffs and eased restrictions on foreign investment by creating the ASEAN Free Trade Area.

The North American Free Trade Agreement
      In 1992, the North American Free Trade Agreement (NAFTA) was signed by Canada, Mexico, and the United States. It took effect in 1994 and created one of the largest free trade areas in the world.

      Inspired by the EC's success in reducing trade barriers between its members, NAFTA created the world's largest free trade area. It basically extended to Mexico the provisions of a 1988 Canada-U.S. free trade agreement that called for elimination of all trade barriers over a 15-year period and incorporated agreements on labour and the environment. Other provisions were designed to give U.S. and Canadian companies greater access to Mexican markets in banking, insurance, advertising, telecommunications, and trucking.

Regional arrangements and WTO rules
      When countries join regional trading groups, they provide preferences to one another. In the EC, for example, German producers can export duty-free to France, whereas U.S. or Japanese exporters still have to pay duties on products shipped to France. In this way German producers become preferred over U.S. or Japanese suppliers, because a customs union represents a departure from MFN treatment. Nevertheless, countries entering a customs union or free trade association are not in violation of their commitments under the World Trade Organization; just as they were permitted under GATT (General Agreement on Tariffs and Trade), customs unions and free trade associations are still permitted through the WTO (World Trade Organization).

      The development of GATT trading rules offers insight into consequences of regional agreements. GATT article XXIV allowed countries to grant special treatment to one another by establishing a customs union or free trade association, provided that (1) duties and other trade restrictions would be “eliminated on substantially all the trade” among the participants, (2) the elimination of internal barriers occurred “within a reasonable length of time” (commonly within 10 years), and (3) duties and other barriers to imports from nonmember countries would “not on the whole be higher or more restrictive” than those preceding the establishment of the customs union or free trade association. The third condition was explicitly aimed at protecting the rights of outside countries.

      The first condition disapproved partial preferential arrangements covering only some products, while accepting broad arrangements covering (substantially) all products. It was supported on the ground that large, unrestricted markets—most notably, that of the United States—provide substantial benefits. Such benefits should also be available to others. For example, when the GATT articles were being drafted, consideration was being given to an integration of the nations of western Europe.

      Shortly after article XXIV was written, it received substantial support in the classic study by Jacob Viner (Viner, Jacob), The Customs Union Issue (1950). Viner, a Canadian-born U.S. economist, saw efficiency as the main gain from international trade, since trade encourages production in a less costly location (see comparative advantage). He contended that a customs union works to increase efficiency in one way but decreases it in another. To explain, Viner drew a distinction between two forces at work when a customs union is established. As two (or more) countries cut tariffs on each other's products, new trade is created. Some goods that were previously bought from domestic producers are now bought from lower-cost producers in the trading partner nation, whose goods now come in duty-free, which improves efficiency.

      When, however, a country removes tariffs on its partner's goods but not on the goods of outside countries, the partner has preferred access. As a result, some purchases are switched—goods are bought from the partner nation rather than from the world at large. Such trade diversion reduces efficiency; purchases are switched from the efficient outside country to the less-efficient partner nation. A customs union (or free trade area) may be predominantly trade-creating, which is desirable, or it may be predominantly trade-diverting, which is undesirable.

      Viner's book thus introduced a skeptical note into the discussion of customs unions, which had previously been given broad approval. Viner's work also supported the distinctions made in article XXIV of GATT. Clearly, if barriers on imports from nonmember countries are kept down, then trade diversion is less likely. Furthermore, the provision to disapprove partial preferential arrangements covering only some products, while accepting broad arrangements covering virtually all products, found support within Viner's framework. Because of the political dynamics of trade negotiations, partial preferential arrangements generally cause more trade diversion than trade creation.

      This can be illustrated in a hypothetical situation in which countries (say, France and Germany) are permitted to get together to make whatever preferential agreements they wish. A natural way for France to open negotiations would be to say to Germany: “We'll cut tariffs on your automobiles and buy from you rather than Japan, if you will cut tariffs on our sugar and buy from us rather than from the Caribbean nations.” In other words, negotiators tend to pick and choose those items previously imported from outside countries; they tend to cut tariffs where trade diversion is greatest. By requiring a comprehensive approach, article XXIV ensured that trade-creating tariff cuts would be made, too.

Paul Wonnacott

Patterns of trade

Degrees of national participation
      Nations vary considerably in the extent of their foreign trade. As a very rough generalization, it may be said that the larger a country is in physical size and population, the less is its involvement in foreign trade, mainly because of the greater diversity of raw materials available within its borders and the greater size of its internal market. Thus, the participation of the United States has been relatively low, as measured by percentage of gross domestic product (GDP), and that of the former Soviet Union has been even lower. The U.S. GDP, however, is so immense by world standards that the United States still ranks as one of the world's most important trading countries. Some of the smaller countries of western Europe (such as The Netherlands) have export and import totals that approximate half of their GDPs.

Trade among developed countries
      The greatest volume of trade occurs between the developed, capital-rich countries, especially between industrial leaders such as Australia, Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, Spain, Sweden, the United Kingdom, and the United States. Generally, as a country matures economically, its participation in foreign trade grows more rapidly than its GDP.

      The EU (European Union) affords an impressive example of the gains to be derived from freer trade between such countries. A major part of the increases in real income in EU countries is almost certainly attributable to the removal of trade barriers. The EU's formation cannot, however, be interpreted as reflecting an unqualified dedication to the free-trade principle, since EU countries maintain tariffs against goods from outside the Union.

Trade between developed and developing countries
      Difficult problems frequently arise out of trade between developed and developing countries. Most less-developed countries have agriculture-based economies, and many are tropical, causing them to rely heavily upon the proceeds from export of one or two crops, such as coffee, cacao, or sugar. Markets for such goods are highly competitive (in the sense in which economists use the term competitive)—that is, prices are extremely sensitive to every change in demand or in supply. Conversely, the prices of manufactured goods, the typical exports of developed countries, are commonly much more stable. Hence, as the price of its export commodity fluctuates, the tropical country experiences large fluctuations in its “terms of trade,” the ratio of export prices to import prices, often with painful effects on the domestic economy. With respect to almost all important primary commodities, efforts have been made at price stabilization and output control. These efforts have met with varied success.

      Trade between developed and less-developed countries has been the subject of great controversy. Critics cite exploitation of foreign labour and of the environment and the abandonment of native labour needs as multinational corporations (multinational corporation) from developed countries transport business to countries with cheaper labour pools and relatively little economic or political clout. Especially after 1999, when trade talks were disrupted by globalization protesters during the WTO (World Trade Organization) ministerial conference in Seattle, Washington, the work of the WTO came under increasing scrutiny from its critics. These critics voiced a number of concerns about the power and scope of the WTO, with the gravest criticisms clustering around issues such as environmental impact, health and safety, the rights of domestic workers, the democratic nature of the WTO, national sovereignty, and the long-term wisdom of endorsing commercialism and free trade to the neglect of other values.

Romney Robinson Ed.

Additional Reading

General texts
The classic works in the field of international trade are Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 2 vol. (1776), available also in many later editions, both complete and in selections; David Ricardo, On the Principles of Political Economy and Taxation (1817), available also in modern editions; John Stuart Mill, Principles of Political Economy, 2 vol. (1848, reissued in 1 vol., 1909; reprinted 1987); Gottfried von Haberler, The Theory of International Trade with Its Applications to Commercial Policy (1936, reprinted 1968; originally published in German, 1933); and Jacob Viner, Studies in the Theory of International Trade (1937, reprinted 1975). Useful textbooks include Richard E. Caves and Ronald W. Jones, World Trade and Payments: An Introduction, 4th ed. (1985); Wilfred J. Ethier, Modern International Economics (1983); Peter B. Kenen, The International Economy (1985); and Peter H. Lindert, International Economics, 8th ed. (1986). Surveys of recent international financial developments may be found in the annual compiled by the International Monetary Fund, World Economic Outlook. For surveys of recent advanced work in international economics, see Ronald W. Jones and Peter B. Kenen (eds.), Handbook of International Economics, vol. 1 (1984); and David Greenaway (ed.), Current Issues in International Trade: Theory and Policy (1985).

Theories of international trade
The Heckscher-Ohlin theory has been the most scrutinized explanation of trade patterns. The classic work is Bertil Ohlin, Interregional and International Trade, rev. ed. (1967). Other surveys are Nicholas Owen, Economies of Scale, Competitiveness, and Trade Patterns Within the European Community (1983); and Edward E. Leamer, Sources of International Comparative Advantage: Theory and Evidence (1984). Elementary treatments of the theory and practice of tariffs may be found in standard texts, such as those listed above. Institutional and historical studies of tariffs include Asher Isaacs, International Trade, Tariff, and Commercial Policies (1948); and F.W. Taussig, The Tariff History of the United States, 8th ed. (1931, reprinted 1967). An analysis of the economic and political issues in trade policy may be found in Bela Balassa, Trade Liberalization Among Industrial Countries: Objectives and Alternatives (1967); Robert E. Baldwin and Anne O. Krueger (eds.), The Structure and Evolution of Recent U.S. Trade Policy (1984); Jagdish N. Bhagwati (ed.), Import Competition and Response (1982); William R. Cline et al., Trade Negotiations in the Tokyo Round: A Quantitative Assessment (1978); William R. Cline (ed.), Trade Policy in the 1980s (1983); I.M. Destler, American Trade Politics: System Under Stress (1986); Gary Clyde Hufbauer and Howard F. Rosen, Trade Policy for Troubled Industries (1986); and Robert Z. Lawrence and Robert E. Litan, Saving Free Trade: A Pragmatic Approach (1986). Accounts of the General Agreement on Tariffs and Trade (GATT) may be found in Gerard Curzon, Multilateral Commercial Diplomacy (1965); Gardner Patterson, Discrimination in International Trade: The Policy Issues, 1945–1965 (1966); and Gilbert R. Winham, International Trade and the Tokyo Round Negotiations (1986). The effects of trade policies on the developing countries are studied in Harry G. Johnson, Economic Policies Toward Less Developed Countries (1967).

International trade arrangements
General analyses include F.W. Taussig, Free Trade, the Tariff, and Reciprocity (1920); League of Nations, Commercial Policy in the Interwar Period: International Proposals and National Policies (1942); Jacques Lacour-Gayet, Histoire du commerce, 6 vol. (1950–55); and Robert Schnerb, Libre-échange et protectionnisme, 4th rev. ed., edited by Madeleine Schnerb (1977). Economic integration is treated in Maurice Allais, L'Europe unie: route de la prospérité (1960); Bela Balassa, The Theory of Economic Integration (1961, reprinted 1982); Bela Balassa et al. (eds.), European Economic Integration (1975); European Free Trade Association, The Effects of EFTA on the Economies of Member States (1969); Joseph Grunwald, Miguel S. Wionczek, and Martin Carnoy, Latin American Economic Integration and U.S. Policy (1972); Michael Hodges and William Wallace (eds.), Economic Divergence in the European Community (1981); James E. Meade, The Theory of Customs Unions (1955, reprinted 1980); Scott R. Pearson and William D. Ingram, “Economies of Scale, Domestic Divergences, and Potential Gains from Economic Integration in Ghana and the Ivory Coast,” The Journal of Political Economy, 88:994–1009 (October 1980); Dennis Swann, The Economics of the Common Market, 5th ed. (1984); Jacob Viner, The Customs Union Issue (1950, reprinted 1983); William Wallace (ed.), Britain in Europe (1980); Paul Wonnacott, The United States and Canada: The Quest for Free Trade (1987); and Bruce Parrott (ed.), Trade, Technology, and Soviet-American Relations (1985).Paul Wonnacott

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