Week Nine Class Notes

International institutions

Bretton Woods Background

Trade is a good thing yet governments (short-sightedly, it would seem) have historically constrained trade. The current international institutional environment reflects the ongoing efforts to overcome these barriers to trade. (Historically, note that reductions in tariffs are not new - this also happened in the 1850's but the policy and economic shifts made the constraints wobble back and forth).

The modern system began with the Bretton Woods meetings in 1944. Representatives from 44 countries met to develop agreement on how to manage international economies after WWII, bearing in mind some of the problems that had led to the war such as trade wars.  As an example, consider the effect of the Smoot-Hawley Tariff which raised tariffs to an average of 55%. This act ended up driving similar responses elsewhere (because employment in nations that exported to the US was harmed) which effectively strangled international trade, making the Depression worse. One purpose of Bretton Woods was to coordinate tariffs.

The Bretton Woods conference established several mechanisms to manage trade and investment around the world. Recall that the intellectual leader of this program was JM Keynes who argued that intervention by governments or institutions (i.e., through both fiscal and monetary policy) could smooth economic flows. Two major institutions that came out of the conference were the World Bank and International Monetary Fund. Participants wanted to develop the International Trade Organization but this was defeated (mostly because there was yet too much dependence on state planning and control). Ultimately, a General Agreement on Trade and Tariffs (GATT) emerged as the global coordination scheme.

The World Bank was intended to provide the institutional structure for investment in war devastated countries. Since this was subsumed by the Marshall Plan, the strategy shifted to investment in developing countries around the world. The World Bank is owned by the governments of about 180 nations.

The IMF designed to stabilize the exchange rate process and to help with short term liquidity problems. Historically, then,  the IMF sought to establish sound monetary practices among member nations through promoting exchange stability, maintaining orderly exchange arrangements and helping members avoid serious exchange depreciations.

The ITO was designed to be the "third leg" of the Bretton Woods stool but this ran into resistance from American trade protectionists and from so called "perfectionists" who argued the ITO did not go far enough in liberalizing trade. Still, 23 of the 44 Woods participants decided in 1946 to negotiate to reduce and bind customs tariffs. This first round of negotiations resulted in 45,000 tariff concessions affecting $10 billion of trade, about one fifth of the world's total. This beginning became GATT. With the goals of regulating and reducing tariffs among member states and providing a forum for dispute resolution, GATT grew to more than 120 members. The general work of trade liberalization happened in negotiating "rounds" such as the Geneva Round or the Kennedy Round and culminated in the Uruguay Round of 1987-1993.

The Uruguay Round was designed to address some of the emerging problems that GATT wasn't prepared to manage such as trade in services or how to manage intellectual property. Among other outcomes, the Uruguay agreement called for reduced agricultural subsidies (which, as we have seen, proves to be very painful). The agreement also addressed improved protection of IP such as patents, copyrights, and so on with the  objective of developing a broad sense of property rights that is more western (if not Anglo),  deeply reduced tariffs on manufactured goods (less than 4%!), and authorized the transition to the World Trade Organization (WTO) to develop a more inclusive, complete forum for dispute resolution

The WTO now stands as the umbrella organization dealing with trade issues. Key successes early on include:

  • liberalization of global telecommunications infrastructure (led by US 1996 Telecommunications Act) (aka GATS)
  • provision of a real dispute resolution mechanism
  • Agricultural reform - (fundamentally aimed at US, Japan, and EU). Note this is not just an issue of subsidies but also of extremely high tariffs. USDA estimates that eliminating ag supports would result in 24% gain in value of farm exports from poor countries (which accounts for quarter of their exports).
  • Continued reform in market access for manufactured goods. Developed countries have high tariffs on manufactured goods that are typically from poorer countries. Even more important, though, is that most of the burden on poor country exports comes from restrictions placed by other poor countries

Among the persistent (and interesting)  questions still on the table are:
  • The lack of agreement on FDI rules
  • Continuing disputes over intellectual property rights - one side argues for protection of knowledge based industry factors (and this is really important to Western firms) but advocates from developing/poorer countries argue will intensify gap between rich and poor-  a wealth transfer mechanism.
  • Rich vs poor countries and their standards - e.g., environmental and labor law differences. As we discussed in class, developed countries tend to favor stricter or stronger standards but developing countries view these as constraints
  • Agricultural subsidies continue to be a significant problem, even though Brazil successfully sued the U.S. in the WTO court over cotton supports.  

Regional trade agreements

Given the growth of the WTO, why do regional trade groups exist?  One clear reason is the pace of change in global institutions: it takes a long time to get change through GATT/WTO. Smaller groups are more nimble and able to adopt change. The scope of such groups ranges from basic free trade areas to full political union. The following chart shows how each varies according to factors, the inclusion of which lead to a more tightly knit group.

Free trade
Trade Policy
Free moving
Factors of
Currency, tax, fiscal policy
Single political entity
Free TradeX

Customs UnionXX

Common MktXXX

Econ UnionXXXX
Polit UnionXXXXX

Free trade zone:  no internal barriers to trade but each country forms its own external trade policy - e.g., NAFTA, EFTA (European Free Trade Association)
Customs Union:  internal free trade and a common external trade policy. Examples: Andean Pact (Bolivia, Columbia, Ecuador, Peru, Venezuela)
Common Market:  free trade, common external trade policy and freedom of factor flow within the member states. That is, capital and labor can move wherever it is needed within the Common Market. This requires significant bureaucracy to coordinate and manage.
Economic Union (like the EU) is all above  plus holding a common currency, common tax laws, and common fiscal and monetary policy. Obviously, this requires a BIG bureaucracy. The
Political Union: In this, the member states become one entity politically - as the EU appeared to be trying to do. Is there an extant example of such a union?

What are the pro's and con's of trade blocs? The economic case should be clear - free trade presumably benefits all. Specifically, the group creates trade benefits (and overall social benefits) when high cost domestic producers are replaced by lower cost producers from within the economic entity. There is also a political case to be made as trade linkages build dependencies  which make antagonistic action (i.e., war) less likely. Moreover, it consolidates political power (sometimes through economic clout).

Drawbacks/barriers include domestic political dissent (due to job losses) and, potentially, national sovereignty issues. As unions become more complete, governments lose the right or ability to unilaterally manage policy. Another issue arises with trade diversion as low cost suppliers from outside the union are replaced by higher cost but internal producers.

Some of the major regional trade groups include:

  • European Union (from the European Community, the Treaty of Rome, the European Economic Community (EEC), and  Euro Steel and Coal Community). Historically, the progress from ECSC to EC has been difficult: differences in productivity across sectors led to the need for substantial subsidies and supports. The harmonization of standards also proved very tricky. In 1986, the EC agreed in(the Single European Act) to eliminate all internal border control on movement of people, goods, capital (at least a Common Market). This included significant changes such as the elimination of cabotage and the harmonization of product standards. In 1991 , the passage of the Mastricht Treaty  created the EU  and called for a single currency, a single European border policy, and European (rather than national) citizenship.
  • NAFTA (North American Free Trade Agreement) dates from 1992 and includes Canada, US, and Mexico. This treaty eliminated virtually all tariffs between the three countries. Other issues include proposed harmonized environmental standards, removal of restrictions on FDI.
  • MERCOSUR (Mercado Comn del Sur) or MERCOSUL (In Brazil, as it is a Portuguese language country) - includes Brazil, Argentina, Paraguay, Uruguay.  Nominally, the group has had the same objectives as other areas but note that the imposition of high tariffs on goods from outside the alliance is creating an artificial environment that favors less efficient producers within (an example of what problem?). Recent economic reversals (devaluation of the Brazilian real, following the Southeast Asian/South Korean/Russian currency crises and difficulties in Argentina) have made this a less than fully functional group although Hugo Chavez is courting this group quite heavily.
  • EFTA - originally included UK, Denmark, Sweden, Austria, Switzerland ,and Portugal. Finland joined in 1961, Lichtenstein in 1991. Note that this was basically a Nordic sort of alliance. However, Finland, Sweden, UK, Denmark left to join EC - so did Portugal.  Current membership includes Norway, Iceland, Lichtenstein, and Switzerland. The group has some reciprocal agreements with EC. But mostly exists because members are indisposed to join EU.
  • ASEAN (Association of South East Asian Nations) - long list of nations and generally much older than other regional groups.
  • APEC - Asia Pacific Economic Cooperation (includes Australia, US, Japan, and China)


Regional economic alliances, even in an era of WTO global reach, are alive and well. They serve to rapidly coordinate activity, to reduce even further tariffs and other trade barriers on internal production, and provide leverage, legitimacy, and economic clout relative to other groups. On the other hand, they create a welter of conflicting rules and policies. They also deplete political capital (as leaders have to go back to authorizing bodies repeatedly). They are worse for weaker countries and the more of them there are, the harder a global system will be. In short, a global scheme would be preferable but (as the Doha for WTO experience shows) is much more difficult to attain.

Recent Discussions

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The U.S. Bureau of Economic Analysis tracks FDI stocks and flows for American firms with data at this website: http://www.bea.gov/international/di1usdbal.htm.…
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