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Workshop on Subsidiarity
in the Governance of the Global Economy

 

DEFINING SUBSIDIARITY IN THE GLOBAL SYSTEM: ECONOMIC, LEGAL, AND POLITICAL CRITERIA

by Geza Feketekuty

 

Introduction

The growing importance of regional economic and trade agreements has raised the question whether it is possible to identify and codify on an a priori basis the appropriate roles of global versus regional agreements and institutions, and whether it would be possible to apply the concept of subsidiarity in this context. New concepts are needed to help the international community to sort out the relationships between the World Trade Organization and the increasing number of regional trade agreements, which have assumed a growing importance in the management of the world economy. Concepts and principles derived from this work might ultimately facilitate the negotiation of a more meaningful set of provisions than those currently contained in GATT Article XXIII, which have never proved very useful and have become even less so as the focus of trade agreements has shifted from tariffs to barriers to trade and investment embedded in national regulations.

Work on subsidiarity might also provide appropriate insights into the possible future role of the World Trade Organization in such trade related domestic policy issues as investment regulations and laws applying to corporate governance, environmental policies, labor standards, competition laws, laws on bribery and corruption, and government regulations in general. With respect to government regulations, a number of recent developments point to the need for new concepts in framing international disciplines, including the growing prominence of regulatory issues in bilateral trade disputes and the inability of WTO members to complete the negotiations on financial services, telecommunications and maritime services.

This paper will explore the ideas underlying the principle of subsidiarity and the economic, social and political issues associated with regulatory and policy decisions, and enforcement actions, at different levels of governance. In evaluating the political dimension, the paper will explore in particular the important historical role played by the concept of national sovereignty in shaping our ideas, our national laws and institutions, and current international agreements and institutions. The paper will then explore the economic, political and social forces that have given increasing prominence to regional trade and economic integration agreements, and the historical, legal and political factors that have shaped the different regional agreements. Finally, the paper will seek to identify some tentative ideas with respect to the development of a priori norms for evaluating the respective roles of national, regional and global institutions in regulatory and policy decisions affecting trade.


The Principle of Subsidiarity and its Rationale

One of the key principles in seeking to allocate responsibility for regulation is the subsidiarity principle. In general, the principle of subsidiarity holds that any particular form of regulation should be carried out at the lowest level of governance consistent with the achievement of various social goals. In effect, this principle establishes a downward bias in favor of keeping regulation at the lowest level of governance consistent with the achievement of various social goals, including regulatory effectiveness, economic efficiency and political legitimacy.

There are, however, two different ways this term has been applied to regulatory activity. In one application of this term, resting on the principle of national sovereignty, the reference point or lowest level of government considered relevant is the nation state, followed by regional groupings such as the EU or NAFTA, and finally international bodies such as the WTO. In an alternative application of this term, the reference point or lowest level of governance is the individual citizen, followed by the family, the local community, the county, the state, the nation, the regional grouping and finally international organizations. To some extent, whether one chooses to adopt the first or the second interpretation of the word depends on whether one thinks of economic and political power emanating from the sovereign nation state, or the individual economic and political actors in society. The historical origin of the word, which can be traced to a papal encyclical by Pope Leo, favors the second interpretation. The centrality of the nation state in the development of regional groupings and international organizations favors the second interpretation.

This author favors an interpretation based on the individual for both economic and political reasons. Politically, the legitimacy of regulations in a democratic society ultimately rests on the acceptance of such regulations by the majority of individual voters. The higher the involvement and understanding of individual citizens in the formulation of regulations, the higher will be the public acceptance and effectiveness of the regulations involved. At the same time, economic efficiency in a market economy is determined by the actions of individual consumers and producers, acting either as individuals or as enterprises. The better adapted regulations are to the conditions facing individual economic actors, and the preferences of such actors as either consumers or producers, the more such regulations are likely to be economically efficient.

The consequences of choosing one interpretation of subsidiarity over another goes beyond whether one chooses to vest all residual regulatory authority in the nation state. It has major implications for the design of the international institutions given responsibility for coordinating or harmonizing regulations at supranational levels. If one chooses the nation state as the reference point, the nation state can be considered the only relevant actor in those supranational institutions. If one chooses the individual as the reference point, one has to consider the relationship of the individual to those supra national institutions. This has a direct bearing on a number of issues currently being debated in the EU, the WTO and elsewhere. One such issue concerns the degree of public transparency that should be provided to decision-making and dispute settlement processes in the WTO, and the extent to which individual interest groups or corporations should be given direct access to dispute settlement procedures. The author of this paper favors using the individual as the ultimate point of reference in applying the subsidiarity principle since political legitimacy in a democratic society is ultimately decided by voters acting as individuals.

Another basic issue concerning the subsidiarity principle is whether it should be seen as locating full responsibility for all aspects of a regulatory issue at a particular level of governance, or whether it should be seen in terms of the allocation of roles with respect to different aspects of an issue. In the first view, the objective of subsidiarity is to find the level of government that should have the political mandate and decision-making power on an issue. This interpretation of the concepts comes out of the struggles inside the European Union between the national governments and the Commission on whether responsibility on an issue has been delegated from the member states to the Community.

In the second view , the objective is to allocate roles among different levels of government, allocating to each level of government a role that is most appropriate to its scope of responsibility, leaving much of the substantive details to the lowest level of government that can effectively carry out a particular task, while higher levels of government seek to carry out those tasks which only they are in a position to perform The author of this paper very much favors this second view, which will be the view adopted in the remainder of this paper.

 

Trade-Offs in the Application of the Subsidiarity Principle

There are several difficulties, however, associated with establishing the optimal level of governance at which regulatory and policy decisions should be made. There are inevitable trade-offs between different goals, since it is often not possible to advance the achievement of one societal goal without adversely affecting the pursuit of another goal. For example, to protect the global atmosphere may require a global decision regarding the use of certain chemicals, yet a global decision that glosses over regional differences will inevitably force some producers to make sub-optimal production decision from an economic efficiency point of view, thereby adversely affecting the achievement of economic growth goals.

To complicate matters further, it is not always clear what is optimal from a strictly economic efficiency point of view. Differences in regulations, whether at the local national or regional (continental) level introduce economic costs by reducing potential economies of scale and scope, or by forcing producers to pay the added costs associated with meeting different regulations. Put another way, regulatory decisions at a high level of governance make it possible to remove the loss of economic efficiency and growth associated with differences in regulations. On the other hand, decisions at a high level of governance introduce added economic costs by leading to the adoption of regulations that that do not suit different local conditions, and by making it more difficult to change the regulation when changed circumstances call for such a change. Decisions at higher levels of governance are more difficult to change because a larger number of people have to agree to the change, and accommodating the views and interests of a larger number of people is not only more difficult, but also takes more time.

In summary, an economic cost of pushing regulatory decisions to a higher level is increased rigidity in decision making, and an inability to adapt regulations to fit local conditions. The economic benefit of pushing regulatory decisions to a higher level is a reduction in the compliance costs associated with meeting different regulations in different jurisdictions, and an expansion of the potential economies of scale and scope.

There are similar trade offs in the political costs and benefits associated with regulatory and policy decisions made at different levels of governance. On one hand, decisions made a high level of governance have the political cost of creating a greater distance between decision makers and those affected by the decisions, thus reducing the influence and involvement of individual citizens in decisions that affect them. Moreover, decisions regulatory decision made at a level above the nation state create fundamental concerns about democratic control of such decisions. Given the central role of the nation state in political life, and the reluctance of nation states to cede that sovereignty to supra-national groupings, decision-making in supra-national institutions is usually the exclusive province of national governments. Individual citizens usually have difficulty in acquiring full information on how a decision was made, much less be able to directly influence a decision. Most supra-national institutions lack the political mechanisms which would allow individual citizens to influence such decisions directly.

On the other hand, decisions made at high levels of governance have the political benefit of assuring citizens of an equal distribution of the burden associated with the achievement of common goals, the establishment of common ground rules or a level playing field for firms competing across jurisdictional boundaries, and assurance that competition among producers facing different regulatory costs will not force decision-makers to adopt lower social goals.

The question we will need to ask whether techniques exist for eliminating or minimizing some of these trade offs in economic efficiency, or between the achievement of economic efficiency goals and the achievement of other societal goals in areas such as the environment, working conditions, health, safety, and the preservation of the cultural and ethnic heritage of different countries or regions. We will address this question later in this paper.

 

National Sovereignty and Issues Related to Enforcement

Under the concept of national sovereignty, which matured in the 19th century, all political power is assumed to reside in the nation state, and decision making powers residing in sub-national or supra-national governmental units are assumed to be delegated by the nation state. The scope of responsibilities of the nation state were significantly enhanced in the course of 20th century as the nation state became responsible for the growth and prosperity of the national economy, and the economic welfare of its citizens.. National governments became responsible for the macroeconomic and microeconomic performance of the economy, for regulating the production and delivery of many services, and for the provision of many social services such as education, public pensions, unemployment insurance, etc..

 

To What Extent Do Current Trade Rules Embody the Subsidiarity Principle?

While the provisions of the GATT do not explicitly address the subsidiarity principle, the rules concerning regional free trade agreements and the structure of the GATT rules and the various codes are not inconsistent with the subsidiarity principle, and in many ways support the subsidiarity principle.

GATT Article XXIV, which sets out the conditions for regional trade agreements that involve an exception from the MFN provision, requires that essentially all trade among signatories of such agreements have to be free of duties or other restrictive border measures. In the absence of the regional free trade exemption, the MFN provision requires all Contracting Parties of the GATT to treat every other Contracting Party alike. In practice, this GATT rule has the effect of creating a de facto distinction between the GATT/WTO as an instrument for the reciprocal reduction of trade barriers and free trade agreements as instruments for managing relationships among countries that have abolished all barriers to trade with each other. This inevitably has meant that regional trade agreements have tended to establish higher levels of discipline than those contained in the GATT.

The GATT is a contract among sovereign nation states. Nation states which are signatories to the agreement agree to abide by some common rules with respect to the application of trade measures or the design and application of policies that affect trade. Enforcement of the common rules, however, remains in the hands of the individual nation states, who can take trade sanctions against another Contracting Party that is found in violation of its obligations and commitments. In the case of customs unions, this enforcement power is delegated to the customs union.

GATT/WTO disciplines in areas of domestic policy related to trade generally do not establish detailed regulations, but rather set out a set of principles and procedures for the design and application of national measures, with the objective of assuring the nondiscriminatory design and application of policy measures, avoiding unnecessary barriers to trade, and/or avoiding unnecessary injury to enterprises engaged in trade. There are some exception to this approach, e.g. the Agreement on Trade- Related Aspects of Intellectual Property Rights sets minimum terms of protection for patents and copyrights, and nothing in the GATT articles precludes the adoption of substantive provisions. Nevertheless, the regulatory role of the GATT can be said to be fairly well focused on the avoidance of "unnecessary" barriers to trade.

Looking at the GATT/WTO rules through the lens of the subsidiarity principle we could say that the rules (a) require regional free trade agreements to contain a higher level of discipline with respect to the use of border measures among countries, (b) leave enforcement actions to national governments or regional trade institutions, and (c ) tend to focus on principles and procedures designed to assure nondiscrimination, national treatment, and the avoidance of unnecessary barriers to trade or injury to firms engaged in trade.


Economic and Political Factors Behind Regional Trade Agreements

The new prominence of regional trade agreements like NAFTA and EC 92, and APEC are the result of fundamental political and economic forces. On one hand, in many industries production facilities located in neighboring countries have become closely integrated into unified production systems. While the term globalization is usually used to describe the integration of production facilities across national borders, the use of this term is somewhat misleading because such integration is far more pronounced on a regional basis among neighboring countries in Europe, or between Canada and the United States, than the world as a whole. Close integration of production facilities inevitably leads to a demand by regionally-integrated firms for greater coherence, convergence or harmonization in many domestic policies critical to the functioning of integrated production systems.

EC92, for example, was less about the removal of traditional trade barriers and more about the integration of regulatory policies that proved a hindrance to regionally-integrated firms. And while the reduction of trade barriers is not unimportant in NAFTA, the strong support by the business community was the result of provisions dealing with investment, intellectual property, transportation, and mobility of managers and professionals.

A regionally-integrated firm will find it difficult to produce the components and services that go into a product in different countries if each country mandated that such components or services inputs be produced to different standards, or if the technology underlying both the individual inputs and the final product was subject to very different national intellectual property laws. Moreover, large differences in regulations will increase a regionally-integrated firm’s costs, if differences in national regulations would force it to use different data processing or production equipment, to adopt different accounting procedures, or to adopt radically different personnel policies or training techniques in each country. A regionally-integrated firm that has adopted just in time production processes will find it cheaper and more efficient if a single transportation carrier can assure delivery of components from a facility in country a to a facility in country b, than if it has to depend on the uncoordinated services of different nationally regulated transportation carriers.

The more intense and pervasive competition generated by deep regional economic integration also leads to higher expectations among voters regarding the commonality of rules. Acceptance of market outcomes in a national context is usually based on a set of common ground rules spelled out in various economic, social, and environmental regulations. The more deeply the international integration of production affects economic activity in the individual countries, the more affected firms and workers tend to insist that the competition be based on similar economic and social conditions, where and to the extent they have a major impact on the cost of production.

Countries also find it politically easier to negotiate agreements that cede national sovereignty in domestic policy areas with neighboring countries, with whom they have developed close economic ties, and with whom they have more in common in the first place. Where neighboring countries have developed close economic ties, the identifiable economic benefits resulting from those ties establish the political legitimacy for sacrificing a degree of national sovereignty. Moreover, neighboring countries with deep economic integration usually have roughly similar economic and social values, and this usually makes it easier to reach agreement on desired policy outcomes.

Beyond their economic rationale, virtually every regional trade agreement also has a political/security rationale. European unification has been driven by the idea that closer economic and political integration in Europe will prevent a repetition of past conflicts. More recently, the expansion of the European Union to the south and east has been driven by a desire to lock these countries into democratic forms of government, and enlightened "Western" policies in areas such as human rights, freedom of the press, treatment of minorities etc. Similarly, one of the motivations for the U.S. Canadian Free Trade Agreement and NAFTA was to reduce potential security problems along the long borders between Canada, the U.S. and Mexico, and to lock Mexican economic and political reforms into an international agreement that would be more difficult to change. A desire to lock in political and economic reforms is also a major factor in proposals for a Free Trade Area of the Americas. The creation of APEC was motivated in part by a desire to fill a vacuum created by the absence of any security arrangements in the area, and to minimize the risk of big power conflicts in the region.

The relevance of these political/security motives is that the provisions of these regional economic integration agreements cannot be analyzed by economic criteria alone, and must recognize the existence of political/security dimensions. Thus, for example, the European Union has pursued a policy of actively encouraging economic integration across border, a policy that some consider more activist than might have been adopted under the strict application of the subsidiarity principle.

 

Historically Determined Differences in Regional Trade Agreements

Notwithstanding the fact that the EU, NAFTA, and APEC all serve to support and facilitate regional economic integration, they differ markedly in scope, institutional structure. and vision. These differences reflect not only historical differences, but fundamental economic and political differences in the three regions of the world covered by these agreements.. An important economic difference among the three regions, for example, is that the gap between the richest and most developed country in the region and the poorest and least developed country in the region is larger in North America than in Western Europe, and is larger in the Pacific Basin than in North America. Moreover, the institutional, social, legal and philosophical underpinnings of national economic policies are more homogeneous in Europe than in North America, and are more homogeneous in North America than in the Pacific Basin as a whole. A third difference is that the history, the ethnic mosaic, and the political power structure of Europe has provided a much more compelling argument for pursuing political unification than the history, ethnic fault lines and political structure of either North America or the Pacific Basin.

These underlying historical, geopolitical and economic differences between Europe, North America and the Pacific Basin not only help explain, but create a viable rationale for the evolution of fundamentally different institutional arrangements in each of these three regions. Any effort to apply the subsidiarity principle to the relationship between the GATT/WTO and regional trade agreements will therefore need to proceed from a solid understanding and appreciation of the underlying historical, social, and geopolitical factors that determine the differences among regional agreements in different regions of the world.


Principles to Guide Application of the Subsidiarity Principle to Regulations

It was noted above that the operational application of the subsidiarity principle is complicated by a trade-off between the responsiveness of regulations to local conditions or changes in condition over time on one side, and the degree to which differences in regulations create barriers to trade or to the economically efficient globalization of production. It was also noted, however, that it may be possible to adopt certain principles or approaches to the formulation of regulations that could reduce this trade-off, and thereby facilitate the application of the subsidiarity principle to rule-making. A number of such principles are embodies in existing GATT rules. The GATT/WTO standards code, for example, requires countries whenever possible to adopt performance rather than design standards. This principle reduces the potential cost that differences in national regulations might impose on firms producing for the world market. Firms confronted by national measures establishing different levels of performance have the option of standardizing on the basis of the highest level of performance set in any one of the major markets. While an internationally negotiated standard might reduce costs, the added bureaucracy associated with an internationally negotiated standard would cancel some or all of that economic advantage.

It is possible to think of similar principles that might be applied to other types of regulations. For example, one could establish the principle that scarce resources whenever possible should be allocated to users through an auction rather than through a discretionary licensing system. Adoption of this rule would assure even distribution of the scarce resource regardless of the level of government allocating the resource. This would allow such resources to be allocated at a level of government closest to the geographic scope of the resource (e.g. local government for local water supplies, local airport authority for landing slots, intermediate governments for broadcast spectrum, etc.)

A third rule might be that when a government finds it necessary to regulate the use of scarce resources, a critical public facility, or a resource subject to a natural monopoly, it should regulate only the most narrowly defined resource that is considered scarce, a critical public facility or a natural monopoly, not all other activities associated with the use of such resources. Thus, while a power distribution grid may constitute a natural monopoly, it does not mean that the government needs to regulate the production of power. Adoption of this rule would reduce the cost imposed by different local or national regulations aimed at the control of natural monopolies or critical public facilities.

A fourth rule might be that whenever a government feels it necessary to restrict ownership of a resource, it should nevertheless permit the retail distribution of that resource by firms willing to lease or rent such resources.

A fifth rule might be that a government that believes it necessary to impose a regulation designed to meet unique local conditions allow global enterprises to substitute a global standard, which though different, establishes a higher level of performance.

Adoption of these rules or principles for the development and application of regulations could facilitate the application of the subsidiarity principle to regulations from the global level down to the local level, and might therefore be an appropriate subject for global rule-making in the WTO.

 

Applying the Subsidiarity Principle to Trade Agreements

Following the current pattern of rule-making, the GATT/WTO should limit itself to the development of disciplines designed to limit the use of trade measures at the border, or disciplines designed to assure that domestic policy measures do not create unnecessary barriers or distortions to trade, or injury to firms engaged in international trade. The author of this paper has argued elsewhere that the changes brought about by the globalization of production would suggest a shift in focus from distortions of trade to distortions of international competition, and were this to happen, the principal focus of the WTO would be to assure that domestic policy measures do not create unnecessary distortions of international competition.

The second principle for the application of the subsidiarity principle to trade agreements could be that substantive rule making should be left to regional trade institutions, national governments, or specialized international agencies established for achieving international cooperation in a given field. At the same time, the specialized international agencies should be encouraged to review their regulations in order to assure they cover only inherently global activities, and that regulations covering inherently global activities be stripped of all unnecessary details. There are, of course areas of activity, where details are essential for the smooth functioning of the global economy.

Third, improvements in the transparency of WTO procedures and expanded opportunities for participation by stakeholders in regulatory decisions might strengthen the legitimacy of the WTO'’ involvement in regulatory issues. Transparency and opportunities for participation by non-governmental representatives could help assure better public understanding of the WTO’s role by reducing concerns that decisions are being made in an arbitrary fashion by faceless bureaucrats behind closed doors.


Conclusion

The principle of subsidiarity can provide some useful insights into debates in the trade community on the appropriate roles of regional trade organizations and the WTO. To some extent, it can be shown that the principle of subsidiarity is firmly embedded in many of the key principles of the WTO. Reflections on the further application of the subsidiarity principle suggests some additional principles that might be adopted. The subsidiarity principle might also find useful application with respect to current debates over the so-called new trade agenda which focus on a broad range of domestic regulatory issues that are believed to impact on trade. This is a dimension that is addressed in many of the issue-specific papers in this volume.


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