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THE SCOPE, IMPLICATION AND ECONOMIC RATIONALE OF A COMPETITION-ORIENTED APPROACH TO FUTURE MULTILATERAL TRADE NEGOTIATIONS

Geza Feketekuty

 

The report of the OECD Trade Committee to the 1995 meeting of the Council at Ministerial Level expressed the view that the ultimate goal of future multilateral trade negotiations is a "free and open rules based system for carrying out economic activities in the world economy" that would ensure " the openness of national markets to global competition." The Committee indicated that "in particular, the ongoing globalisation of production and markets, strongly influenced by the technological revolution in services, points to the need for a multi-policy approach ...[that] could address coherently the implications for international competition arising from government and private actions in different policy fields." The Report went on to say "it will [thus] be necessary to take an integrated approach to the factors that could adversely affect the openness of national markets to global competition.

This paper examines a number of issues related to the application of a competition-oriented approach to future multilateral trade negotiations. In this context, the paper will examine (a) the overall rationale for a competition-oriented approach, (b) the criteria that might be applied in selecting topics and establishing an orientation for negotiation under such an approach, (c) an examination of how various topics that have been proposed for negotiation would fit the proposed criteria, (d) the likely impact of a competition-oriented approach to the operation of the global trading system, (e) the economic benefits of a competition-oriented approach, and (f) a short note on the applicability of the theory of contestable markets.

 

Rationale for Shifting the Focus from Trade Barriers to International Competition

There are several reasons for shifting the focus of trade liberalization and trade-rule-making efforts from an exclusive focus on the removal of explicit trade barriers to a broader consideration of the impact of various policy instruments on international competition and the operation of the international market.

First, the globalization, customization and increasing automation of production has significantly reduced the traditional distinction between international trade and investment, or more broadly the distinction between trade and factor movements. The futility of making this distinction became quite obvious in the course of negotiating the General Agreement for Trade in Services (GATS) during the Uruguay Round, and the GATS framework as a result provides an integrated framework for tackling all the various policy instruments that can affect the many different ways in which firms located in one country may choose to supply services to another country (e.g. through cross-border trade, through investment and production in third countries or the importing countries, or through the movement of the producers.

As a result of the increased globalization, customization and automation of manufacturing, trade in goods is increasingly taking on the characteristics of trade in services. The technological revolution in computer and telecommunication technology has permitted a wide dispersion of the various production activities associated with manufacturing, and past trade liberalization has made it economically advantageous to disperse the production of parts and services inputs internationally on the basis of comparative advantage. The increasing customization of production has created an economic advantage in some industries for locating production activities linked to customization in close proximity to key markets. The increasing automation of production has steadily increased the proportion of services inputs relative to traditional manufacturing inputs in the manufacturing process, and in some ways the performance of individual manufacturing tasks in a globalized process can viewed as a chain of services inputs. The bottom line is that a negotiating process focusing on bilateral trade barriers misses the real economic options available to firms engaged in production and trade, and therefore no longer serve as a useful basis for focusing policy decisions..

Globalization of production has also made it much more difficult to implement trade rules based on the assumption that trade involves an exchange of goods with a distinct national origin. Obviously, where an increasing proportion of trade involves a flow of goods in various stages of production, containing inputs from a large number of different countries, it becomes increasingly difficult to maintain the notion that such goods have a particular national identity. Under current trade laws and agreements focused on barriers to trade in goods with distinct national identities, policy makers are often pushed into making decisions that are neither in their ultimate commercial interest nor economically rational. This is because the apparent origin of a product, that is the country from which a partially or finished product is being imported, may not be the country where the principal value was added, and the principal value may well have originated in the importing country.

The globalization of production has also reduced the extent to which it can be assumed that the economic interests of nationally owned firms necessarily coincide with the economic interests of the country of origin. National economic decisions in a globalized world require difficult trade offs between the national economic interests that flow from the global market position of nationally owned firms and the economic interests that flow from economic activity carried out locally by firms owned by foreign nationals. Given the globalization of financial markets, even the nationality of some firms is no longer as clear as it was in the past. In this context, it becomes much more important how policies affect the activities of economic actors and the operation of the market per se, both nationally and internationally, than the national identity of either firms or the products.

In this new globalized environment, in which the national identity of both products and firms is difficult to determine, the best rules are likely to be ones that focus on the impact of policies on the operation of global markets, regardless of the "nationality" of either the products or firms involved. Such rules could be designed to meet the economic requirement of improving static and dynamic economic efficiency, and meeting the political requirement of ensuring that national interests are being treated fairly by foreign governments. This can be shown to be the case, for example, with respect to rules requiring nondiscriminatory treatment of domestic and foreign products and firms. In such case, politically motivated efforts by any one government to remove discriminatory treatment by another government also can be shown to contribute to national and global economic gains from an improved operation of the global market.

The globalization process has resulted in a deepening of international specialization, and a deep interpenetration of national economies that has been referred to as deep integration. What this means is that the economic interests of individual nations have become so closely knitted together, that the traditional distinction between a domestic economic policy instrument and a foreign economic instrument (foreign trade or foreign investment measure) has become less meaningful. Any measure that has a significant impact on production decisions by a globalized firm has become a matter of concern for other national governments and the world community as a whole. This is true whether one looks at the issue from a producer (i.e. a traditional mercantilist) or a consumer point of view. From a producer point of view, any measure that affects the operation of foreign owned firms, the availability of essential inputs into production activities carried out in other countries, or market access for goods or services produced with inputs generated abroad becomes potentially a trade issue. From a consumer point of view, one could say that any measure which forces firms producing global products to adopt less economically efficient production methods, or to carry out production activities in less efficient locations, should become a matter of concern for governments representing foreign consumers and the world community as a whole.


Criteria for Identifying the Issues

In thinking through a competition-oriented approach to trade liberalization and trade rule-making, it would be useful to consider the criteria that might be applied in identifying the policies that might be the subject of future multilateral negotiations under such an approach, and in establishing the basic orientation of such negotiations.

Consistent with the principal objective of the global trading system to promote economic efficiency and economic growth, such criteria should seek to establish the policy conditions under which global competition among firms will result in an economically efficient allocation of resources, both in static and dynamic terms. In order to achieve this outcome, all firms would need to face equivalent access to resource inputs and to consumers, and receive equivalent treatment under domestic regulation, regardless of their ownership, or the national origin of the inputs utilized by such firms. Any discrimination among firms creates the possibility that an economically more efficient firm will be disadvantaged viz. a viz. a less efficient firm, with consumers forced to pay higher prices than necessary, or will have to settle for products that less perfectly meet their needs..

Each national governments has to have the right to set and pursue its own politically-determined social objectives in areas such as health, safety, social equity, environment and national security through appropriate policies, laws and regulatory measures. Societal objectives in such areas cannot be achieved through the operation of the market mechanism. At the same time, pursuit of economic efficiency and growth goals would imply a desirability of achieving these societal goals in the economically most efficient manner.

The efficient operation of a market also requires the existence of some basic rules regarding the operation of the market, such as rules concerning permissible forms of competitive behavior, the transparency of laws and regulations and due process with respect to the enforcement and adjudication of such laws and regulations.

The above considerations, would suggest three criteria for identifying policies for negotiation, namely

  • policies, laws or measures that discriminate between firms on the basis of the nationality of the owners, or the national location of production facilities. (except where and to the extent such discrimination is essential for the achievement of legitimate social objectives.)
  • policies, laws, or regulations which unnecessarily impede or distort the operation of market forces, or limit the entry and exit of forms. An unnecessary impediment is one that is not necessary for the achievement of a desired social objective, in the sense that no alternative means for achieving the social objective exist which would less impede or distort the operation of market forces.
  • policies, laws or measures which are essential for the efficient operation of the global market.

 

In addition to the above criteria, one might consider additional criteria to take account of the fact that international negotiations involve costs as well as benefits, and that any international agreement in trade has a political as well as an economic dimension. International negotiations involve costs such as the time of officials directly involved in the negotiations, as well as the time and effort of private sector leaders, politicians and legislators involved in the domestic consensus building process leading up to the negotiations. It obviously would not make sense to pursue negotiations aimed at an improvement in economic efficiency if the negotiating costs exceeded the probable economic gains. This suggests that the application of the criteria outlined above should be conditioned by the following additional criterion

o distortions created by discriminatory measures, or measures that adversely affect the operation of any particular market should be substantial enough to warrant the costs associated with negotiations.

None of the criteria suggested here are inconsistent with the kind of implicit criteria that have been used in evaluating and preparing topics for past multilateral trade negotiations. The traditional approach, which has been to analyze the impact of various tariff and non-tariff barriers on trade, and by extension on economic activity, consumer welfare and jobs, can be seen as a subset of the approach proposed here, which focuses on the impact of various policy measures on international economic activity in the form of both trade and investment flows. It is interesting to note here that Adam Smith in his Wealth of Nations treated his arguments in support of trade as a subset of his broader arguments in support of letting markets work. Obviously, any policy measure that can be shown to have a substantive impact on international trade, will ipso facto also have a major impact on the operation of the international market. The advantage of the more encompassing competition-oriented approach , however, is not only that it expands the scope of analysis beyond trade to cover investment and other factor flows, but also that it shifts the focus from an analysis of the effects of a removal of barriers per se, to an examination of the effects of various policies on the operation of the international market.

 

Evaluating the Policy Measures Potentially Subject to Trade Negotiations

Since the competition-oriented criteria for selecting policy measures for international trade negotiations are roughly consistent with the implicit trade oriented criteria that were applied in selecting policy measures for past trade negotiations, it can be shown that all such measures addressed in previous rounds of multilateral trade negotiations would be appropriate topics for negotiations organized around a competition-oriented focus, to the extent that past negotiations have not removed the trade barriers involved. As a rough approximation we can probably safely say that none of the trade barriers addressed in previous negotiations has been entirely eliminated as an issue at this stage. This means that application of the criteria suggested here would undoubtedly require continuing attention to traditional trade barriers such as tariffs, quotas, government procurement restrictions, standards, subsidies and countervailing duties, dumping and anti-dumping remedies, practices of state enterprises, regulatory barriers to trade in services, and intellectual property laws.

A number of additional topics have been suggested for future negotiations, including environmental measures, measures affecting investment and corporate governance, competition, bribery and corruption, regulatory measures, and labor standards. Theoretically, discriminatory practices in any of these policy areas could potentially meet the competition-oriented criteria for selecting negotiating topics. The purpose of this note is not to go over the empirical evidence currently available regarding the potential impact of discriminatory measures in any of these policy areas on international competition, but rather to explore their applicability on more conceptual grounds..

It is difficult to conceive how it would be possible to maintain public support for the global integration of national markets without some understanding regarding rules for investment and competition. This was the view expressed by Sir Leon Brittan in his speech to the Davos Symposium a few years ago. The integral role of investment and competition policies to the operation of a global trading system was already seen by the drafters of the ITO charter in the immediate post war period. While the inclusion of investment and competition disciplines did not prove politically feasible at that time, and it proved politically feasible to liberalize trade barriers without a parallel understanding on investment and competition rules over the past few decades, the globalization of the market and the establishment of a comprehensive system of international disciplines for traditional trade measures have increasingly changed the economic and political realities. As a result of globalization, as was argued above, investment and competition measures today have a much greater impact on trade than in the past. Second, the strengthening of trade disciplines through past negotiation creates an increasing temptation to substitute investment or competition barriers for trade barriers to satisfy domestic political pressures for protection.

The need to address investment and competition measures that impact on trade in a trade context does not require the harmonization of domestic rule making in these areas. What will be needed is to assure that national policy measures in these aras do not distort or impede international competition. The work program under way in the OECD and elsewhere on trade related investment and competition issues should ultimately provide a basis for deciding which investment or competition policy measures are most likely to impede or distort international competition, and how such distortions and impediments might best elimnated or reduced to acceptable lvels with the least interference in national decision making.

Anecdotal evidence suggests that bribery and corruption has a major impact on trade in infrastructure equipment, which is frequently purchased by governments or government-regulated monopolies. Since government owned or regulated monopolies tend to be insulated from competitive pressures, they are usually in a position to incorporate the cost of bribes in the prices charged to consumers. Bribes can also play an important role in heavily regulated industries, where such regulations give officials discretionary authority over economically attractive activities.

The case for the inclusion of environmental measures or labor standards largely falls outside the competition oriented criteria discussed above. The main concern in these policy areas is that the environmental or labor policies of any one country can have extraterritorial effects on the environment or the labor standards of other countries. Consideration of the possible inclusion of these policy areas in future trade negotiations may well have to be considered on the basis of environmental and labor policy considerations, rather than on the basis of the possible impact of discriminatory measures on the operation of international markets. Empirical work under way on these topics should help clarify this issue.

 

Likely Impact of a Competition-Oriented Focus on the Operation of the Trading System

The criteria suggested above could not only provide a basis for selecting policies that might be included in multilateral trade negotiations, but could also serve to help orient such negotiations and to evaluate possible negotiating outcomes. They could also serve as a useful standard for reviewing and possibly renegotiating existing trade rules.

The key advantage of a competition oriented focus is that it forces negotiators to ask how a proposed discipline will affect international competition and the operation of international markets, not merely to assume that the removal of a barrier or the adoption of an associated rule or remedy will automatically improve economic efficiency and the operation of international markets. While it can be shown that the reduction or elimination of tariffs and quotas in most cases will enhance international competition and improve the functioning of international markets, and ipso facto, improve economic efficiency, this is not necessarily the case with respect to all previously negotiated trade disciplines on domestic policy measures or the associated remedies which can be invoked when these disciplines are breached. A competition oriented approach should thus provide a more explicit focus in trade negotiations, and in the monitoring and enforcement of trade agreements, on the ultimate impact of an agreement or enforcement action on international competition and the functioning of international markets.

Another question which needs to be addressed is whether the criteria articulated above make sense from the point of view of the political requirement of maintaining public support for an open trading system. More specifically, the question is whether the criteria articulated above are likely to lead to a set of rules that would be acceptable to producer as well as consumer interests. The political reality is that it has not proven feasible in the past to base trade liberalization and trade rule-making efforts exclusively on the probable economic gains for consumers. Without support from producers, it would be difficult to establish the necessary political consensus for trade liberalization and the adoption of associated trade disciplines. The success of the basic approach followed in the context of the GATT and the WTO is that it enables national trade negotiators to pursue producer interests in opening markets abroad, and end up with an improvement in consumer welfare. While from a consumer welfare point of view much of the economic gain from trade liberalization can be achieved from the unilateral removal of trade barriers by individual nations, the reciprocal approach to the removal of trade barriers dictated by the politics of trade policy usually ends up with the same result.

The competition-oriented criteria outlined in this paper could quite easily be translated into politically viable rules by focusing on the reciprocal reduction or elimination of discriminatory policies, and the adoption of rules ensuring equal access to markets and equal treatment in the application of national laws and governmental measures, regardless of the nationality of the firm or the product. A focus on the equitable enforcement of such rules from a producer point of view would also bring about improvements in economic efficiency and resulting gains in consumer welfare.

The sharpened focus on the impact of negotiated trade rules on international competition would help mitigate the danger of regulatory capture of trade remedies by producer interests. This is not to say that regulatory capture by producer interests is not always a risk in the politics of trade, and that this risk can be ignored in the design of trade rules. The point is that a negotiating process and a rule-making system oriented towards enhancing international competition is likely to provide a better basis for avoiding regulatory capture by producer interests than a negotiating process and rule-making system focused exclusively on the removal trade barriers per se.

 

Economic Rationale for a Competition-Oriented Approach to Trade Negotiations

The economic rationale for a competition-oriented approach as against the traditional trade barriers approach to trade negotiations is twofold - namely (1) that it covers a wider range of policy instruments that affect international competition and the functioning of international markets, and (2) that it more directly focuses on the impact of trade policy measures and disciplines on international competition and the functioning of global markets. All the economic arguments that have traditionally been made in support of trade liberalization per se would apply to more broadly cast negotiations aimed at removing barriers to international competition and at improving the functioning of international markets, and one could expect that such negotiations would further enhance the achievement of the economic objectives involved.

The first coherent articulation of the economic benefits of market competition and of trade liberalization was by Adam Smith in The Wealth of Nations. Adam Smith clearly saw trade liberalization as a means for obtaining the economic benefits of market competition, and treated his arguments in support of open trade as a subst of his more general argument in support of open market competition. Setting the openness of national markets to global competition as the pri ncipal objective of trade liberalization is thus solidly rooted in the history of economic thought.

The economic gains associated with market liberalization come both in the form of static and dynamic economic gains. Static gains come from the improved allocation of a specific set of resources on the basis of comparative advantage. Any measure which creates an artificial advantage or disadvantage as between products originating in different countries, or as between firms with different national ownership, is likely to result in a less than Pareto optimal allocation of resources. To the extent that a competition oriented negation is likely to remove a wider range of discriminatory measures distorting international competition, or is likely to remove more effectively policy measures that have a discriminatory impact on firms or products that are given different national identities, such an approach will bring about additional static efficiency gains.

Dynamic gains come from the beneficial effects of increased competition on the efficiency of the production process itself, or the improved targeting of consumer demand. Such gains come from the beneficial effect of new competition in introducing established firms to improved production and product technologies, management practices and product designs, and motivating them to adopt enfficiency-enhancing or product-enhancing innovations. A competition-oriented approach is likely to prove particularly advantageous from the point of view of enhancing the dynamic gains from trade, because it puts a new emphasis on investment and competition issues, and the resulting entry and establishment of new firms in national markets.

A competition-oriented approach is also likely to yield economic benefits in as much as it leads governments to adopt more efficient regulatory practices. Much has been learned in recent years about the economics of regulation, including techniques for more efficiently allocating scarce resources, for the use of price incentives in achieving socially desirable production practices, for minimizing the scope of natural monopolies through new techniques for separating monoply from nonmonopoly activities, and for avoiding regulatory capture. A competition-oriented approach is likely to provide a clearer and more direct focus on the ways in which regulations can distort international cmpetition and on how such distortions can be avoided or minimized. By establishing a clear link between past work on the economics of regulation and the operation of markets on one hand and international trade and factor movements on the other hand, a competition-oriented approach can provide new and added insights into the development of appropriate international disciplines in the regulatory area. The economic gains that can come from an international impetus for domestic regulatory reforms could be quite significant, and would be much more difficult to obtain from a purely trade-barrier oriented approach.

Regulatory reforms resulting in increased competition and in reduced discretionary regulatory intervention in individual business decisions, would also reduce the economic cost associated with bribery and corruption. Given the increasing economic importance of infrastructure investments in the years ahead, regulatory reforms that seek to curb the opportunity for bribery and corruption in international transactions could be quite significant. Further economic gains could be obtained from other efforts to directly reduce bribery and corruption through the development of appropriate international agreements to curb such practices.

The economic gains from regulatory reform and from increased global competition could be particularly important with respect to the provision of infrastructure services. The efficient provision of infrastructure services is central to the operation of global firms, and the capture of he potential economic gains from the globalization of production. As noted earlier, the globalization of production and markets pushes international specialization to a new plane by opening the possibility of international specialization in the provision of individual production activities. Any improvement in the efficiency and therefore the cost of infrastructure services, and any improvement in the range of customized services offered by infrastructure service providers, will translate into increased opportunities for international specialization through the globalization of production. What could be particularly useful in this context, is the adoption of regulatory reforms separating the management of monopoly distribution channels in aras such as energy, telecommunications, and transportation from the competitive provision of services through such channels.

An integrated approach to policies affecting international competition would moreover have the economic advantage of providing greater policy coherence. Executives responsible for managing global corporations have argued that the current bifurcated approach to the management of policies affecting access to foreign markets adds a significant burden to the management of the global operations of the firm, adding to their cost and reducing their economic efficiency. As one business leader put it, after you governments have torn apart our business through often incompatible decisions on interlinked policy issues, we are left with the job of putting some coherence back into our business decision, and in effect pulling our business back together again.

 

Competition-Oriented Negotiations and Contestable Market Theory

The appendix of the OECD Trade Committee’s report uses the term "global contestability of national markets" as a synonym for the term "openness of national markets to global competition." Some have objected to the use of this terminology on the grounds that the economic literature on contestability was largely focused on explaining while atomistic competition was not necessary to achieve Pareto-optimal outcomes in industries subject to large economies of scale or economies of scope, such as is the case with respect to many infrastructure services.

The basic argument put forward by proponents of a "contestable market" approach to the regulation of utilities was that as long as an industry was open to the potential entry to new firms, the presence of a large number of firms was not essential for the achievement of a Pareto-optimal outcome. In contrast, the use of a contestable market paradigm in the trade field would serve as a criterion for deciding when government intervention in the form of international disciplines was needed to assure competitive entry of foreign firms into nationally regulated markets. Opponents of the use of this term in a trade context have argued that you cannot use a theory that was used to argue against excessive government intervention These objections are without foundation since the validity of a theory does not hinge on the policy conclusions drawn from its particular application to particular situations. There is nothing intrinsic in the theory of contestable markets that prevents it from being usefully applied to international trade. Nevertheless, the author of this paper has studiously avoided using the term to avoid sidetracking the debate.

As the authors of Contestable Markets and Industry Structure, the principal work on contestability, point out, the ability of potential entrants to discipline a small number of competing firms hinges on whether potential entry is truly possible, rather than theoretically possible. Of course, what makes the application of contestability theory different from the application of contestability theory to domestic markets is the existence of national governments, which are often under political pressure to protect national industries through whatever national policy instrument is readily at hand.


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