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Geza Feketekuty and Robert A. Rogowsky1

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 globalization 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."2 

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 economic benefits of a competition-oriented approach, (c) the criteria that might be applied in selecting topics and establishing an orientation for negotiation under such an approach, (d) an examination of how various topics that have been proposed for negotiation would fit the proposed criteria, (e) the likely impact of a competition-oriented approach to the operation of the global trading system, 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 markets. 

First, the globalization and customization of production has significantly reduced the operational utility of the traditional distinction between international trade and investment, or more broadly the distinction between trade and factor movements. Before globalization, manufacturing enterprises treated trade and foreign investment as alternative strategies for penetrating foreign markets, and in that context it made some sense to treat trade and foreign investment policies as distinct policy instruments, and to negotiate distinct international regimes. This distinction between trade and investment in the business and government policy context was reinforced by economic theory, e.g. the Heckscher-Ohlin theorem which showed that trade and factor movements were substitutes.

In the context of globalization, businesses increasingly treat trade and foreign investment not as alternative strategies for penetrating foreign markets, but as complementary means for carrying out comprehensive global production strategies. Decisions concerning the optimal location of individual production activities, e.g. the production of individual components, parts and services; the assembly of components, and the customization of the final product, thus ultimately determine trade and investment flows in the current environment. A number of factors enter into such decisions, including the relative cost and availability of critical local inputs, access to transportation, the relative importance of proximity to customers, and the impact of national and local laws, regulations and policies. The growing importance of customization in many products dictates that certain development and customization activities be carried out in close proximity to major customers. 

In light of the increasing complementarity of trade and foreign investment in a globalized economy, the traditional policy separation of trade and foreign investment in both domestic policy and international negotiations makes less and less sense. This became quite obvious with respect to trade in services during the recently concluded Uruguay Round. The General Agreement for Trade in Services (GATS), which resulted from these negotiations, provides an integrated framework for addressing cross-border trade, investment and movement of the producers. National schedules of commitments are meant to cover the full gamut of trade barriers, domestic regulatory measures, investment and licensing rules, and visa requirements that can affect the international activities of services firms. This provides a single organizational and legal focal point for addressing 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.

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. 

Cross-border trade is no longer the predominant mode of international transactions. Consider the following facts:
  • U.S. and foreign multinationals have established 200,000 overseas affiliates with global sales totaling $4.8 trillion in 1992. This exceeded global exports of $3 trillion by almost 60 percent.3
  • Sales through U.S.-owned overseas affiliates measured $1.6 trillion in 1993,4 well over twice U.S. cross-border exports valued at $645 billion.5
  • Purchases from foreign-owned, U.S.-based affiliates measured $1.3 trillion in 1993,6 nearly twice U.S. cross-border imports of $707 billion.
  • Intra-firm trade between U.S. firms and affiliated firms located overseas accounts for 24 percent of the United States' merchandise exports,7 18 percent of merchandise imports,8 19 percent of service exports,9 and 12 percent of service imports. These transactions are reflected in the U.S. current account,10 but they reflect the globalization of manufacturers and service providers rather than competitiveness.
  • Since 1985, the stock of U.S. direct foreign investment abroad has increased 157 percent, to $612 billion. The stock of foreign direct investment in the United States has increased 173 percent, to $504 billion.11 Both inbound and outbound investment are growing faster than the volume of U.S. cross-border trade.
  • During 1985-93, income from U.S. direct investment abroad increased by 122 percent, to $68 billion, and the balance on direct investment income increased by 93 percent, to $45 billion.12
  • In 1993, U.S.-owned overseas affiliates employed 6.7 million workers,13 while foreign-owned affiliates located in the United States employed 4.7 million U.S. workers and accounted for 6.1 percent of GDP.

The large and growing volume of transactions conducted through foreign affiliates signals the changing nature of competition in a international marketplace and requires a different way of thinking about rules of the game for global competitiveness. 

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 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 cases, 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. This means that the economic interests of individual nations have become so closely knit 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 that 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 their own consumers and the world community as a whole. 

Economic Rationale for a Competition-Oriented Approach to Trade Negotiations 

The economic rationale for a competition-oriented approach to replace a traditional trade barriers approach to trade negotiations is twofold. First, it more directly focuses on the impact of policy measures on the efficient functioning of global markets. Second, it includes under its purview a wider range of policy instruments that affect international competition. All the economic arguments that have traditionally been made in support of trade liberalization per se would apply to negotiations aimed at removing barriers that impede international competition. Such negotiations would further enhance the functioning of international markets.

Adam Smith, in The Wealth of Nations, was the first to articulate in a comprehensive way trade liberalization as a means of obtaining the economic benefits of market competition. He treated open trade as a subset of his more general argument for free and open market competition. Opening national markets to global competition as the principal objective of trade liberalization is solidly rooted in the history of economic thought. 

Market liberalization offers both 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 that creates an artificial advantage or disadvantage between products originating in different countries or between firms with different national ownership, is likely to result in a less than Pareto optimal allocation of resources and, in turn, inefficiency. If competition-oriented negotiation can remove a wider range of discriminatory measures than traditional trade negotiations, it will bring about additional static efficiency gains. 

Dynamic gains arise from the numerous on-going beneficial effects of increased competition on the efficiency of the production process. These beneficial effects range from enhancing existing human capital to steadily increasing diffusion of technology across firms and economies. A competition-oriented approach is likely to prove particularly advantageous for enhancing the dynamic gains from trade because it puts a new emphasis on investment and competition issues, and the resulting entry and evolution of new firms in national markets.

Classical growth theory has emphasized population growth and ongoing technical change leading to growth. More recent literature has focused on technical change as a source of ongoing higher economic growth. Theory and empirical analysis show that trade liberalization alters the market conditions and incentive structure under which firms operate--including available technologies and incentives to fund R&D and education--in ways that lead to sustained increases in economic growth.

Consider the four primary forces for growth that arise from endogenous technical change: (i) returns from specialization, (ii) returns from R&D, (iii) growth through learning-by-doing, and (iv) growth through accumulation of human capital. Typically, enhanced growth results from the efficiencies gained by increased specialization and the introduction of new products and processes. This lineage extends from Adam Smith's observation that specialization in production encourages specialized skills, processes and capital. The gains from specialization, or diversity, he noted, are limited only by the extent of the market. Trade, and even more so deeper integration, hence lead to greater specialization, which leads to greater efficiency and, in turn, to long-term growth. 

More recent theory highlights the gains from increased innovation and product variety in consumer goods and the returns from process specialization. Krugman refers to "slicing up the value chain," breaking up the production process into geographically separated segments to take advantage of low wages, market access or technologies.14 Much of the current gains from auto-related production in the U.S.-owned maquiladora plants in Mexico, U.S./Canadian auto production, and Japanese production in the U.S., for example, are found in process specialization in geographically dispersed production. More integrated markets provide a larger base over which to spread the costs of investment in specialization.

The logic of enhanced R&D providing sustained dynamic growth is easily seen. In addition to the economies of scale and scope to be had by creating larger open markets, R&D has substantial spillover effects that enhance economic growth. Recent empirical work suggests that for Canada, over half the overall benefit of R&D activity is felt as externalities, or the effects of other firms in the same or other industries.15 Similarly, learning-by-doing typically leads to temporal spillovers as knowledge-specialized production and processes spills over to new and improved products. This argument is made strongly for semiconductor chips.

Dynamic growth effects arise in other ways as well. Economic integration and more competitive industries can enhance technical knowledge diffusion even in the absence of larger trade flows.16 The global economy's knowledge base is expanding at an increasingly rapid rate. Greater competition leads to a reduction of product redundancy and greater success in identifying and satisfying niche markets. Firms, less bound by national borders, can achieve hitherto unsuspected economies of scale and scope. Empirical evidence consistently shows that economies that start at a higher technological base progress at a faster rate. Sachs and Warner show strong income convergence for open economies and no convergence for closed economies.17 As knowledge expands and diffuses more rapidly, incomes will gradually converge onto both a higher for all countries and at the same time a more equal level.

Reducing border measures is not enough. Consider that Ontario exported three times as much to British Columbia as to the enormously larger California.18  Political barriers, even between very close and similar nations, can be serious obstacles that leave room for improvement from deep integration.

Baldwin offers some measure of such improvement with the dynamic gains from trade in the EU. He distinguishes between a "medium-term growth bonus: from induced capital formation and a "long-term growth bonus" due to induced technical change.19 The medium term growth bonus is the increase in the growth rate during the transition to the new higher steady state level of income due to the increase in productivity of existing factor endowments, which in turn leads to increased saving and investment. This process converges on a higher level of output and capital stock at a higher level of income. Baldwin argues that the static gains of EC92, ranging from 2.5 to 6.5% of GDP, are at least 30% too low. 

A competition-oriented approach is also likely to yield economic benefits by leading governments to adopt more efficient regulatory practices. Much has been learned in recent years about the economics of regulation, including mechanisms 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 by separating monopoly 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 competition 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. 

The economic gains from regulatory reform and from increased global competition could be particularly important with respect to the provision of infrastructure services, such as energy, telecommunications, and transportation from the competitive provision of services through such channels. The efficient provision of infrastructure services is central to the operation of global firms, and the capture of the potential economic gains from the globalization of production. 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. 

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 eclectic 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 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. 

Regulatory reforms that reduced discretionary regulatory intervention in individual business decisions by relying on increased competition 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. 

Integrating economies will enhance the learning by doing that leads to improved products, the knowledge fostered by R&D that spills over across products, the human capital investment that falls across sectors, and the specialization available in larger markets that permits profitable investment in specialized capital and processes. It is in this way that more deeply integrated markets lead to sustained increases in the rate of innovation and, hence, economic growth.

Criteria for Identifying the Issues 

In thinking through a competition-oriented approach to trade liberalization and trade rule-making, it is useful to consider the criteria that might be used to identify the policies appropriate for 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 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 compared to a less efficient firm, with consumers forced to pay higher prices than necessary, or to settle for products that less perfectly meet their needs. 

Each national government 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 always be achieved through the operation of the market mechanism. At the same time, economic efficiency and growth maximization goals require achieving these societal goals in the economically most efficient manner. 

The efficient operation of a market also requires the existence of some basic rules, 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 suggest three broad 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 that unnecessarily impede or distort the operation of market forces, or limit the entry and exit of firms. An acceptable impediment is one for which no less distorting alternative means exists for achieving a recognized social objective. 
  • policies, laws or measures essential to the efficient operation of the global market. 

In addition to the criteria above, one might apply a de minimus rule which would filter out all policy measures that have a relatively small impact on foreign markets. 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. The benefits of negotiations aimed at an improvement in economic efficiency should exceed the negotiating costs. 

The criteria suggested here are consistent with the implicit criteria 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 more general 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. 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 markets, and the resulting impact on economic growth, productivity, wages and the standard of living.

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, 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 trade barriers remain. Since most trade barriers addressed in previous negotiations have not been entirely eliminated, the criteria suggested here would undoubtedly call for 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, 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 meet the competition-oriented criteria for selecting negotiating topics. The purpose here is not to go over the empirical evidence on the 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 deeper economic integration, investment and competition measures today have a much greater impact on trade than in the past. Moreover, 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. What will be needed is to assure that national policy measures 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 be eliminated or reduced to acceptable levels 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. Bribery and corruption can also be an important issue in heavily regulated industries, where political contributions or kickbacks can be used to influence discretionary regulatory or procurement decisions.

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. 

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 that can be invoked when these disciplines are breached. A competition oriented approach could 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. 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. 

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 politics of trade requires that such national liberalization measures be posed as payments for the reciprocal reduction of foreign barriers. Consumer interests are rarely strong enough to overcome the resistance of import competing industries which benefit from trade barriers, and only the mobilization of export competitive industries provides for necessary political support. The approach followed in the context of the GATT and the WTO is to cloak negotiations aimed at an improvement in consumer welfare as an effort designed to serve producer interests in export competitive industries.

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. However, a negotiating process and a rule-making system oriented toward enhancing 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 of trade barriers per se. 

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."20 The term "global contestability of national markets" was first used by Robert Lawrence in a paper he wrote for the OECD, called One might well ask whether the use of the word contestability in this trade policy context is consistent with the use of the earlier use of this term by William J. Baumol, John C. Panzar & Robert D. Willig in their classic work on Contestable Markets and the Theory of Industry Structure.21 The latter work was largely focused on explaining why atomistic competition is 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 is that the presence of a large number of firms is not essential for the achievement of a Pareto-optimal outcome as long as an industry is open to the potential entry of new firms,. 

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. There is nothing intrinsic in the theory of contestable markets that prevents it from being usefully applied to international trade. Nevertheless, the authors of this paper have avoided using the term to avoid sidetracking the debate. 

As Baumol et al point out, the ability of potential entrants to discipline a small number of competing firms hinges on whether potential entry is truly possible, and that is the appropriate standard that ought to be applied in either a domestic regulatory context or an international trade context.22 What makes the application of contestability theory in a trade context different from the application of contestability theory in a domestic regulatory context is the difference in roles played by national governments. In a domestic regulatory context, a national government as regulator is likely to take a more objective view in competition-related enforcement actions than in an international trade context, since political pressure to protect national industries against international competition can under certain circumstances create a temptation to relax anti-trust enforcement.


1 Director, Center for Trade and Commercial Diplomacy, Monterey Institute of International Studies. Former Chairman of the OECD Trade Committee; Director of Operations, U.S. International Trade Commission, respectively. The views expressed are those of the authors and, in the case of Mr. Rogowsky, do not necessarily reflect those of the International Trade Commission or any individual Commissioner.

2 Organization for Economic Cooperation and Development, Trade Committee. "After the Uruguay Round: The Way Ahead", Report to the OECD Council at Ministerial Level. Paris: May 1995

3 American Enterprise Institute, "The Foreign Investment Debate: Opening Markets Abroad or Closing Markets at Home, ed. Cynthia Beltz (Washington, DC) 1995.

4 U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, June 1995, p. 32.

5 Ibid, p. 85.

6 U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct Investment in U.S., preliminary 1993 estimates, Table A-8.

7 U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, June 1995, p. 39.

8 Ibid.

9 Survey, Sept. 1995, p. 76


Survey, June 1995, p. 61.


U.S. Department of Commerce, Bureau of Economic Analysis, U.S. Direct Investment Abroad, preliminary 1993 estimates, Table 11-G-3.

Paul Krugman, "Growing World Trade: Causes and Consequences," William C. Brainard and George L. Perry, Brookings Papers on Economic Activity, 1995, (Washington, DC: Brookings Inst., 1995):327-362.

J.I. Bernstein, "Costs of Production, Intra-and Inter-industry R&D Spillovers: Canadian Evidence." Canadian Journal of Economics, vol. 21 (may 1988):324-347.

See for a discussion and literature, Barro and Sala-I-Martin, Economic Growth, (chapter 8), (McGraw-Hill, Inc, 1995).

Jeffrey Sachs and Andrew Warner, "Economic Reform and the Process of Global Integration," Brookings Papers on Economic Activity, 1995, Brainard and Perry, eds. (Washington, DC: Brookings Inst., 1995):1-118.

18 John McCallum, "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, 85(3):615-23.

Baldwin, R.E, "The Growth Effects of 1992," Economic Policy, vol. 4, no.2, Oct. 1989): 247-248. See also, Baldwin, R.E. "Measurable Dynamic Gains from Trade," Journal of Political Economy, vol. 100, no.11,Feb., 1992):162-174

20 See Organization for Economic Cooperation and Development, 1995, p.11.

William J. Baumol, John C. Panzar & Robert D. Willig, Contestable Markets and the Theory of Industry Structure, (New York: Harcourt Brace Jovanovich, 1988; Revised Ed) 

22 Ibid. p.469, p.477-478.