carbon tax

Pascal Lamy’s recent comments on the challenges facing the WTO

Pascal Lamy is a former Director-General of the WTO (2005-2013) and former European Commission Trade Commissioner (1999-2004). He is President emeritus of the Jacques Delors Institute. As one would expect, he is a frequent speaker on trade matters. Two events in the last several months presented some thoughts on the challenges for the WTO moving forward.

Mr. Lamy was interviewed by the Lowy Institute in Australia in early July on their COVIDcast addressing the future of globalisation. See The Interpreter, July 3, 2020, COVIDcast: The future of globalisation, https://www.lowyinstitute.org/the-interpreter/covidcast-future-globalisation. Similarly, on June 17, 2020, he and Robert Zoellick (former President of the World Bank and former U.S. Trade Representative) participated in a Peterson Institute for International Economics Trade Winds program, What future for the global trading system?, https://www.piie.com/events/what-future-global-trading-system.

Below are some of my notes on points made by Mr. Lamy I thought were of interest along with my commentary.

globalization vs. deglobalization

On the future of gobalization, Mr. Lamy is of the view that the next few years will be a period of more obstacles for trade and investment. These obstacles will change the speed of globalization but won’t lead to broad scale deglobalization. There will be some onshoring to address fragility of supply chains. However, the clamor for onshoring will be “more bark than bite”.

In the United States both the Administration and parts of the Congress have called for onshoring production of medical equipment. There has been some utilization of the Defense Production Act by the Trump Administration to get producers to use facilities to produce needed equipment. Many U.S. industries and unions have urged the government to take action to permanently reshore production of various medical equipment. See Joint Statement on Policy Objectives for Reshoring and Safeguarding Domestic PPE Manufacturing (embedded below).

joint-statement-of-reshoring-of-PPE-production

However, the U.S. has not entered into long-term contracts to support significant reshoring efforts, possibly supporting Mr. Lamy’s prediction of “more bark than bite”.

precautionism

Efforts by countries to recover from the economic damage caused by COVID-19 will be complicated by what Mr. Lamy called “precautionism” (governments protecting people from risk) and which he distinguished from protectionism (protecting producers from international competition). In Mr. Lamy’s view, protectionism can be addressed by eliminating restrictions or other obstacles. Precautionism involves risk profiles which will differ among Members and possibly may differ among issues being considered and hence will be much more difficult to address to achieve a level playing field. Mr. Lamy in the Trade Winds program used the example of the tourism sector which has been devastated by governments’ efforts to control the spread of COVID-19 and noted that there are a number of different initiatives by countries to get some reopening of tourism (e.g., nonessential air travel) between particular countries, but that there isn’t a common approach which in his view reflects differing risk profiles of countries.

I would note that precautionism is not limited to the response to the COVID-19 pandemic. The WTO’s Sanitary and Phytosanitary Agreement and the Technical Barriers to Trade Agreement both recognize the right of Members to take measures to protect their populations at such level as is deemed appropriate by the Member although encouraging use of international standards.

To the extent the aftermath of the COVID-19 pandemic is a more cautious risk profile for major trading nations, recovery will likely be slower and more fragmented.

Borrowings during the pandemic to lessen the economic collapse

Mr. Lamy made several points on the massive amounts of stimulus funds being provided by certain governments to limit the economic challenges being faced from efforts to slow the spread of COVID-19.

His first point is that the size of the government programs will necessarily distort trade and create a playing field that is not level. Rescue plans for companies or industries, subsidies provided, increased state ownership are all elements of the distortions that he sees occurring. He believes countries will have to come to grips with the emergency needs and see that markets return to their proper role with reduced government involvement.

The second point is that only a few countries are positioned to provide this type of financial assistance because of the inability for most countries to borrow huge amounts of money for such stimulus activities. Hence the north-south divide is growing according to Mr. Lamy. While this point is certainly true, multilateral organizations like the IMF and World Bank and regional development banks are working to provide debt forgiveness and other financial assistance to some developing and to least developed countries to provide some greater flexibilities.

WTO reform — U.S.-China tensions

Mr. Lamy views the WTO as weaker today than it was ten years ago. He attributes the main source of the weakened situation of the WTO to the growing divergence between the United States and China. In his view, the tension between the two has prevented convergence on a range of issues.

Because the world has changed so much over the years, the WTO rulebook must be updated. China’s state capitalism economic system is creating significant problems for the world trading system. China’s trading partners are concerned about the high level of state ownership (30% for China) and the government support to the state-owned sectors. These facts lead to conflict with partners both in terms of market access in China and in terms of Chinese competition in other markets. Mr. Lamy notes that the WTO’s rules on state aid are weak. He doesn’t believe one can coexist with China in the WTO if rules on state aid are not toughened (what he describes as achieving “competitive neutrality”). Even with new rules, the geopolitical rivalry between the U.S. and China will remain.

Mr. Lamy agrees with the United States that the current WTO rules do not constrain China’s state capitalism practices which distort competition. He believes that China was making good progress on moving towards a market economy until the 2008-2009 financial crisis. China had lowered state ownership to 15% of the economy. With the financial crisis, China poured huge sums into the economy, including through state-owned enterprises. With the change in political leadership, the country shifted away from a convergence model and has continued to bolster its state capitalism model, now 30% of the economy. For the foreseeable future, the WTO will not be able to achieve convergence by China to a market-economy model, but will have to work on whether coexistence can be made to handle at least many of the distortions.

The Untied States has been pushing the WTO to come to grips with the fact that the WTO set of rules was created for market economies, and to recognize that such rules don’t work for large state capitalism economies. One of the WTO’s Deputy Directors-General, Alan Wolff, in a speech earlier this year, in reviewing principles that undergird the WTO identified convergence, not coexistence, as one of the core principles. See DDG Wolff: “There can be no permanent retreat from what has been created,” 10 June 2020, https://www.wto.org/english/news_e/news20_e/ddgaw_11jun20_e.htm (“Of necessity, the WTO is about convergence, not coexistence”)

In his comments during the Peterson Institute’s Trade Winds webinar, Mr. Lamy indicated that coexistence is possible if there are strong state-aid rules and reviewed the ability of Germany and France to work together in the EC despite France having had relatively high state ownership (around 15%) in the early years. The ability to work with a country with significant state-control was due to stringent state aide rules. The U.S., Japan and EU have been working to pull together improved disciplines on industrial subsidies, action that China has already indicated it will not accept. Mr. Lamy is of the view that China can be brought to the table by parties seeking “competitive neutrality” and by indicating to China that China will not gain additional market access without agreeing to new rules on state aid.

In a post last week, I reviewed an opinion piece by Peter Carl, a former EC Director General for Trade. His take on the same situation was that the EU, US and others should pursue improved disciplines on state aid but when such efforts are rejected by China, the EU and others should leave the WTO and start a new organization without China where convergence would be possible. See July 25, 2020, A new WTO without China?  The July 20, 2020 Les Echos opinion piece by Mogens Peter Carl, a former EC Director General for Trade and then Environment, https://currentthoughtsontrade.com/2020/07/25/a-new-wto-without-china-the-july-20-2020-les-echos-opinion-piece-by-mogens-peter-carl-a-former-ec-director-general-for-trade-and-then-environment/.

Mr. Lamy also reviewed how a functioning WTO is very important for developing and least developed countries. Trade and investment is a big lever for such countries in their development efforts. Thus, if the WTO continues to weaken, it is these countries that will be most hurt. Similarly, these same countries are likely most adversely affected by the trade and economic fallout from the COVID-19 pandemic.

WTO agenda

During the Peterson Institute’s Trade Winds program in June, Mr. Lamy indicated that proponents of open trade were in for a difficult time. He listed five issues of concern. Three were dealt with above (precautionism, government infusions to address COVID-19 pandemic, deglobalization/onshoring). He also reviewed the weaponization of trade, citing both the Trump Administration’s actions and the dispute between Japan and the Republic of Korea, and new forms of protectionism citing investment controls and new instruments.

Mr. Lamy believes that the WTO agenda needs to be looked at in two stages. The first or short term involves finding a new Director-General, and needs to include a cooling down period. My understanding of the cooling down period is to have governments who have poured trillions of dollars into their economies back out of such increased state involvement and permit reestablishment of a level playing field. This period will be a few years and will permit some increase in trust through small steps. He believes there will be a coalition for open trade and that the EU will be the leader depending on the outcome of the upcoming Presidential election in the U.S.

Longer term, Mr. Lamy believes that the WTO must go back to dealing with the big problems:

coexistence with China as long as China has 30% of its economy state-controlled; will require improved rules on state aid;

dealing with the trade and environment nexus; issue keeps rising on the global agenda; EU planned global carbon tax will be important issue;

around the challenge of precautionism, the world will need a new effort to level the playing field possibly similar to prudential rules in the finance system.

EU role in the WTO during the US-China tensions

The EU is serving as a stabilizing force in the WTO. Indeed, the more U.S.-China tensions increase, the more the EU will step in to provide stability. Mr. Lamy states that many WTO members want the EU to be a shield to protect them from having to pick sides with either the U.S. or China. This is a big role for the EU. If EU comes out of the COVID-19 pandemic stronger, it will bolster the role that the EU can play in the WTO to maintain stability.

Mr. Lamy cited the Appellate Body crisis as one where the EU by creating the multi-party interim arbitration agreement took the lead to maintain stability in the organization and got many countries to follow.

Conclusion

Mr. Lamy paints a picture of a challenging time for the world trading system in the coming years. He agrees that the WTO rules do not adequately address distortions that flow from China’s state capitalism economic system. His proposed solution is to coexist but work on obtaining stronger rules on state aid. While the U.S., Japan and the EU agree such improved rules are needed, there is a certain irony in his recognizing the need for stronger rules on state aid, as it was the EU, among others, who pushed for weaker subsidies disciplines during the Uruguay Round.

Mr. Lamy also paints a bleak picture of distortions created by countries’ efforts to stem off economic collapse as countries impose shutdowns to try to control the COVID-19 spread. His argument is from 30,000 feet and is conclusory – the introduction of such huge amounts of money necessarily distorts competition. My own view is that while the question of whether there are distortions is an important one, large parts of the funding don’t increase manufacturing or production but rather form a safety net under employers, employees and state and local governments dealing with an extraordinary situation that doesn’t reflect market forces. Of more use would be agreeing on identification of outcomes that are viewed as distortive versus those outcomes which simply offset the economic fallout from the pandemic. Many industries will end up much smaller after the pandemic than before and any rescue funds provided will reflect an effort to address the extraordinary event of governments mandating closure of markets. Presumably such funding should be agreed to be nonobjectionable. Whereas if an industry in a country expands with government assistance to take advantage of the closure of competitors because of restrictions flowing from efforts to address the pandemic, presumably such subsidies would be problematic.

The longer term issues Mr. Lamy raises will certainly take center stage at some point, but his list does not include any of the large number of pending issues before the WTO where progress will hopefully be made in the coming next year or so – fisheries subsidies, electronic commerce, etc.

What is clear is that the next Director-General will face a very challenging landscape with fundamental differences among many Members that will make forward movement by the WTO and its Members a challenging undertaking.