Rethink the WTO’s Role in a Digital, Divided World

The strains facing the WTO are not easily resolved. However, as momentum for trade liberalization has historically come from ‘coalitions of the willing’ – based on sectoral and plurilateral interests – this should be the priority for policy action.

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Matthew Oxenford

Former research associate, International Economics, Chatham House

The WTO headquarters in Geneva. Photo: Getty Images.

The WTO headquarters in Geneva. Photo: Getty Images.

The World Trade Organization (WTO) faces arguably the most acute challenge in its 24-year history. Since the election of Donald Trump in 2016, a US administration hostile to multilateralism and tempted by protectionism has worked to undermine the WTO by leaving the body on the brink of being unable to perform one of its central roles: adjudicating the rules of global trade.

If the immediate crisis weren’t enough, structural shifts in markets have raised questions about the long-term suitability of the WTO as a rules-based order for international commerce. What, given certain constraints inherent to the WTO system, are the options for reform?

During the 2016 US presidential campaign, trade was a prime target of Trump’s populist electioneering. While the president subsequently has not – or, at least, not yet – followed through on a campaign threat to withdraw the US from the WTO altogether, his administration has prevented the Appellate Body of the WTO’s Dispute Settlement Body, a central component of the multilateral trading system, from functioning properly.

The US has blocked the nomination of new Appellate Body members, whose appointment requires unanimous consent. In December 2019, the four-year terms of two of the body’s three current members will expire, leaving it without a quorum to make decisions.

However, the WTO had profound difficulties even prior to this situation, many of which can be traced back to the period around the institution’s founding in 1995 and which inform the current crisis.

The WTO took shape at a singular historical moment. The 1990s were a period when the consensus on the desirability of trade liberalization was arguably at its strongest since the Second World War; global communism had just collapsed, while developing economies in Asia and Latin America were making significant market reforms.

The economies of the US, the EU, Japan and Canada – termed the ‘Quad’ by trade negotiators for their pivotal role in driving forward past rounds of trade liberalization – were at the peak of their influence. Their leadership acted as an accelerant to global trade integration, encouraging countries to join the General Agreement on Tariffs and Trade (GATT), the WTO’s predecessor. Whereas the initial GATT rounds of trade negotiations had involved fewer than 30 members, by 1994 the total had risen to 123, eventually rising to 164 in the WTO today.[1]

This fleeting moment of political and ideological unity allowed the WTO to be structured to address many of the perceived failings of the GATT. In particular, the GATT system, which had allowed significant exemptions and ambiguous opt-outs for countries, was superseded by the more standardized ‘single undertaking’ system and binding dispute settlement.[2]

The WTO also made dispute resolution more efficient by moving from a system requiring unanimous approval to enforce a ruling to one requiring unanimity only when blocking a decision.

However, the ‘one size fits all’ inflexibility of the WTO system created significant strain. Major economies, particularly the US, had reservations about the constraints on sovereignty implied by compliance with binding dispute settlement. The promise of the WTO was that a steady stream of further negotiations and liberalization would consistently create new agreement and clarity, limiting the need for supranational dispute settlement beyond basic interpretation of continuously updated rules.

Instead, the combination of the greater centrality of developing economies, such as China and India, in the trading system and in trade negotiations with the shift towards binding rules – which made the stakes of negotiating the rules themselves higher – rendered consensus in new rounds of trade negotiations impossible to achieve. As a result, trade liberalization and negotiations ground to a halt, and – as can be seen in today’s tensions – US concerns over infringement of sovereignty re-emerged in force.

The WTO’s effectiveness has further been undermined by developments in technology, which have changed the nature of global trade. Between 2005 and 2015, cross-border digital trade increased 45-fold. E-commerce now accounts for 12 per cent of consumer goods trade.[3]

The growing trade in ‘intangible goods’ – including downloadable consumer content, software, data and other digital intellectual property – is blurring the line between goods and services. Physical goods are now also more likely to have services embedded in them, for example through service contracts, software or leasing arrangements. This makes goods trade more dependent than ever before on complicated ‘behind the border’ regulatory issues more commonly associated with services.

While the WTO’s ambitions have always included liberalizing services trade, as an institution it remains ill-suited to responding to this evolution. Services trade liberalization increasingly hinges on regulatory convergence around the services offered, a more difficult area in which to achieve compromise than trade in goods.

Whereas tariffs on goods can be adjusted through one-off changes in government policy, negotiations over services trade involve continuous harmonization of ever-evolving supranational standards. As an international body operating by consensus, the WTO cannot guarantee this convergence will occur.

Additionally, the WTO’s framework for services trade – enshrined in the General Agreement on Trade in Services (GATS) – divides services trade into four ‘modes of supply’, yet the increasing amounts of digital trade fit neatly into none of these categories.[4] As a result, the GATS rules are increasingly unwieldy in the modern economy.

Towards coalitions of the willing

If there is to be any further momentum for trade liberalization, its advocates must first be realistic in their ambitions and recognize that global trade governance has gone beyond what is politically sustainable. The WTO’s ‘single undertaking’ model required an unrealistic level of sustained consensus among its members.

Allowing for greater flexibility in member state obligations would acknowledge this, even if the price of reform is less harmonized dispute settlement. Such a move is likely to be inevitable, given evidence that supranational dispute settlement remains controversial beyond the WTO.

The problem, however, is that as trade becomes ever more oriented towards services and intangible goods, the need for common rules will only grow. The most likely route to success may lie not with the WTO, but with sector-specific forums and plurilateral agreements involving limited coalitions of states.

One example of qualified success in sector-specific regulatory harmonization can be seen in the development of common banking standards. This process, first through the so-called ‘Basel’ mechanism under the Bank for International Settlements (BIS) in 1992, and more recently through the Financial Stability Board (FSB), was primarily designed to ensure a minimum level of regulatory harmonization between jurisdictions.[5]

Yet one of the additional consequences of this standardization was the reduction of many regulatory barriers, which ultimately allowed finance to become one of the most globalized service sectors. Ironically, this occurred despite the lack of formal trade agreements containing robust financial services chapters.

Could variations on the financial industry model be applied more widely? Implementation of Basel and FSB rules depends on global support within the industry and among regulators, yet the same precondition is likely to apply to regulatory convergence in almost any service sector. There is thus no obvious reason why similar harmonization of standards could not be achieved through professional or industry bodies in other regulated service sectors, in order to facilitate and regulate cross-border trade.

By empowering global, sector-specific standard-setting bodies in this way, industry-driven ‘bottom up’ approaches could make it easier to overcome political obstacles to reform. With banking, for example, all the players involved are already agreed on the benefits of coordination, and it is in everyone’s interests to develop common global regulations. Should stronger or different regulation be needed (as was the case after the 2008 financial crisis), the framework for agreeing adjustments already exists.

Similar forums exist in many other professional service sectors, as well as in digital governance.[1] Working with governments, these specialist organizations could help to gain buy-in from their members on the development of new trade policies and rules for their sectors. This in turn could help to ensure the cooperation of governments responsible for regulatory convergence.

Plurilateral agreements, too, provide potential scope for greater ambition. The Trade in Services Agreement (TiSA), in negotiation since 2012, approaches the liberalization of trade in services on a selective basis – starting with a smaller group of negotiating parties (including the Quad) that wish to pursue deeper service-sector liberalization.

TiSA is unlikely to progress during the Trump presidency. However, if a less hostile administration arrives in Washington, this sort of agreement has a better chance of success than might another WTO negotiating round. Moreover, it would still cover over 70 per cent of global services trade,[6] while creating a set of common standards for other countries to build on. Indeed, even under the Trump administration, the US is one of 76 WTO members beginning to negotiate a plurilateral agreement on e-commerce.

In this future, the WTO will have a diminished but real role to play: acting as a repository and negotiating forum for plurilateral agreements, performing a monitoring and data collection role, and developing common standards on the goods trade and tariff liberalization still within its remit.

Major international organizations have adapted to this sort of reduced remit in the past: after the breakdown of the Bretton Woods system, the International Monetary Fund found its mandate similarly diminished, but was able to reinvent itself as a lender of last resort and as a provider of liquidity in a more flexible, dynamic monetary system. It is not implausible that, after some time in the political wilderness, the WTO could similarly reinvent itself in a newly dynamic global trade system.

What needs to happen

  • The WTO is unlikely to achieve consensus on a resolution to the dispute-settlement impasse. Securing political support for continued trade liberalization should be prioritized over the preservation of the existing structure.
  • As trade involves ever more services and intangible goods, progress on governance may be more achievable through sector-specific forums and plurilateral agreements than through full WTO negotiations.
  • Regulatory harmonization conducted by single sectors such as banking offer a potential template for other services industries to reduce the barriers to trade without a formal trade agreement. This would rely on empowering professional standard-setting bodies and leveraging mutually agreed interests.
  • Plurilateral processes, selectively involving coalitions of states committed to similar goals, can provide scope for raising policy ambition. A good example is the Trade in Services Agreement (TiSA).
  • With a diminished role as a rule-setter, the WTO would likely focus on providing a forum for negotiation in more limited sectors and a repository for plurilateral agreements, as well as on monitoring and data collection.

Notes

[1] Bodies that perform some governance and coordination functions in non-trade capacities include the Internet Corporation for Assigned Names and Numbers (ICANN), the International Telecommunication Union (ITU) and others.

[1] WTO (undated), ‘The GATT years: from Havana to Marrakesh’, https://www.wto.org/english/thewto_e/whatis_e/tif_e/fact4_e.htm.

[2] Baldwin, R. (2016), ‘The World Trade Organization and the Future of Multilateralism’, Journal of Economic Perspectives, (30)1, Winter 2016, pp. 95–116, https://www.aeaweb.org/articles?id=10.1257/jep.30.1.95

[3] Manyika, J., Lund, S., Bughin, J., Woetzel, J., Stamenov, K. and Dhingra, D. (2016), Digital Globalization: The New Era of Global Flows, McKinsey Global Institute, https://www.mckinsey.com/business-functions/digital-mckinsey/our-insigh…

[4] GATS is the WTO’s set of rules on services governance.

[5] Bank for International Settlements (2018), ‘Basel Committee Charter’, 5 June 2018, https://www.bis.org/bcbs/charter.htm.

[6] Matthews, B. C., Wayne, E. A. and Pan, C. (2018), ‘Trade in Services Agreement: A Way Out of the Trade War?’, Atlantic Council blog, 23 July 2018, https://www.atlanticcouncil.org/blogs/new-atlanticist/trade-in-services….

This essay was produced for the 2019 edition of Chatham House Expert Perspectives – our annual survey of risks and opportunities in global affairs – in which our researchers identify areas where the current sets of rules, institutions and mechanisms for peaceful international cooperation are falling short, and present ideas for reform and modernization.