Trump’s tariffs and the demise of WTO Eng.Nadeem Mumtaz Qureshi

Trump’s tariffs and the demise of WTO
Eng.Nadeem Mumtaz Qureshi

President Donald Trump, with his sweeping imposition of tariffs on America’s main trading partners, has ignited a firestorm. It is unclear, when the ash settles, whether he would have achieved his objective of making America great again. Or have damaged it beyond repair.

But what is clear is that his actions have upended some 80 years of received economic wisdom. This held free trade and open markets to be pillars, revered and irreproachable of the new world order that took shape after the second world war.

Tariffs are essentially import duties that are imposed on the imports from another country. And the irony is that it was America along with its main trading partners – the developed industrial nations of the West – that was instrumental in establishing the General Agreement on Tariffs and Trade (GATT) whose primary purpose was to abolish tariffs. This agreement was signed in 1947 in Geneva and an organization of the same name was established.

A bit of history: GATT’s mandate was to promote international trade primarily by removing tariffs. The signatories including the USA were sovereign countries called the contracting parties. The number of contracting parties grew from the original 23 to well over a hundred by the early 1990s. Over the years the original agreement was revised several times at specially called meetings of the contracting parties called negotiating rounds.

The last such negotiation, known as the Uruguay round, began in 1986. Its conclusion in 1994 led to the formation of the World Trade Organization. The WTO, which eventually replaced GATT, was given enhanced powers to promote international trade. The central objective of WTO continued to be the lowering or elimination of trade barriers, tariff and non-tariff, imposed by member nations. Indeed, membership required a commitment to open markets by reducing or removing such barriers.

It is not clear what will happen to WTO now that Mr. Trump seems to have all but written its epitaph. Time will tell. But, perhaps for developing countries like Pakistan there is, in the imminent demise of WTO, an opportunity.

It was never in the interest of Pakistan to lower its trade barriers. But we were obliged to do so under pressure from WTO and its powerful sponsors especially the USA and its proxies – the IMF and the World Bank. One could argue that it is this lowering of trade barriers – import duties – which held back Pakistan from industrial development.

To understand why this was so, one has to turn to the experience curve. This is a concept used by business economists to analyze the competitive position of key players in a given industry. Simply put, it says that a company’s unit cost of producing a good declines steadily in proportion to the cumulative number of such goods produced by the company. At the same time cumulative experience enables it to continue to improve the quality of its product.

This means, other things being equal, that a car manufacturer, for example, who has produced two million cars since the company started will have a lower cost per unit and higher quality than another manufacturer who has produced one million cars. The company with more experience (i.e. cumulative number of cars produced) is in a stronger competitive position. So a company that is the first or earliest to enter a certain business builds up an advantage through experience that later entrants into the market find difficult or impossible to overcome.

Toyota was a much later entrant to the car business than the major American producers such as General Motors and Ford. The logic of the experience curve would have it that Toyota should never have been able to compete with them on their home turf. Yet it does and very successfully.

This is because the Japanese Government, in the early stages of Japan’s industrial development effectively closed its markets by imposing high tariffs on finished imported goods. This protected its local manufacturers, such as Toyota from foreign competition in the domestic Japanese market. Here they could gain experience without having to worry about foreign competition. And once they had acquired this experience they were ready to compete with previously established competitors in international markets.

Japan’s industrial development policy was straightforward. It consisted of two central elements. First, closing the country’s markets (read high tariff barriers) to all but primary raw materials. And second, recognizing that industrial development required the active involvement of the government in developing and implementing industrial policy. This is what helped Japan to become an industrial powerhouse in a period not exceeding 25 years after the end of the second world war.

The inexorable logic of the experience curve applies to countries just as it does to companies. Those that have industrialized earlier have an inherent advantage over those that industrialize later. The only way to offset this advantage is through protection offered by tariff barriers.

It is extraordinary to maintain, as do the IMF and World Bank, that open markets – the absence of tariff barriers – contribute to industrial development. The history of industrial development over the last two centuries suggests that the exact opposite is true: Late comers to industrialization have succeeded, if they have succeeded at all, is through a regime of protected markets and government supported and enforced industrial policies.

Pakistan is in a difficult position. When we joined WTO we were compelled to lower import duties. This opened the gates for experienced international manufacturers to flood our markets with low cost products. Our own hapless manufacturers, still on the early stages of the experience curve, were not able to compete. Many went out of business. And it was only the brave or foolish who were willing to invest in manufacturing.

Mr. Trump’s actions by heralding the demise of WTO, provide an opportunity for Pakistan and indeed other LDCs to reinstate high import duties on all but the most basic raw materials. This will catalyze investment in the industrial sector by protecting nascent manufacturers until they build up the cumulative experience in their domestic markets to compete with established global competitors.