WORLD TRADE ORGANIZATION (WTO)CAITLYN ELLER AND GAIA MENGARALLI

©2019

TYPES OF TRADE

Unilateralism –type of free trade agreement that is

imposed on or benefits one trading partner but

not the other/s

Generalized System of Preferences (GSP) –preferential tariff reduction for developing countries

Everything But Arms (EBA) – specific initiative within

GSP for highest preferential treatment of Least Developed Countries (LDC) in all goods except armaments

Regionalism –preferential trade

agreements where members are defined by a geographic commonality

Multilateralism –agreements between three or more nations that dictate the

rules of preferential trade, tariffs, and customs for all

International Monetary

Fund(IMF)

World Trade Organization

(WTO)

World BankEuropean Union(EU)

North American Free Trade Agreement

(NAFTA)

Association of Southeast Asian Nations (ASEAN)

Most Favored Nation (MFN) – status given to all

members within WTO to ensure equal preferential trade for all

The World Trade Organization (WTO) is a system of trade and tariff liberalization between countries that was born from its predecessor, the General Agreement for Tariff and Trade (GATT) in order to increase trade cooperation.

Tenets of the WTO:

• Non-discrimination

• Reciprocity

• National treatment requirement (according to which all imported goods must be subjected to exactly the same treatment as like domestic products)

Note: there are some exceptions to the principle of RECIPROCITY and the application of the MNF clause that havebeen introduced for a more integrated trade system. To give examples, we can mention the existence of tradeareas and customs unions, trans-boundary and neighborhood exchanges and the very important Part IV of theGATT which, under the pressure of the UNCTAD, introduced a new framework for trade relations betweendeveloped and developing Countries

WTO FOUNDATION

WHY NATIONS WANT TO BE PART OF THE WTO• If the WTO does not provide economic trade benefits, what are some other reasons why membership

to GATT/WTO might be so highly coveted by nation-states? What symbolism or value does the world put on these agreements?

Some hypotheses:

• Evidence from previous studies suggests that upon entering the WTO, there can be immediate benefits to trade, even if they lessen over time

• It has also been shown that different types of accession to trade agreements relate to how those trade agreements are fully carried out and implemented in countries, which might contribute to a delay in trade benefits, informal benefits

• Membership might symbolize a goal for some nations, more-so than an immediate plan of action

• Membership might also stand for more recognition on the world stage of a country’s global position and influence, leading to political improvements along with supposed economic benefits

However, is it enough?

ROSE’S MOTIVATIONS FOR THE STUDY

According to Rose, empirical evidence did not exist, that showed that the GATT/WTO encouraged trade. As an academic, he therefore wanted to fill the literature gap and conduct a study which would confirm or deny the widespread notion among other economists and world leaders that the GATT/WTO encouraged trade and did so at a higher rate than other forms of trade.

In the world sphere, some prominent rivals to the WTO are the International Monetary Fun (IMF) and the World Bank

Given these, a study such as this has the potential to shift international preference towards other systems.

RIVAL INSTITUTIONS

International Monetary Fund World Bank

International financial institution that provides loans to countries, specifically for development, with the main goal of reducing global poverty

International organization whose members work towards global goals of cooperation, economic stability and growth, and other human rights initiatives, such as reducing poverty

AUTHOR: ANDREW K. ROSESOURCE: THE AMERICAN ECONOMIC REVIEW, VOL. 94, NO. 1 (MAR., 2004), PP. 98-114 PUBLISHED BY: AMERICAN ECONOMIC ASSOCIATION STABLE URL: HTTP://WWW.JSTOR.ORG/STABLE/3592771

CORE QUESTION:

Do We Really Know That the WTO Increases Trade?

To estimate the effect on international trade of multilateral trade agreements that the WTO,

the GATT, and the GSP extended from rich countries to developing countries.

TASK OF THE ARTICLE:

MAIN SECTIONS BY WHICH THE DATA IS DISCUSSED:

1. Empirical Methodology

2. Data set

3. A graphical event study

4. Results

5. Sensitivity analysis

1. EMPIRICAL METHODOLOGYWhen we look at the Empirical Methodology we mean a way of gaining knowledge by direct and indirect

observation or experience . The result of this methodology is the Empirical Evidence, that can be eitherquantitative or qualitative.

Rose’s observation is based upon the augmentation of the basic gravity equation with a number of extravariables that affect trade, with the aim of accounting for as many extraneous factors as possible.

We can divide the nature of these factors under three groups of interest:

culture (e.g. common language);

geography (e.g. whether none, one, or both are landlocked);

history (e.g. whether one colonized the other);

Comparing the trade patterns between Members and Non-Members of GATT/WTO should demonstrate whether if the Members inside the systems should have significantly higher trade than outsiders or not.

FIRST OF ALL:WHAT IS THE GRAVITY MODEL?

It is a conventional device used to estimate the effects of a variety of phenomena on international trade.

Rose underlines that for economics, it is also a successful model mainly in two senses:

-First, the estimated effects of distance and output (the traditional gravity effects) are sensible. The model takes the Newton’s Law on Gravity:

-Second, it explains most of the variation in international trade so that we can re-use the Newton’s Low in these terms: “Relative economic masses and trade frictions determine bilateral trade”

Tinbergen, 1962

LARGER EXPLANATION OF GRAVITY MODELBasic gravity model equation:Xij= δ0 Yi

δ1(Yi/Li) δ2 Yj

δ3(Yj/Lj)δ4 Dij

- δ5 Pij δ6

Explanation of each variable in the equation:

Xij= trade between exports of Country i and imports of Country j

δ= it is the constant term of the regression

Y= Gross Domestic Product (GDP)

(Yi/Li) and (Yj/Lj)= per capita GDP

Dij= it is the geographical distance between Country i and Country j

Pij= it is the qualitative variable that corresponds to the policy variable

LINEAR VERSION OF GRAVITY MODEL

The most important difference between this version and the previous one is that

the linear Gravity equation is based on the BLUE – Best Linear Unbiased Estimatoriid= indipendent and identically

distributed random variables

In the Linear Regression Model, that explains the relation between a dependent variable and an independent variable, the BLUE of the coefficient is given by the OLS estimator. Why it is called BEST? Because it gives the lowest variance of the linear estimators

In linear relationships, any given change in anindependent variable will always produce a corresponding change in the dependent variable.

THE USE OF OLS SYSTEM

At a very basic level, the relationship between a variable (Y) anda variable (X) may be represented using a line of best-fit, whereY is predicted (at least to some extent) by X. If this relationship islinear, it may be represented mathematically using the straight

line equation 'Y = α + βx'.

α= it indicates the value of Y when X is equal to zero

β= it indicates the slope line, also called the REGRESSIONCOEFFICIENT. It describes the change in Y that is associated witha unit change in X.

To wrap up:to estimate the straight line we need the additive equationwritten above so that instead of multiplying we can just usesums in a easier way.

Main Equation Format:1n(Xijt) = β0 + β11nDij + β21n(YiYj)t

Main variables explained as:• 1n(X) = linear average value of trade between i and j at t• β = vector of nuisance coefficient• D = distance• i = country 1• j = country 2• Y = GDP

Main additional variables:• Pop = population• Lang = if i and j have a common language• CU = unity if i and j use the same currency at time t• Cont = if i and j share a border• Island = number of island nations in the pair• Area = area of the country in KM• t = time

Rose’s Equation

CONDITIONING VARIABLES• Demographic or other background variables that act on the other factors in the model/equation

• These include: culture (e.g., whether a pair of countries share a common language), geography (e.g., whether none, one, or both are landlocked), and history (e.g., whether one colonized the other).

• Controlling these variables allows for the most accurate analysis of trade agreement versus no trade agreements level of trading

• Numbers that show members of WTO having higher trade than outsiders/non-members, even with these additional variables, would mean that it is a beneficial trading system/agreement

Some Additional Variables Rose Uses:

• Bothinijt = unity if both i and j are GATT/WTO members at t• Oneinijt = unity if either i or j is a GATT/WTO member at t• GSPijt = unity if i was a GSP beneficiary of j or vice versa at t

• FTA = unity if i and j both belong to the same regional trade agreement

• Landl = number of landlocked countries in the country-pair • ComNat = unity if i and j remained part of the same nation

during the sample (e.g., France and Guadeloupe)

• ComCol = unity if i and j were ever colonies after 1945 with the same colonizer

• Colony = unity if i ever colonized j or vice versa• CurCol = unity if i is a colony of j at time t or vice versa

• {T} = comprehensive set of time "fixed effects”• p and 4 = vectors of nuisance coefficients• Eijt = the omitted other influences on bilateral trade,

assumed to be well-behaved

AUTHOR’S FAVORED VARIABLES FOR STUDY

y1 – measures the effect on international trade if both countries are GATT/WTO members

If trade is created when both countries are part of GATT/WTO, the effect should be positive.

y2 - measures the trade effect if one country is a member and the other is not

If trade is diverted from non-members, then the effect should be negative.

y3 – measures the effect of General System of Preferences (GSP) on trade

1ST EXAMPLE OF AUGMENTED VARIABLE IN COUNTRY PAIR:ADJACENCY

A= Poland

B= Germany

C= Sweden

The relative distance between them are thesame BUT the volume of trade is majorbetween A and B because they are adjacentto each other

2ND EXAMPLE OF AUGMENTED VARIABLE IN COUNTRY PAIR:REMOTENESS

A= France

B= Switzerland

C= Hungary

D= Romania

•= Germany

The relative distance between A/B and C/D is the same BUT, given the position of an additional Country such Germany, the remoteness of Country C/D let them trade more than A/B

WHY IS GRAVITY MODEL SUCCESSFUL

1) The estimated effects of distance and out-put (the traditional gravity effects) are sensible, economically and statistically significant, and reasonably consistent across studies.

2) The gravity model explains most of the variation in international trade. That is, the model seems reliable and fits the data well

3) The variability in gravity model, in that it can be modified based on the number of variables makes it more accurate than other options

On the contrary, the classic, Ricardian theory of economic trade does not account for multiple actors, types of trade, or additional variables. Using only comparative advantage, we can determine exports in a closed, perfect trade system, but not imports or random factor impacts.

2. DATA SET - WHERE• When we look at the data set we are referring to a collection of related sets of information

composed of separate elements but that can be manipulated as a unit by a computer.

• Rose uses the data set called “Direction of Trade” made by the IMF to cover the bilateral trade between 178 Countries for which the Fund gives data between 1948 and 1999 with the intent to cover all the global trade.

• He records the costs of exports and imports in American dollar and he calculates an average value of bilateral trade striking a balance of the four possible movements between a pair of Countries:

-exports from Country i to Country j

-exports from Country j to Country i

-imports into Country j from Country i

-imports into Country i from Country j

2. DATA SET

For the Population and real GDP data (in constant American dollars) the data have been takenfrom the Penn World Table, the World Bank's World Development Indicators, and the IMF's International Financial Statistics

For the country-specific variables data have been obtained from CIA's World Factbook

Further data have been analyzed by checking if the Countries were involved in currency union or in a Regional Trade Agreement

To verify the accession and participation of the Members of GATT/WTO he toke the data directly by the web site of WTO itself

The data regarding the GSP derive from booklets published by United Nation at intervals in 1974, 1979 and 1984

3. A GRAPHICAL EVENT STUDY: OPENNESSThe top left-hand diagram examines openness

in the five years before, during (marked by the

vertical line), and after the entry in GATT/WTO.

It is the degree to which imports and exports takeplace and affect the size and growth of a nationaleconomy.

The middle line shows the little level of

openness, while the two other lines show an

interval of plus and minus in standard

deviations.

Result: Openness does not seem to vary much

in the decade around entry into the multilateral

trade system.

4. RESULTS

As we already anticipated, he uses standard

regression analysis to isolate the effects of

the multilateral trading system on trade and

he does so just to be more persuasive in

demonstrating his theory.

We want to focus on the label DEFAULT that

in this case represents the augmented

Gravity Model estimated with Ordinary Least

Squares as we already have seen before.

From this table we can demonstrate 4 main

results:

1. Countries belonging to the same regional trade association , Countries sharing a language, Countries sharingland border, Countries sharing colonial history TRADE MORE.

2. The different effects gained by using these variables demonstrate that the Gravity Equation seems to wellexplain most of the reasons why international trade varies across almost a quarter million observations.

3. It is evident that having membership in the GATT/WTO does not have any substantial effect on trade. Thedummy variables for one or both of the countries being GATT/WTO Members both have small negativecoefficients.

4. In the same time, the extension of the GSP from one Country to another seems to have a large positive effect

so that the GSP is estimated to raise trade over 100%

When we look at the sensitivity analysis we mean the study of how to divide up initial data from amathematical model in order to test it for accuracy or specificity using different robustness checks foradditional information.

What are robustness checks?

Robustness checks involve reporting alternative specifications that test the samehypothesis taking into consideration two effects:

5. SENSITIVITY ANALYSIS

FIXED EFFECT

-The effect is fixed when it is interestingin itself- It is constant across individuals

e.g.: value of Dollars, global business cycle, extent of globalization, oil shocks etc..

RANDOM EFFECT

-The effect is random if it is interesting in theunderlying population-It varies from moment to moment

.

5. SENSITIVITY ANALYSIS: 1ST EXAMPLE

With a cross-sectional analysis , Rose demonstrated that the data from the 1950's show positive and significant effects of GATT membership.

However, these coefficients shrink in the 1960's with the large expansion of the GATT and turn negative in the 1970's.

The effects are also small in the 1980's and unstable in the 1990's.

5. SENSITIVITY ANALYSIS: 2ND EXAMPLE

Rose considered five different regional

groupings and four different income

groupings.

The results are easy to summarize:

the GSP remain economically and

statistically significant throughout while

the GATT/ WTO membership seems to

have a negligible (often negative)

effect.

The only exception is trade for South

Asia, where the GATT/WTO effect is

economically large but statistically

marginal.

FURTHER ROBUSTNESS CHECKS

Rose simplifies the description of further checks dividing them into threedifferent categories:

A) SAMPLE SENSITIVITY ANALYSIS

B) ESTIMATION SENSITIVITY ANALYSIS

C) DYNAMIC ANALYSIS

A) SAMPLE SENSITIVITY ANALYSISWhen we refer to the activity of sampling we mean the process in which a

predetermined number of observations are taken from a larger population.

Rose makes a division by Country groupings including:(a) industrial countries;(b) non-African countries;(c) countries outside Latin America and the Caribbean;(d) non-OPEC countries; (e) observations which exclude regional trade agreements;

Restricting the sample of countries to the industrial countries group only we can see for example that GATT/WTO Members trade only 60% more than non-Members, so that the result is not economically significant

NB: The GSP shows a positive effect once again.

B) ESTIMATION SENSITIVITY ANALYSIS

When we refer to the estimation analysis we mean the process of finding anapproximation the value of which is usable for purposes even if our data may becompletely uncertain

An example of this kind of estimation is given by the re-estimation of what have beenconsidered so far using five-year averages in place of annual observations

As a result, these estimates show that small poor countries are less likely to trade and also less likely to be GATT/WTO members.

NB: The GSP shows a positive effect once again.

C) DYNAMIC ANALYSIS

When we refer to the dynamic analysis we mean the process of testing and evaluatingdata showing the path of their change in different points of time

For this reason Rose reports and addition of a set of variables which are equal to 1 if Country i or Country j entered in the GATT/TWO at different stages. These stages are considered in 5, 10, 15 or 20 years ago.

As a result, in this case the final coefficients are positive but still lightly significant: Also with this dynamic analysis does not reveal an economically substantive role for

the GATT/WTO members

The main difficulty in practice is finding variables that are correlated with bilateral GATT/WTOmembership.

The author tried with two sets of instrumental variables:

• Measures of democracy and polity

• Measures of freedom, civil rights, and political rights

However, this cannot account for all unexpected behavior.

Missing data due to two main reasons:

• Missing trade data since trade cannot be less than zero

• Missing regressor data, primarily GD small, poor countries typically have their trade recordedbut are less likely to have national accounts data. Without GDP data, these observations aredropped from the regression analysis, seriously reducing the sample size in a non-randomway. The author chose not to use various Econometrics techniques that could have estimatedthe missing data

Chosen exclusion of these data points impact developing country results more and if included,could account for an analysis that favors WTO more.

AUTHOR’S AWARENESS OF LIMITATIONS

CONCLUSIONS

According to Rose, membership in the GATT/WTO does not seem to have an economically/statistically significant effect on trade, as his quantitative examination demonstrates that once standard gravity effects have been taken into account, bilateral trade cannot be dependably linked to being a member of the GATT/WTO.

However, he has found that the General System of Preferences (GSP) increases trade.

As an academic, Rose concludes that “it is surprisingly hard to demonstrate convincingly that the GATT and the WTO have encouraged trade.” However, even with these results, Rose is careful to addendum his harsh critique of the WTO with:

“Rather, since common sense and conventional wisdom accord an important role to the GATT/WTO in creating trade, I prefer to view this negative result as an interesting mystery”

...encouraging others to look on for further results.

Reason 1 - GATT/WTO has not forced most countries to lower trade. Typically, countries that encounter barriers, especially developing, have received special and differential treatment.

Reason 2 - Members of the WTO seem to extend most-favored-nation status even to countries outside the trade system, even when they are under no formal obligation to do so, and when doing so might lessen the benefits they receive from being in the WTO.

AREAS FOR FUTURE RESEARCH

Rose’s work: focus was on total trade

Future interests:

1) Industry-specific trade flow research –

• Trade is less successful in certain industries, such as textiles and agriculture

• Are there trade or other types of barriers such as knowledge transfer, amount of machinery, potential monopolies, socioeconomic factors on which countries are willing to perform the labor, that these industries face and could account for the loss

2) Import versus Export trade

3) Services versus Goods in Multilateral trade

4) Area/Development Index Rating-Specific research

• More in-depth research on poorer countries with lower GDP per capita because of the data biases that arise in many studies that don’t have access to formal records

• Implementation of multi-year studies in order to also implement record-keeping devices

5) Trade differences between formal and informal accession and membership to the WTO

CRITICISM OF ROSE

Critique of Rose’s Analysis by Nenci

• 1) Does not consider trade prior to implementation of the GATT/WTO

• 2) Does not consider difference between institutionalized and informal systems of trade

• 3) Does not consider differences between developed and developing countries

Other Criticisms of Rose

• According to some, Rose did not properly use fixed effects, excluding country-specific and relative trade costs in his gravity model equation, accounting for incorrect data sums

• Negative coefficients, while present in Rose’s robustness checks are not statistically significant

• Membership in WTO does not include all aspects of a country’s trade relationships and countries are not immediately required to change laws in relation to membership, a lag effect

• Rose only considers formal members of WTO, not any other actors

• Doesn’t consider countries that do not trade, leaving out zero and negative coefficients in the dataset (but author acknowledges this)

GENERAL CRITICISMS OF THE WTO:

Conflicts of Interest and Scale• Number of topics discussed and regulated through WTO are too numerous to effectively cover with a large, one

member, one vote system• Power players within the WTO still have the political power to unduly influence less prominant members towards

their goals• In other cases, because of the large membership, dissent is common and agreement on measures takes an

inordinate amount of time

Conflicts of Membership and Favoratism• Developing countries obtain many extra benefits such as bypassing patent regulations which can have a stymying

effect on innovation long-term because business profits are not protected• Does not force developing countries to change trade policy dramatically• Many countries extend most-favored nation status to outsiders, decreasing usefulness of WTO