Does the WTO matter?

Pushan Dutt, Ilian Mihov, Timothy Van Zandt, 1 May 2011

a

A

On 30 October 1947, the General Agreement on Tariffs and Trade (GATT) was signed between 23 countries. Since then, world exports of goods and services have grown rapidly, in nominal terms, in real terms, and in terms of share of world GDP.

Figure 1 shows that nominal world exports increased from $71 billion in 1948 to nearly $16 trillion in 2009. In terms of share of world GDP, exports doubled from 12% in 1960 to more than 24% in 2009, reaching a peak of 29% in 2008.

During this time, the GATT, and in its current incarnation, the WTO has formulated and implemented the rules of world trade.

  • The biggest overhaul of trading rules took place in the Uruguay Round of negotiations, from 1986 to 1994, which culminated in the creation of the WTO in 1995.

The agenda of GATT/WTO has been to promote trade by reducing trade barriers through multilateral agreements and by providing a venue for settling trade disputes.

Figure 1. 

From the 23 original signatories, the number of WTO members has grown to 153 countries, with an additional 30 countries currently granted observer status. They are currently in negotiations for WTO accession. Along with the expansion in membership, the rules imposed in favour of free trade have become broader and stronger, leaving aside the agricultural and textile sectors.

For any particular country, the event of joining the GATT/WTO typically represents the biggest one-time liberalisation of its trade. Joining the agreement both requires that the country reduces its own trade barriers and allows it to benefit from market access to other member countries.

The trade effects of membership

One would therefore expect that membership in the WTO is followed by a large expansion in trade, and that the WTO is an important institution for the growth of trade.

However, its raison d'être as the promoter of world trade was cast in doubt by a paper by Andrew Rose (2004). Rose found a negligible impact of WTO membership on the volume of bilateral trade flows between countries. Rose’s analysis of the data was exhaustive, but the findings were surprising enough that they spawned multiple follow-up attempts to validate or overturn Rose's result.

For instance, Subramanian and Wei (2007) show that the impact of GATT/WTO depends on what the country does with its membership, with whom it negotiates, and which products the negotiation covers.

  • Developing countries (e.g., India) enjoyed special exemptions in particular sectors (e.g., textiles) from the liberalisation of trade; once these exceptions are accounted for, Rose turns out to be wrong – the WTO does promote trade.

Tomz et al. (2007) argue that many countries are mistakenly classified as outside the GATT, even though they were de facto members with similar rights and obligations.

  • They show that Rose’s mis-coding of these countries as GATT members systematically underestimates the effect of GATT on trade flows.

Helpman et al. (2008), Felbermayr and Kohler (2005) and Liu (2009) take a different tack. They highlight the sample selection bias in the traditional formulation used to test the impact of the WTO. Many country pairs exhibit zero trade, which Rose’s empirical formulation ignored by examining only strictly positive trade flows.

  • Members of GATT/WTO have systematically more trading relationships; ignoring zeros underestimates the WTO’s effect on the volume of trade.

Meanwhile, a second stream of research built theoretical models of trade that emphasized firm-level productivity differences in trade patterns (the so-called ‘new new’ trade theory). These models (Eaton and Korum 2002; Melitz 2003) arose out of empirical work showing striking firm-level differences in trading behaviour. The data show that only a few firms export, only a few exporting firms sell to more than a few countries, and most exporters sell only a small fraction of their output abroad. Moreover, exporting behaviour is positively associated with productivity and size. (Bernard and Jensen 1995, Bernard and Jensen 1999, Bernard and Jensen 2004, Aw et al. 2000, Eaton et al. 2004).

Incorporating firm-level heterogeneity, and modelling firms’ decisions to export, leads to a reassessment of the role of trade liberalisation. Trade liberalisation, by inducing exit and entries of firms, changes the extensive margin of trade – the introduction of new commodities and the retirement of old ones. These models also show that differences in bilateral trade flows reflect both differences in the amount of each good traded (the intensive margin of trade) as well as differences in the number of goods traded (the extensive margin of trade).

The importance of this extensive margin was also documented by Hummels and Klenow (2005). They showed that larger countries export more varieties of goods rather than larger quantities of each good. On the import side, Broda et al. (2006) find that it is mainly the variety of imports that matters rather than the volume of imports for productivity growth.

New work showing how WTO membership matters

Our paper (Dutt et al. 2011) attempts to bring together these two strands in the literature – the importance of the extensive margin and the WTO’s role on trade flows between pairs of countries. We decompose the volume of trade into an extensive and an intensive margin and analyse the impact of WTO membership on each of the margins.

Figure 2 shows the importance of the extensive margin (i.e. the change in trade due to the change in the number of trading links, counting each product shipped to a particular market as one link) and the intensive margin (i.e. the average sales across all links); the focus is on the evolution of trade over the period 1970-1999.1

  • Line 1 shows the aggregate real volume of exports over time for country pairs that had strictly positive exports in 1970.
  • Line 2 shows the evolution of trade volume between these country pairs in sectors where there was positive trade in 1970.

We can think of this as the intensive margin of trade.

  • The difference (plotted as Line 3) shows the evolution of trade in sectors where there was zero trade at the beginning of the period within the set of countries that traded with each other in 1970.

Line 3 captures the evolution of the extensive margin of trade.

Figure 2 strongly suggests that from the 1980s onwards, trade in sectors that these countries already had positive trade in 1970 remains relatively flat. At the same time, the growth in the overall trade volume is closely mirrored by the expansion of trade in new products, i.e. at the extensive margin.

Figure 2.  

WTO membership matters for the extensive margin

Our empirical results show that WTO membership has been instrumental in raising the varieties of goods exported (the extensive margin) while its impact on trade in existing varieties (the intensive margin), is insignificant and even negative in a few cases. In our most demanding specification (with time-varying importer and exporter country dummies) we find that the WTO raises the extensive margin by 42% when we measure the extensive margin as a simple count of the number of varieties exported. If we use the more micro-founded Hummels-Klenow measure of the extensive margin, which calculates the fraction of goods sold by the exporter in a particular destination but weights each product by its importance in world exports to this destination, then WTO membership raises the extensive margin by 29%. Interestingly, the impact of the WTO on the intensive margin (exports of existing varieties) is negative.

This suggests that even with the expansion in the variety of exports, the total volume of exports might hardly change – a result consistent with Rose’ findings.

The negligible impact on the intensive margin is at odds with the predictions of some of the “new new” trade models (e.g. Melitz 2003) where trade liberalisation affects both intensive and extensive margins.

A conjecture

An intriguing possibility raised by our research is that the WTO is not at all about reducing trade barriers, variable or fixed. Rather it serves to resolve uncertainty in the mind of potential exporters regarding the evolution of international trade rules. This in turn may increases their willingness to bear the fixed costs of exporting newer products into newer markets. As far as we know, none of the standard models in the “new new” trade literature explicitly model uncertainty, and this has the potential to be a promising area of future research.

References

Aw, Bee Yan, Sukkyun Chung, and Mark J Roberts (2000), “Productivity and Turnover in the Export Market: Micro-Level Evidence from the Republic of Korea and Taiwan (China)”, The World Bank Economic Review, 14(1),65-90.

Bernard, Andrew B and J Bradford Jensen (1995), “Exporters, Jobs, and Wages in US Manufacturing: 1976–1987”, Brookings Papers on Economic Activity. Microeconomics:  67-119.

Bernard, Andrew B and J Bradford Jensen (1999), “Exceptional Exporter Performance: Cause, Effect, or Both?”, Journal of International Economics, 47:1-25.

Bernard, Andrew B and J Bradford Jensen (2004), “Why Some Firms Export”, The Review of Economics and Statistics, 86(2):561-569.

Broda, Christian M, Joshua E Greenfield, and David E Weinstein (2006), “From Groundnuts to Globalisation: A Structural Estimate of Trade and Growth”, NBER Working Paper No.W12512.

Dutt, Pushan, Ilian Mihov, and Timothy Van Zandt (2011), “Does WTO Matter for the Extensive and the Intensive Margins of Trade?”, CEPR Discussion Paper 8293.

Eaton, Jonathan, Samuel Kortum, and Francis Kramarz (2004), “Dissecting Trade: Firms, Industries, and Export Destinations”, The American Economic Review, 94(2): 150-154.

Eaton, Jonathan and Samuel Kortum (2002), “Technology, Geography, and Trade”, Econometrica, 70(5):1741-1779

Felbermayr, Gabriel J and Wilhelm Kohler (2006). “Exploring the Intensive and Extensive Margins of World Trade”, Review of World Economics, 142:642–674.

Helpman, Elhanan, Marc Melitz, and Yona Rubinstein (2008). “Estimatng Trade Flows: Trading Partners and Trading Volumes”, Quarterly Journal of Economics, 123(2):441-487.

Hummels, David and Peter J. Klenow (2005). “The Variety and Quality of a Nation’s Exports”, American Economic Review, 95(3),704-723.

Liu, Xuepeng (2009), “GATT/WTO Promotes Trade Strongly: Sample Selection and Model Specification”, Review of International Economics, 17(3):428-446.

Melitz, Marc J (2003), “The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity”, Econometrica, 71:1695-1725.

Rose, Andrew K (2004), “Do We Really Know That the WTO Increases Trade?”, American Economic Review, 94:98-114.

Subramanian, Arvind and Shang-JinWei (2007). “The WTO promotes trade, strongly but unevenly”, Journal of International Economics, 72(1):151-175.

Tomz, Michael, Judith L Goldstein, and Douglas Rivers (2007). “Do We Really Know That the WTO Increases Trade? Comment”, The American Economic Review, 97(5): 2005-2018.


1 The data are based on the 4-digit Standard International Trade Classification, revision 2, with 790 4-digit level product categories and accounts for 98% of all world trade.

Topics: International trade
Tags: Doha Round, WTO

Comments

A Note to “Does the WTO matter?”

Recently, in their article titled “Does the WTO Matter?”, appeared in VOX on the 1st of May 2011, Dutt, Mihov and Van Zandt open to a new line of research with the following conjecture “An intriguing possibility raised by our research is that the WTO is not at all about reducing trade barriers, variable or fixed. Rather it serves to resolve uncertainty in the mind of potential exporters regarding the evolution of international trade rules. This in turn may increase their willingness to bear the fixed costs of exporting newer products into newer markets. As far as we know, none of the standard model in the “new new” trade literature explicitly model uncertainty, and this has the potential to be a promising area of future research”.

With our note, we would like to draw the attention on some recent contributions in the literature which investigate into this research direction and seem confirming this conjecture.

The starting point of Sala, Schröder and Yalcin (2010) is that negotiations and commitments within the WTO do not regard applied rates, rather the bound rate, which constitutes the ceiling rate above which countries commit not to raise their applied duties (Bchir et. al., 2006). The implication is twofold. First, the difference between applied and bound rate - technically referred as the “tariff-overhang” - varies substantially across products and countries and can be substantial (Evenett, 2007). Second, negotiations for the reduction of bound rates may in practice command no reduction of the applied rates. This paper - based on a modeling approach of the “new new” trade theory - focuses on how the negotiation effort within the WTO in terms of bound rates can command market access, even if applied rates result unchanged. However, the argument presented is relevant to explain also how the nature of this negotiations can affect differently the intensive and the extensive margin of trade, as found by Dutt et al. (2011).

The intensive margin of trade refers, in the terminology used by Dutt et al., to existing trade links, trade relations which are already in place. To observe a change in an existing trading relation, the domestic price or the international price of the commodity should change. But if a reduction in the bound rate can leave unaltered the applied rate, prices will also be unaffected. On the contrary, the extensive margin refers to “‘new links”, new trade transactions, comprising the cases of new varieties exported to existing or new markets or existing varieties exported to new markets. In all cases, the situation involves entry of a new firm either in a new market or with a new product: the profitability of such a strategy depends clearly on the expected protection rate and therefore on plausible future tariff reversions. The tariff-overhang acts as a ceiling to the risk of such an occurrence in two ways. It effectively limits the future possible increment of a tariff and, there where the overhang is small, makes the likeness of the tariff increase more negligible. Therefore, even if current rates remain unchanged, negotiations in terms of bound rates that reduce the overhang are affecting the extensive margin of trade, but not the intensive margin of trade.

While Sala et al. (2010) offer some numerical simulations for the market access implications of the reduction of bound rates, they do not validate this channel empirically. This is the aim of Handely and Limão (2010) who develop a similar independent model and test it empirically to the case of Portugal’s accession to the European Community in 1986. According to the authors, the Portugal case shares indeed a number of similarities with a developing country committing to the bound system within the WTO. In the case of Portugal, firm’s entry was strongest in those industries characterized by greater uncertainty prior to EC entry, in line with the implications of the theory above outlined.

References

Bchir, M. H., Jean, S. and Laborde, D. (2006). Binding overhang and tariff-cutting formulas, Review of World Economics, 142, 2: 207–232.
Evenett, S. (2007). Reciprocity and the Doha Round impasse, lessons for the near-term and after. Aussenwirtschaft (4)
Handley, K. and Limão N. (2010). Trade and investment under policy uncertainty: theory and firm evidence. Mimeo, University of Maryland.
Sala, D., Schröder, P., and Yalcin, E. (2010). Market access through bound tariff. Scottish Journal of Political Economy 57 (3): 272-289.
 

Associate Professor of Economics and Political Science at INSEAD
Ilian Mihov
Professor of Economics, Novartis Chaired Professor of Management and Environment and Dean of Research, INSEAD
Timothy Van Zandt
Professor of Economics and Shell Fellow of Economic Transformation, INSEAD

Vox Talks