February 25, 2020
Like many professional fields, trade has a special language all its own. However, unlike some that use actual words, trade is a language of acronyms: WTO, GSP, AD/CVD, TAA, TPA, TTIP, USMCA, and on and on. One of the more interesting ones, and the subject of today's column, is MFN, which stands for "most favored nation."
One of the things that makes this acronym interesting is that its meaning is not obvious even if you know what the letters stand for. Is there a most favored nation? If so, which one is it? What does it mean to be most favored? It certainly sounds like a good thing, but is it really? The answer is none of the above. It simply means that under World Trade Organization rules, a trade concession given to one must be given to all. (Of course, there are always exceptions in trade rules, and they will be discussed below.) The idea was to promote both trade liberalization and trade certainty. By requiring concessions to be given to all WTO members, the benefits of trade liberalization were spread more broadly, and there was more uniformity and clarity in the system. If a country's auto tariff was 10 percent, then it was 10 percent for all members.
This worked pretty well for the first 60 years, but lately the rule has come under increasing pressure both internally and externally. Internally, the exceptions risk swallowing the rule. The biggest one is for regional or bilateral trade agreements. In those, like the United States-Mexico-Canada Agreement, the parties are allowed to deviate downward from their normal tariffs and give members of the agreement a better deal so long as the agreement covers "substantially all trade." Many of the agreements do not meet that condition, but so far there have been few complaints and no enforcement. These agreements have also been justified on the basis of promoting more trade liberalization, although cynics have pointed out that they may cause more trade diversion than expansion as supply chains shift away from countries outside the agreement to countries inside it. Recent growth in the number and breadth of trade agreements have made this a bigger problem than it used to be.
The other exception—the right to increase tariffs selectively to combat unfair trade practices like dumping or subsidization—also seems to be growing in use. These cases often make the headlines, but until the Trump administration came along, they consistently affected only a small percentage of global trade.
The new external threat comes from the United States, where there is a rumor the administration will seek to renegotiate its tariff schedule in order to promote reciprocity. The president has talked about this. He seems to believe that tariff differences between nations disadvantage the United States. The example cited most often is auto tariffs, where the United States’ is 2.5 percent and the European Union's is 10 percent. It appears he would like to match their 10 or have them match our 2.5. For other countries where it is less than 10, the United States’ would be lower as well. This is a terrible idea that would destroy the trading system we have painfully built up over the past 70 years. It would also cost the United States a lot. Its auto tariff is 2.5 percent because it got concessions from other countries for lowering it. If the United States wants to raise it, it will have to pay—WTO rules require compensation if it wants to negotiate a higher rate. The United States could avoid payment by leaving the WTO, but then other nations would have no restraints on their retaliation against it and it would be worse off.
Terrible idea though that is, it makes us think seriously about the continuing relevance of MFN. It was designed for a world where multilateral trade negotiations were standard procedure, as they were for a long time. One can argue that is no longer true. In the wake of the Doha Round's failure, we seem to be moving to a world of plurilateral and bilateral negotiations. This is second best but better than nothing. Discussions about the WTO's future inevitably include the concept of a two-track system, where countries who want more ambitious trade liberalization—coalitions of the willing—can go ahead and do that while the others remain behind, just watching. That would be the final nail in the MFN coffin, but it may make the most sense for us to recognize that and not cling too tightly to a great idea whose time has passed. That would, however, be different from Trump's rumored approach both because the goal remains trade liberalization through reduction of barriers, albeit on a smaller scale, and because the United States would not have to pay compensation for it. Any new concessions it makes would be matched by those of others.
The path of WTO reform may not ultimately move in that direction, and we should not write off MFN if there is still life in it. But it is currently on life support, and eventually we will have to decide if it is worth trying to save or whether it is best interred along with the other artifacts of the twentieth century.
William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.
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