for transborder commercial relations.
While it is not surprising that the Second World War’s human atrocities led to stronger rights of the individual in the form of human rights treaties, it is not quite so intuitive that the war’s nightmares also inspired economic change. The connection that world leaders perceived between the inferno that the world had just experienced and future economic policy among nation states was the severe inward turn toward protectionism during the late-1920s Great Depression. Leaders traced protectionist policies directly to the rise of fascist regimes in nations isolated after the First World War. The initial economic instrument, the General Agreement on Tariffs and Trade (GATT), was seriously flawed. Critics noted aptly that it possessed neither sheriff nor jail, yet it succeeded in bringing together in a single document the basic rules to be applied when countries wished to restrict the free flow of goods across borders.
The general rule was that trade was to be unrestricted, except in the specified situations, and under the enumerated conditions, described in the treaty. The exceptions included tariffs—border taxes—that the rules permitted Members to charge on a product’s importation. Other exceptions to unhindered trade involved the kinds of licenses with which Members could limit imports, the technical standards to which they could subject products, and the proper remedy for “unfairly traded” imports—dumped and subsidized goods.
In 1995, almost half a century after the historic Bretton Woods meeting, trade ministers created the WTO as the umbrella organization to administer the nearly two dozen agreements that became annexes to its Charter. This marked completion of the process begun by the GATT to form both a central organization to administer global trade rules and a dispute settlement system to interpret them. Because of the WTO, and the seven wideranging rounds of multilateral GATT trade negotiations that preceded its creation, detailed WTO Agreements now provide an elaborate set of rules spanning a broad range of subjects to govern how Members must act in the global marketplace. Negotiators prescribed rules for trade in agriculture and in textiles and for national laws governing subsidies, dumping, intellectual property rights, investment, and customs procedures applied at the border. Ministers established detailed procedures for “safeguard” actions that Members may take temporarily to protect domestic industries from import surges, for border protections against unsafe or unsanitary products, and a separate agreement governing the mushrooming trade in services.
2.2 Economic Underpinnings: Comparative Advantage
(A) Introduction
World trading rules are based on the concept of comparative advantage, described by British economist David Ricardo at a time nearly two hundred years ago when the sun never set on the British Empire. How does this theory help us understand why nations will export some products and import others, rather than simply producing all products domestically, which would render unnecessary any international trade?
(B) Absolute Advantage
In 1776 in The Wealth of Nations, Adam Smith introduced the theory of absolute advantage that set the stage for Ricardo’s brilliant and powerful further observation forty years later.2 Adam Smith analogized an individual worker to a country: If Worker A is more skilled than Worker B at making coats, and Worker B is more skilled than Worker A at making shoes, then Worker A will sell coats to Worker B and use the proceeds to purchase shoes from Worker B, rather than making both coats and shoes. It is cheaper—that is, more economically efficient—for Worker A to do so. We may say that Worker A has an absolute advantage over Worker B in the production of coats. By the same logic, Worker B has an absolute advantage over Worker A in the production of shoes.
Analogously, if Country A’s climate is ideally suited for growing grapes, but its workforce is not sufficiently trained to assemble computer chips, whereas Country B has a highly trained labor force but is located in the far North—a climate unwelcoming to grapes—we may say that Country A has an absolute advantage, in relation to Country B, in the production of wine. Country B has an absolute advantage over Country A in the production of computer chips. Therefore, Country A should not make both wine and computer chips. Country A will find that it is “cheaper” to export wine to Country B in order to earn the foreign exchange needed to buy Country B’s computer chips. In this way, the income of both countries will be highest.
In transitioning to Ricardo’s comparative advantage, it is important first to define “cheaper” in economic terms: Country A’s “opportunity costs” are lower. Opportunity cost describes the trade-offs that a country makes in choosing to produce with its finite resources one product instead of another; we may think of them as lost opportunities. So when we say that it is “cheaper,” or economically more efficient for Country A to produce wine rather than computer chips, we mean that Country A’s opportunity cost for making wine is lower than its opportunity cost for making computer chips. Country A will make fewer trade-offs in the production of wine than in the production of computer chips. Country A will use fewer of its finite resources.
(C) Comparative Advantage
To introduce David Ricardo’s contribution to the economics of trade, we may begin with a famous example used by economist Paul Samuelson to help us understand the comparative aspect of the theory. Suppose that a lawyer has created a court submission that must be typed and that she is a faster typist than any secretary she could hire. To use Adam Smith’s terms, she has an absolute advantage in both legal and typing work. Even though she could type the submission faster than could a secretary, the theory of comparative advantage tells us that the lawyer nonetheless should hire a secretary. Why? Because the value created by her legal services is greater than the value created by her typing services.
The opportunity cost, or trade-off, that she would make by spending an hour typing is the three hundred dollars that she could earn by performing legal work, which is greater than the opportunity cost of spending that hour on legal work (she has “lost” the lower value of secretarial earnings). Even though the attorney has an absolute advantage, then, in typing—she is faster at typing than anyone she could hire—and thus the typing will be slower, the total value created by the legal office will be greater if the lawyer sticks to her legal work. Translating this concept to international trade means that if each country produces only those goods in which it has a comparative advantage, nations together will create greater world wealth. Trade allows countries to specialize in the goods and services in which they are the most efficient producers. Such specialization will raise the gross domestic products (GDPs) of all trading partners. Consumer standards of living for this reason are higher in an atmosphere of open trade than when government measures artificially restrict trade.
Another example demonstrates that in a world of perfectly competitive markets, trade will be beneficial to countries whenever there are relative differences in costs of production. In Country A, one hour of labor produces six bushels of wheat or four bushels of corn. In Country B, that hour results in one bushel of wheat or two bushels of corn. Using only Adam Smith’s observations, we would conclude that Country A has an absolute advantage as to Country B in the production both of wheat and of corn. Does this mean that trade cannot benefit Country B at all and that it should simply leave production of wheat and corn to Country A? Because of David Ricardo, we know that the answer is no, because Country A’s absolute advantage in wheat production (six bushels to one) is greater than its absolute advantage in corn production (four bushels to two). In other words, Country A has a comparative advantage in wheat as compared with corn.
What may we conclude about Country B? Of course, Country B is at an absolute disadvantage as to both wheat and corn, but its labor force is one-sixth as productive as to wheat and one-half as productive as to corn. That is, Country B has a comparative advantage, in relation to Country A, in the production of corn. According to the principle of comparative advantage, both countries will benefit if Country A trades its wheat for Country B’s corn.
2.3 Four Pillars of GATT
(A)
