THE WORLD TRADE ORGANIZATION (WTO)

The World Trade Organization has become the primary multilateral forum through which
governments conclude trade agreements and settle associated disputes.
A. GATT: The Predecessor to the WTO
The General Agreement on Tariffs and Trade (GATT) was established in 1947 by
twenty-three nations as a multilateral agreement whose objective was to abolish quotas
and reduce tariffs.
1. Trade without Discrimination. The fundamental principle of trade without
discrimination was embedded in the most-favored-nation (MFN) clause, i.e., the
principle that each member nation must open its markets equally to every other
member nation. Several major rounds of negotiations from 1947 to 1993 led to a
wide variety of multilateral reductions in both tariff and nontariff barriers. At the
conclusion of the Uruguay Round in 1994, the World Trade Organization was
created in 1995 for the purpose of institutionalizing the GATT.
B. What Does the WTO Do?
The World Trade Organization (WTO) was founded in 1995 as a permanent world
trade body for the purposes of (i) facilitating reciprocal trade negotiations and (ii)
enforcing trade agreements between or among member nations. The WTO adopted the
principles and agreements reached under the auspices of the GATT, but it expanded its
mission to include trade in services, investment, intellectual property, sanitary
measures, plant health, agriculture, textiles, and technical barriers to trade. Currently
the 150 member countries of the WTO collectively account for more than 97 percent of
the value of world trade. Major decision-making units include: the Ministerial
Conference, the General Council, the Council for Trade in Goods, the Council for Trade
in Services, and the Council for Trade-Related Intellectual Property Rights (TRIPS).
1. Normal Trade Relations. The WTO replaced the GATTs most-favored-nation
(MFN) clause with the concept of normal trade relations, which prohibits any sort
of trade discrimination. With the following exceptions, it restricts this privilege to
official members:
Developing countries manufactured products have been given preferential
treatment over those from industrial countries.
Concessions granted to members within a regional trading alliance, such as the
EU, have not been extended to countries outside the alliance.
Exceptions can be made in times of war or international tension.
2. Dispute Settlement. Under the WTO there is now a clearly defined mechanism
for the settlement of disputes. Countries may bring charges of unfair trade
practices to a WTO panel; accused countries may appeal; WTO rulings are binding.
If an offending country fails to comply with a judgment, the rights to compensation
and countervailing sanctions will follow. The Doha Round began in Doha, Qatar
in 2001 to address disputes between developed and developing nations. Issues
surrounding agricultural subsidies have been particularly difficult.

III. THE RISE OF BILATERAL AGREEMENTS

Currently, bilateral agreements, also known as preferential trade agreements (PTAs) (and
also referred to by some as free trade agreements (FTAs)) are sometimes negotiated by
 partner nations as a way to circumvent the multilateral trading system and meet their mutual
trading objectives.

IV. REGIONAL ECONOMIC INTEGRATION

Regional trade agreements or RTAs involve multiple countries engaged in the process of
economic integration. Neighboring countries tend to ally with one another because of their
proximity, their somewhat similar tastes, the relative ease of establishing channels of
distribution, and a willingness to cooperate with one another for the greater benefit of the
allied parties. The two basic types of regional economic integration that address barriers to
trade are:
Free Trade Agreements, in which all barriers to trade, i.e., tariff and nontariff barriers,
are abolished among member nations, but each member determines its own external
trade barriers with non-FTA countries.
Customs Unions, in which all barriers to trade, i.e., tariff and nontariff barriers, are
abolished among member nations, and common external barriers are levied against non-
member countries.
1. Common Market. When moving beyond the reduction of tariff and nontariff
barriers, a common market may be created, allowing for the free flow of capital and
labor. It may go even further by harmonizing commercial, monetary, and fiscal
policies and establishing a common currency, plus a supranational political structure
dedicated to dealing with common economic issues.
A. The Effects of Integration
Regional economic integration can affect member countries in social, cultural,
economic, and/or political ways. (MNEs are, or course, particularly interested in the
economic effects.)
1. Static and Dynamic Effects. Static effects represent the shifting of resources
from inefficient to efficient firms as trade barriers fall. Dynamic effects represent
the gains from overall market growth, the expansion of production, the realization of
greater economies of scale and scope, and the increasingly competitive nature of the
market. Static effects may occur when either of two conditions occurs [See Fig 8.1]:
a. Trade creation. Trade creation occurs when production shifts from less
efficient domestic producers to more efficient regional producers for reasons of
absolute or comparative advantage.
b. Trade diversion. Trade diversion occurs when, as a result of the imposition
of common external barriers, trade shifts from more efficient external sources to
less efficient suppliers within the group. (When lower cost, externally-sourced
products are suddenly confronted by trade barriers, the effective delivered cost
of those products increases; thus, the quantity that can be purchased for a given
amount of money is reduced.)
Dynamic effects of integration occur when trade barriers come down and the
size of the market increases. Because of the larger size of the market,
competitors are able to reduce their unit costs by capturing economies of
scale. As a result, customers gain access to a wider variety of lower cost, higher
quality products. Another important effect of the FTA is the increase in
efficiency due to increased competition.
 MAJOR REGIONAL TRADING GROUPS
Trading groups can be organized by type and/or location. Firms are interested in regional
trading groups because they can serve as potential markets, sources of raw materials, and
production locations.
The European Union
The European Union (EU) represents the most advanced regional trade and investment
group in the world today.
1. Predecessors. The EU evolved from the European Economic Community (EEC)
to the European Community (EC) to the European Union (EU). [Key milestones are
summarized in Table 8.1.] The European Free Trade Association (EFTA) consists of
Iceland, Liechtenstein, Norway, and Switzerland; all but Switzerland are linked to
the EU via a customs union.
2. Organizational Structure. Detailed information on the history, structure, and
function of the EU is available on its extensive website. [See Map 8.1.]
a. Key Governing Bodies. The European Commission provides the EUs
political leadership and direction; it consists of commissioners appointed by
member countries for five-year renewable terms. The commission is
responsible for proposing EU legislation, implementing EU legislation, and
monitoring compliance with EU laws by member nations. The European
Council is composed of representatives from the government of each member
country. The Council is responsible for passing laws and making and enacting
major policies. Composed of 785 members (allocated on the basis of country
population) elected every five years, the European Parliament has three major
responsibilities: legislative power, control over the budget, and supervision of
executive decisions. Parliament considers legislation presented by the
European Commission; if the legislation is approved, it is then submitted to the
European Council for final adoption. The European Court of Justice ensures
consistent interpretation and application of EU treaties. Dealing mostly with
economic matters, it serves as an appeals court for individuals, firms, and
organizations fined by the commission for infringing upon Treaty Law.
3. The Single European Act. The EU has been moving toward a
single market ever since the passage of the Single European Act. It is designed to
eliminate any remaining nontariff barriers to trade in Europe.
4. Monetary Union: The Euro. The Treaty of Maastricht, signed in 1992, sought to
foster both political and monetary union within the EU. While the move toward a
common currency has partially eliminated different currencies as a barrier to trade,
not all members have adopted the euro. (Members adopting the euro at the time of its
launch on January 1, 1999, were Austria, Belgium, Germany, Finland, France,
Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain; Greece followed
suit on January 1, 2001. Slovenia adopted the euro on January 1, 2007. Of the 15
members of the EU prior to the expansion in 2004, only the UK, Denmark, and
Sweden elected not to adopt the euro.) Now one of the most widely traded currencies
in the world, the euro facilitates price transparency for customers and eases pricing
decisions and transaction reconciliations for firms.
5. Expansion. The EU expanded from 15 to 25 countries in 2004 by admitting
countries primarily from central and eastern Europe. [See Map 8.1.] Although this
 expansion increased the EUs population and added to its economic output, the
integration of such disparate countries will not be easy [See Table 8.2]. Most are
poor, agriculturally-based, newly democratized economies which, when taken
together, will seriously strain the EUs financial resources. Another challenge is the
issue of governance, because economically large members of the EU fear that the
addition of so many new countries will weaken their control and influence. In 2007,
the EU increased its membership by two additional countries Romania and
Bulgaria, bringing the total number of member states to twenty seven.
6. Bilateral Agreements. The European Union has signed numerous bilateral trade
agreements with other countries outside Europe. In addition, the EU has entered into
an agreement with the European Free Trade Association (with the exception of
Switzerland) to form the European Economic Area (EEA).
7. How to do Business with the EU: Implications for Corporate Strategy.
There are at least three ways in which the competitive strategies of foreign firms that
choose to do business within the EU are affected. First, they must determine their
production site location(s) on the basis of total costs that include labor, transportation,
and other strategic factors. Second, foreign firms must decide upon an entry strategy,
i.e., new investments, expanding existing investments, or joint ventures and mergers.
Third, firms must be sensitive to essential national differences, particularly in areas
such as economic growth rates and cultural traditions. In addition, the trade-offs
between the advantages of pan-European strategies and more localized strategies
must be continually examined.