Lecture 9: WTO and trade

policy changes 1

Björn Brey
ECN434 9.2.2026
Trade policies: What, how and why?

What is trade policy?

How does it work?

Why use trade policies?

The common case: Ad-valorem tariff rate

What are the implications on?

e.g. Domestic production, Domestic and foreign prices, Domestic demand

Might implications be different if Switzerland or the US introduces the tariff?

 International trade policy games

• Trade protection in one country

normally hurts other countries (and the
world as a whole), no matter what the
reason for the protection is.
• Other countries may retaliate or for
other reasons introduce their own
trade policies.
• The result may be a “trade policy
game”, in which each country tries to
react to the trade policy choices of
other countries.
International trade policy game
When one country gains and the other loses from policy, the outcome may typically be
a policy game – as in this simple example:
• Assume
- 2 countries (H and F)
Stylized payoff matrix - 2 policy options each
• free trade, t = 0
• optimal tariff, t = t*
Home
- Typical effects
• gain from own policy
t=0 t = t* • lose from the other country’s policy
Foreign

t=0 100 110

100 70
70 80
t = t* 110 80
International trade policy game
When one country gains and the other loses from policy, the outcome may typically be
a policy game – as in this simple example:
• Assume
- 2 countries (H and F)
Stylized payoff matrix - 2 policy options each
• free trade, t = 0
• optimal tariff, t = t*
Home
- Typical effects
• gain from own policy
t=0 t = t* • lose from the other country’s policy
Foreign

t=0 100 110

100 70
Non-cooperative equilibrium ?
70 80 • Both countries choose to protect
t = t* 110 80 ➢ even if free trade is better for all
(and they know it)
• Need binding agreement to get free trade
The need for trade agreements
• Conclusions from trade theory
- Free trade is best for the world.
- Countries may for some reason find it beneficial to limit trade.
- When many countries limit trade we may end up with the “worst possible” solution.

• Trade policy game

- Binding international agreements are necessary to ensure the best possible solution in the trade policy game
(Prisoners´ dilemma).

• Problem (or challenge):

- International cooperation must be based on voluntary participation; hence an agreement must be so good that
all parties find it beneficial to take part in.

• Two types of international cooperation

- Global agreements (GATT, GATS, WTO)
- Regional trade agreements (RTA) and Preferential trade agreements (PTA)
 The World Trade Organization (WTO)

• The World Trade Organization (WTO) is an international organisation dealing with

the global rules of trade between nations
• Established in 1995
• But its trading system goes back to 1947 when the General agreement on tariffs
and trade (GATT) where established.
- The idea was to establish an International Trade Organisation (ITO) after World War II,
in line with other multilateral organisations, but the initial agreement was not ratified.
- The alternative was to establish the GATT agreement, but not an organisation.
 WTO – key elements

Builds on several agreements • General principles

➢ GATT – General agreement on tariffs and trade ➢ Non-discrimination
✓ National treatment
➢ GATS – General agreement on ✓ Most favoured nation (MFN)
trade in services principle
➢ TRIM – Trade related aspects of ➢ Reciprocity
investment measures ➢ Transparency
➢ TRIPS – Trade related aspects of intellectual • Dispute settlement mechanism
property rights ➢ Member countries in a trade
- Includes rules for copyright, dispute can bring their case to a
computer programs, trademarks, WTO panel of experts to rule.
patents, geographical indications.
• Trade policy review mechanism
➢ Ensures transparency
Previous GATT rounds and
results
Round Year Number of member Average tariff reduction
countries (manufactures)

Geneva 1947 19 countries 18.9

Annecy 1948 20 countries 2.0
Torquay 1950 33 countries 3.0
Geneva 1956 35 countries 2.4
Dillon 1960 - 61 40 countries 4.0
Kennedy 1964 - 67 74 countries 35.0
Tokyo 1973 - 79 84 countries 29.6
Uruguay 1986 - 93 125 countries 30-40
Doha (WTO) 2001 - ?? 164 countries not yet completed
 If so many countries joined the WTO
why are there still so many different tariff rates?
• Countries can have different tariff levels in the WTO.
• Bound tariffs = legal ceilings.
• Applied MFN tariffs = what firms actually pay (often lower).

• MFN does not require Norway and India to have the same
tariff. It requires Norway to treat WTO partners equally in
its own tariff.

• Free trade agreements: Allowed under GATT Article XXIV,

letting members grant each other preferential tariffs inside
an FTA/customs union.
The implications of tariff reform in practice!

• We discussed infant industry protection.

• India being one famous example (License Raj)

• Today we are going to look at (forced) trade reforms:

• India's Trade Liberalization in the 1990s

• What were its effects? Did it lead to growth? Inequality?

Opening up to trade
 Background: India before 1991
• Closed, inward-looking economy with License Raj.
• High tariffs and import substitution. State-led industrialization.
• But more imports than exports.
• Collapsing export market due to fall of Soviet Union.
• Gulf war increased oil prices (a key import).
• Sluggish GDP growth rate.
• High fiscal deficit and external debt in the 1980s.
• Twin deficit: Foreign exchange and balance of payment crisis in 1991.
 Background: Crisis 1991
• Foreign exchange reserves fell below 2 weeks of
imports.

• High inflation (over 13%).

• IMF and World Bank stopped support.

• Conditions imposed by IMF and World Bank for

further support (in line with Washington
Consensus).

• $7 billion loan from IMF (with Indian gold

reserves as security)
 Background: Trade Liberalization Reforms
• Reduction of tariffs (from >50% to ~20% by late
1990s).

• Abolition of quantitative restrictions (import quotas).

• Devaluation of the rupee to boost exports.

• Promotion of exports via incentives.

• Encouragement of FDI and opening sectors to private

firms.
 Industrial policy reforms: Details
•List of industries reserved for the public sector drastically slashed
• From 18: industries, including iron and steel, heavy plant and machinery, telecommunications and telecom
equipment, minerals, oil, mining, air transport services and electricity generation and distribution.
• To 3: defense aircraft and warships, atomic energy generation and railway transport.

• Industrial licensing by central government was reduced.

• Monopolies and Restrictive Trade Practices Act was abolished and replaced
by new competition law.

•But only slow opening up of reservations for small enterprises: 14 items were
removed from the reserved list in 2001, and another 50 in 2002.

•Many state level differences in policy remained.

 Trade policy reforms: Details
• Severe tariff-rate cuts during the period in 1991.
• By 1991 imports of manufactured consumer goods were completely banned.
• Certain lists of goods were freely importable, but for most items where domestic substitutes were
being produced, imports were only possible with import licenses.

• Abolished for capital goods and intermediates in 1993.

• Possible due to shift to flexible rate as import licensing no longer necessary to preserve balance of
payments.

• Removing quantitative restrictions on imports of capital goods and intermediates was relatively easy,
because the number of domestic producers was small and Indian industry welcomed the move as
making it more competitive.

• Only much later, restrictions on manufactured consumer goods and agricultural products were
removed (April 1, 2001). Due to World Trade Organization complaint brought by the United States.
Effect on economic growth?
Growth by sector (see Ahluwalia 2002)
Overview of 2 research papers on the issue

•1) On intermediate input liberalization as engine of

manufacturing growth
•“Imported intermediate inputs and domestic product
growth: Evidence from India” by Goldberg et al 2010 (QJE)

• 2) The effect on inequality.

•“Factor Immobility and Regional Impacts of Trade
Liberalization: Evidence on Poverty from India” by
Topalova 2010 (AEJ:Applied)
“Imported intermediate inputs and domestic product growth:
Evidence from India” by Goldberg et al 2010 (QJE)

•They use detailed trade and firm-level data to investigate

the relationship: declines in trade costs -> imports of
intermediate inputs -> domestic firm product scope.

•Lower input tariffs account for 31% of new products

introduced by domestic firms.

•Mechanism: Access to new input varieties unavailable

beforehand.
The diversifying effects of free trade
Take-aways:

Import growth highest

for intermediate
products (col 1)

Many new varieties

introduced, esp.
intermediate (col 3)

Intensive margin growth

for intermediate and
final product (col 5)
Overall increase in imports
Take-aways:

Tariff reduction increased

imports (col 1).

Similar effects on overall value

of imports of intermediate and
final goods (col 2-3)

Important: Here tariff refers to the tariff rate at point t in time!

But mainly diversification in intermediate goods

Take-aways:

Underlying dynamic of
increase in imports different
for intermediate and final
goods.

Variety of goods increasing

mainly for intermediates (col
2).

Little extensive margin effect

for final goods (col 3).
Impact on type of produced goods
Take-aways:

Declining costs of
input imports
increased firm product
variety (row 1)

No effect of increased
foreign competition on
variety of products
(row 2)
“Factor Immobility and Regional Impacts of Trade Liberalization:
Evidence on Poverty from India” by Topalova 2010 (AEJ:Applied)

•They use variation in sectoral composition across districts and

liberalization intensity across production sectors allows a
difference-in-difference approach (shift-share approach as
discussed last week).

•Rural districts, in which production sectors more exposed to

liberalization were concentrated, experienced slower decline in
poverty and lower consumption growth.

•The impact of liberalization was most pronounced among the

least geographically mobile at the bottom of the income
distribution

• And in Indian states where inflexible labor laws impeded factor

reallocation across sectors.
 Who are the losers?
•The non-migrating poor:

Important: Here tariff refers to the tariff reduction! The DELTA between two periods!
Takeaways for theory prediction

•Standard trade theory (Heckscher-Ohlin) predicts that trade

liberalization should benefit abundant factors (unskilled labor in
India) and reduce poverty, assuming perfect mobility of labor
and capital.

•If factors are immobile in the short run, adjustment occurs

mainly in wages rather than through sectoral reallocation.

•Even as the rural poor should have gained the most, they were
also least able to reallocate to the expanding low-skilled sectors
in cities.

• Inflexible labor laws -> factor reallocation was constrained,

amplifying the negative effects on poverty.