By Charles Benoit, CPA Trade Counsel
U.S. Trade Representative Robert Lighthizer recently published an op-ed in the Wall Street Journal detailing a five-point plan for reforming the World Trade Organization (WTO).
Lighthizer’s plan received superficial criticism from all his usual detractors.
But what he proposed is genius.
Lighthizer’s plan will expose the hypocrisy of so-called ‘free traders’ and deftly challenges them to essentially put up or shut up once executed.
This article breaks down Lighthizer’s five-point plan. It explains how success is possible whether or not others play ball, and why it should be the most consequential development in U.S. trade since the signing of the General Agreement on Tariffs and Trade (GATT) in 1947.
THE GATT BACKSTORY
Before we jump in, a quick primer on the GATT, because that’s what Ambassador Lighthizer’s five-point plan is all about.
After WWII, the U.S. was a manufacturing powerhouse and wanted export access to the markets it had just saved from totalitarian domination.
To that end, the GATT was negotiated among the world’s market economies. Primarily drafted between the Allied powers, twenty-three nations eventually signed on, including Brazil, India, and even China—although Beijing dropped out after the country’s communist takeover.
The GATT did two overarching things, these are the primary two principles of the agreement:
- First, it set tariffs among all the signatories under a principle called “Most-Favored Nation” (MFN).
- Second, it required all the signatories to provide ‘National Treatment’ to goods imported from other signatory countries.
The National Treatment principle (GATT Art. III)
National Treatment is the fundamental non-discrimination principle underlying free trade agreements. Its wording requires that laws, taxes, and regulations of all signatories not discriminate against competitive products imported from other GATT nations.
For example, Canada can’t set its sales tax at 10 percent for American whiskey and 0 percent for Canadian whiskey. That would have the exact same effect as a 10 percent tariff on American whiskey, and so that’s why National Treatment is essential for tariff agreements.
The MFN principle (GATT Art. I)
The other fundamental principle is “Most-Favored Nation” (MFN), the mechanism by which tariffs are negotiated and implemented.
The weight of Lighthizer’s plan focuses on MFN.
For this reason, it’s important to understand something known as “Unconditional MFN.”
This will sound crazy, but Unconditional MFN means that if a GATT nation gives a low tariff to one country, then every other country gets the benefit of that low tariff, even if they didn’t lower any of their tariffs or even show up for the negotiation.
Conversely, “Conditional” MFN would only extend the lowest MFN tariff to a country if that country ‘paid’ for it.
So when you hear “Unconditional MFN”, think no reciprocity.
If you’re thinking that Unconditional MFN sounds like a raw deal, you’re spot on. When it first appeared in the U.S. in the 1920s, it was argued that it would be “too complicated” to have different tariffs for different countries. That notion is absurd today, and was then too. More history surrounding the origins of Unconditional MFN in the United States is offered at the end of this article.
Half a century of GATT negotiating rounds lowered U.S. MFN tariffs to an average of just 3.4%, the lowest.
By 1947, negotiators in Geneva concluded the GATT as a single ‘multilateral’ trade agreement to replace a web of earlier bilateral agreements they had amongst themselves.
Ever since then, a copy of each country’s MFN tariff schedule has been stored in Geneva. These country schedules are called their “Schedule of Concessions”.
Since 1947, there have been eight formal GATT negotiating rounds: Geneva (1947), Annecy (1949), Torquay (1950-51), Geneva (1956), Dillon Round (1960-61), the Kennedy Round (1964-67), the Tokyo Round (1973-79) and the Uruguay Round (1986-94).
During each round, the United States and other developed countries continued to lower tariffs without ever expecting developing countries like India or Brazil to do likewise. Thus India and others retained their own high tariffs while still enjoying all the benefits of trans-Atlantic tariff concessions.
It was free riding via Unconditional MFN all the way.
At the end of the Uruguay Round in 1994, a few more agreements were added in addition to the GATT, notably on intellectual property and subsidies, and the WTO was created as a body to administer them. While most of those rules turned out to be a bust, the MFN tariffs, inscribed in every country’s Schedule of Concessions in Geneva, have persisted remarkably.
Following those eight rounds, America’s simple average MFN-bound tariff rests at just 3.4 percent, the lowest of any GATT nation. Japan is at 4.5 percent, the EU at 5 percent, Canada at 6.6 percent. Countries that were able to sit back while the big players negotiated away their tariffs have not chosen to unilaterally lower them. South Korea rests at 16.5 percent, the Philippines at 25.7 percent, Thailand at 28 percent, Turkey at 29.9 percent, Peru at 29 percent, Brazil at 31.4 percent, Argentina at 31.8 percent, Mexico at 36.2 percent, Indonesia at 37.1 percent, India at 48.5 percent, and Pakistan at 69.90 percent. The reality is even worse than this, because many developing countries haven’t even agreed to ‘bound’ all their tariffs, meaning despite being GATT signatories, they can charge anything they want on their unbound tariff lines.
China joined the WTO in 2001, so they missed out on most of that free-riding the others enjoyed. But still, the world signed off on China locking in a 10% average MFN tariff.
What about all of America’s free trade agreements (FTAs)?
At this point, you’re likely thinking “but we give better tariff rates all the time to our FTA partners, how does that work with Unconditional MFN?
Well, the GATT allows two key exceptions to Unconditional MFN:
- An exception for FTAs: you can offer another country a lower tariff than your GATT/WTO-bound rate through an FTA.
- At the end of the Kennedy Round, an exception to Unconditional MFN for Developing Countries was added: developed countries can unilaterally offer lower tariffs to developing countries. Each GATT country gets to pick which other countries it considers to be “” In the United States, this is done through what is known as the “Generalized System of Preferences” (GSP) tariff program.
These two exceptions to Unconditional MFN have largely eaten up the rule at this point. Because of the United States’ FTAs and the GSP program, much of the world is able to export to the USA at a tariff lower than our MFN rate.
The MFN rate is sometimes called the “Least Favored Rate” rate for this reason.
Now back to Lighthizer…
At a June Ways & Means Committee hearing, Lighthizer expressed strong disdain for Unconditional MFN. He noted that even as late as the Uruguay Round in the 90s, the United States and a handful of other developed countries let the whole world free-ride while the U.S. reduced many tariffs to zero. Regarding negotiations with Europe to lower pharmaceutical tariffs to zero, Lighthizer observed:
“And [the WTO Pharma agreement is] one of these agreements where [some rich countries] got together and said we will all agree to have zero tariffs on a certain list of pharmaceutical products. And then we will just give that benefit to the rest of the world, which struck me as, like, really, really crazy.
“So we have a position where, with respect to certain pharmaceuticals, we are committed to zero tariffs. And China, and India, and others who are major producers are not so committed. So I guess I just don’t buy that approach.”
Here, Lighthizer explicitly condemned Unconditional MFN as “really, really crazy.”
Lighthizer is right of course. He and President Trump expect tariff reciprocity.
As for GSP, Lighthizer told Ways & Means it was “completely crazy” that we unilaterally give many developing countries tariff free access, while they still maintain their high GATT-Bound MFN tariffs. He’s got that in his crosshairs too.
Both statements were part of his testimony urging a “broad reset” of tariffs at the WTO, where he complained about the wide gulf between countries’ GATT/WTO bound tariffs.
Lighthizer understands that our 3.4 percent simple average bound tariff rate at the GATT/WTO – the lowest of all – is the #1 trade rip-off crippling the American middle class and sending our factories to low-wage countries.
Lighthizer’s 5 points for WTO reform
In his WSJ op-ed, Lighthizer identified five points for WTO reform. The first three are all about tariffs and MFN. To avoid keeping you in suspense, these first three points dare the world to prove they really want free trade, and come down and meet us at our 3.4% level.
Point No. 1: reset bound tariffs
“First, WTO members need to agree on baseline tariff rates that apply to all, with minimal exceptions. A good starting point would be benchmark rates based on the average tariffs in industrialized countries, with limited deviations for each member to address its own political sensitivities.”
This is terrific. By “baseline,” Lighthizer is referring to each country’s bound MFN tariffs. His second sentence reiterates what he said in his recent congressional testimony: all other countries need to come down and at least approximate our 3.4 percent level. Success on this point, achieving something close to reciprocity in the GATT schedules, would be the biggest trade ‘win’ in the history of U.S. trade. No exaggeration. It dwarfs everything else.
Point No. 2: restore genuine Unconditional MFN
“Second, we need to end the free-trade-agreement land grab. Except for agreements intended to foster regional integration among contiguous states—like those governing trade within the EU, or the U.S.-Mexico-Canada Agreement—WTO members should be required to extend genuine, unconditional most favored-nation treatment to one another.”
This criticism raised eyebrows everywhere. It was met with calls of hypocrisy since Lighthizer is currently in the middle of negotiating bilateral FTAs with various countries.
But beyond the simple weirdness of condemning bilateral FTAs while seeking them out, there’s the weirdness of Lighthizer saying he wants “genuine Unconditional MFN” when he mocked the idea as recently as June.
So what’s going on? Lighthizer is goading his counterparts into admitting that none of them find Unconditional MFN smart policy let alone politically palpable either. In which case, why even have the GATT?!
Unconditional MFN is a bad idea – or “crazy” as Lighthizer, says in principle. But when you’re sitting at the bottom of the totem pole like the United States is at 3.4%, then you’re at a major competitive disadvantage for many reasons, including that the FTA exception is worth far more to higher tariff countries than it is to us. The United States has the least to lose from everyone rejecting FTAs and bringing their lower tariffs to their GATT Schedules.
If the rest of the world wants to keep the GATT and WTO, then they should honor its founding principles, and stop all their FTAs, and instead lower their GATT bound tariffs to where we are. (Prediction: they won’t, which is an excellent reason to walk away)
In the early 2000s, ideological purists who really believed in Unconditional MFN and the globalist mindset (mostly in academia) criticized FTAs for undermining the principle. (But businesses chasing the bottom of labor and environmental standards will always be happy to take lower tariffs any way they can get them, principles be damned, and so the free trade lobby’s criticism of FTAs faded).
USTR Bob Zoellick (2001-2005) was the target of these academics’ purist criticism.
During Zoellick’s tenure, the ninth GATT tariff negotiation round began, known as the Doha Round.
Zoellick’s idea was to try to entice GATT countries to give in to his demands during Doha negotiations by going on an FTA negotiating spree. Zoellick called this strategy “competitive liberalization” and started signing FTAs with random countries around the world. It was a contrast to Europe, which gave a nod to Unconditional MFN by pausing FTA negotiations during Doha.
Zoellick’s plan didn’t work, and Doha failed.
If one takes a step back, and looks at it from a numbers perspective, failure was probably a certainty. The United States doesn’t have much left to give, given our paltry 3.4% average. The BRICs likely weren’t too concerned about Lighthizer signing an FTA with a handful of small economies like Jordan.
So to get back to Lighthizer’s plan, when he denounces FTAs a slight on “genuine” Unconditional MFN, he’s supporting his Point #1. One either thinks the Principle in GATT Article I is worth defending, or one doesn’t.
Getting the opposition scoffing at defending Unconditional MFN is certainly a good thing! Then we can just say arriverdici to Geneva altogether.
Point No. 3: no more “Special & Differential” (S&D) treatment for developing countries
“Third, countries with large or advanced economies should not have access to special and differential treatment. If the WTO rules truly embody world-class standards to which all should aspire, China, India and other advanced economies should follow the same rules that bind America, the EU and Japan.”
The fact that China calls itself a developing country at the WTO rightfully infuriates many. But if that ended tomorrow, not a whole lot would change. The most significant Special & Differential provision in the GATT isn’t in any of the rules that regulate economic activity, but rather in the provisions that govern GATT tariff negotiations. GATT Art. XXXVI, paragraph 8, says that developed countries do not “expect reciprocity” in trade negotiations with developing countries. Obviously, that’s terrible, and so you can see here that Point No. 3 is actually another pillar in support of the total aim of Point No. 1. Everybody needs to come down and meet the U.S. at 3.4 percent.
Point No. 4: we need rules for state capitalism.
“Fourth, the WTO needs new rules to stop the economic distortions that flow from China’s state capitalism. It’s impossible to sustain public confidence in an international trade system when nonmarket practices destroy prospects for workers and businesses around the world.”
The GATT and WTO were never intended to accommodate non-market economies, an important point Lighthizer makes often. The key GATT/WTO principle – National Treatment – captures the activities of governments, like legislation and taxes. But if governments affect policy through the market activity of state-controlled businesses, they’re able to sidestep all the non-discrimination requirements imposed by the WTO.
This Point No. 4 is distinct from the first three, which are focused on tariffs.
Lighthizer recognizes that there’s no clever-enough set of written rules to discipline China such that they should be promised an MFN tariff schedule.
The Chinese Communist Party will never extend National Treatment, and MFN tariffs and National Treatment are a yin/yang—you can’t get one without the other.
The world tried special tough written rules for China in its 2001 WTO Accession Protocols, and they categorically failed, which Lighthizer has documented in his reports to Congress on China’s WTO compliance.
What the world needs for China is tariff freedom, the ability to impose tariffs freely without the costs and delays of trade remedy litigation.
Point No. 5: abolish the current form of WTO Dispute Settlement.
In short, Lighthizer wants a move to “a single-stage process akin to commercial arbitration.” Lighthizer is passionate about this, but a ‘win’ here is no substitute for demanding tariff reciprocity in the GATT.
Since the founding of the WTO, the body has heard an average of just 19 cases per year, and most of them don’t involve the United States. Even total victory on this point is inconsequential in the greater scheme. WTO disputes ultimately affect just a small iota of American commerce. Conversely, our 3.4 percent simple average GATT-bound tariffs have been hollowing out our industrial capacity for 70 years.
Where do we go from here?
At the 2018 G7 Summit in La Malbaie, Quebec, President Trump called the bluff of world leaders criticizing him for his tariffs on steel and aluminum. Responding to those criticisms, President Trump offered a zero-for-zero deal to the other leaders: no tariffs all around. Not one took him up on the offer.
But while it may be easy for foreign leaders to slink back from an off the cuff proposition at a summit, the formal processes and mechanisms of the GATT will demand a response. The Coalition for a Prosperous America has publicly called for the USTR to begin the GATT Article XXVIII process of renegotiating our MFN bound tariff rates.
If the rest of the world, and well-funded multinational business advocacy groups, are as invested in free trade as they claim, they’ll support Lighthizer’s effort for something closer to tariff reciprocity in the Schedule of Concessions.
And if they don’t, that’s all right. President Trump will be happy to meet them at their level, and we’ll get tariff reciprocity at their rates.
It’s a win-win approach to right a 73 year old imbalance.
P.S.: a quick summary of the U.S. origins of Unconditional MFN for the history enthusiasts
In the 19th and early 20th century, when the United States negotiated tariffs with another country, that was it. The tariffs in that deal were the tariffs applied between the U.S. and that country. If the U.S. negotiated a subsequent deal with a different country with lower tariffs than the preceding deal, then so be it. If the first country wanted that lower tariff rate we offered the second country, they’d have to bring something to the table. Generally, this meant our trade deals were reciprocal. There was no free riding.
However, in 1919, President Wilson’s appointee to the Tariff Commission, William Culbertson, authored a report arguing in favor of Unconditional MFN.
Culbertson’s report argued for Unconditional MFN in part because the “United States could not realistically have a country-by-country trade policy”. (Laughable now, as we do precisely that in practice). Trade historian Douglas Irwin notes that the unconditional MFN provision was not made explicit to Congress and “sparked virtually no debate in Congress, which was preoccupied with setting the many duties in the tariff schedule.”
The new unconditional MFN policy was unveiled in a new commercial treaty with Germany in 1924. “The decision to adopt unconditional MFN went relatively unnoticed at the time. The implications were not fully appreciated by contemporary observers, because no immediate policy changes were evident.” It meant, however, that if the United States ever negotiated a lower tariff with another country, Germany automatically would get the benefit of that tariff without offering anything in return.
In March, 1934, President Roosevelt and his Secretary of State, Cordell Hull, succeeded in getting Congress to pass the unfortunately named Reciprocal Trade Agreements Act of 1934, which began rapidly lowering U.S. tariffs on the principle of Unconditional MFN. “Within 2 years of the  Act’s passage, bilateral reciprocal agreements had been completed with Cuba, Belgium, Haiti, Sweden, Brazil, Canada, and the Netherlands – and these were only the first of many. By the middle of the Second World War, a total of 30 bilateral trade agreements with some 25 countries were in operation.” For this reason, “unconditional MFN acted as a trade accelerator”, lowering U.S. tariffs for many of our trading partners without them offering anything in return. By 1945, “the duties on many items had already dropped by half since 1934”.
The principle was picked up in GATT Article I, and has been with us ever since.
 Likely, the primary motivation for him criticizing Europe’s 72 FTAs is the reason he states elsewhere in the article: Europe’s approach to “Geographical Indications” (GIs), and their spreading of this approach through FTAs. Most of us know that for a bottle of sparkling wine to be labeled Champagne, it has to be made in Champagne, France. That’s a GI – a legal protection for a product term that indicates a place & process. Europe legislates its GIs, they become statutory law, and the EU asks its FTA partners to do the same. The U.S. doesn’t like this, and prefers – mostly – using the trademark system to protect GIs. Under the U.S. trademark system, a group of producers can form a trade association, and that trade association can apply to register a GI as a “certification mark”, and hold that certification mark on behalf of its members. Except, sometimes, we still follow the European model here. For example, the U.S. Tax and Trade Bureau has used its regulatory authority to establish 249 American Viticultural Areas for wine labels, like the French pioneered. And for spirits, we’ve demanded that all our FTA partners legislate domestically in their country that bourbon is a product of the USA. To me, this isn’t the hill to die on as we watch our factories close shop.
 Dobson, John M. Two Centuries of Tariffs: The Background and Emergence of the U.S. International Trade Commission, p. 36. Washington, DC: U.S. International Trade Commission, 1976, available at https://www.usitc.gov/publications/other/pub0000.pdf