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Richard E. Baldwin - Regulatory Protectionism, Developing Nations, and a Two-Tier World Trade System - Brookings Trade Forum 2000 Brookings Trade Forum 2000 (2000) 237-280

Regulatory Protectionism, Developing Nations, and a Two-Tier World Trade System

Richard E. Baldwin
Graduate Institute of International Studies, Geneva

[Comments and Discussion]

Army generals, it is said, are always preparing to fight the last war they won. Is the World Trade Organization (WTO) in danger of following the same logic? The WTO-GATT (General Agreement on Tariffs and Trade) has all but won the war against tariffs. Tariffs on imports of OECD-manufactured goods--which account for more than two-thirds of world merchandise trade--are to average only 3.8 percent when the Uruguay Round cuts are fully implemented, with duty-free treatment applying to fully two-fifths of these trade flows. As in all wars, victory is never total. Tariffs on rich nations' food and clothing imports and poor nations' industrial imports are still high, as table 1 shows, but these items account for little of world trade. Moreover, the industrial tariffs of poor nations, at least, seem to be falling of their own accord. Trade is nonetheless far from unfettered.

"Regulatory protection" is but one name for the tens of thousands of cost-raising, behind-the-border measures that continue to substantially inhibit trade. Most of these measures are seemingly innocuous when viewed individually, but tangled together they are able to significantly fragment world markets. This point is not new. The last time "globalization" was in fashion--when it was called internationalization and interdependence--Robert Baldwin wrote, "[t]he lowering of tariffs has, in effect, been like draining a swamp. The lower water level has revealed all the snags and stumps of non-tariff barriers that still have to be cleared away." 1 The intervening thirty years have witnessed completion of the swamp draining, but the stumps have started to grow; three [End Page 237] [Begin Page 239] decades of ever tighter regulation of goods--most of which was adopted for purely domestic policy aims--have escalated regulatory protection.

Trade nevertheless is, overall, much freer than it was when GATT was signed. Somewhat paradoxically, this means that remaining barriers have a more important, not less important, impact on production. The magnification effect of globalization is the name for this. Falling tariff levels, teamed with lower transportation and communication costs, have cleared away many manmade and natural obstructions to trade, making the international playing field flatter than it has ever been. 2 This very flatness, however, means that even a slight tilt tends to have large effects on the location of production. In particular, seemingly minor differences in technical norms can have an outsized effect on production. While it is easy to exaggerate the international footloose character of production, one thing is clear. As the field gets flatter, regulatory protection's influence on production will continue to grow, forcing its liberalization ever higher on the negotiators' agendas.

The main thesis of this paper has five steps: technical barriers to trade (TBTs) are important; liberalization of TBTs will continue; this liberalization will involve hegemonic harmonization or mutual recognition of rules and test; such liberalization will almost surely entail preferential arrangements among rich nations, creating in essence a two-tier system of market access with developing nations in the second tier. The final step is to conclude that the WTO should be modified to address the potentially discriminatory aspects of regional TBT liberalization initiatives. The WTO, in short, should be gearing up to "fight" the battle of frictional barrier liberalization.

TBT Liberalization Is Important

TBTs result from norms (regulations and standards) that control the sale of goods in a particular market by specifying required product characteristics or production processes. 3 There are two distinct aspects of this control: content of the norm and testing procedures necessary to demonstrate that a product complies with the norm. TBTs thus come in two basic forms, content-of-norm TBTs and testing TBTs. The mind-numbing minutiae and technical complexity behind most regulations and standards make it difficult to speak of [End Page 239] TBTs as a whole. Some examples may help. We start with a content-of-norm example.

All cars sold in Sweden must have wipers on the headlights. This policy may have started as a meritorious safety regulation (Swedes keep their lights on at all times for safety's sake, and in the old days Sweden had lots of dusty roads). Today it mainly serves to raise the relative price of imported cars. From the drawing board onward, Volvos and Saabs--and their factories--are designed with headlight wipers in mind. For other carmakers--Renault for example--the Swedish market is too small to really matter, so Renaults are not optimized for headlight wiper installation. Thus, while it is expensive to put headlight wipers on both Swedish and French cars, the regulation raises the relative cost of French cars in Sweden. This gives the Swedish carmakers an edge in Sweden. Indeed, the outcome may well be that Renault will only export to Sweden its luxury models for which headlight wipers are already an option, so the regulation may act as a zero import quota for low-end cars.

Testing can also lead to TBTs. A frequent source of U.S.-Japan trade tensions in the 1990s was asymmetric testing procedures. For example, Japanese manufacturers, who were trusted by Japanese regulators, could establish compliance with regulations by having a few units tested periodically while foreign firms had to have each import shipment tested. 4

Vertical and Horizontal TBTs

It is useful to classify content-of-norm TBTs into two subtypes, horizontal and vertical. Vertical-norm TBTs involve norms that can readily be characterized as being more or less stringent. For example, the United States adopted a law (the so-called Corporate Average Fuel Economy [CAFE] standard) requiring each car company's fleet to attain certain maximum levels of emissions when averaged over all company models sold in the United States. This norm would have forced European carmakers to invest in more emission abatement than their U.S. rivals since U.S. auto makers lower their average, in part, by selling small-engine cars while European car companies sell mainly high-end cars with big motors. Europe also has much stricter rules than the United States on the permissible level of growth hormones in beef. TBTs stemming from such "vertical norms" generate much emotion and media attention since they can be portrayed as protecting local consumers from low-quality imports. [End Page 240]

Horizontal norm differences, however, are probably more common. Many TBTs arise when a nation, or subnational government, adopts the specifications of the local firm's differentiated product as its norm. For example, France and Germany regulate the nature of permissible electric plugs (both have two round pegs, but the German pegs are wider). The two plugs are equally safe and equally expensive to produce, but they are different. This raises the French firm's cost of selling in Germany (since German firms do not have to modify their product to meet the regulations while French firms do). It also raises the cost of German firms selling in France, so TBTs based on horizontal norm differences tend to create reciprocal trade barriers.

It is easy to see why horizontal TBTs arise so often. Citizen concern and industrial efficiency demand product norms, and a typical rich nation will have tens of thousands of standards and regulations. Most are highly technical, and a large fraction covers intermediate inputs--products unknown to most voters. Owing to their technical complexity and political invisibility, product norms are often written, directly or indirectly, by domestic firms to which they apply. Quite naturally, these firms write the norms in a way that favors their varieties or at least disfavors foreign varieties. The result is a horizontal content-of-norm TBT.

Of course, the mere fact that standards and regulations inhibit trade and competition is by no means an argument for their removal. Good governance requires regulation to protect the health, safety, and well-being of citizens, animals, and plants as well as to facilitate market transactions. The main problem with TBT liberalization is that it is difficult to know whether a particular norm serves the public interests or protectionists' interest, and, indeed, both motives are often combined in a single TBT.

Modeling TBTs

As the examples show, product norms and testing procedures can distort trade when they raise foreign firms' costs relative to those of domestic firms. Of course, in certain industries, the impact of TBTs is radically more complex. In industries with network externalities, like mobile telephones, standards can be manipulated to throw up barriers against nonlocal firms. In industries with patent races, like pharmaceuticals, a regulation that merely delays the introduction of foreign goods can radically alter the market outcome in favor of home firms. In industries with learning curves, product standards that apply to only a fraction of the market--government or military purchases, for example--can have large effects on the market equilibrium. Modeling TBTs in such [End Page 241] "sexy" industries will certainly be the focus of much future work, but in this chapter I focus on mundane industries where TBTs act by raising the costs of foreign firms more than the costs of local firms.

IMAGE LINK= The cost-raising aspects of TBTs can affect foreign firms' fixed costs of selling to the regulated market as well as their marginal costs of doing so. Figure 1 shows how a typical TBT involves up-front, one-time costs--for example, of learning about the regulation and bringing the product into conformity--as well as ongoing costs, such as periodic testing, or higher marginal production costs that stem from a low scale of production.

The Economics of Regulatory Protection

Surprisingly little work has been done on the economic effects of TBTs, even at an abstract level. Most trade economists working in the subject tend to assume that TBTs affect trade in the same way as frictional barriers (that is, tariff-like measures that generate no revenue or rents). Most of the simulation studies of the European Union's (EU) 1992 program, for example, [End Page 242] modeled the liberalization effects as lowering the real cost of intra-EU trade by about 2 percent. 5 The industrial organization literature has focused on the impact of standards on a narrow range of industries, namely, industries marked by network externalities such as mobile phones, consumer electronics, computers, and the like. As the survey by Carmen Matutes and Pierre Regibeau argues, the general presumption is that harmonization of standards within a single market can be manipulated by incumbents to raise barriers to entry. 6 In such industries, regional TBT liberalization--which usually involves some form of harmonization of standards--would be presumed to act as a trade barrier to outsiders. While these network industries tend to attract a lot of attention, they cover only a fraction of the trade affected by TBTs.

A Baseline Model

TBTs can affect fixed costs as well as variable costs, so even a minimalist model requires imperfect competition and increasing returns. With these elements, however, almost anything can happen theoretically. As Elhanan Helpman and Paul Krugman show, quotas can lower prices, export subsidies can improve welfare, and small countries can have positive optimal tariffs. Clearly then, one should not be surprised that, theoretically, TBTs have an ambiguous impact on trade flows and welfare. 7

To highlight the main sources of ambiguity, a baseline model is helpful. Specifically, consider an industry marked by Cournot oligopolistic competition with firms facing constant marginal costs and two types of fixed costs, a firm-specific fixed cost of setting up production (unrelated to TBTs) and a fixed cost of selling to each market (related to TBTs). To allow discrimination, we need three nations: home (H), partner (P), and rest of world (R), assumed ex ante identical to reduce complexity. The inverse demand function of a typical nation is pj = 1 - Qj, where pj and Qj are the price and total sales in market i (i = H, P, or R). The total quantity in market j is (Sniqi j), where qi j is sales of a typical i-based firm in market j; ni is the corresponding number of i-based firms. Marginal production costs are normalized to zero. The three markets are assumed to be segmented.

Here we focus on TBTs based on horizontal norm differences and model them as simply as possible; nonlocal firms face higher variable costs or fixed costs (or both) when selling to the local market. Specifically, firms located in [End Page 243] home (called H-based firms for short) face no additional costs when selling to the home market. Partner-based (P-based) firms face a specific cost 0 < t when selling to the H-market. Rest-of-world-based (R-based) firms in the home market face per unit cost, t* , that is initially identical to t. The home and partner nations are always identical. TBTs may also impose an additional fixed cost on nonlocal firms. To capture this simply, we assume that each market has its own norm, and complying with these costs F in each market. (F is the same in each market since we are addressing horizontal norm differences.)

The equilibrium is found by solving the nine segmented market first-order conditions for the nine levels of sales. The model's linearity allows us to find solutions for prices, consumption, welfare, the numbers of firms, trade flows, and so on. In particular, the equilibrium price in market H, pH, equals the sum of two terms. The first term, 1/(1 + Sni), reflects the level of overall competition. The second term, (SniciH)/(1 + Sni), reflects the average marginal cost of firms active in the market (ciH is the market-specific marginal cost, normalized to zero for H-based firms, to t for P-based firms and to t* for R-based firms). 8 The focus of my inquiry, however, is on the distortionary impact of TBTs, so I highlight the "trade bias," defined as the difference between home's imports from wholly P-based firms and home's imports from wholly R-based firms; this roughly corresponds to a preference dummy in a gravity model equation. When TBTs among all nations are symmetric (that is, there is no discriminatory dimension favoring P-based firms over R-based firms), the bias equals zero. Specifically, 9

Trade Bias = pH(n-n*)-t-n*t*)             (1)

where n is the number of home and partner firms (always identical in the exercises we consider) and n* is the number of rest-of-world firms. In some cases, [End Page 244] I allow the number of firms to vary with TBTs. The equilibrium expressions for n and n* are messy, but it is easy to show that the equilibrium "n" falls as the fixed cost F rises, and it rises as the R-based firms' fixed cost F* rises. 10 Likewise, the equilibrium n* falls as F* rises or F falls.

TBT Liberalization

TBT liberalization can take the form of lower fixed costs or lower marginal costs of selling to a particular market, or both. Each of these may be "open" or "exclusionary." The trade impact of these various forms differs radically, as we shall see.

Open versus Exclusionary Mutual Recognition: Liberalization of Fixed-Cost TBTs

Consider first the liberalization of fixed-cost TBTs; for simplicity's sake, we neutralize variable-cost TBT discrimination by assuming t = t*. Initially suppose that the same fixed-cost TBT applies on an most favored nation (MFN) basis, so R-based firms, H-based firms, and P-based firms have to pay a total of 2F to sell in both H and P markets. The liberalization considered is meant to resemble one aspect of the EU members' mutual recognition of one another's norms and testing. After the liberalization, a product that complies with either home's or partner's norms can be sold freely in both markets. That is, H-based firms and P-based firms have to pay only a total of F to access both the H and P markets.

This mutual-recognition privilege may or may not extend to R-based firms. On one hand, mutual recognition can be "open": that is, R-based firms can also sell to both H and P markets after certifying their product in either. In this case, the fixed-cost liberalization benefits all firms equally; after liberalization, the total fixed cost of selling to the three markets is reduced from 3F to 2F. This raises profits and attracts new entrants in all nations. Given symmetry, n and n* rise equally so the trade bias remains at zero (t = t* and n = n*). In short: open, fixed-cost TBT liberalization is not discriminatory--even when it is regional.

On the other hand, mutual recognition can be "exclusionary" in the sense that it applies only to products made in H or in P. In practice this exclusion is enforced by rules of origin. For example, the EU-Swiss Bilateral Accords [End Page 245] encompass TBT liberalization, but only Swiss-made goods circulate freely in the EU market after having been certified in Switzerland. In our model this means that H and P firms pay only F to access the combined H-P market, but R-based firms must continue to pay 2F. This results in improved profitability for H and P firms, which will lead to a rise in n. There is also a drop in n* as the new H-based and P-based firms crowd out R-based firms. This creates a positive trade bias as can be seen by inspection of (1) combined with the facts that t = t* and n > n*.

In short, regional liberalization of fixed-cost TBTs is not discriminatory when it is "open," but it is discriminatory when combined with rules of origin.

TBT Liberalization That Favors Rest-of-World Firms

Open, fixed-cost TBT liberalization can actually favor rest-of-world firms. Owing to fixed market-entry costs, not all firms will sell to all markets. Rather, firms will sell to markets where their cost advantage makes sinking F worthwhile. For example, an East Asian manufacturer of electronic components might not find it worthwhile to export to Europe if each European nation had its own product norm (each involving a compliance cost) but might find Europe very interesting with an EU-wide norm. In the context of our model, suppose that home and partner are geographically close, and this gives H- and P-based firms a distance-related marginal cost advantage (compared with R-based firms) in the H and P markets. If this advantage is large enough, R-based firms may chose not to sell in either the home or the partner markets, since the operating profit they would earn on such sales would not cover the per market fixed cost F. An open, fixed-cost liberalization, which lowered the fixed cost from F in each market to F for both the H and P markets could induce new R-based firms to start selling in the H and P markets. In terms of the trade bias, we see that a rise in n* (number of R-based firms selling in the H and P markets) would reduce the bias.

To make the point more formally, we start with the MFN situation where each firm must incur a fixed cost F to sell in each of the three markets. To simplify, suppose that TBT-related marginal costs are zero (t = t* = 0), but H and P firms have a natural advantage since R-firms face a trade cost of T when selling to the H or P markets, but H- and P-based firms face zero trade costs when selling into each others' markets. From the first-order conditions, a typical R-based firm's sale to the H-markets equals pH - T, where pH is the equilibrium H-market price, while the sales of a typical P-based firm in H, [End Page 246] namely, pH, will be higher than that of an R-based firm. Noting that with linear-demand operating profit equal to the volume of sales is squared, we see that R-based firms may not find it profitable to sell to either the H or the P market when T is sufficiently large. Specifically, we can have a situation where (pH - T) 2 < F, so R-based firms sell to neither the H nor the P markets, but (pH) 2 > F, so H-based firms and P-based firms will sell to both markets. Now, consider the impact of an open, fixed-cost TBT equalization between the H and P nations. Postliberalization, R-based firms will sell to both H and P markets as long as the sum of operating profit earned in the H and P markets exceeds F. With symmetry, 2(pH - T) 2 > F is the condition, where pH is the postliberalization price. The impact of this on the trade bias is straightforward. The liberalization has no impact on P-based firm sales to home (since the liberalization only affected F and all P-based firms were already selling to home), but it induces a whole new set of R-based firms to export to home. The trade bias, which was positive before the liberalization, now falls.

Liberalization of Variable-Cost TBTs

Regional TBT liberalization can easily affect the variable cost of complying with product and process norms. For some products, such harmonization may create a preference for EU products. The EU could, for example, adopt a common norm that is systematically more costly for non-EU firms to comply with, owing to scale economies or specific technological advantages in the EU. This sort of case may arise when, for example, EU firms sell the majority of their output in the EU (and so design their products and factories with the EU norm in mind). If scale economies are important, the per unit cost of meeting the EU norm may be lower for EU firms than for non-EU firms for whom the EU is a minor market. Alternatively, adoption of a common norm and testing procedure might result in scale economies that would lower compliance costs for all firms.

In the formal analysis, the first type of harmonization--call it prejudiced harmonization--shows up as a change from the initial situation of t = t* to a situation where t* exceeds t. This sort of regional liberalization has the usual "supply switching" effect of inducing H and P consumers to switch away from R-made products and toward H-made and P-made goods. In particular, taking n = n*, for simplicity, the trade bias--which reduces to n(t* - t) in this case--is positive. In the second type of harmonization--call it neutral harmonization--t = t* both before and after liberalization, but the level of costs falls. Plainly, this will have no effect on the trade bias. [End Page 247]

Trade-Reducing Regional TBT Liberalization

TBT liberalization may affect trade bias by altering firms' ability to price discriminate internationally, that is, by switching the nature of competition from segmented markets to integrated markets. As the literature on trade policy and imperfect competition has made clear, the impact of protection can be radically different with and without international price discrimination. 11 Only one of such implications is exposed here; see Richard Baldwin and Anthony Venables for more on the economics of preferential liberalization. 12

Markets are segmented when firms can assume that their customers will not resell across markets. Markets are integrated when firms treat the two markets as one. As it turns out, even when the two markets are symmetric, that is, equilibrium prices are identical, market segmentation matters. In particular, the volume of trade is higher under market segmentation due to "reciprocal dumping" trade. The relevant link with TBTs is that product regulations may help firms to segment markets. Consequently, the imposition or liberalization of TBTs may have important effects that are not captured by standard nontariff-barriers (NTB) analysis.

To make the point as cleanly as possible, consider two identical nations, each with a single firm. The firms produce identical output--a consumer good--at identical costs; trade in the good is subject to some natural transport costs. Initially, the two nations impose a safety regulation of a very special type. For safety's sake, the good and its instructions must be sealed in tamper-resistant packaging. The instructions must be written in the language of the country, and only the language of the country (to avoid confusing consumers). Presume that instructions would be included in any case and translation costs are minimal, so the regulation has a negligible impact on marginal and fixed costs.

Using the analogy of tariff analysis, this regulation would seem to have no trade effects. This is incorrect. The regulation prevents resale by consumers or middlemen and thus allows each firm to treat the two markets as segmented. When the two markets are segmented and yet there are some natural trade costs, the two firms engage in reciprocal-dumping trade à la Brander and Krugman. 13 In particular, firms charge a lower producer price for their exports than they do for their local sales. If the regulation is changed to require, for example, instructions to be printed in both languages, the markets become integrated [End Page 248] in the sense that resale across markets is possible. Of course, such arbitrage goes on until producer prices are equalized.

Interestingly, this market integration has a dramatic and counter-intuitive trade effect. All trade halts since each firm supplies only its local market. The reason is that due to arbitrage, firms treat a sale in either market as if it were a sale in the local market and in this case, there is no return to incurring the trade costs of selling abroad. Nevertheless, prices fall since the potential competition due to arbitrage is a more powerful source of competition than are actual imports without arbitrage possibilities.

Empirical Evidence

The economics profession does not yet have direct empirical measurements of the trade-inhibiting effects of TBTs in general. There is hope that this lacuna will soon be filled since there is a World Bank project on this topic under way. At this point, indirect evidence is all that can be marshaled.

Sapir's Evidence

André Sapir aims to gauge the impact of EU integration on nonmember nations since 1960. To this end, he estimates year-by-year gravity equations for the 1960-92 period on aggregate, bilateral trade flows among a set of Western European nations. 14 The key interest lies in the sign and size of the dummies he introduces for all the European preferential trade arrangements (PTA). Interpreting the dummy coefficients, however, requires a bit of care. Sapir does not include a dummy for trade flows among the original six members of the EU; this level of integration is taken as the standard against which all other PTAs are judged. Thus the signs of the included PTA dummies tell us whether the particular bilateral trade flow is higher or lower than it would have been if the two nations had joined the EU in 1958. Standard controlling variables, such as gross domestic product (GDP) of sending and receiving nation, distance, and common language, are included.

It is important to note that all tariffs and quotas on intra-EU trade and all industrial-goods tariffs on intra-European Free Trade Association (EFTA) trade had been eliminated by 1968. The signing in 1973 of the EU-EFTA free trade agreements removed all tariffs on industrial trade between EFTA and EU nations (industrial goods account for the vast majority of EU-EFTA trade). As a result, all of Western Europe was part of an industrial duty-free zone by [End Page 249] 1973. The importance of this fact should be clear. Almost all of the Western European integration since 1973 has involved the removal of frictional trade barriers, with TBT liberalization being an important component of this, especially the Single Market Programme (initiated in 1987). It is also important to note that the EFTA nations did not participate in the Single Market integration until the European Economic Area agreement entered into force on January 1, 1994.

It would be interesting to directly measure the impact that this frictional barrier liberalization had on intra-EU trade, but Sapir's results do not permit this. We can, however, garner some evidence on the trade volume impact of the liberalization by looking at changes in the coefficient on the EFTA-EFTA and EC-EFTA dummies.

IMAGE LINK= The annual point estimates are plotted in figure 2. According to the estimates, up to 1975 EFTA-EFTA trade volumes were higher than the EU-EU flows, controlling for the usual factors. This somewhat unexpected result (the received wisdom is that the EU membership provides the tightest integration in Europe) may be because of Sapir's omission of an adjacency variable. 15 In [End Page 250] any case, the point estimates on the EFTA-EFTA dummies are never significant (at the 95 percent confidence level) when they are positive (not shown in the figure). The EFTA-EFTA dummy becomes solidly negative in the early to mid-1980s but become statistically significantly less than zero only in 1989.

The rapid decline in the EFTA-EFTA coefficient, together with the fact that EFTA was not pursuing any significant intra-EFTA integration initiative, suggests that EU-EU trade was being promoted by the Single Market's removal of frictional barriers. (Recall that the dummies indicate market access relative to the market access available on trade among the original six EU members).

A second piece of evidence comes from the evolution of the coefficients on the EC-EFTA dummy. The jump up in market access due to the 1973 free trade agreements (FTAs) is clear in the point estimates. Somewhat less evident is the gradual decline of point estimates after the mid-1980s. The modest change in the point estimates, however, hides the fact that point estimates become significantly less than zero in 1985 and remain significant right up to the end of the period (not shown in the figure).

Head and Mayer

Keith Head and Thierry Mayer find more conflicting evidence using industry-level data and the more sophisticated gravity model approach inspired by Shang-Jin Wei. Head and Mayer use fairly disaggregated industry-level data (three-digit NACE) to estimate the so-called border effects, that is, the effect that an international border has on purchasing patterns. In particular, the authors set out to answer three questions. 16 How big were border effects in Europe before the nontariff liberalization embodied in the Single European Act? How closely were the industry-by-industry border effects associated with indirect measures of the severity of trade barriers? Has the change in border effects been associated with the removal of trade barriers under the Single European Act?

In addressing the first question, they pool the ninety-eight industries in their sample over the 1984-86 period to find a large border effect. Depending upon the exact specification, they find that EU nations buy between thirteen and twenty times more from local producers than from producers based in other EU nations. 17 This base-line regression provides no direct evidence on the cause of this border effect, but two facts are suggestive. First note that there were no tariffs or quotas on intra-EU trade during this period, so nontariff barriers [End Page 251] are a likely culprit. This suspicion is reinforced by the fact that the regression results also show EU membership stimulate trade by something like 50 percent. The point is that the only nonmember nations in their sample--Spain and Portugal--have enjoyed duty-free industrial trade with the EU since the 1970s, yet they did not participate in the EU's factor-market and nontariff barrier liberalization. Consequently, one possibility is that the impact of EU membership reflects the trade-inhibiting effects of the EU's preferential liberalization of nontariff barrier, and the border effect reflects the impact of the remaining nontariff barriers.

The authors, however, fail to find any correlation between industry-specific border effects and two measures of intra-EU NTBs. The first measure is based on a 1980s survey of EU firms, the second on an educated guess by Pierre Buiges. 18 This presents a puzzle. Industry-specific border effects are uncorrelated with proxies for trade barriers, yet EU membership has an important impact on trade flows. This suggests one of three interpretations. Deep EU integration does matter, but the trade barrier proxies are faulty; deep EU integration does matter, but it is due to something other than TBTs and similar to nontariff barriers; or nontariff barriers do not matter, and the Spanish and Portuguese trade flows are unusually low for some reason that is unrelated to trade barriers. Unfortunately, the authors' results do not allow us to distinguish among these.

Results pertaining to the third Head-Mayer question are also interesting. Year-by-year regressions using their pooled data show a marked decline in the border effect, suggesting that policy changes or transport cost reductions have been important. However, the decline seems to be much sharper before the Single European Act came into force. Again, the interpretation of this finding is ambiguous. Either the Single European Act was ineffective at liberalizing regulatory protection, or it was effective at removing the barriers, but the barriers had little impact on trade.


One of the most direct attempts to measure the trade impact of TBTs is Johannes Moenius. 19 The paper focuses on the trade impact of standards (voluntary norms) rather than on TBTs more generally due to data limitations. In particular, the author has constructed a unique data set on industry-specific standards that includes information on whether a specific standard is country [End Page 252] specific or common to the specific bilateral trade relationship. The latter aspect is of the greatest interest. The point is that standards shared bilaterally may preferentially lower marginal or fixed costs of market and thus may have a trade-distorting effect. As argued earlier, however, the expected sign of the distortion is not clear.

Moenius's data set is an enormous panel covering 471 industries in twelve West European nations from 1980 to 1995. He finds that a shared standard has a large trade-promoting effect among the nations sharing the standard. For instance, in his central regression, which controls for a wide range of other factors, he finds that a 1 percent increase in the number of bilaterally shared standards results in a one-third percent increase in bilateral trade volume. This is perhaps the only clear empirical result in the literature on the discriminatory impact of preferential TBT liberalization. The sharing of a common norm promotes bilateral trade, so--by the usual logic of relative prices--we can conclude that a shared norm inhibits trade with nations that do not share the standard.

The impact of country-specific standards is even more intriguing. Moenius finds that country-specific standards in importing countries promote trade in manufacturing sectors but hinder trade in nonmanufacturing sectors such as agriculture. Since the current comparative advantage of many developing nations lies in nonmanufacturing sectors, this result suggests that TBTs may create a bias against developing nations. Testing this hypothesis directly, by including developing nation data, would be an important contribution to the literature.

Finally, it is worth citing some important but highly indirect evidence. Governments and firms engaged in international trade act as if TBTs have important trade-inhibiting effects. They also act in a way that suggests that they believe that preferential TBT liberalization has an important discriminatory trade effect. As the discussion of TBT liberalization below makes clear, the TBT liberalization in the EU's Single European Act induced non-EU governments to negotiate trade arrangements--notably EU membership, the European Economic Area agreement, and the EU-Swiss Bilateral Accords--that redressed the discrimination thus arising. Moreover, the rapid spread of 'mutual recognition agreements' between the EU and its major trading partners (the United States, Canada, Australia, and so on) shows that firms and governments take the trade-inhibiting impact of TBTs seriously enough to invest time and energy in lowering them.

Given this admittedly scant empirical evidence that TBTs are important, we turn next to the real-world TBT liberalization schemes that have been pursued [End Page 253] in the past. The lessons from historical attempts are crucial to predicting the path of future TBT liberalization.

Liberalization Experiences

TBTs inhibit trade by raising costs faced by foreign firms more than those faced by domestic firms. Liberalization requires a lowering of the gap, and there are two main dimensions to this, content-of-norms and conformity assessment. Liberalization of the first involves making product norms more cosmopolitan and thus narrowing the cost advantage of domestic firms. Liberalization of the second involves lowering the excess costs that foreign firms face in demonstrating compliance of their goods to accepted norms.

There are two ways forward along both dimensions, harmonization (that is, convergence to a single norm or conformity assessment procedure) and mutual recognition (that is, acceptance of foreign norms and conformity procedures). Harmonization can be accomplished through negotiation, that is, by narrowing the differences among various nations' norms, or through the hegemonic route, that is, other nations adopt the norms of a hegemon. 20

We turn first to the European experience for one simple reason. The introduction argued that the growing prominence of TBTs on the world trade agenda is largely because of the near-total victory over the "easy" barriers, tariffs, and quotas in OECD nations. Intra-European trade reached this stage more than three decades ago. Subsequent liberalization interest has focused on behind-the-border measures, with TBTs being one of the chief attention-getters. More generally, since trade integration among European nations is two or three decades ahead of WTO integration, Europe's experience with thorny issues--such as labor standards and trade, trade and competition policy, trade among rich and poor nations, dispute settlement, and so on--provides a natural departure point for the study of most "new" trade issues.

EU Initiatives

The EU recognized TBTs as a barrier to the Common Market in 1957 with Article 100 of the EEC Treaty, also known as the Treaty of Rome (see box 1 for details). This requires approximation (Euro-speak for harmonization) of national regulations for the proper "functioning of the common market." As [End Page 254] in the WTO-GATT system, Europe's first liberalization efforts focused on the "easy" barriers, tariffs, and quotas. With these eliminated by 1968, liberalization attention turned to TBTs. 21 [End Page 255]

The Old Approach, 1969-84

The EU systematically took up the removal of technical barriers in 1969 with its General Program, which launched what came to be called the "old" approach to TBT liberalization. The old approach was, in essence, based on the idea that the EU would become as a unified economic area, functioning much like a single national economy. Specifically, the General Program was composed of four Council resolutions and a framework decision was adopted on May 28, 1969. The resolutions concerned a detailed timetable for a large number of directives on industrial products, the same for foodstuffs, expression of the council's intention to institute mutual recognition of conformity assessments, and a procedure for adapting directives to technological advances. The framework decision prescribed a standstill of member state measures concerning products covered by the General Program, and a requirement that member states inform the Commission of new provisions for products not covered; this also was largely ignored. 22

In short, the old approach dealt with the content-of-standards issue through negotiated harmonization. It strove for the adoption of a single standard laid out in detailed technical regulations for single products or groups of products implemented by unanimously agreed-on "directives" of the European Council (the EU's main decisionmaking body). 23 Once adopted, such directives supplant national laws, regulations, and standards. The conformity-assessment issue was tackled in a more decentralized fashion. For products on which directives were adopted, EU members recognized conformance assessments performed by designated bodies in any EU nation. To prevent new TBTs, the so-called framework decision provided for standstill and notification rules on new national standards and regulations.

Evaluation of the Old Approach

"This approach to technical harmonization failed completely, " according to Giandomenico Majone, although it deserves credit as the world's first serious attempt to tackle TBTs. 24 The detailed timetable was roundly ignored, and harmonization of standards and regulations proceeded much more slowly than the development of new national TBTs. For example, 10 years were required to adopt a directive on gas containers made of unalloyed steel, and the average delay for the fifteen directives adopted en masse in 1984 was 9.5 years. [End Page 256] Furthermore, rules on "standstill" and notification were ignored since the council qualified these rules as a "gentleman's agreement." In practice, member states had full discretion to adopt new national regulations--as long as they did not cross EU case law. The Commission received an average of only eleven notifications annually between 1975 and 1982 while thousands of new regulations sprang up in member states. 25 The manifest failure of the old approach is confirmed by many such as Michael Emerson (the chief Commission economist on the Cecchini Report) who states that little progress was made since the exhaustively detailed directives were "difficult to agree and quick to become obsolete." 26

The New Approach, 1985-Present

The EU's "new approach," formally launched in January 1985, is something of a misnomer since it evolved over the 1960s and 1970s. 27 In particular, decisions of the European Commission and the EU Court that are described in box 1 and box 2 introduced the main elements of the approach by the end of the 1970s. The genius of the new approach is to distinguish sharply between the goals ("essential safety requirements" in Euro-ese) and means ("harmonized standards") of product and process regulation. Two elements must be distinguished, "mutual recognition" and "technical harmonization."

For the vast majority of European products, TBTs are eliminated by the principle of "mutual recognition" of testing and content-of-norms. EU case law and interpretations by the European Commission (see box 1) create the presumption that the standards and regulations of all member states are merely different means of implementing equivalent regulatory goals. Thus, products made or sold in one member state have "Single-Market access." That is, they can be sold freely and without further testing in all member states (and in Norway, Iceland, and Liechtenstein since the 1994 EEA agreement). Nonetheless, member states are free to set standards and regulations on their territory, but any resulting barriers to trade are allowed only if they can be justified as being the least-trade-restrictive means of achieving a legitimate purpose (for example, [End Page 257] health, safety, consumer protection, environmental protection). The EU Court has taken a very narrow view of allowable justifications. 28 Of course, implicit is the mutual recognition of conformity assessments performed by any body sanctioned by a member of the EEA.

For products where regulation-linked trade restrictions are justifiable, the EU has turned to technical harmonization. It is here that the new approach is truly new. With the new approach, the goals are completely harmonized through [End Page 258] Council directives that supplant national law. Detailed technical specifications and standards that show how to comply with these requirements are left to private European standard-setting bodies, such as the Comité Européen de Normalisation (CEN) and Comité Européen de Normalisation Electrotechnique (CENELEC). 29 For example, the Lifts Directive (95/16/EC), which is [End Page 259] only fifteen pages long (not counting the annex), lays out essential health and safety requirements relating to the design and construction of lifts and safety components. Paragraph 1.2 in annex 1 states, "The car must be designed and constructed to offer the space and strength corresponding to the maximum number of persons and the rated load of the lift set by the installer." The Council leaves the listing of technical specifications that would fulfil this goal to CEN.

The effectiveness and political acceptability of this TBT liberalization is bolstered by two principles. First, the essential safety requirements must be transcribed into member states' laws. Second, while the resulting harmonized standards must also be transposed at the national level--and all conflicting national standards must be withdrawn--the standards are voluntary. More specifically, goods made in accordance with harmonized standards are presumed to conform to the essential requirements and are thus free to circulate in the EEA. However, a firm may choose to deviate from these, say because of an innovation. In this case, Single Market access can be obtained by presentation of a certificate of conformity with essential requirements issued by a designated body. 30

For products subject to technical harmonization (rather than mutual recognition), the conformity-assessment aspect of TBT liberalization is addressed by the 1989 "global approach." 31 Four stages (design, production, marketing, and sales-service) are distinguished, and at each stage conformity may be assessed by one of three bodies: the manufacturer, the local member state's regulatory authority, or a designated third-party certification body. 32 Depending on the precise product in question, approval from the various standards bodies must be obtained at various stages. Products for which this procedure is clear and for which a harmonizing "essential requirements" directive exists can earn the CE mark; this mark ensures free access to all EEA markets.

The entire process of content-of-standards technical harmonization was expedited by the 1986 Single European Act (that is, the 1992 program) which replaced unanimity with qualified majority voting in the European Council for all internal market decisions, including TBT issues. Majority voting also now applies to CEN and CENELEC decisions on the adoption of standards.

The new approach also made substantial progress on the prevention of new TBTs with the 1983 Mutual Information Directive. Member states must notify [End Page 260] the Commission of new regulations. Either the Commission or other member states can object to the regulation and request that it be modified to reduce its trade-distorting effects. In either case, adoption of the new regulation must be delayed and may be prevented altogether, if the Council adopts a harmonization directive in the meantime. Additionally, national standard-setting organizations are required to notify the Commission and certain European standards bodies of proposed standards and regulations before their adoption. A standing committee can determine whether such standards would substantially interfere with trade and can then refer the matter to a European standards organization or require the national agency to collaborate with interested member states. When the matter is referred to a European standards body, member states cannot enact their own standard until a European standard is set, or a one-year period elapses. Some exceptions, concerning urgent health and safety considerations, are permitted. While this directive is not radically different from the gentleman's agreement in the old approach, the Commission actively pursues cases of noncompliance as an infringement of European Community law (a Council directive has the force of a national law in all member states and is enforceable through the EU Court). This notification, comment, and objection procedure is credited with reducing the emergence of new TBTs in Europe.

Given the sparse empirical evidence available, it is too early to convincingly evaluate the new approach. In terms of output, however, it has been a clear success. In 1975 there were 20 harmonized standards in the EU; in 1999 there were nearly 5,500. 33

It is important to note that Europe's success with managed mutual recognition is not a very good indicator of the route's success in the wider world, as box 3 argues.

The Reaction of European "Outsiders": EEA and Switzerland

TBT liberalization in the EU had discriminatory effects on the West European nations that were not EU members. In the late 1980s, EFTA firms and governments had decided that they had to react. Several considered applying for EU membership (Austria actually did), while others considered bilateral negotiations. Jacques Delors forced the decision in January 1989 by proposing the European Economic Area agreement. 34 The agreement is very complex [End Page 261] and required the creation of extensive institutions, but for our purposes it can be thought of as bringing the members of EFTA into the new approach (see box 4).

While the effort to counter discrimination is easy to understand, the outcome is not. Two aspects of the EEA are truly extraordinary. First, the EEA is unbalanced in terms of the rights and obligations of EFTA nations when it comes to future EU legislation. In essence, it forces the EFTA nations to accept future council directives (the acquis communautaire) concerning the Single [End Page 262] Market, without formal participation in the formation of these new laws. 35 Second, the EU insisted on a good deal of supranationality among EFTA nations to simplify the task of keeping the Single Market homogeneous. EFTA nations have resisted such supranational authority since the end of World War II, so it is astounding that they said they would accept it. As it turns out, virtually none of the EFTA governments was willing to live with the EEA as it [End Page 263] was negotiated. By the end of negotiations, all but Iceland and Liechtenstein (populations 300,000 and 30,000 respectively) had put in EU membership applications, so for most EFTA nations the EEA was to be merely a transitional arrangement. Swiss voters rejected the EEA in December 1992, effectively freezing their EU application. Norwegian voters rejected EU membership but implicitly accepted the EEA. The EEA thus consists of the EU 15 on the one hand, and Norway, Iceland, and Liechtenstein on the other.

In 1997 Switzerland initialed a bilateral accord with the EU after six years of on-and-off talks; this should enter into force in 2001. This bilateral deal essentially extends EEA rights and obligations to Switzerland.

As far as the liberalization of TBTs is concerned, the lessons from this episode are twofold. First it is not easy to deeply liberalize TBTs among [End Page 264] nations--even among rich industrialized nations that share similar views on the subject of regulation (for example, protection of human, animal, and plant life). Moreover, when a new nation gains access to an existing arrangement, the likely result is a lopsided arrangement in which the newcomer is forced to accept an immutable status quo. Second, deep TBT liberalization requires institutions that permit surveillance, enforcement, and adjudication.

TBT Liberalization in the GATT-WTO

Compared to the EU's active and ongoing efforts to reduce TBTs and avoid new ones, TBT liberalization in the WTO is quite passive, aimed primarily at avoiding the most obvious protectionist misuse of standards and regulations. [End Page 265] [Begin Page 268] These disciplines, which have evolved over the decades--see box 5 for details--are contained mainly in the so-called TBT agreement that was part of the Uruguay Round. These apply to standards and regulations governing both products and production processes. There are five main disciplines, most favored nation for import restrictions, national treatment once the good has entered, the sham principle, the least-restrictive-means principle, and the transparency principle. MFN and national treatment require no comment. The sham principle states that standards and regulation should not be "a disguised restriction" on international trade. The least-restrictive-means principle states that regulations should accomplish their regulatory goal by means that are the least restrictive to trade. As part of this, there is a general preference for performance standards as opposed to standards based on product characteristics. There is also a "requirement" to use international standards, but this is largely nullified since the requirement does not apply when international standards would be an "ineffective or inappropriate" means of fulfilling legitimate regulatory objectives. The transparency principle takes several forms. There is an obligation on signatories to go through a notice-and-comment period when introducing new measures that may affect trade. Signatories should also maintain an information clearinghouse for standards-related inquiries.

Additionally, there are a number of hortatory elements such as the one urging signatories to give "positive consideration" to unilaterally recognizing foreign standards and regulations.

It is difficult to judge the liberalizing impact of the TBT agreement, but few would claim that it has had a major impact. For one, compliance with the TBT agreement has been quite spotty, outside of OECD nations. 36 TBTs have, however, been the subject of many disputes. Of the forty-eight requests for consultation made to the WTO's Dispute Settlement Body during the first two years of its existence, eleven concerned standards or invoked the TBT agreement. 37 As of December 1999, the count had risen to twenty-five. 38 Another measure of the TBT agreement's success, or lack of it, is the fact that much of the energy and momentum in TBT liberalization has developed outside the WTO framework, in regional arrangements (EU, the North American Free Trade Agreement [NAFTA], Asia Pacific Economic Co-operation [APEC]), the U.S.-EU Mutual Recognition Agreement [MRA], and so on) and on a sectoral [End Page 268] basis. According to John Wilson, there is "little evidence to indicate that the WTO Committee on Technical Barrier to Trade has influenced the debate." 39


There are three main international standard-setting organizations, the International Organization for Standardization (ISO), the International Electrotechnical Commission (IEC), and the International Telecommunications Union (ITU). The ISO and IEC are private, nongovernmental agencies in which each member country designates its own representative. In the most important of the three, the ISO, most members are the national standards bodies from member countries, and these may be private or public bodies. Development of standards is a lengthy process involving voluntary participation and a consensus decisionmaking rule. 40 Member nations are not obliged to transpose the adopted standards. Moreover, compliance to an ISO standard does not bring with it automatic market access.

According to Sherry Stephenson, European members have dominated the international standardization process. 41 For example, European members hold two-thirds of the ISO secretariats (roughly equivalent to a chair). The United States, by contrast, participates in almost all of the ISO's work, but it held only 13 percent of the secretariats. Stephenson claims that the predominance of European members in this process derives from the fact that there are eighteen European countries with long-established and sophisticated national standards bodies well acquainted with international standardization. 42 Most of these coordinate their actions under the aegis of the EU.

While the ISO and brethren organizations have an important role to play in TBT liberalization, their actions are essentially limited to areas where sector-by-sector negotiations can lead to Pareto improvements. In concrete terms, the ISO has produced about 10,000 standards in its fifty-year history. While this is a large number, it is small compared to the 100,000 or so standards that exist in the United States and EU today. 43 [End Page 269]

The EU-U.S. Mutual Recognition Agreement

In June 1997, the EU and the United States signed a Mutual Recognition Agreement (MRA) that deals with the trade-inhibiting aspects of conformity assessment. The MRA commits each party to recognize the results of product testing or certifications of both governments in the six specified sectors. This should liberalize trade in these sectors by reducing the cost of duplicative testing, inspection, and certification. The covered sectors are telecommunications equipment, electromagnetic compatibility, electrical safety, recreational craft, pharmaceutical good manufacturing practice, and medical devices.

Importantly, the agreement does not mutually recognize standards and regulations. Article 4 of the MRA states: "This Agreement shall not be construed to entail mutual acceptance of standards or technical regulations." It merely permits some EU standards to be assessed by U.S.-based laboratories and some U.S. standards to be assessed by EU-based laboratories. EU and U.S. industries, nevertheless, viewed this as an important step to reducing trade barriers. Indeed, the initiative came mainly for industry-to-industry talks in the TransAtlantic Business Dialogue.

A number of other MRAs have also been signed. One of the first outside Europe is the Joint Accreditation System--Australia and New Zealand (JAS-ANZ). This is an open system that promotes mutual recognition of testing in its member nations and beyond. As part of its mandate, JAS-ANZ facilitated the negotiation of an MRA with the EU.

Future Liberalization

Having argued that TBTs are important and having examined the main liberalization efforts, the next step is to argue that TBT liberalization will continue, and that it will almost surely proceed along the lines of mutual recognition agreements among rich nations augmented by some unilateral harmonization by poor nations to the standards of rich nations.

The argument requires a bit of background. First, it is necessary to clarify how TBTs are different from old-fashioned trade barriers like tariffs and quotas. Second, a political economy framework is needed to help us understand historical liberalization efforts and to predict the path of future TBT liberalization. [End Page 270]

Obscurity, not Sovereignty

It is often asserted that liberalization of behind-the-border measures--product norms being a prime example--intrinsically engages issues of sovereignty that did not arise in tariff-cutting talks. 44 This is misleading.

Tariffs, like many TBTs, are adopted in pursuit of governance goals--for example, income distribution--that the community of nations views as legitimate. However, through GATT-WTO, the same community rejects tariffs (or more specifically the raising of bound rates) as a legitimate means of attaining such goals, the simple reason being that tariffs are not the least-restrictive means of fulfilling the goals. Developed nations can achieve the same goal with income transfers, active labor market policies, and the like. 45 The point is that tariffs are not prohibited because nations rejected income distribution as a legitimate policy goal. Tariffs are prohibited because equivalent but less-trade-restrictive measures clearly exist.

This brings us to the key distinction between tariffs and TBTs as far as liberalization efforts are concerned. TBTs are harder to liberalize because it is radically more difficult to objectively determine whether less-trade-restrictive measures could accomplish the same legitimate governance goals.

In short, the difference between regulatory protection and tariffs boils down to issues of obscurity, not sovereignty. This simple but important point has significant ramifications for the nature of future liberalization.

Negotiated Harmonization Does Not Work

TBT liberalization can proceed in two ways, mutual recognition or harmonization, with harmonization coming in two basic "flavors," negotiated harmonization and hegemonic harmonization. I argue that negotiated harmonization does not work.

Begin with the historical evidence. The EU in the 1970s was a near-ideal setting for such an approach. EU members had a "constitutional" obligation to approximate product norms, made regular side payments by way of the EU budget, had a supranational judicial system for dispute settlement, and had similar income levels and regulatory goals. Even in this near-ideal setting, negotiated [End Page 271] harmonization by unanimity proved unworkable in all but a handful of cases. This suggests that the prospect of negotiated harmonization in the wider world is nil for most products.

More can be learned by studying why the EU failed at harmonization in the 1970s. As a matter of fact, the "failure" took the form of interminable delays (in one famous example, it took eleven years to set norms for mineral water). 46 Why the delay? International negotiations must strive for a balance of commercial gains since each government must align a political consensus behind the final liberalization package. Moreover, when it comes to product norms, all governments must be convinced that the synchronized norm meets their governance goals. Obscurity renders both tasks enormously difficult. It is difficult and time consuming to determine the commercial impact of each proposed norm. Further complexity is added by the need to determine whether each proposed norm permits an appropriate level of regulatory protection in each nation. Given that a typical international negotiation involves many proposals, and many modifications of each of these, leads one to the conclusion that obscurity can quickly render such negotiations impractical. In fact, obscurity-induced delays are important enough to make the negotiated harmonization approach a nonstarter.

Mutual Recognition

This leaves hegemonic harmonization and mutual recognition as the only routes forward, and, in fact, both routes are currently being pursued. Hegemonic harmonization is the default option for many small nations that are heavily dependent on a large trading partner such as the EU. The Europe Economic Area agreement and the EU-Swiss Bilateral Accords, for instance, commit nations to the EU's standards and regulations en masse and without substantial modification.

Mutual recognition, or more precisely mutual recognition teamed with some "new approach" harmonization in sensitive areas, is the standard procedure inside the EU. It is also the liberalization route adopted in the bilateral trans-Atlantic trade talks, APEC, and other regional arrangements. 47 Interestingly, the most important MRA pursued to date--the U.S.-EU MRA--is limited to mutual recognition of conformity assessments, not of norms themselves. [End Page 272]

Political Economy of TBT Liberalization

Good governance demands product regulation, so the existence of standards and regulations is no mystery. But why do these norms inhibit trade?

Obviously, protection does not result from random acts of nature, and trade liberalization is not the outcome of heroic deeds by high-minded civil servants and political leaders. Protection is endogenous. In a price-like manner, proposed protection "clears" the political market by equalizing the demand and supply of protection. 48 Regulatory protection, like most protection, arises from Mancur Olsen's asymmetry. Asymmetric organization and information costs means that industries organize more effectively than consumers. Norm-setting agencies are thus "captured" by domestic firms in the regulated industry. The obscurity factor greatly enhances the ease of capture since most industrial standards and regulations are way off the radar screens of voters and politicians. Obscurity also shapes the mode of capture. In many nations and industries, domestic firms are the de facto authors of their own norms. This is easy to understand.

When regulating a technical field, take elevators for example, obscurity abounds. The government, which probably does not employ many full-time experts on elevator manufacturing, asks the opinions of domestic elevator-producing firms. With an eye to their foreign competitors, these firms quite naturally push for norms and conformity practices that raise the production cost of imported goods beyond that of locally produced goods. For the domestic firms this is a straightforward cost-benefit exercise. Domestic firms incur the costs of influencing the norm-setting process when these norms create sufficient rents. This is not to call the domestic industry greedy philistines. Most firms are convinced of the superiority of their own products. Crafting standards to reflect characteristics available only in local products may strike the firms as a way of promoting the public interest. Given the obscurity factor, it is difficult, maybe even impossible, to separate the protectionist and public interest content of a particular norm. A good example is the European paper industry (see box 6).

Taking it as a given that the level of protection is set in a political market, trade liberalization poses a puzzle. Why should a nation find it politically optimal to remove barriers that it previously found politically optimal to impose? This is especially puzzling since the revision-of-optimality has occurred on a [End Page 273] very regular basis over fifty years, and the revisions coincide with multilateral trade negotiations.

The Juggernaut Model of Reciprocal Trade Liberalization

Elsewhere, I have proposed a puzzle solution that focuses on exporters as the key antiprotection force and import competitors as the key pro-protection force. 49 Announcement of a reciprocal trade talk--where better foreign market access is bought with domestic liberalization--starts the juggernaut rolling by multiplying the ranks of pro-trade forces. Exporters, in search of foreign market access, cast off their normal indifference to domestic protection and don the cloak of antiprotectionists. The same goes on in other nations, so the political market for protection clears at a lower level, implying some liberalization in all participating nations. With the phasing in of the liberalization, export interests get stronger as they expand output and employment. Import [End Page 274] competitors get weaker as they scale back or shut down. A few years down the road, another round is launched, and the juggernaut rolls on. Barriers are initially lower, but antitrade forces are weaker and pro-trade forces stronger than they were at the conclusion of the last round, so barriers again come down. The endpoint of this process is zero tariffs in the markets of nations engaged in periodic reciprocal trade talks. Tariffs remain high in countries where exporters get better market access "for free" (for example, developing nations owing to MFN and special and differential treatment) and in markets left off the bargaining table (for example, food and clothes).

Application to TBT Liberalization

Consider next the application of this model to TBT liberalization. In the political economy approach, changing the level of regulatory protection requires a change in the forces that determined the political equilibrium. In particular, liberalization has to offer something to domestic firms that they find more attractive than the status quo. A tried-and-true method is to engage nations in an exchange-of-market-access negotiation. The political economy reasoning, however, differs somewhat from the model explained above.

Most of the TBT liberalization seen so far has occurred among nations and within industries where the exporting and import-competing firms are one and the same--that is to say, in trading relationships dominated by intraindustry trade. We must therefore modify the juggernaut model to allow a different set of political actors. When it comes to TBT liberalization, the key distinction will be between large efficient firms and smaller less efficient firms. Two-way regulatory protection results in fragmented markets where firms are dominant in their home market while being marginal players in other markets. This market fragmentation reduces competition, raises profit margins, and thus keeps too many firms in business and keeps prices too high. Tearing down these barriers defragments the markets, producing a pro-competitive effect that puts pressure on profits, especially those of the inefficient (and therefore small) firms. The end result is an industrial restructuring that involves weaker firms merging, exiting, or getting bought up. In the end, a more efficient industrial structure emerges with fewer, bigger, more efficient firms competing more effectively with one another.

The key result is that two-way liberalization of TBTs systematically favors large firms' profits. Intuitively, big firms gain from the liberalization and from the exit of the small firms. Given this, the juggernaut logic applies directly with large firms in the role of the main pro-liberalizers and small firms in the [End Page 275] role of the main anti-liberalizers. Of course, a negotiating framework based on reciprocity is again of the essence. Large and small firms would be united in their opposition to unilateral liberalization.

With all this on the table, it is a simple matter to predict that large multinational firms will continue to press for two-way liberalization of TBTs, and this liberalization is most likely to take the form of preferential arrangements among rich nations.

A Two-Tier World Trade System?

Most liberalization of regulatory protection in the past has been bi- or plurilateral and based on the MRA approach. Future liberalization is likely to continue being so for reasons just discussed. Yet the MRA approach requires a high level of trust in a nation's governance capacity. Since few developing nations are able to generate such trust, the ongoing liberalization process will almost surely exclude them. A two-tier system of market access may thus emerge, with developing countries occupying the second tier. Note that this proposition is not entirely based on abstract reasoning. The EU's Single Market program liberalized TBTs on a preferential basis, which implied that non-EU Western European nations had second-class access to EU markets. Outsiders, such as the EFTA nations, had to scramble to redress the situation by joining the EU or the EEA.

A couple of features make this two-tier market access more pernicious, "escalation" and the "magnification effect." The magnification effect of globalization emphasizes the tendency for a general lowering of natural and manmade barriers to trade to make the remaining barriers and discrimination more important, not less important.

"Escalation" concerns the link between product sophistication and the cost of TBTs. Product regulation applies to all goods ranging from apples to jet engines. Generally speaking, however, these norms become more restrictive, complex, and costly as one moves up the product-sophistication scale. What this means is that preferential TBT liberalization has an "escalating" effect on the level of discrimination facing third nations. The analogy with tariff escalation should be clear. Even now, OECD nations tend to have higher tariffs on industrial goods than on raw materials apart from food. In the 1970s, when OECD tariffs were more important, this pattern of protection had the unintentional [End Page 276] effect of distorting developing nations' post-tariff comparative advantages away from industry.

What is wrong with a two-tier system?

--It is undisciplined. The WTO's TBT agreement contains no explicit strictures on the form of MRAs or on their discriminatory effects on third nations.

--It violates the nondiscriminatory and multilateral spirit of the WTO, and this, in turn, tends to undermine the rule-based world trade system. 50 For both bilateral MRAs and hegemonic harmonization, the basic principle is "might makes right."

--It harms the competitiveness of firms located in excluded nations--a group that is likely to be dominated by developing nations.

For instance, bilateral foreign direct investment flows clearly show that the EU's Single Market program led to investment diversion and trade diversion. 51 By the same logic, the EU-U.S. MRAs may well divert investment and trade from nations such as Mexico. At the moment, MRAs outside of Europe concern only testing and so have a limited impact on competitiveness. If the MRA process gets extended to norms as well as testing, the actual content of standards will be affected. Public choice reasoning would indicate that such an outcome is likely to lead to product norms that disfavor goods made in excluded nations. A good European example of this, described in box 6, involved an attempt by French and German paper firms to impose a standard that would negate the resource-based comparative advantage of Swedish and Finnish firms (by requiring that cardboard boxes contain a high fraction of recycled paper and rags as opposed to new wood). One could similarly imagine the United States and the EU agreeing to a standard that would offset the comparative advantage of developing country manufacturers.

Some Proposals

Professors are generally better at identifying and framing policy problems than they are at coming up with workable solutions. Yet even admitting this absolute disadvantage, there do seem to be a couple of basic proposals that would redress some of the problems. [End Page 277]

Open Liberalization or Article 24 Disciplines

TBT liberalization can have radically different results when it is "open" and when it is "exclusionary" (see above for the arguments). When it is open--as is the case in the EU's Single Market--the TBT liberalization may actually improve the market access of third nations. 52 For example, a Turkish-made skateboard can, in principle, be sold in all fifteen EU markets after having been certified in any one. To illustrate the importance of open liberalization, consider what the impact would be if EU's mutual recognition principle were limited to EU-made goods. Recalling that EU nations are allowed to have different standards, third-nation discrimination in this counterfactual world could be enormous. EU-made goods would have to comply with one norm, while third-country goods would have to comply with fifteen different norms.

Generally, exclusion in TBT liberalization is enforced through rules of origin. This then suggests the first proposal. Regional TBT liberalization initiatives, including MRAs, should not in principle include rules of origin. If they do, they are likely to be discriminatory, and thus they should be subject to disciplines like those that fall under GATT Article 24. The point is simple. Rules of origin in a free trade agreement are essential to prevent tariff evasion. However, rules of origin make no sense in an MRA. A good, regardless of where it was made, either meets the requisite norms, or it does not. Country of origin should not be an issue. Given this, rules of origin in a TBT liberalization arrangement create unnecessary discrimination. GATT allows for such deviations from the MFN principle, but all such deviations are subject to disciplines designed to ensure that the primary intent of the preferential liberalization is liberalization rather than preference.

I would propose that these disciplines include something like the "substantially all trade" dictate in Article 24. This would clearly be difficult since all existing MRAs are limited to a relatively narrow range of industrial goods. Recall that the substantially-all-trade rule was adopted to reduce the likelihood that the main motive behind a free trade agreement was to discriminate against third parties. A similar discipline would be welcome for MRAs. For example, one might imagine that the EU and Japan could craft an MRA on the norms and testing of semiconductors that would substantially raise the costs faced by U.S. chip makers in the EU and Japanese markets. The regulatory protection thus provided might be very appealing to the body politic of both the EU and Japan. Of course, the United States is big enough to counter [End Page 278] such moves. But what would happen if the United States and the EU signed an MRA deal in grapes that had the effect of reducing the competitiveness of Chilean grapes? Surely, this is exactly the sort of thing the WTO was set up to discipline.

Additionally, something akin to the test on a custom union's common external tariff should be applied to MRAs, although obscurity of TBTs would make this difficult to apply. The point is that the signatories of an MRA should be forced to examine the impact of their preferential liberalization on third nations. There should be an obligation to pay compensation to third parties if the MRA results in worsened market access conditions. The details of such a stricture would require a great deal of elaboration, but the "injury test" in antidumping and countervailing duty cases might provide an example of how one might proceed.

It is worth noting that the issue of rules of origin in MRAs could become important. Reportedly, the EU asked for rules of origin during the negotiation of the EU-U.S. MRA but were rebuffed by the United States. 53 The stance of the United States, however, was based on the impracticality of ascertaining "the" country of origin for sophisticated industrial goods (nowadays, things are made nowhere in particular). The impact of such rules on third nations was not, apparently, an issue for either the EU or the United States.

GSP-like Treatment

A second proposal concerns policies that could actively seek to offset any anti-developing-nation bias that arises from regional TBT liberalization. The WTO TBT agreement already contains hortatory statements about providing technical assistance to developing nations. The WTO, or some other organization such as the World Bank or the UN Conference on Trade and Development, should more explicitly promote the TBT equivalent of the Generalized System of Preferences (GSP). For instance, industrial nations might directly or indirectly subsidize conformance assessment procedures for products made in developing nations. Right now, the WTO's TBT agreement prevents members from charging foreign firms certification fees that are too high. To offset the cascading effects of discriminatory TBT liberalization, the WTO might encourage a subsidization of fees charged to firms based in developing nations. [End Page 279]


This paper covered the economics of TBTs, evidence on their importance, and the various initiatives made to liberalize them. It was found that most liberalization of regulatory protection in the past has been discriminatory and based on the MRA approach; future liberalization is likely to continue to do so. The MRA approach requires a level of trust in a nation's governance capacity that few developing nations are likely to be able to provide. Consequently, a two-tier system of market access is likely to emerge, with developing countries occupying the second tier.

I have pointed out that the discriminatory liberalization of regulatory protection, unlike preferential tariff cutting, is largely undisciplined despite violating the WTO's MFN spirit; this lack of discipline may undermine the rules-based system as TBT liberalization becomes increasingly important. More directly, MRAs--especially when they employ rules of origin to exclude third nations from the liberalization--can harm the competitiveness of firms located in excluded nations.

I also propose that the WTO be modified to discipline regional TBT liberalization. Specifically, bilateral and plurilateral TBT liberalization schemes should not include rules of origin. Rules of origin exclude third nations from the liberalization without serving a legitimate purpose (either a product meets the norms or it does not). If nations do choose to include rules of origin, then the liberalization schemes should be presumed to be discriminatory and should thus be subject to Article 24-like disciplines. Finally, some sort of GSP-like policy to offset the impact on developing nations should also be considered.


1. Baldwin (1970, p. 2).

2. See Baldwin and Martin (1999) for a detailed comparison of current and pre-World War II levels of openness.

3. According to common usage, regulations are mandatory, while standards are voluntary.

4. Sykes (1995, p. 25).5. Gasiorek, Smith, and Venables (1992, p. 45).

6. Matutes and Regibeau (1996, pp. 183-209).

7. Helpman and Krugman (1989).

8. For a given market, say H, there are three types of firms active; H-based firms, P-based firms and R-based firms. Normalizing marginal production cost to zero (with linear demand the intercept, call this a, and the marginal cost, call this c, always enter together as a - c in the first order conditions, and by choice of units we can normalize a - c to unity). The first order conditions are: pH = qHH for H-based firms, pH = t + qPH for P-based firms and pH = t* + qRH for R-based firms. With ni (i = H, P, R) firms in each nation, the sum of all the first order conditions is (Sni)pH = nH qHH + nP (t + qPH ) + nR (t* + qRH ). Using the definition QH = nH qHH + nP qPH + nRqRH and the demand function pH = 1 - QH , the sum of first order conditions becomes pH = 1 + nPt + nR t*, so pH = 1/ (1 + S(ni) + (nP t + nR t*)/ (1 + Sni), which presents that two terms discussed in the text.

9. Using the first-order conditions pH = t + qPH for P-based firms and pH = t* + qRH for R-based firms, we have nPqPH - nRqRH = nP (pH - t) - nR (pH - t*). Rearranging this and employing the convention that nP = n and nR = nt yields the expression in the text.

10. The simulations and full solution of the model can be found in the MAPLE worksheet "brook.mws" available from the author upon request, and on (posted September 27, 2000).

11. Markusen and Venables (1988, pp. 299-316).

12. Baldwin and Venables (1995).

13. Brander and Krugman (1983, pp. 313-21).

14. Sapir (1997).

15. Most EFTA-EFTA trade is among adjacent nations, namely, among Nordic nations or among Alpine nations.

16. Head and Mayer (1999); Wei (1996).

17. Head and Mayer (1999, pp. 14, 17).

18. Buiges and others (1990).

19. Moenius (1999).

20. Liberalization additionally involves surveillance, enforcement, adjudication, and the introduction of new standards.

21. The year 1968 also saw the eradication of tariffs on intra-EFTA industrial trade by the Stockholm Convention. The eradication of tariffs on EU-EFTA industrial trade began with the 1973 EU-EFTA free trade agreements.

22. See Lauwaars (1988, p. 152) for details.

23. An exception, which was a precursor to the new approach, was the "low-voltage" directive of 1973; see Lauwaars (1988, p. 156) for details.

24. Majone (1994).

25. See Pelkmans (1990, p. 109); Majone (1994, p. 166).

26. Emerson and others (1988, p. 21).

27. Commission communication of January 31, 1985, to the Council, "Technical Harmonization and Standardisation, a New Approach." Elements of this emerged earlier in 1973 with the Council's favorable experience in framing the low-voltage directive, in 1974 with the Dassonville case, and in 1979 with the Cassis de Dijon case. Other elements emerged later, for example, the "global" approach to conformity assessment in 1989. For a succinct summary, see [October 2000].

28. See Sykes (1995) for legal analysis.

29. These harmonized standards are prepared in accordance with the "General Guidelines" agreed between the Commission and the mandate issued by the Commission after consultation with the member states.

30. Pelkmans (1990, p. 105).

31. "A Global Approach to Certificate and Testing," European Commission, July 24, 1989.

32. Pelkmans (1990, p. 107).

33. Moenius (1999, p. 1).

34. The idea was first suggested at a meeting of EFTA and EU ministers in Luxembourg in 1984. This produced the Luxembourg Declaration. EEA talks began informally in 1989, continuing more formally in 1990 and 1991. It was signed May 2, 1992, in Oporto, together with an agreement establishing the EFTA Court of Justice and the EFTA Surveillance Authority.

35. EFTA nations do participate in Euro-standards bodies, such as CEN and CENELEC.

36. Stephenson (1997, p. 42).

37. Stephenson (1997, p. 17).

38. Wilson (2000, pp. 16-17).

39. Wilson (2000, p. 20).

40. Stephenson (1997).

41. Stephenson (1997).

42. Stephenson (1997, p. 51).

43. Stephenson (1997, p. 47).

44. See Vogel (1997); Bagwell and Staiger (1998); Brittan (1998).

45. Counterexamples strengthen the point. For developing nations that do not have sophisticated systems for gathering and distributing tax revenue, tariffs are more likely to be tolerated. Moreover, GATT allows import prohibitions when these are the only practical means of pursing a legitimate goal, such as reducing the consumption of illegal drugs.

46. Stephenson (1997, p. 59 n. 31).

47. See Stephenson (1997); Wilson (2000); and OECD (1998) for details.

48. Mancur Olsen is the Freud of this literature. See Hillman (1989) for the basic logic and Dixit, Grossman, and Helpman (1997) for recent refinements.

49. Baldwin (1994, chap. 3).

50. Note that the TBT agreement actually encourages MRAs, so the current course of liberalization is by no means GATT illegal.

51. Baldwin, Forslid, and Haaland (1996, pp. 635-59); Sapir (1997).

52. The Cassis de Dijon mutual recognition principle applies to any good that is made or marketed in an EU nation.

53. Wilson (2000, p. 39).


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