The US restructured the world trade system following WWII with GATT. GATT was an unambitious treaty. The 1940s saw the rise of a number of grand international organizations, including the UN, the World Bank, and others that were supposed to transform the world. They accomplished little while GATT created the framework for globalization.
Prior to World War II, governments created international trade policies and tariffs as if they were domestic policies. Government parliaments raised or lowered tariffs at the demand of special interests. Most of the trade was inside each European Empire. The British traded within the British Empire, the French within the French Empire, and so on.
There was some movement to create bilateral trade treaties. This created an overlapping web of treaties, each based on self-interest. If one state defected from the free trade agreement by raising tariffs, the injured state would raise tariffs to punish the defection.
One feature was the “Most-Favored Nation” condition. Because any trade treaty was negotiated bilaterally, this meant that a later treaty could offer lower tariffs to different states. For instance, Britain and Italy sign an agreement to lower their tariffs to 10%. Later, France and Italy sign their agreement to lower tariffs to 5%. This would redivert trade away from Britain. MFN guaranteed that the treaty would automatically adjust to match new tariffs rates.
The 19th century system worked reasonably well given it’s ad-hoc structure. It had three major flaws: 1) Protectionist pressure 2) Imperialism 3) Unstable cooperation
World War I and the Great Depression obliterated this system. The fall of the four major Eastern European Empires (Russia, Ottoman, Austrian, German) left the region in a financial crisis. The Great Depression in the US finished off world trade with the Smoot-Hawley Tariffs. The First World War led to a spike in tariff rates, as national self-interest shifted towards security and demands for increased revenue. Continued pressure from the Great Depression, World War II, and the disintegration of European empires prevented the old trade regime from reviving itself.
Switching to GATT
The United States shifted power over tariffs from Congress to the President. In the late 1930s, FDR made trade policy a foreign policy matter rather than a domestic tax policy.
Congress and the President have different constituencies. Presidents support Free Trade while members of Congress are more likely to oppose it. From FDR to the present, the US has not had a President opposed to Free Trade, nor should it ever.
Free Trade is Kaldor-Hicks efficient. This means that a majority benefit and a minority do not. For example, we can expect 8 to benefit and 2 to lose out. Protections make 2 win and 8 suffer.
Protectionists make their case by stringing together anecdotes about those negatively affected. People’s beliefs will be distorted because it is easy to see concentrated negative effects but not see the diffused benefits. Free trade helps all consumers and helps the national ecomomy as a whole.
Congressmen represent special interests within their small districts, so they often voice the concerns of special interests who want protection. They do not represent Americans, consumers, or other industries which are helped by trade.
At the start of the Great Depression in 1929, Congressmen decided to “protect” American industries from European competition by raising the tax on trade. In a disastrous move, the Smoot-Hawley Tariff further provoked widespread retaliation, unprecedented high tariffs, and a 66% contraction in world trade quantity. This made the Great Depression much worse than it had to be. World trade came to a stand still. Indeed, the collapse of global encouraged the rise of Japanese imperialism and sparked World War II.
The United States restructured its trade policies in the 1930s. Roosevelt and Cordell Hull favored free trade and altered the US tariff policies during the New Deal. The Reciprocal Trade Agreements Act of 1934 converted tariffs into a foreign policy issue, favoring negotiation powers to the executive branch, rather than the traditional way where Congress set tariffs as a matter of domestic policy. The RTAA alone could not fully reverse the damaging effects of the Depression, but indicated that the most protectionist world power made a turnabout.
The RTAA was based around a simple principle: Every state should lower its tariffs as a matter of reciprocal foreign policy and ignore domestic protectionist pressures. Diplomacy encourages free trade.
This is one of FDR’s greatest and most significant reforms, especially for foreign policy. This was expanded even further with the General Agreement on Tariffs and Trade under the Truman Administration.
GATT helped to lower industrial and agricultural tariffs to historic lows, and by the end of GATT and the start of the WTO in the mid 1990s, the United States industrial tariff rate dropped to a mere 3.1%. Partly as a consequence, world trade increased nearly 700% in the 50 years following GATT implementation.
Since GATT lacked international institutions and organizations, how did it work so well? At its core, it relied on self-interest and reciprocation. GATT created a framework to solve multinational coordination and collective action problems, but had absolutely zero enforcement powers on its own. It allowed multiple nation-states to coordinate their negotiations, agree on common arbitration, and create standardized and transparent rules for international commerce. Once basic transparency and rules are created, the new trade regime would be self-enforcing, as nation-states use reciprocal tariffs to bilaterally enforce compliance. At the same time, the adjudication would prevent another international tariff war.
The GATT framework essentially created the following goals and procedures.
1) Protection would be in the form of visible tariffs rather than hard to monitor non-tariff barriers;
2) there would be reciprocal tariff reduction;
3) there would be no discrimination against GATT members to prevent unfair trade diversions;
4) ad-hoc courts would settle disputes and create a system of jurisprudence;
5) enforcement would be carried out by the interested nation-state parties rather than all members or GATT itself.
GATT openly accepted many of the customary norms of the 19th century by granting full sovereignty to nation-states to make bilateral trade decisions on a pragmatic basis. GATT, as an international law, was little more than a framework for regular diplomacy.
Economic self-interests encouraged nation-states to unilaterally comply with trade rules most of the time, but in special cases, they violated these rules when the utility benefits outweighed the costs. GATT’s structure made any violations known.
In addition to unilateral compliance, nation-states are encouraged to retaliate and reciprocate with other nation states, helping to ensure greater mutual compliance. The enforcement lands upon interested nation-states, who are motivated to win. For instance, during the “chicken war” between the United States and Europe, the Europeans violated GATT by raising their poultry tariffs, so the US imposed retaliatory tariffs in the interests of American chicken farmers.
Not only is there an incentive to enforce the rules, but there is also an incentive to ignore or openly violate unenforceable rules. For example, some of GATTs rules on non-tariff barriers were idealistic to say the least, as nations can enact ‘invisible’ protectionism through abusive health and safety laws. So without impacting GATT’s overall credibility, nation-states effectively ignored or bypassed those troublesome sections.
GATT’s greatest achievement was isolating these tariff wars thereby preventing a world-wide cascade failure as occurred in the 1930s. GATT provided transparancy rather than mandatory legal compliance as you would see in domestic courts of law.