Cato Online Forum

The Transatlantic Trade and Investment Partnership Will Be Good for Both World Trade and the World Trade Organization

By Joost Pauwelyn
October 2015

This essay makes two central arguments. First, the Transatlantic Trade and Investment Partnership (TTIP) is less of a threat to multilateral trade than were first generation free trade agreements (FTAs), which involved a proliferation of preferential tariff treatment. And second, unlike these shallow FTAs, deep FTAs — such as TTIP — force us to re-think the operating system of the World Trade Organization (WTO).

1. Not As Preferential As You’d Think1

If the Korea-U.S. FTA (KORUS) and the EU-Canada Comprehensive Economic and Trade Agreement (CETA) are any sign of what TTIP might become, many TTIP obligations will also benefit third countries. Either de jure or de facto, the commitments will be extended on a “most-favored nation” (MFN) basis.

First generation FTAs focused on reducing tariffs. Tariff concessions are “club goods” (non-rivalrous but excludable). Old-style FTAs create trade within the FTA but, by discriminating, also risk diverting trade from third countries.

TTIP still has an important tariff component: dismantling remaining tariff peaks in agriculture, motor vehicles, textiles and processed goods, for example. But tariffs have fallen so sharply — 2.8 percent is the trade weighted average tariff rate for EU-U.S. manufacturing trade — that TTIP’s main promise lies elsewhere: behind-the-border rules and regulations.

For a variety of reasons it is far more difficult to limit “rules concessions” to FTA partners only. Many TTIP concessions — with the exception of tariffs and certain concessions in government procurement and services trade — will therefore be more like “public goods” than “club goods”. This is the case for several reasons.

First, there is the issue of technical necessity. Many obligations cannot be negotiated on a “bilateral basis.” Examples include transparency and publication requirements, commitments in respect of subsidies, anticompetitive business conduct, privatization or corruption, and obligations to ratify and comply with certain environmental, labor or IP conventions.

Second, there is volition. Although some issues could technically be committed or implemented on a bilateral basis, in practice (as in KORUS), they are implemented on an MFN basis. Examples include notice and comment procedures, advance customs rulings, commitments on the listing of pharmaceutical products, medical devices and their reimbursement or in respect of electronic authentication, rules on liability of online service providers and intermediaries or the prohibition of certain performance requirements in the field of investment.

Third, there is the operation of the MFN principle. Even where the text of TTIP reserves certain concessions to TTIP parties or nationals only, U.S. and EU MFN obligations under the WTO treaty, bilateral investment treaties (BITs) or other FTAs may actually extend them to certain third parties as well, as follows:

(i) unlike GATT and GATS, TRIPS does not have a regional trade exception; as a result (with limited exceptions in the field of copyrights), any TRIPS-plus commitments in TTIP will have to be extended on an MFN basis to all WTO members;
(ii) mutual recognition or equivalence clauses in TTIP may also allow other WTO members to seek approval of their standards if they meet the same level of protection (under SPS, TBT and GATS);
(iii) because of broad MFN clauses in US BITs, investment-related concessions the US grants to the EU in TTIP may also have to be extended to third countries that have a BIT with the US (most EU/EU member states’ BITs, in contrast, include an MFN exception for FTAs),
(iv) if the US or EU make bigger concessions in TTIP than in earlier FTAs, MFN clauses in these earlier FTAs may oblige them to extend this better treatment also to existing FTA partners (see, for example, the MFN clauses in the CARIFORUM-EU economic partnership and Korea-EU FTA for cross-border services and establishment).

And finally, there is the problem of circumvention. Strict rules of origin in the goods sector allow for hard discrimination when it comes to tariffs. By contrast, the origin of services, capital and IP rights is harder to pin down or restrict. To qualify as a service supplier, investor or IP right holder of country X, it may be enough to incorporate a legal entity in X or to have some business operations there. A Japanese or Swiss company may, therefore, benefit from TTIP concessions by having or setting up an EU or U.S. subsidiary or branch or by shifting assets to such EU or U.S.-based entity.

To the extent TTIP concessions are “public goods” they can, of course, be granted only once, and only once can negotiators get something for them in exchange. This may somewhat explain the move to mega-regionals. If countries are going to exchange “public goods,” they may as well do it with major trading nations and in a larger group, not only to bind as many countries as possible to the “new rules” but also to get as much as possible in exchange for the “public goods” that they are giving away.

The “public goods” nature of many TTIP concessions also raises another problem: free-riding. If third parties will already benefit from certain TTIP concessions, why should they pay a high price to join TTIP? At that stage, it will have to be TTIP’s “club goods” (tariff concessions and exclusive government procurement or services commitments) that do the bidding to entice countries like China or Brazil into TTIP.

In sum, the problem with TTIP for outsider-countries is less about discrimination (as discussed above, “rules concessions” in many fields apply equally to everyone). The problem is, rather, regulation: Will outsiders be able to meet the new rules and are these rules adapted to outsider concerns? WTO exceptions for FTAs (TTIP will need to meet the conditions in both GATT Art. XXIV and GATS Art. V) focus on discrimination; they do not address today’s concerns.

Bilateral streamlining of U.S. and EU regulations and standards may reduce the trade costs for third country exports to the European Union and the United States through, e.g., economies of scale or having to meet only EU or U.S .requirements to get into both markets. Because of the combined market size of the TTIP members, some third countries can also be expected to adopt the common standards agreed between the EU and U.S. negotiators, making these standards de facto common global standards that, in turn, may create efficiency gains. This is why most economic studies are predicting positive gains from TTIP for both parties and non-parties. Other studies foresee a negative impact for third countries either by discarding the hoped for positive spillover effects, or by pointing out that TTIP risks harmonizing standards upwards thereby making it more difficult especially for developing countries to get market access.

2. Time to Re-think the WTO’s Operating System?

As Petros Mavroidis recently concluded: “the WTO is the victim of its own success: by effectively addressing tariffs, it paved the way for negotiation on regulatory barriers. Alas, this negotiation is best suited to like-minded countries [as in TTIP] … PTAs risk becoming the ‘termites’ of the world trading system not because of the trade diversion that they have provoked, but because of the forum diversion they represent. PTAs … probably because they are by definition more flexible instruments than the WTO and also because there is no need to work out compromises that will satisfy 160 odd countries, have managed to better respond to the needs of the business community worldwide than the WTO does”.2

But the rise of deep PTAs must not mean the end of the WTO. Rather than fighting FTAs as evil (as many WTO commentators did in the 1990s) or seeking to “multilateralize” FTAs as soon as possible to restore the centrality of the WTO (a view often voiced in Geneva today), the better option is to conceive a new “division of labor” between the WTO and FTAs.

The WTO must focus on tariffs and general principles shared by all 161 WTO members (such as national treatment, transparency, disciplines on subsidies and trade remedies, minimum standards in IP and services). The WTO’s dispute settlement system has proven remarkably successful in settling disputes and developing a detailed jurisprudence in these areas. By necessity, because the WTO membership is so diverse, and has different priorities and preferences, other areas are better tackled in FTAs or smaller clubs of like-minded countries (plurilaterals). What matters in these areas is for the WTO to be a clearing house, offering transparency, debate and learning, guarding against WTO-minus backtracking in FTAs or plurilateral agreements, and devising certain overarching principles, e.g., on good regulatory practice (currently discussed in the Technical Barriers to Trade Committee).3

Not only in the WTO but also in financial and tax regulation and international standard-setting more broadly, reaching agreement on detailed, set-in-stone cross-border rules has become increasingly difficult4: (i) because of economic development in emerging countries, there are more players and veto-holders; (ii) the financial crisis and environmental imperatives have increased the political salience of many of the debates and activated a wider array of domestic societal groups; (iii) with the end of the Washington consensus, new models of economic development and industrial policy have emerged calling for an end to one-size-fit-all rules and more flexibility to allow for a degree of regulatory divergence.

Even in TTIP, it is hard to imagine genuine harmonization of many of the core substantive U.S. and EU rules and regulations. Instead of agreed upon outcomes or standards, TTIP is more likely to commit to agreed upon procedures to consult and cooperate: Obligations of means or conduct instead of obligations of result; “informal international lawmaking” rather than hard-to-adapt treaty rules.5

For the WTO to adapt to this new model, certain of its long-held mantras will need to evolve6:

  1. The myth of the single-undertaking, with the same obligations on all WTO members (this has never been the case but will be even less so in the future), must give way to “variable geometry”;
  2. (Some) WTO negotiations can no longer being about reciprocal concessions (where if one country wins something, others must necessarily lose) but, rather, the negotiation of basic rules that are good for everyone (the Trade Facilitation Agreement is an example in this direction);
  3. WTO rules must not necessarily all be subject to hard-core dispute settlement (based on the assumption that states deviate from the treaty to gain a trade advantage). Instead, peer review, monitoring, information sharing and capacity-building may for certain areas be more appropriate (e.g., where non-compliance occurs not to game the system but for lack of resources or capacity). In an organization like the WTO, where every single agreement or decision is subject to being referred to dispute settlement, agreement — even non-binding as in the TBT committee — has become close to impossible (hard law-enforcement makes law-making even harder).
  4. The WTO’s sacred consensus principle, which nowadays blocks even the discussion of plurilateral initiatives from taking place in the WTO, will have to yield. Consensus is also required to bring any plurilateral into the realm of the WTO treaty (Annex 4), even if such plurilateral is not binding on all WTO members. No WTO member should see any commitment imposed on it or any of its rights diminished without its consent; but should a single WTO member be able to block progress within the WTO on any issue that other WTO members can agree on?

The TTIP is likely to be more trade creating than diverting — or, at least, less diverting than previous shallow FTAs. That it may inspire new thinking about the scope and functions of the WTO is also something to embrace.

Notes:
1 For a more extensive treatment, see Joost Pauwelyn, Taking the Preferences Out of Preferential Trade Agreements: TTIP as a Provider of Public Goods? in Morin, Jean-Frédéric, Tereza Novotná, Frederic Ponjaert and Mario Telò, The Politics of Transatlantic Trade Negotiations: TTIP in a Globalized World, Farnham, Ashgate, 2015.
2 Petros Mavroidis, Dealing With PTAs in the WTO, 14 WTR (2015) 107-121 at 114.
3 See Joost Pauwelyn, New Trade Politics for the 21st Century, 11 JIEL (2008) 559.
4 See E. Helleiner & S. Pagliari, The End of An Era in International Financial Regulation ? A Post-Crisis Research Agenda, 65 International Organization (2011) 169-200.
5 Joost Pauwelyn, Rule-based Trade 2.0? The Rise of Informal Rules and International Standards and How They May Outcompete WTO Treaties, 17 JIEL (2014) 739-751.
6 See Joost Pauwelyn, The WTO in Crisis: Five Fundamentals Reconsidered, WTO Public Forum, Summer 2012, http://www.wto.org/english/forums_e/public_forum12_e/art_pf12_e/art9.htm

The opinions expressed here are solely those of the author and do not necessarily reflect the views of the Cato Institute. This essay was prepared as part of a special Cato online forum on The Economics, Geopolitics, and Architecture of the Transatlantic Trade and Investment Partnership.

Joost Pauwelyn is a law professor at the Graduate Institute in Geneva and Georgetown University in Washington, DC.