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international trade
Encyclopdia Britannica Article
Introduction
economic transactions that are made between countries. Among the items
commonly traded are consumer goods, such as television sets and clothing;
capital goods, such as machinery; and raw materials and food. Other
transactions involve services, such as travel services and payments for
foreign patents (see service industry). International trade transactions are
facilitated by international financial payments, in which the private
banking system and the central banks of the trading nations play important
roles.
International trade and the accompanying financial transactions are
generally conducted for the purpose of providing a nation with
commodities it lacks in exchange for those that it produces in abundance;
such transactions, functioning with other economic policies, tend to
improve a nation's standard of living. Much of the modern history of
international relations concerns efforts to promote freer trade between
nations. This article provides a historical overview of the structure of
international trade and of the leading institutions that were developed to
promote such trade.
Historical overview
The barter of goods or services among different peoples is an age-old
practice, probably as old as human history. International trade, however,
refers specifically to an exchange between members of different nations,
and accounts and explanations of such trade begin (despite fragmentary
earlier discussion) only with the rise of the modern nation-state at the
close of the European Middle Ages. As political thinkers and philosophers
began to examine the nature and function of the nation, trade with other
countries became a particular topic of their inquiry. It is, accordingly, no
surprise to find one of the earliest attempts to describe the function of
international trade within that highly nationalistic body of thought now
known as mercantilism.
Mercantilism
Mercantilist analysis, which reached the peak of its influence upon
European thought in the 16th and 17th centuries, focused directly upon
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the welfare of the nation. It insisted that the acquisition of wealth,

particularly wealth in the form of gold, was of paramount importance for
national policy. Mercantilists took the virtues of gold almost as an article
of faith; consequently, they never sought to explain adequately why the
pursuit of gold deserved such a high priority in their economic plans.
Mercantilism was based on the conviction that national interests are

inevitably in conflictthat one nation can increase its trade only at the
expense of other nations. Thus, governments were led to impose price
and wage controls, foster national industries, promote exports of finished
goods and imports of raw materials, while at the same time limiting the
exports of raw materials and the imports of finished goods. The state
endeavoured to provide its citizens with a monopoly of the resources and
trade outlets of its colonies.
The trade policy dictated by mercantilist philosophy was accordingly
simple: encourage exports, discourage imports, and take the proceeds of
the resulting export surplus in gold. Mercantilists' ideas often were
intellectually shallow, and indeed their trade policy may have been little
more than a rationalization of the interests of a rising merchant class
that wanted wider marketshence the emphasis on expanding
exportscoupled with protection against competition in the form of
imported goods.
A typical illustration of the mercantilist spirit is the English Navigation
Act of 1651 (see Navigation Acts), which reserved for the home country
the right to trade with its colonies and prohibited the import of goods of
non-European origin unless transported in ships flying the English flag.
This law lingered until 1849. A similar policy was followed in France.
Liberalism
A strong reaction against mercantilist attitudes began to take shape
toward the middle of the 18th century. In France, the economists known
as Physiocrats demanded liberty of production and trade. In England,
economist Adam Smith demonstrated in his book The Wealth of Nations
(1776) the advantages of removing trade restrictions. Economists and
businessmen voiced their opposition to excessively high and often
prohibitive customs duties and urged the negotiation of trade agreements
with foreign powers. This change in attitudes led to the signing of a
number of agreements embodying the new liberal ideas about trade,
among them the Anglo-French Treaty of 1786, which ended what had
been an economic war between the two countries.
After Adam Smith, the basic tenets of mercantilism were no longer
considered defensible. This did not, however, mean that nations
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abandoned all mercantilist policies. Restrictive economic policies were

now justified by the claim that, up to a certain point, the government
should keep foreign merchandise off the domestic market in order to
shelter national production from outside competition. To this end,
customs levies were introduced in increasing number, replacing outright
bans on imports, which became less and less frequent.
In the middle of the 19th century, a protective customs policy effectively

sheltered many national economies from outside competition. The French
tariff of 1860, for example, charged extremely high rates on British
products: 60 percent on pig iron; 40 to 50 percent on machinery; and 600
to 800 percent on woolen blankets. Transport costs between the two
countries provided further protection.
A triumph for liberal ideas was the Anglo-French trade agreement of
1860, which provided that French protective duties were to be reduced
to a maximum of 25 percent within five years, with free entry of all
French products except wines into Britain. This agreement was followed
by other European trade pacts.
Resurgence of protectionism
A reaction in favour of protection spread throughout the Western world in
the latter part of the 19th century. Germany adopted a systematically
protectionist policy and was soon followed by most other nations. Shortly
after 1860, during the Civil War, the United States raised its duties
sharply; the McKinley Tariff Act of 1890 was ultraprotectionist. The
United Kingdom was the only country to remain faithful to the principles
of free trade.
But the protectionism of the last quarter of the 19th century was mild by
comparison with the mercantilist policies that had been common in the
17th century and were to be revived between the two world wars.
Extensive economic liberty prevailed by 1913. Quantitative restrictions
were unheard of, and customs duties were low and stable. Currencies
were freely convertible into gold, which in effect was a common
international money. Balance-of-payments problems were few. People
who wished to settle and work in a country could go where they wished
with few restrictions; they could open businesses, enter trade, or export
capital freely. Equal opportunity to compete was the general rule, the
sole exception being the existence of limited customs preferences
between certain countries, most usually between a home country and its
colonies. Trade was freer throughout the Western world in 1913 than it
was in Europe in 1970.
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The new mercantilism

World War I wrought havoc on these orderly trading conditions. By the
end of the hostilities, world trade had been disrupted to a degree that
made recovery very difficult. The first five years of the postwar period
were marked by the dismantling of wartime controls. An economic
downturn in 1920, followed by the commercial advantages that accrued
to countries whose currencies had depreciated (as had Germany's),
prompted many countries to impose new trade restrictions. The resulting
protectionist tide engulfed the world economy, not because policy
makers consciously adhered to any specific theory but because of
nationalist ideologies and the pressure of economic conditions. In an
attempt to end the continual raising of customs barriers, the League of
Nations organized the first World Economic Conference in May 1927.
Twenty-nine states, including the main industrial countries, subscribed to
an international convention that was the most minutely detailed and
balanced multilateral trade agreement approved to date. It was a
precursor of the arrangements made under the General Agreement on
Tariffs and Trade (GATT) of 1947.
However, the 1927 agreement remained practically without effect.
During the Great Depression of the 1930s, unemployment in major
countries reached unprecedented levels and engendered an epidemic of
protectionist measures. Countries attempted to shore up their balance of
payments by raising their customs duties and introducing a range of
import quotas or even import prohibitions, accompanied by exchange
controls.
From 1933 onward, the recommendations of all the postwar economic
conferences based on the fundamental postulates of economic liberalism
were ignored. The planning of foreign trade came to be considered a
normal function of the state. Mercantilist policies dominated the world
scene until after World War II, when trade agreements and supranational
organizations became the chief means of managing and promoting
international trade.
The theory of international trade

Comparative-advantage analysis
The British school of classical economics began in no small measure as a

reaction against the inconsistencies of mercantilist thought. Adam Smith
was the 18th-century founder of this school; as mentioned above, his
famous work, The Wealth of Nations (1776), is in part an antimercantilist
tract. In the book, Smith emphasized the importance of specialization as
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a source of increased output, and he treated international trade as a

particular instance of specialization: in a world where productive
resources are scarce and human wants cannot be completely satisfied,
each nation should specialize in the production of goods it is particularly
well equipped to produce; it should export part of this production, taking
in exchange other goods that it cannot so readily turn out. Smith did not
expand these ideas at much length, but another classical economist,
David Ricardo, developed them into the principle of comparative
advantage, a principle still to be found, much as Ricardo spelled it out, in
contemporary textbooks on international trade.
Simplified theory of comparative advantage

For clarity of exposition, the theory of comparative advantage is
usually first outlined as though only two countries and only two
commodities were involved, although the principles are by no means
limited to such cases. Again for clarity, the cost of production is
usually measured only in terms of labour time and effort; the cost of a
unit of cloth, for example, might be given as two hours of work. The
two countries will be called A and B; and the two commodities
produced, wine and cloth. The labour time required to produce a unit
of either commodity in either country is as follows:
cost of production (labour time)
country A
wine (1 unit) 1 hour
cloth (1 unit) 2 hours
country B
2 hours
6 hours
As compared with country A, country B is productively inefficient. Its

workers need more time to turn out a unit of wine or a unit of cloth.
This relative inefficiency may result from differences in climate, in
worker training or skill, in the amount of available tools and
equipment, or from numerous other reasons. Ricardo took it for
granted that such differences do exist, and he was not concerned with
their origins.
Country A is said to have an absolute advantage in the production of

both wine and cloth because it is more efficient in the production of
both goods. Accordingly, A's absolute advantage seemingly invites the
conclusion that country B could not possibly compete with country A,
and indeed that if trade were to be opened up between them, country
B would be competitively overwhelmed. Ricardo, who focused chiefly
on labour costs, insisted that this conclusion is false. The critical
factor is that country B's disadvantage is less pronounced in wine
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production, in which its workers require only twice as much time for a
single unit as do the workers in A, than it is in cloth production, in
which the required time is three times as great. This means, Ricardo
pointed out, that country B will have a comparative advantage in wine
production. Both countries will profit, in terms of the real income they
enjoy, if country B specializes in wine production, exporting part of its
output to country A, and if country A specializes in cloth production,
exporting part of its output to country B. Paradoxical though it may
seem, it is preferable for country A to leave wine production to
country B, despite the fact that A's workers can produce wine of equal
quality in half the time that B's workers can do so.
The incentive to export and to import can be explained in price terms.

In country A (before international trade), the price of cloth ought to
be twice that of wine, since a unit of cloth requires twice as much
labour effort. If this price ratio is not satisfied, one of the two
commodities will be overpriced and the other underpriced. Labour will
then move out of the underpriced occupation and into the other, until
the resulting shortage of the underpriced commodity drives up its
price. In country B (again, before trade), a cloth unit should cost three
times as much as a wine unit, since a unit of cloth requires three times
as much labour effort. Hence, a typical before-trade price
relationship, matching the underlying real cost ratio in each country,
might be as follows:
country A country B
Price of wine per unit $ 5
Price of cloth per unit $10
The absolute levels of price do not matter. All that is necessary is that
in each country the ratio of the two prices should match the
labourcost ratio.
As soon as the opportunity for exchange between the two countries is

opened up, the difference between the winecloth price ratio in
country A (namely, 5:10, or 1:2) and that in country B (which is 1:3)
provides the opportunity of a trading profit. Cloth will begin to move
from A to B, and wine from B to A. As an illustration, a trader in A,
starting with an initial investment of $10, would buy a unit of cloth,
sell it in B for 3, buy 3 units of B's wine with the proceeds, and sell
this in A for $15. (This example assumes, for simplicity, that costs of
transporting goods are negligible or zero. The introduction of transport
costs complicates the analysis somewhat, but it does not change the
conclusions, unless these costs are so high as to make trade
impossible.)
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So long as the ratio of prices in country A differs from that in country

B, the flow of goods between the two countries will steadily increase
as traders become increasingly aware of the profit to be obtained by
moving goods between the two countries. Prices, however, will be
affected by these changing flows of goods. The wine price in country
A, for example, can be expected to fall as larger and larger supplies of
imported wine become available. Thus A's winecloth price ratio of 1:2
will fall. For comparable reasons, B's price ratio of 1:3 will rise. When
the two ratios meet, at some intermediate level (in the example
1
earlier, at 1:2 /2), the flow of goods will stabilize.
Amplification of the theory

At a later stage in the history of comparative-advantage theory,
English philosopher and political economist John Stuart Mill showed
that the determination of the exact after-trade price ratio was a
supply-and-demand problem. At each possible intermediate ratio
(within the range of 1:2 and 1:3), country A would want to import a
particular quantity of wine and export a particular quantity of cloth.
At that same possible ratio, country B would also wish to import and
export particular amounts of cloth and of wine. For any intermediate
ratio taken at random, however, A's export-import quantities are
unlikely to match those of B. Ordinarily, there will be just one
intermediate ratio at which the quantities correspond; that is the final
trading ratio at which quantities exchanged will stabilize. Indeed,
once they have stabilized, there is no further profit in exchanging
goods. Even with such profits eliminated, however, there is no reason
why A producers should want to stop selling part of their cloth in B,
since the return there is as good as that obtained from domestic sales.
Furthermore, any falloff in the amounts exported and imported would
reintroduce profit opportunities.
In this simple example, based on labour costs, the result is complete

(and unrealistic) specialization: country A's entire labour force will
move to cloth production and country B's to wine production. More
elaborate comparative-advantage models recognize production costs
other than labour (that is, the costs of land and of capital). In such
models, part of country A's wine industry may survive and compete
effectively against imports, as may also part of B's cloth industry. The
models can be expanded in other waysfor example, by involving more
than two countries or products, by adding transport costs, or by
accommodating a number of other variables such as labour conditions
and product quality. The essential conclusions, however, come from
the elementary model used above, so that this model, despite its
simplicity, still provides a workable outline of the theory. (It should be
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noted that even the most elaborate comparative-advantage models

continue to rely on certain simplifying assumptions without which the
basic conclusions do not necessarily hold. These assumptions are
discussed below.)
As noted earlier, the effect of this analysis is to correct any false first
impression that low-productivity countries are at a hopeless
disadvantage in trading with high-productivity ones. The impression is
false, that is, if one assumes, as comparative-advantage theory does,
that international trade is an exchange of goods between countries. It
is pointless for country A to sell goods to country B, whatever its
labour-cost advantages, if there is nothing that it can profitably take
back in exchange for its sales. With one exception, there will always
be at least one commodity that a low-productivity country such as B
can successfully export. Country B must of course pay a price for its
low productivity, as compared with A; but that price is a lower per
capita domestic income and not a disadvantage in international
trading. For trading purposes, absolute productivity levels are
unimportant; country B will always find one or more commodities in
which it enjoys a comparative advantage (that is, a commodity in the
production of which its absolute disadvantage is least). The one
exception is that case in which productivity ratios, and consequently
pretrade price ratios, happen to match one another in two countries.
This would have been the case had country B required four labour
hours (instead of six) to produce a unit of cloth. In such a
circumstance, there would be no incentive for either country to
engage in trade, nor would there be any gain from trading. In a
two-commodity example such as that employed, it might not be
unusual to find matching productivity and price ratios. But as soon as
one moves on to cases of three and more commodities, the statistical
probability of encountering precisely equal ratios becomes very small
indeed.
The major purpose of the theory of comparative advantage is to
illustrate the gains from international trade. Each country benefits by
specializing in those occupations in which it is relatively efficient;
each should export part of that production and take, in exchange,
those goods in whose production it is, for whatever reason, at a
comparative disadvantage. The theory of comparative advantage thus
provides a strong argument for free tradeand indeed for more of a
laissez-faire attitude with respect to trade. Based on this
uncomplicated example, the supporting argument is simple:
specialization and free exchange among nations yield higher real
income for the participants.
The fact that a country will enjoy higher real income as a consequence
of the opening up of trade does not mean, of course, that every family
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or individual within the country will share in that benefit. Producer

groups affected by import competition obviously will suffer, to at least
some degree. Individuals are at risk of losing their jobs if the items
they make can be produced more cheaply elsewhere.
Comparative-advantage theorists concede that free trade would affect
the relative income position of such groupsand perhaps even their
absolute income level. But they insist that the special interests of
these groups clash with the total national interest, and the most that
comparative-advantage proponents are usually willing to concede is
the possible need for temporary protection against import competition
(i.e., to allow those who lose their jobs to international competition to
find new occupations).
Nations do, of course, maintain tariffs and other barriers to imports.
For discussion of the reasons for this seeming clash between actual
policies and the lessons of the theory of comparative advantage, see
State interference in international trade.
Sources of comparative advantage

As already noted, British classical economists simply accepted the fact
that productivity differences exist between countries; they made no
concerted attempt to explain which commodities a country would export
or import. During the 20th century, international economists offered a
number of theories in an effort to explain why countries have differences
in productivity, the factor that determines comparative advantage and
the pattern of international trade.
Natural resources
First, countries can have an advantage because they are richly
endowed with a particular natural resource. For example, countries
with plentiful oil resources can generally produce oil inexpensively.
Because Saudi Arabia produces oil very cheaply, it holds a comparative
advantage in oil, and it exports oil in order to finance its purchases of
imports. Similarly, countries with large forests generally are the major
exporters of wood, paper, and paper products. The supply available
for export also depends on domestic demand. Canada has large
quantities of lumber available for export to the United States, not only
because of its large areas of forest but also because its small
population consumes little of the supply, leaving much of the lumber
available for export. Climate is another natural resource that provides
an export advantage. Thus, for example, bananas are exported by
Central American countriesnot Iceland or Finland.
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Factor endowments: the Heckscher-Ohlin theory

Simply put, countries with plentiful natural resources will generally
have a comparative advantage in products using those resources. A
related, but much more subtle, assertion was put forward by two
Swedish economists, Eli Heckscher and Bertil Ohlin. Ohlin's work was
built upon that of Heckscher. In recognition of his ideas as described in
his path-breaking book, Interregional and International Trade (1933),
Ohlin was a recipient of the Nobel Prize for Economics in 1977.
The Heckscher-Ohlin theory focuses on the two most important factors
of production, labour and capital. Some countries are relatively
well-endowed with capital; the typical worker has plenty of machinery
and equipment to assist with the work. In such countries, wage rates
generally are high; as a result, the costs of producing labour-intensive
goodssuch as textiles, sporting goods, and simple consumer
electronicstend to be more expensive than in countries with plentiful
labour and low wage rates. On the other hand, goods requiring much
capital and only a little labour (automobiles and chemicals, for
example) tend to be relatively inexpensive in countries with plentiful
and cheap capital. Thus, countries with abundant capital should
generally be able to produce capital-intensive goods relatively
inexpensively, exporting them in order to pay for imports of
labour-intensive goods.
In the Heckscher-Ohlin theory it is not the absolute amount of capital
that is important; rather, it is the amount of capital per worker. A
small country like Luxembourg has much less capital in total than
India, but Luxembourg has more capital per worker. Accordingly, the
Heckscher-Ohlin theory predicts that Luxembourg will export
capital-intensive products to India and import labour-intensive
products in return.
Despite its plausibility the Heckscher-Ohlin theory is frequently at
variance with the actual patterns of international trade. As an
explanation of what countries actually export and import, it is much
less accurate than the more obvious and straightforward natural
resource theory.
One early study of the Heckscher-Ohlin theory was carried out by

Wassily Leontief, a Russian-born U.S. economist. Leontief observed
that the United States was relatively well-endowed with capital.
According to the theory, therefore, the United States should export
capital-intensive goods and import labour-intensive ones. He found
that the opposite was in fact the case: U.S. exports are generally more
labour intensive than the type of products that the United States
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imports. Because his findings were the opposite of those predicted by

the theory, they are known as the Leontief Paradox.
Economies of large-scale production

Even if countries have quite similar climates and factor endowments,
they may still find it advantageous to trade. Indeed, economically
similar countries often carry on a large and thriving trade. The
prosperous industrialized countries have become one another's best
customers. A main reason for this situation lies in what is called the
economies of large-scale production (see economy of scale).
For many products, there are advantages in producing on a large scale;

costs become lower as more is produced. Thus, for example,
automobiles can be made more cheaply in a factory producing 100,000
units than in a small factory producing only 1,000 units. This means
that countries have an incentive to specialize in order to reduce costs.
To sell a large volume of output, they may have to look to export
markets.
The smaller the country, and the more limited its domestic market,
the more incentive it has to look to international trade as a way of
gaining the advantages of large-scale production. Thus, Luxembourg or
Belgium has much more to gain, relatively, than the United States.
Indeed, the advantages of large-scale production were one of the
major sources of gain from the establishment of the European
Economic Community (EEC; ultimately replaced by the European
Union), which was formed for the purpose of providing free trade
between most western European countries.
Even a large country such as the United States, however, can gain in
some cases by exporting in order to exploit the economies of
production lines. For example, the Boeing Company has been able to
produce airplanes more efficiently and cheaply because it is able to
sell large numbers of aircraft to other countries. The importing
countries also gain because they can buy aircraft abroad at prices far
lower than they would pay for domestically produced equivalents.
Technology
Technological development can also provide a distinctive trade
advantage. The relatively advanced countriesparticularly the United
States, Japan, and those of western Europehave been the principal
exporters of high-technology products such as computers and precision
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machinery.
One important aspect of technology is that it can change rapidly. This

is perhaps most obvious in the computer field, where productivity has
increased and costs have fallen sharply since the early 1960s (see
Moore's law). Such rapid changes present several challenges. For
countries that are not in the front rank, it raises the question of
whether they should import high-technology products or attempt to
enter the circle of the most advanced nations. For the countries that
have held the technological lead in the past, there is always the
possibility that they will be overtaken by newcomers. This occurred in
the second half of the 20th century when Japan advanced
technologically in its automobile production to the point where it
could challenge the automobile leadership of North America and
Europe. Japan quickly became the world's foremost producer of
automobiles, and by the end of the 20th century, Korean automakers
were attempting to follow the Japanese example with the aggressive
export of automobiles.
Technological advances also strengthen global trade in a general
sense: e-commerce (electronic commerce), for example, reduced the
impact of geographic distance by facilitating fast, efficient, real-time
ties between businesses and individuals around the world. Indeed, at
the end of the 20th century, information technology, an industry that
scarcely existed 20 years earlier, exceeded the combined world trade
in agriculture, automobiles, and textiles.
The product cycle

The spread of technology across national boundaries means that
comparative advantage can change. The most technologically
advanced countries generally have the advantage in making new
products, but as time passes other countries may gain the advantage.
For example, many television sets were produced in the United States
during the 1950s. As time passed, however, and technological change
in the television industry became less rapid, there was less advantage
in producing sets in the United States. Producers of television sets had
an incentive to look to other locations, with lower wage rates. In time,
the manufacturers established overseas operations in Taiwan, Hong
Kong, and elsewhere. Concurrently, the United States turned to new
activities, such as the manufacture of supercomputers, the
development of computer software, and new applications of satellite
technology.
Romney Robinson
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Paul Wonnacott
Ed.
State interference in international trade

Methods of interference
Regardless of what comparative-advantage theory may say about the

virtues of unrestricted trade, all nations interfere with international
transactions to some degree. Tariffs may be imposed on importsin some
instances making them so costly as to bar completely the entry of the
good involved. Quotas may limit the permissible volume of imports. State
subsidies may be offered to encourage exports. Money-capital exports
may be restricted or prohibited. Investment by foreigners in domestic
plant and equipment may be similarly restrained.
These interferences may be simply the result of special-interest pleading,

because particular groups suffer as a consequence of import competition.
Or a government may impose restrictions because it feels impelled to
take account of factors that comparative advantage sets aside. It is of
interest to note that insofar as goods and services are concerned, the
general pattern of interference follows the old mercantilist dictum of
discouraging imports and encouraging exports.
A company that finds itself barred from an attractive foreign market by
tariffs or quotas may be able to sidestep the barrier simply by
establishing a manufacturing plant within that foreign country. This
policy of foreign plant investment expanded enormously after World War
II, with U.S. companies taking the lead by investing particularly in
western Europe, Canada, Asia, and South America. Industry in other
developed countries followed a similar pattern, with many foreign
companies establishing plants within the United States as well as in other
areas of the world.
The governments of countries subject to this new investment find

themselves in an ambivalent position. The establishment of new
foreign-owned plants may mean more than simply the creation of new
employment opportunities and new productive capacity; it may also
mean the introduction of new technologies and superior business-control
methods. But the government that welcomes such benefits must also
expect complaints of foreign control, an argument that will inevitably
be pressed by domestic owners of older plants who fear a new
competition that cannot be blocked by tariffs. This has been a pressing
problem for many governments, particularly insofar as investment by U.S.
firms is involved, and it is a chief complaint of critics who view
globalization as a form of economic exploitation. Some countries, such as
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the United Kingdom and Canada, have been liberal in their admissions
policy; others, notably Japan, have imposed tight restrictions on
foreign-owned plants.
Romney Robinson
Tariffs
A tariff, or duty, is a tax levied on products when they cross the
boundary of a customs area. The boundary may be that of a nation or
a group of nations that has agreed to impose a common tax on goods
entering its territory. Tariffs are often classified as either protective
or revenue-producing. Protective tariffs are designed to shield
domestic production from foreign competition by raising the price of
the imported commodity. Revenue tariffs are designed to obtain
revenue rather than to restrict imports. The two sets of objectives
are, of course, not mutually exclusive. Protective tariffsunless they
are so high as to keep out importsyield revenue, while revenue tariffs
give some protection to any domestic producer of the duty-bearing
goods. A transit duty, or transit tax, is a tax levied on commodities
passing through a customs area en route to another country. Similarly,
an export duty, or export tax, is a tax imposed on commodities leaving
a customs area. Finally, some countries provide export subsidies;
import subsidies are rarely used.
How tariffs work
Tariffs on imports may be applied in several ways. If they are
imposed according to the physical quantity of an import (so much
per ton, per yard, per item, etc.), they are called specific tariffs. If
they are levied according to the value of the import, they are
known as ad valorem tariffs.
Tariffs may differentiate among the countries from which the
imports are obtained. They may, for instance, be lower between
countries that have previously entered into special arrangements,
such as the trade preferences accorded to each other by members
of the European Union.
Tariffs may be imposed in different ways, each of which will have a

different effect on the economy of the country imposing them. By
raising the prices of imported goods, tariffs may encourage
domestic production. As expenditures on domestic products rise,
domestic employment tends to do likewise. This is why tariffs are
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favoured by industries that find themselves pressed by foreign

competitors. The tariff may also encourage tendencies toward a
monopolistic market structure to the extent that it lessens foreign
competition, with a resulting decrease in the incentive to
modernize or innovate. Because tariffs increase the price of an
imported commodity, they may also reduce its consumption. The
decrease in demand could be large enough in relation to the world
market to force the price of the import down.
Measuring the effects of tariffs
It is difficult to gauge the effect of tariff barriers among countries.
Clearly, the way in which import demand responds to changes in
tariffs will depend on a variety of factors. These include the
reaction of producers and consumers to price changes, the share of
imports in domestic production and consumption, the
substitutability of imports for domestic products, and so on. The
reaction to tariff levels will differ from country to country as well as
from commodity to commodity. Thus, the amount of a tariff does
not necessarily determine its restrictive effect. Typically, such
comparisons apply only to products for which tariffs are the major
protective device. This is generally true for nonagricultural products
in developed countries (other strategies, such as import quotas, are
a common means of protecting agricultural commodities). Although
tariffs on imported raw materials will protect domestic producers of
those commodities, such tariffs will also increase the costs to
domestic manufacturers who use those raw materials. These
conditions necessitate a distinction between nominal and effective
rates of protection.
The nominal rate of protection is the percentage tariff imposed on
a product as it enters the country. For example, if a tariff of 20
percent of value is collected on clothing as it enters the country,
then the nominal rate of protection is that same 20 percent.
The effective rate of protection is a more complex concept:

consider that the same productclothingcosts $100 on
international markets. The material that is imported to make the
clothing (material inputs) sells for $60. In a free-trade situation, a
firm can charge no more than $100 for a similar piece of clothing
(ignoring transportation costs). Importing the fabric for $60, the
clothing manufacturer can add a maximum of $40 for labour, profit
markup, rents, and the like. This $40 difference between the $60
cost of material inputs and the price of the product is called the
value added.
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The same situation may be considered with tariffssay, 20 percent

on clothing and 10 percent on fabric. The 20 percent tariff on
clothing would raise the domestic price by $20 to $120, while a 10
percent tariff on fabrics would increase material costs to the
domestic producer by $6 to $66. Protection would thus enable the
firm to operate with a value-added margin of $54the difference
between the domestic price of $120 and the material cost of $66.
The difference between the value added of $40 without tariff
protection and that of $54 with it provides a margin of $14. This
means that the effective rate of protection of the domestic
processing activitythe ratio of $14 to $40would be 35 percent.
The effective rate of protection derived35 percentis greater
than the nominal rate of only 20 percent. This will be the case
whenever the tariff rate on the final product is greater than the
tariff on inputs. Because countries generally do levy higher tariffs
on final products than on inputs, effective rates of protection are
usually higher than nominal ratesoften much higher.
The effective rate of protection also depends on the share of value

added in the product price. Effective rates can be very high if value
added to the imported commodity is a small percentage or very low
if value added is a large percentage of the total price. Thus,
effective protection in one country may be much higher than that in
another even though its nominal tariffs are lower, if it tends to
import commodities of a high level of fabrication with
correspondingly low ratios of value added to product price.
Nontariff barriers
Other government regulations and practices may also act as barriers to
trade. Quotas or quantitative restrictions may prohibit the importation
of certain commodities or limit the amounts imported. Such quotas are
usually administered by requiring importers to have licenses to import
particular products. Quotas raise prices just as tariffs do, but, being
set in physical terms, their impact on imports is direct, with an
absolute ceiling set on quantity. Increased prices will not bring more
goods in. There is also a difference between tariffs and quotas in their
effect on revenues. With tariffs, the government receives the revenue:
under quotas, the import license holders obtain a windfall in the form
of the difference between the high domestic price and the low
international price of the import.
Another barrier is the voluntary export restraint (VER), noted for
having a less-damaging effect on the political relations between
countries. It is also relatively easy to remove. This approach was
applied in the early 1980s when Japanese automakers, under pressure
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from U.S. competitors, voluntarily limited their exports of

automobiles to the U.S. market. Like quotas, VERs limit the quantity
of trade and therefore tend to raise the prices of imported goods. In
this case, the VER made Japanese automobiles less available in the
United States and raised the prices that U.S. consumers had to pay for
them, thereby making domestically produced cars more attractive.
This approach also allowed Japanese exporters to charge higher prices.
As a result, the Japanese exporters, rather than U.S. importers,
reaped much of the windfall from the VER. VERs are usually not
voluntary in any meaningful sense. In this example, the Japanese
automakers agreed to a VER in order to avoid a U.S. import quota.
Still other barriers include state trading organizations and government
procurement practices that may be used preferentially. In the United
States, buy American legislation requires government procurement
agencies to favour domestic goods. Customs classification and
valuation procedures, health regulations, and marking requirements
may also have a restrictive effect on trade. Japan, for example, has
restricted imports of U.S. apples on the grounds that the apples could
be contaminated with the fire blight disease. Finally, excise taxes may
act as a barrier to trade if they are levied at higher rates on imports
than on domestic goods.
Protectionism in the less-developed countries

Much of the industrialization that took place in the late 20th century
in some less-developed countries was characterized by the expansion
of import-competing industries protected by high tariff walls. In many
of those countries, tariffs and various quantitative restrictions on
manufactured goods were high, but the effective rates of protection
were often even higher, because the goods tended to be highly
fabricated and the proportion of value added in production after
importation was low. While countries such as Taiwan, Hong Kong, and
South Korea oriented their manufacturing industries mainly toward
export trade, they tended to be exceptional cases. More commonly,
developing nations have mistakenly sought to compete with
foreign-made goods for the domestic market. High protection in these
countries has often contributed to a slowdown in production, while the
export of primary commodities has discouraged expansion of exports of
the more valuable manufactured goods. Although domestic production
of nondurable consumer goods fosters rapid economic growth at an
early stage, less-developed countries have encountered considerable
difficulties in producing more-sophisticated, value-added
commodities. They suffer all the disadvantages of small domestic
markets, in addition to a lack of incentives for technological
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improvement.
Bela Balassa
Trent J. Bertrand
Paul Wonnacott
Arguments for and against interference

Revenue
Developing nations in particular often lack the institutional machinery
needed for effective imposition of income or corporation taxes (see
income tax). The governments of such nations may then finance their
activity by resorting to tariffs on imported goods, since such levies are
relatively easy to administer. The amount of tax revenue obtainable
through tariffs, however, is always limited. If the government tries to
increase its tariff income by imposing higher duty rates, this may
choke off the flow of imports and so reduce tariff revenue instead of
increasing it.
Economic development
Protection of domestic industry
Probably the most common argument for tariff imposition is that
particular domestic industries need tariff protection for survival.
Comparative-advantage theorists will naturally argue that the
industry in need of such protection ought not to survive and that
the resources so employed ought to be transferred to occupations
having greater comparative efficiency. The welfare gain of citizens
taken as a whole would more than offset the welfare loss of those
groups affected by import competition; that is, total real national
income would increase. An opposing argument would be, however,
that this welfare gain would be widely diffused, so that the
individual beneficiaries might not be conscious of any great
improvement. The welfare loss, in contrast, would be narrowly and
acutely felt. Although resources can be transferred to other
occupations, just as comparative-advantage theory says, the
transfer process is sometimes slow and painful for those being
transferred. For such reasons, comparative-advantage theorists
rarely advocate the immediate removal of all existing tariffs. They
argue instead against further tariff increasessince increases, if
effective, attract still more resources into the wrong
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occupationand they press for gradual reduction of import barriers.

Romney Robinson
The infant-industry argument
Advocates of protection often argue that new and growing
industries, particularly in less-developed countries, need to be
shielded from foreign competition. They contend that costs decline
with growth and that some industries must reach a minimum size
before they are able to compete with well-established industries
abroad. Tariffs can protect the domestic market until the industry
becomes internationally competitive and, it is often argued, the
costs of protection can be recouped after the industry has reached
maturity. In short, the infant-industry argument is based principally
on the idea that there are economies of large-scale production in
many industries and that developing countries have difficulty in
establishing such industries.
Advocates of such protection, however, can have their arguments
turned against them. While an individual country can, in some
circumstances, gain from protecting its infant industries, this
protection is particularly costly for the international community as
a whole. Where there are major advantages in large-scale
production, there are also large advantages in relatively free
international trade. By closing off markets, protection reduces the
ability of firms to gain economies of large-scale by exporting. If a
group of countries imposes infant-industry protection, it will split
up the market; each country may end up with small-scale,
localized, inefficient production, thus reducing the prosperity of all
of the countries. One way in which less-developed nations have
tried to deal with this problem has been through the establishment
of customs unions or other regional groupings (see International
trade arrangements).
Infant-industry tariffs have been disappointing in other ways; the

infant-industry argument is often abused in practice. In many
developing countries, industries have failed to attain international
competitiveness even after 15 or 20 years of operation and might
not survive if protective tariffs were removed. The infant industry is
probably better aided by production subsidies than by tariffs.
Production subsidies do not raise prices and therefore do not curtail
domestic demand, and the cost of the protection is not concealed
in higher prices to consumers. Production subsidies, however, have
the disadvantage of drawing upon government revenue rather than
adding to it, which may be a serious consideration in countries at
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lower levels of development. (See also economic development.)

Bela Balassa
Trent J. Bertrand
Paul Wonnacott
Unemployment
Tariffs or quotas are also sometimes proposed as a way to maintain
domestic employmentparticularly in times of recession. There is,
however, near-unanimity among modern-day economists that
proposals to remedy unemployment by means of tariff increases are
misguided. Insofar as a higher tariff is effective for this purpose, it
simply exports unemployment; that is, the rise in domestic
employment is matched by a drop in production in some foreign
country. That other country, moreover, is likely to impose a
retaliatory tariff increase. Finally, the tariff remedy for unemployment
is a poor one because it is usually ineffective and because more
suitable remedies are available. It has come to be generally
recognized that unemployment is far more efficiently dealt with by
the implementation of proper fiscal and monetary policies.
National defense
A common appeal made by an industry seeking tariff or quota
protection is that its survival is essential for the national interest: its
product would be needed in wartime, when the supply of imports
might well be cut off. The verdict of economists on this argument is
fairly clear: the national-defense argument is frequently a red herring,
an attempt to wrap oneself in the flag, and insofar as an industry is
essential, the tariff is a dubious means of ensuring its survival.
Economists say instead that essential industries ought to be given a
direct subsidy to enable them to meet foreign competition, with
explicit recognition of the fact that the subsidy is a price paid by the
nation in order to maintain the industry for defense purposes.
Autarky
Many demands for protection, whatever their surface argument may
be, are really appeals to the autarkic feelings that prompted
mercantilist reasoning. (Autarky is defined as the state of being
self-sufficient at the level of the nation.) A proposal for the restriction
of free international trade can be described as autarkic if it appeals to
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those half-submerged feelings that the citizens of the nation share a

common welfare and common interests, whereas foreigners have no
regard for such welfare and interests and might even be actively
opposed to them. And it is quite true that a country that has become
heavily involved in international trade has given hostages to fortune: a
part of its industry has become dependent upon export markets for
income and for employment. Any cutoff of these foreign markets
(brought about by recession abroad, by the imposition of new tariffs by
some foreign country, or by numerous other possible changes, such as
the outbreak of war) would be acutely serious; and yet it would be a
situation largely beyond the power of the domestic government
involved to alter. Similarly, another part of domestic industry may rely
on an inflow of imported raw materials, such as oil for fuel and power.
Any restriction of these imports could have the most serious
consequences. The vague threat implicit in such possibilities often
results in a yearning for autarky, for national self-sufficiency, for a life
free of dependence on the hazards of the outside world.
There is general agreement that no modern nation, regardless of how
rich and varied its resources, could really practice self-sufficiency, and
attempts in that direction could produce sharp drops in real income.
Nevertheless, protectionist argumentsparticularly those made in the
interests of national defenseoften draw heavily on the strength of
such autarkic sentiments.
The terms-of-trade argument

When a country imposes a tariff, foreign exporters have greater
difficulty in selling their products. As their exports decline, they may
cut prices in order to keep their sales from falling drastically. Thus, for
example, when a tariff of $10.00 is imposed, foreign exporters may cut
their price by, say, $6.00. The foreign exporter is being taxed when
the tariff is imposed; the other $4.00 is reflected in a higher price to
the consumer. The use of tariffs to tax foreign exporters in this way is
known as the terms-of-trade argument for protection. The terms of
trade represent the relative price of what a nation is exporting,
compared with the price paid to foreigners for imported goods. When
the price of what is being exported rises, or when the price paid to
foreigners for imported goods falls (as it may when a nation imposes a
tariff), terms of trade improve.
Balance-of-payments difficulties
Governments may interfere with the processes of foreign trade for a
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reason quite different from those thus far discussed: shortage of

foreign exchange (see international payment and exchange). Under
the international monetary system established after World War II and
in effect until the 1970s, most governments tried to maintain fixed
exchange rates between their own currencies and those of other
countries. Even if not absolutely fixed, the exchange rate was
ordinarily allowed to fluctuate only within a narrow range of values.
If balance-of-payments difficulties arise and persist, a nation's foreign

exchange reserve runs low. In a crisis, the government may be forced
to devalue the nation's currency. But before being driven to this, it
may try to redress the balance by restricting imports or encouraging
exports, in much the old mercantilist fashion.
The problem of reserve shortages became acute for many countries

during the 1960s. Although the total volume of international
transactions had risen steadily, there was not a corresponding increase
in the supply of international reserves. By 1973 payment imbalances
led to an end of the system of fixed, or pegged, exchange rates and to
a floating of most currencies. (See also gold standard;
gold-exchange standard.)
Romney Robinson
Paul Wonnacott
Contemporary trade policies

There are many ways of controlling and promoting international trade
today. The methods range from agreements among governmentswhether
bilateral or multilateralto more ambitious attempts at economic
integration through supranational organizations, such as the European
Union (EU).
Trade agreements
The term trade agreement or commercial agreement can be used to
describe any contractual arrangement between states concerning their
trade relationships. Trade agreements may be bilateral or
multilateralthat is, between two states or between more than two
states.
Bilateral trade agreements
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A bilateral trade agreement usually includes a broad range of

provisions regulating the conditions of trade between the contracting
parties. These include stipulations governing customs duties and other
levies on imports and exports, commercial and fiscal regulations,
transit arrangements for merchandise, customs valuation bases,
administrative formalities, quotas, and various legal provisions. Most
bilateral trade agreements, either explicitly or implicitly, provide for
(1) reciprocity, (2) most-favoured-nation treatment, and (3) national
treatment of nontariff restrictions on trade.
Reciprocity
In a trade agreement, the parties make reciprocal concessions to
put their trade relationships on a basis deemed equitable by each.
The principle of reciprocity is extremely old, and in one form or
another it is to be found, implicitly at least, in all trade
agreements. The concessions may, however, be in different areas.
In the Anglo-French Agreement of 1860, for example, France
pledged itself to reduce its duties to 20 percent by 1864. In return,
Britain granted duty-free imports of all French products except
wines and spirits. The principle of reciprocity implies only that the
gains arising out of foreign trade are distributed fairly.
The most-favoured-nation clause
The most-favoured-nation (MFN) clause binds a country to apply to
its partner country any lower rate of import duties that it may later
grant to imports from some other country. The clause may cover a
list of specified products only, or specific concessions yielded to
certain foreign countries. Alternatively, it may cover all
advantages, privileges, immunities, or other favourable treatment
granted to any third country whatever. The clause is intended to
provide each signatory with the assurance that the advantages
obtained will not be attenuated or wiped out by a subsequent
agreement concluded between one of the partners and a third
country. It guarantees the parties against discriminatory treatment
in favour of a competitor.
The effect of the MFN clause on customs duties is to amalgamate

the successive trade agreements concluded by a state. If the rates
in different agreements are fixed at varying levels, the clause
reduces them to the lowest rate specified in any agreement. Thus,
goods imported from a country benefiting from MFN treatment are
charged the rate of duty applicable to imports from another country
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which, in a subsequent trade agreement, has negotiated a lower

rate of duty.
The coverage of the MFN clause can be considerably reduced by a

minute definition of a particular item so that a concession, while
general in form, applies in practice to only one country. A historical
illustration of this technique can be found in the German Tariff of
1902, which admitted at a special rate
large dappled mountain cattle, reared at a spot at least
300 metres above sea level, and which have at least one
month's grazing each year at a spot at least 800 metres
above sea level.
The advantages granted under the MFN clause may be conditional or

unconditional. If unconditional, the clause operates automatically
whenever appropriate circumstances arise. The country drawing
benefit from it is not called on to make any fresh concession. By
contrast, the partner invoking a conditional MFN clause must make
concessions equivalent to those extended by the third country. A
typical wording was that of the 1911 treaty between the United
States and Japan, which stated that
in all that concerns commerce and navigation, any
privilege, favour or immunity. . .to the citizens or
subjects of any other State shall be extended to the
citizens or subjects of the other Contracting Party
gratuitously, if the concession in favour of that other
State shall have been gratuitous, and on the same or
equivalent conditions, if the concession shall have been
conditional.
The conditional form of the clause may at first sight seem more
equitable. But it has the major drawback of being liable to raise a
dispute each time it is invoked, for it is by no means easy for a
country to evaluate the compensation it is being offered as in fact
being equivalent to the concession made by the third country.
The effect of the unconditional form of the MFN clause is, finally, to
wipe out any relevance that the principle of reciprocity may have
had to the purely bilateral preoccupations of the negotiating
parties, since the results of the bargaining process, instead of being
limited to the participants, influence their relationships with other
states. In practice, therefore, a country negotiating a trade
agreement must measure the advantages it is willing to concede in
terms of the benefits these concessions will provide collaterally to
that third country which is the most competitive. In other words,
the concessions that may be granted are determined by the
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minimum protection that the negotiating state deems indispensable

to protect its home producers. This sets a major limitation on the
scope of bilateral negotiations.
Proponents of free trade consider that the unconditional MFN clause

is the only practical way by which to obtain the progressive
reduction of customs duties. Those who favour protectionism are
resolutely against it, preferring the conditional form of the clause
or some equivalent mechanism.
The conditional MFN clause was generally in use in Europe until
1860, when the so-called Cobden-Chevalier Treaty between Great
Britain and France established the unconditional form as the
pattern for most European treaties (see Richard Cobden). The
United States used the conditional MFN clause from its first trade
agreement, signed with France in 1778, until the passage of the
Tariff Act of 1922, which terminated the practice. (The Trade
Reform Bill of 1974, however, in effect restored to the U.S.
president the authority to designate preferential tariff treatment,
subject to approval by Congress.)
The Conference of Genoa, Italy, in May 1922 and the World

Economic Conference in May 1927 both recommended that trade
agreements include the MFN clause whenever possible. But the
Great Depression of the 1930s led instead to a rise of restrictions in
world trade. Imperial or regional systems of preference came into
being: the Ottawa Agreements of 1932 for the British
Commonwealth, similar arrangements for the French empire, and a
series of tariff and preference agreements negotiated in eastern
and central Europe from 1931 on.
The national treatment clause
The national treatment clause in trade agreements was designed
to ensure that internal fiscal or administrative regulations would
not introduce discrimination of a nontariff nature. It forbids
discriminatory use of the following: taxes or other internal levies;
laws, regulations, and decrees affecting the sale, offer for sale,
purchase, transport, distribution, or use of products on the
domestic market; valuation of products for purposes of assessment
of duty; legislation on prices of imported goods; warehousing and
transit regulations; and the organization and operation of state
trading corporations.
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Multilateral agreements after World War II

The conclusion of World War II spurred efforts to correct the problems
stemming from protectionism, which had increased since 1871, and
trade restrictions, which had been imposed between World Wars I and
II. The resulting multilateral trade agreements and other forms of
international economic cooperation led to the General Agreement on
Tariffs and Trade (GATT) and laid the foundation for the World Trade
Organization (WTO).
The General Agreement on Tariffs and Trade
The General Agreement on Tariffs and Trade was signed in Geneva
on Oct. 30, 1947, by 23 countries, which accounted for four-fifths of
world trade. On the same day, 10 of these countries, including the
United States, the United Kingdom, France, Belgium, and the
Netherlands, signed a protocol bringing the agreement into force on
Jan. 1, 1948.
GATT took the form of a multilateral trade agreement that set forth
the principles under which the signatories, on a basis of reciprocity
and mutual advantage, would negotiate a substantial reduction in
customs tariffs and other impediments to trade, and the elimination
of discriminatory practices in international trade. As more
countries joined, GATT became a charter governing almost all world
trade except for that of the communist countries.
The agreement also contained a variety of clauses providing
exceptions to the rules in special situations. These included
balance-of-payments disequilibrium; serious and unexpected
damage to domestic production; the requirements of economic
development or, subject to very broad reservations, of agricultural
policy; the need to protect domestic raw material production; and
the interests of national security. In addition, GATT rules permitted
various departures from the MFN principle. For example, within the
former EEC, France could permit duty-free entry of goods from its
fellow memberssuch as Germany and Italywithout extending such
duty-free treatment to the products of non-EEC nations.
Prior to the creation of GATT's successor organization, the WTO,
multilateral trade conferences, called rounds, were held
periodically by GATT countries to resolve trade problems. Most of
these took place in Geneva, former site of GATT headquarters and
current site of the WTO. At the time, the formula for multilateral
tariff bargaining under GATT represented a major innovation in
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intergovernmental cooperation. In appraising the concessions that

they could afford to make, this approach to GATT negotiations
permitted governments to account for the indirect advantages that
they could expect from the full set of bilateral negotiations. GATT
made positive contributions to the growth of world trade, with
three GATT sessions seen as having particular historic
importancethe so-called Kennedy, Tokyo, and Uruguay rounds.
As the economic integration of western Europe progressed, some

Americans became concerned at the prospect of being excluded
from these advances in trade policy. Pres. John F. Kennedy pursued
the goal of an Atlantic partnership and secured special negotiating
powers under the Trade Expansion Act of 1962. The act authorized
tariff reductions of up to 50 percent, subject to reciprocal
concessions from the European partners. This marked a
fundamental shift away from the traditional protectionist posture of
the United States and led to the Kennedy Round negotiations in
GATT, held in Geneva from May 1964 to June 1967.
The Kennedy Round continued the process of tariff reduction begun
two decades earlier by the industrial countries. While developing
countries drew little immediate advantage from the Kennedy Round
negotiations, they were able to obtain the addition of a new part
titled Trade and Development to the GATT charter, calling for
stabilization, as far as possible, of raw material prices; reduction or
abolition of customs duties or other restrictions that differentiate
unreasonably between products in their primary state and the same
products in finished form; and renunciation by the advanced
countries of the principle of reciprocity in their relations with
less-developed countries.
Maurice Allais
Paul Wonnacott
The next ministerial meeting of GATT opened in Tokyo on Sept. 12,

1973, and was attended by representatives of ministerial or
comparable level from 102 countries. On September 14 the meeting
closed with the adoption of what came to be called the Tokyo
Declaration.
The declaration differed markedly from previous GATT documents
in the inordinately large portion of its language devoted to
strengthening the negotiating position of the less-developed
countries. Specifically, the trade negotiations would aim at
improving the conditions of access for products of interest to such
countries while ensuring stable, equitable, and remunerative prices
for primary products. Tropical products would be given special and
priority treatment. The principle of nonreciprocity in negotiations
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between developed and less-developed countries, an established

principle in GATT, was reaffirmed: the importance of maintaining
and improving the Generalized System of Preferences (a provision
for lower tariff rates) granted by developed countries to
less-developed countries, as well as the need for special measures
and the importance of providing special, differential, and more
favourable treatment for less-developed countries, were
recognized. Special attention was to be given to the trade interests
of the least-developed countries.
The Tokyo Declaration was followed by several years of

multinational trade negotiations that came to be called the Tokyo
Round, concluding in 1979 with the adoption of a series of tariff
reductions to be implemented generally over an eight-year period
beginning in 1980. Further progress was also made in dealing with
nontariff issues. Most notably, a Code on Subsidies and
Countervailing Duties was negotiated. This code had two main
features: it listed a number of unacceptable subsidy practices, and
it introduced a requirement that formal procedures be followed
before the imposition of countervailing duties on imports subsidized
by foreign nations. Specifically, before the imposition of a
countervailing duty, an investigation had to establish that
competing domestic firms were being injured. The code was not
signed by all of the members, however, and the signing nations
agreed only to follow the prescribed rules before applying
countervailing duties to the exports of other signatories. Thus,
while the code represented progress in dealing with a new topic, it
also represented a departure from the MFN principle: signatories
were not required to extend the benefits of the code to GATT
members who did not sign the code.
A new set of negotiations was initiated at a conference in Uruguay

in 1986. Because traditional tariffs were becoming much less
important, most of the attention was focused on other impediments
to international transactions, such as those affecting trade in
services or intellectual property. The Uruguay Round led to the
replacement of GATT by the WTO in 1995. Whereas GATT focused
almost exclusively on goods (though much of agriculture and textiles
were excluded), the WTO encompassed all goods, services, and
intellectual property, as well as some investment policies. The
combined share of international trade of WTO members came to
exceed 90 percent of the global total.
Paul Wonnacott
Ed.
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The World Trade Organization

As the successor to the General Agreement on Tariffs and Trade
(GATT), the World Trade Organization (WTO) was established to
supervise and liberalize world trade.
During negotiations ending in 1994, the original GATT and all

changes to it introduced prior to the Uruguay Round of trade
negotiations were renamed GATT 1947. This earlier set of
agreements was distinguished from GATT 1994, which comprises the
modifications and clarifications negotiated during the Uruguay
Round (referred to as Understandings) plus a dozen other
multilateral agreements on merchandise trade. GATT 1994 became
an integral part of the agreement that established the WTO. Other
core components include the General Agreement on Trade in
Services (GATS), which attempted to supervise and liberalize trade;
the Agreement on Trade-Related Aspects of Intellectual Property
Rights (TRIPS), which sought to improve protection of intellectual
property across borders; the Understanding on Rules and Procedures
Governing the Settlement of Disputes, which established rules for
resolving conflicts between members; the Trade Policy Review
Mechanism, which documented national trade policies and assessed
their conformity with WTO rules; and four plurilateral agreements,
signed by only a subset of the WTO membership, on civil aircraft,
government procurement, dairy products, and bovine meat (though
the last two were terminated at the end of 1997 with the creation
of related WTO committees). These agreements were signed in
Marrakech, Morocco, in April 1994, and, following their ratification,
the contracting parties to the GATT treaty became charter
members of the WTO. By the early 21st century, the WTO had more
than 145 members.
Critics of the WTO, including many opponents of economic

globalization, have charged that the organization undermines
national sovereignty by promoting the interests of large
multinational corporations and that the trade liberalization it
encourages leads to environmental damage and declining living
standards for low-skilled workers in developing countries. Some
WTO members, especially developing countries, resisted attempts
to adopt rules that would allow for sanctions against countries that
failed to meet strict environmental and labour standards, arguing
that the sanctions would amount to veiled protectionism. Despite
these criticisms, however, WTO admission remained attractive for
nonmembers, as evidenced by the increase in membership after
1995. Most significantly, China entered the WTO in 2001, after years
of accession negotiations, and many other countries were slated to
join through accession in succeeding years.
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The Organisation for Economic Co-operation and Development

On April 16, 1948, 16 European countries responded to a U.S. offer
of economic aid under the European Recovery Program by setting up
the Organisation for European Economic Co-operation (OEEC).
Although the immediate aim was to coordinate the distribution of
U.S. credits, the OEEC convention was also designed to foster free
trade between the members and allow their participation in
customs unions or similar institutions. The members by 1955
consisted of Britain, France, West Germany, Italy, Spain, the
Benelux countries, Austria, Denmark, Sweden, Norway, Switzerland,
Portugal, Greece, Ireland, Turkey, and Iceland.
The OEEC did much to facilitate the recovery of intra-European
trade and particularly to abolish most of the quantitative
restrictions on imports within the area. On Sept. 30, 1961, it was
converted into a new institution, the Organisation for Economic
Co-operation and Development (OECD), and membership was
extended to the United States and Canada. Japan joined in 1964,
followed by Finland (1969), Australia (1971), New Zealand (1973),
and others to total 30 OECD member nations by the beginning of the
21st century.
The three fundamental aims of the OECD are to promote the

economic growth of member countries, to contribute to the
economic growth of less-developed countries, and to foster the
growth of world trade on a multilateral, nondiscriminatory basis.
Having little power to enforce its decisions, the OECD at the start of
the 21st century served mostly as a consultative body, influencing
trade through its studies of such matters as the impact of social
policies, globalization, and protectionism.
Economic integration
Forms of integration
The economic integration of several countries or states may take a
variety of forms. The term covers preferential tariffs, free-trade
associations, customs unions, common markets, economic unions, and
full economic integration. The parties to a system of preferential
tariffs levy lower rates of duty on imports from one another than they
do on imports from third countries. For example, Great Britain and its
Commonwealth countries operated a system of reciprocal tariff
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preferences after 1919. In free-trade associations no duty is levied on

imports from other member states, but different rates of duty may be
charged by each member on its imports from the rest of the world. A
further stage is the customs union, in which free trade among the
members is sheltered behind a unified schedule of customs duties
charged on imports from the rest of the world. The 19th-century
German Zollverein was a customs union. A common market is an
extension of the customs union concept, with the additional feature
that it provides for the free movement of labour and capital among
the members; an example was the Benelux common market until it
was converted into an economic union in 1959. The term economic
union denotes a common market in which the members agree to
harmonize their economic policies generally, as is the case with the
European Union. Finally, total economic integration implies the pursuit
of a common economic policy by the political units involved; examples
are the states of the United States or the cantons of the Swiss
Confederation.
Economic integration may be brought about by the political will of a
state powerful enough to impose it, as under the Roman Empire or the
European colonial systems of the 19th century, or it may result from
freely negotiated agreement between sovereign states, as was more
common in the 20th century.
The attempts at economic integration made after World War II can be
appraised only by reviewing them against the background of the long
process through which, over the centuries, the nations of the world
have progressively achieved economic integration. Thus, for instance,
the world's greatest power in the 17th century, France, was divided
into a number of provinces separated from one another by various
customs barriers involving a multitude of duties, tolls, and
prohibitions. Trade regulations and fiscal charges differed from one
region to the next; there was not even a single system of weights and
measures. Not until after the Revolution did the economic integration
of France really get under way.
Intranational integration
The United States
The economic integration of the United States was not achieved all
at once, but as the result of a long process during which the powers
of the federal authorities were constantly reinforced. The
Constitution empowered the federal government to regulate the
conditions of trade with other countries and to set up a single
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system of duties. It also abolished the right of individual states to

maintain separate customs legislation and to issue their own
currencies. It authorized the federal government alone to issue
currency and established the principle of free movement of
persons, merchandise, and capital between the federated states.
But the conflict of interest between North and South was settled
only by the American Civil War, and although the economies of the
states can be considered as integrated for practical purposes, there
remain many economic and fiscal disparities among them.
The difficulties faced by the 13 original states should not be

underestimated. During the years prior to the adoption of the
Constitution there were bitter trade disputes among the states,
which imposed tariffs against each other and refused to accept each
other's currencies. Everything seemed to justify the words of a
contemporary liberal philosopher, Josiah Tucker, Dean of
Gloucester (England):
As to the future grandeur of America, and its being a
rising empire under one head, whether republican or
monarchical, it is one of the idlest and most visionary
notions that ever was conceived even by writers of
romance. The mutual antipathies and clashing interests
of the Americans, their differences of governments,
habitudes, and manners, indicate that they will have no
centre of union and no common interest. They never can
be united into one compact empire under any species of
government whatever; a disunited people till the end of
time, suspicious and distrustful of each other, they will
be divided and sub-divided into little commonwealths or
principalities, according to natural boundaries, by great
bays of the sea, and by vast rivers, lakes, and ridges of
mountains.
Switzerland
The Swiss example is no less instructive. Although the Helvetic
Confederation emerged as a political entity in the 14th century, its
economic integration was achieved, only after many vicissitudes,
with the constitution of 1848. The terms of this document
established a common currency, set forth the principle of a
common protective system for the cantons, and provided for free
movement of goods and Swiss citizens throughout the national
territory. Swiss economic integration is all the more remarkable in
that it comprises peoples who speak four different languages.
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Integration of colonial empires

When the colonial powers of Europe founded their empires from the
16th century onward, they attempted to monopolize trade with the
colonies and to turn it to their own profit. This policy involved four
main restrictions: (1) The colonies were to trade exclusively with the
mother country. (2) They were not to undertake manufacturing;
transformation of raw materials into finished goods remained a
monopoly right of the mother country. (3) Imports and exports of the
colonies were to be carried only in ships flying the mother country's
flag. (4) The mother country exempted colonial products from duty, or
imposed lower rates.
This system, although progressively attenuated, applied in various

forms from the 16th to the 19th century. Based on force, it was to the
benefit of the home countries and detrimental to the economic growth
of their colonies. (See colonialism.)
The Zollverein
The best-known example of the early customs unions is the German
Zollverein (literally, customs union). Even though Napoleon had
reduced the number of German states from 300 to 40 at the beginning
of the 19th century, those that remained were isolated from each
other by their own customs systems. In addition, numerous internal
customs barriers hampered trade within each state. At the same time,
there was no single external tariff, and the German industries that had
sprung up during the Napoleonic Wars were being crushed by English
competition. These difficulties were at the root of the creation of the
Zollverein.
The starting point was Prussia's abolition of all internal duties and its
adoption of an external tariff in 1818. In the next few years a number
of other German states followed the Prussian example. Bavaria and
Wrttemberg set up a customs union in 1828, and by 1830 four
separate customs unions were in existence. Prussia then sought to
break up the local customs unions and attach them to a general
customs union, the Zollverein. The coverage of the Zollverein
increased until, by 1871, it included all the German states.
In its first phase, from 1834 to 1867, the Zollverein was administered
by a central authority, the Customs Congress, in which each state had
a single vote. A common tariff, the Prussian Tariff of 1818, shielded
the member states from foreign competition, but free trade was the
rule internally.
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During a second phase, from 1867 to 1871 (following Prussia's victory

over Austria at Sadowa), executive power was wielded by a federal
council (Bundesrat) composed of governmental delegates, in which
decisions were taken by an absolute majority. Prussia was entitled to
17 of the 58 votes and held the chair of the council. Legislative power
lay with a customs parliament (Zollparlament) composed of deputies
directly elected by popular vote, and, like the council, taking
decisions by a majority vote. This arrangement transformed what had
been a confederation into a federal state.
After the victory over France and the proclamation of the German
empire in 1871, the customs parliament and the federal council were
replaced by the parliament and the executive council of the empire.
The federal state had become a nation.
The progressive destruction of a tangled maze of regulations,

prohibitions, and controls set the stage for the subsequent rapid
development of the German economy. Although economic integration
occurred before political unification, it would not have been possible
had not many difficulties been swept away by irresistible pressure
from Prussia with its military victories.
The Benelux Economic Union

In 1921 Luxembourg, a former member of the Zollverein, signed the
Convention of Brussels with Belgium, creating the BelgiumLuxembourg
Economic Union. Belgium and Luxembourg thereby had the same
customs tariff and a single balance of payments since 1921.
The union was expanded after World War II to include the Netherlands.
At the beginning of 1948 most import duties within the Benelux area
were abolished, and a common external tariff was put into operation.
Exceptions were made, nevertheless, for a few agricultural products,
and it was also felt necessary to introduce a system of quotas.
It was rapidly perceived that a simple customs union was inadequate,

and a treaty on Oct. 15, 1949, set as its target the progressive and
complete liberalization of trade between the partners, systematic
coordination of their international commercial and monetary policies,
and the adoption of a joint bargaining position in negotiations with
other countries. Though the experiment was optimistically viewed
everywhere as the precursor of a wider European economic
integration, it faced difficulties arising from the very different postwar
situations of Belgium and the Netherlands. The two economies were
competitive rather than complementary. Other problems arose in
connection with the free access of Dutch agricultural products to the
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Belgian market. Moreover, the Belgian economic system was more

liberal than the Dutch, where rigorous price control had long been a
standard practice.
The development of Benelux received strong impetus from the

formation of the European Economic Community in the 1950s. When
the Treaty of Rome in 1957 created the EEC, or Common Market, it
spurred the members of Benelux to confirm and strengthen their own
integration in the Benelux Treaty of Economic Union signed at The
Hague on Feb. 3, 1958. The Hague treaty, however, contained little
that was new, and in outline form it was no more than the codification
of results already achieved.
The Benelux Economic Union made all of its decisions unanimously,
and all members of the union became founding members of the EU.
The European Coal and Steel Community

An important step in European integration was taken in May 1950 when
the French foreign minister, Robert Schuman, proposed that a common
market for coal and steel be set up by countries willing to delegate
powers over these sectors of their economies to an independent
authority. The motive behind the plan was the belief that a new
economic and political framework was needed if European unity was to
be achieved and if the threat of a future Franco-German conflict was
to be avoided. In April 1951 France, West Germany, Italy, and the
three Benelux countries signed a treaty in Paris setting up the
European Coal and Steel Community (ECSC).
The signatories bound themselves to abolish all customs barriers and
other restrictions on the movement of coal and steel between their
countries; to renounce all discriminatory practices among producers,
purchasers, or users (with respect to price and delivery conditions,
transport charges, selection of suppliers, etc.); to end government
subsidies or grants-in-aid; and to eliminate all practices interfering
with the operation of markets.
The constitution of the community
When first promulgated, the constitution of the Coal and Steel
Community allowed that it be governed by a High Authority,
assisted by a Consultative Committee, a Common Assembly, a
Special Council of Ministers, and a Court of Justice.
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There was, however, a basic incompatibility between the

community's provenance, limited to the coal and steel industries,
and the sovereignty of the member countries, each of which was
responsible for its own general economic policy. As a practical
matter, during the first 17 years of the community's existence,
authority on all substantive issues remained vested in the national
governments. The High Authority was autonomous only in matters of
secondary importance. Thus, the coal crisis of 1958when West
German, Belgian, and French stocks of unsold coal rose to
unmanageable proportionswas resolved at the national level. All
the High Authority could do was to confirm the measures taken,
even when they were contrary to the provision of the treaty.
Similarly, the reduction of the labour force in coal mining from
650,000 persons at the end of 1957 to 300,000 10 years later was
effected by individual countries; there was no communitywide
action.
The treaty reserved for member countries responsibility for their
own trade policies toward third countries. This hindered the
establishment of an effective common market since a common
market requires a unified system of protection from foreign
competition. At the height of the coal crisis, for example, when
stocks of coal rose in Belgium, West Germany, and France, Italy
nonetheless continued to buy cheap supplies from the United
States.
Later developments
Despite such difficulties much was accomplished by the community.
The markets for steel and coal were liberalized to a considerable
degree; the community served as a useful forum in which questions
of common interest could be examined; and it fostered the growth
of an international spirit, which did much to facilitate the
negotiation of the Treaty of Rome and the creation of the EEC and
the European Atomic Energy Community (Euratom). These advances
contributed to the formation of the EU.
The European Economic Community

The European Coal and Steel Community represented only an initial
step in the movement for European integration. On March 25, 1957, its
six member governments signed the Treaty of Rome, under which they
agreed to establish the European Economic Community, or Common
Market, which came into being on Jan. 18, 1958. It expanded with the
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entry of the United Kingdom, Ireland, and Denmark in 1973, Greece in

1981, Spain and Portugal in 1986, and the former East Germany as part
of reunified Germany in 1990. In the process, it represented the most
far-reaching attempt at economic integration among sovereign
countries. Its founding treaty stands as the model, in whole or part,
for all subsequent attempts at economic integration.
The Treaty of Rome aimed to establish a common market and

progressively bring the economic policies of members into alignment
so as to
promote the harmonious growth of economic activity in the
Community as a whole, regular and balanced expansion,
augmented stability, a more rapidly rising standard of
living, and closer relations between the participating
states.
The treaty pledged the signatories to
abolish customs duties and quantitative restrictions on the

entry and outflow of merchandise, to abrogate all other
measures having an equivalent effect, and to fix a common
customs tariff for imports from nonmember states.
They also agreed to abolish, as between members, all barriers to the

free movement of persons, services and capital.
Formation of a customs union
The Treaty of Rome had set a timetable for the abolition of customs
duties between member states. On balance, this timetable was met
and in some areas exceeded so that, by the middle of 1968, tariff
barriers had been abolished for agricultural as well as industrial
products. By that date also, most quota restrictions had been lifted.
The customs posts had not disappeared, however; they were still
needed for such tasks as assessing and collecting the compensatory
taxes that equalized the differences in taxes between member
countries.
Tariffs on imports from outside the community were gradually
brought closer, and on July 1, 1970, a common community tariff
was put into effect.
Development of a common agricultural policy
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When the Treaty of Rome took effect at the beginning of 1958,

agriculture was subsidized in all six member countries. The various
price-support mechanisms differed substantially, as did
foreign-trade policies and tariff levels. The cumulative impact of
governmental intervention of various kinds over the years had led to
major differences in agricultural price levels among the member
nations. With the average price of wheat in the six countries in 1959
indexed at 100, the relative price levels in individual countries were
as follows: Germany, 108; France, 78; Italy, 108; Belgium, 101;
Luxembourg, 119; and the Netherlands, 86. The achievement of
common policies in agriculture appeared to be so difficult that the
treaty limited itself to setting forth a number of general provisions
on which agreement seemed feasible. Despite this, a common
agricultural policy was achieved: all tariff and quota restrictions on
trade in farm products among member countries were abolished; a
common set of tariffs on agricultural imports from non-EEC
countries was established; and a common system of price supports
took the place of the former national systems.
The price supports required difficult compromises among the
member governments because of the differences in their domestic
price levels for farm products. The EEC wheat price, for example,
was set roughly halfway between the prices of the lowest-cost
suppliers in the community, France and the Netherlands, and those
of West Germany, which was the highest. France exerted
considerable political pressure to persuade West Germany to accept
a substantial lowering of the returns to its wheat producers.
Since its inception, the common agricultural policy experienced
several fundamental problems, especially recurrent surpluses and
conflicts of interest between large- and small-scale producers.
Surpluses originated as a result of the price support system, and
while this system helped marginal farmers stay in business, it often
encouraged more-productive farmers to overproduce, creating
surpluses that had to be purchased with EEC funds. It also caused
conflicts of interest between net food exporters that received
greater relative support and countries that were net food importers
(e.g., the United Kingdom); those that imported more than they
exported made large contributions to the common policy but
received little return in export subsidies and price supports.
Toward a harmonization of policies
Another fundamental aim of the Treaty of Rome was to achieve a
general harmonization of national economic policies. The treaty
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envisaged the working out of common rules covering such matters

as competition, taxation, and other economic legislation. It also
called for the development of common policies in such areas as
foreign trade and transportation. Members were asked to concert
their economic policies in the fields of fiscal and monetary policy,
balance-of-payments policy, and social welfare.
The European Union

The European Community
The EEC remained a leading proponent of economic integration
until 1993, when, renamed the European Community (EC), it
became the principal component of the European Union (EU), a
broader entity seeking economic and political cooperation. The EC
was formed by the Maastricht Treaty (formally known as the Treaty
on European Union; 1991), which went into force on Nov. 1, 1993.
The treaty also provided the foundation for an economic and
monetary union, which included the creation of a single currency.
The EC remained the principal component of the EU until 2009,
when the Lisbon Treaty eliminated the EC and enshrined the EU as
its institutional successor.
EU institutions
Governance and representation within the EU occur through a
number of institutions, many of which were formed as part of the
EEC. Chief among these are the Council of the European Union, a
legislative organization that represents member states; the
European Parliament, which has legislative and supervisory roles;
and the European Commission, an executive body. The Parliament is
the only EU institution whose members are elected by the votes of
individual citizens of EU nations. Other EU institutions are the Court
of Justice, the Court of Auditors, the European Central Bank (which
oversees monetary policy and introduced the euro), the Economic
and Social Committee, the Committee of the Regions, the European
Investment Bank, and the European Ombudsman. In addition to the
institutions, the agencies of the European Union are charged with
overseeing particular interests, such as occupational safety,
training, or social and environmental concerns.
New members
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As was true for the EEC, any European state can request
membership in the EU. Candidate countries must demonstrate an
adherence to the principles of democracy, market economy, and
human rights. Acceptance is granted through a unanimous decision
by member countries.
The European Free Trade Association

The efforts that led to the creation of the EU were paralleled by
another attempt to foster trade in the region. At the same time that
the EEC was being organized in the 1950s, Great Britain sought to
organize a free-trade area that would include 17 member countries of
the Organization for European Economic Co-operation. Had it
succeeded, this would have given Britain access to the benefits of the
industrial common market on the Continent while avoiding possible
infringements of British sovereignty. The effort failed, however,
mainly because of French opposition. Britain then undertook the
formation of a free-trade area in association with Austria, Denmark,
Norway, Portugal, Sweden, and Switzerland. Together they made up
the European Free Trade Association (EFTA).
The convention setting up EFTA was signed in Stockholm on Jan. 4,

1960. The preamble stated that one of the main purposes of the
organization was to facilitate the future establishment of a wider
multilateral association for abolition of customs barriers. More
specifically, EFTA was meant to liberalize trade with the six Common
Market countries without subscribing to the commitments of political
character embodied in the Treaty of Rome. In the meantime, EFTA
gave its seven members a stronger bargaining position vis--vis the
other six, as well as the means of creating a large market of their own.
Operation of EFTA
The EFTA treaty, like that of the EEC, provided for a transitional
period, set forth rules governing competition, and called for the
abolition of all indirect protection and trade discrimination. The
Association chose to be governed by the EFTA Council, composed of
one member from each participating state. Over time the council
set up a joint consultative committee comprising representatives of
industry, business, and labour; a set of six permanent technical
committees (on customs, trade, economic development,
agriculture, economics, and budget); and working parties dealing
with special topics.
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EFTA had one special problem arising from its nature as a free-trade
area. Since the duties charged on imports from outside countries
were likely to differ from one member to another, traders could
take advantage of the differences by channeling imports through
the country levying the lowest rates and delivering them to
customers in another member country. Rules were established to
prevent this by classifying merchandise according to whether it was
produced or fabricated in one of the member countries. In the case
of goods made from imported raw materials, the rules required that
the import content not exceed 50 percent of the export price of the
finished product.
EFTA's record
Although a 10-year transitional period was originally envisaged,
internal customs barriers on industrial goods were eliminated on
Jan. 1, 1967, three years ahead of schedule. Bilateral trade
agreements were also negotiated to increase trade in agricultural
products.
EFTA passed through two grave crises in the 1960s. The first was in
1961 when Britain, acting unilaterally, informed its partners that it
had applied for membership in the EEC. The upshot was a joint
declaration in which EFTA members committed themselves to
coordinate their action and remain united throughout the
negotiations. The second crisis occurred in October 1964, when, to
shore up the pound sterling, Britain suddenly introduced a surcharge
of 15 percent on all its industrial importsan act that was in
violation of the treaty.
Finland became an associate member of EFTA in July 1961, and
Iceland was admitted to full membership in March 1970. In 1973
Britain and Denmark left the association when they were accepted
as members in the EECBritain, after two previous unsuccessful
tries. At the beginning of the 21st century, the remaining EFTA
member countries were Iceland, Norway, Liechtenstein, and
Switzerland. The group continued to advance global trade; for
example, in 2003 EFTA signed separate free-trade agreements with
Singapore and Chile.
Comecon
Since the Russian Revolution of 1917, Soviet policy had clearly been
influenced by the desire for self-sufficiency, further reinforced by
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Soviet suspicions of the capitalist world and by a strong desire for

centrally directed planning. In response to the Marshall Plan, a
Soviet-sponsored effort to integrate the economies of eastern Europe
began as early as Jan. 25, 1949. (It was disbanded on June 28, 1991.)
Bulgaria, Hungary, Poland, Romania, Czechoslovakia, and the Soviet
Union were the founding members of the resultant organization,
Comecon (Council for Mutual Economic Assistance). Albania joined in
1949, and the German Democratic Republic in 1950, though Albania
ceased to participate after 1961. In its early years the activities of
Comecon were limited mainly to the registration of bilateral trade and
credit agreements among the member countries. After Joseph Stalin's
death in 1953, it made efforts to promote industrial specialization and
to reduce parallelism in the economies of its members. In 1956 and
1957, when most of its standing commissions began to operate,
attempts were made to harmonize the long-term plans of the
members. The establishment of the EEC in 1958, together with
pressures from the eastern European countries for a greater degree of
independence, induced the Soviet leadership to rethink the
organization. A new charter was signed by the members in Sofia, Bulg.,
on Dec. 14, 1959.
Comecon sought to coordinate the development of technology and
industrialization, growth of labour productivity, and industrial
specialization in member countries. Its objectives, however, were
hindered by certain political and economic constraints. One of the
most serious was the absence of flexible and realistic price systems in
the member countries. This made it impossible to base trade on
relative prices; instead it was conducted mainly on a barter basis
through bilateral agreements between governments. In negotiating
such agreements, the parties were led to use world pricesi.e.,
prices prevailing in the trade of countries outside Comecon. Another
hindrance to economic integration was the highly centralized
economic planning in the member countries, which had only limited
success in coordinating their plans. There were also serious
nationalistic tensions within the council. The Romanian government,
for example, announced its intention to pursue all-around
industrialization, including the development of its heavy industries, in
opposition to the policy of specialization in raw materials and
agricultural products that was said to have been Comecon's plan for
Romania.
Among the practical achievements of Comecon, however, were the

organization of railroad coordination (1956); construction of a
high-voltage electricity grid (1962); creation of the International Bank
for Economic Cooperation (1963); the pooling of 93,000 railway freight
cars (1964); and construction of the Friendship oil pipeline from
Russia's Volga region to the eastern European countries. Comecon
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initially was composed of the old Soviet Union's eastern European

satellites, but in 1962 the Mongolian People's Republic became a
member, followed by Cuba in 1972 and Vietnam in 1978.
Comecon was often called the eastern European counterpart of

western Europe's EEC. Although their general aims were indeed the
same, the two organizations differed radically in their approach to the
problems involved. While Comecon sought to achieve cooperation
among nations with centrally planned economies, the EEC aimed to
achieve decentralized integration by means of an economic market in
which goods, services, capital, and persons could have full freedom of
movementa market regulated by uniform economic legislation.
The collapse of communist governments across eastern Europe in

198990 was followed by a shift to private enterprise and market-type
systems of pricing, all of which undermined Comecon's system of trade
and by 1991 left the organization defunct. Under agreements made
early in 1991, Comecon was replaced by the Organization for
International Economic Cooperation, a group intended to assist with
the move from centralized to market economies. Each nation was
deemed free to seek its own trade outlets, and the obligation of
membership was reduced to a weak pledge to coordinate policies on
quotas, tariffs, international payments, and relations with other
international bodies. Over time, the former Comecon countries moved
away from the Soviet-era trade restrictions and developed trade
relationships with other nationsparticularly those of the EU.
Maurice Allais
Ed.
Economic integration in Latin America

Progress toward economic integration in Europe encouraged the Latin
American republics to make similar attempts. By the late 20th century
several organizations had been established to work toward such
integration; they included the Central American Common Market; the
Latin American Free Trade Association; the Andean Community of
Nations; and the Caribbean Community and Common Market.
The Central American Common Market
On June 10, 1958, El Salvador, Guatemala, Honduras, Nicaragua,
and Costa Rica signed a multilateral treaty aiming at free trade and
economic integration. The Central American Common Market
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(CACM) provided for the establishment of a free-trade area within

10 years. The participating countries also agreed to the industrial
integration of the region. These arrangements were completed by
the signing on Dec. 13, 1960, of the Treaty of Managua. Its aims
were similar to those of the EEC, namely, the establishment of a
common market within five years and the organization of integrated
industrial development. Most barriers on the region's internal trade
were then removed or reduced.
Economic integration in Central America has been hampered by
disagreements and military conflicts in the area. Following a
dispute with El Salvador in 1970, Honduras in effect withdrew from
common market membership by implementing tariffs on imports
from other member countries. In 1980, however, Honduras signed a
treaty with El Salvador, settling their dispute and restoring
Honduran participation in the common market trade agreements in
1981. During the 1980s, tensions between the revolutionary
government of Nicaragua and its neighbours, as well as other
disorders, disrupted trade between the nations of Central America.
In an effort to promote freer trade in the larger region, the group
began working on trade agreements with the Caribbean Community
and Common Market (Caricom, see below) in 1991, and CACM
negotiated an agreement with the Dominican Republic in 1998.
Throughout this time, CACM also took steps to protect its interests
against Mexico's increasing economic dominance in the region,
especially after Mexico, Canada, and the United States signed the
North American Free Trade Agreement.
The Latin American Free Trade Association and the Latin
American Integration Association
On Feb. 18, 1960, Argentina, Brazil, Chile, Mexico, Paraguay, Peru,
and Uruguay signed a treaty setting up the Latin American Free
Trade Association (LAFTA), predecessor to the Latin American
Integration Association. By 1970 the seven signatories had been
joined by Ecuador, Colombia, Venezuela, and Bolivia. The treaty
provided for a 12-year transition period during which all obstacles
to trade were to be eliminated. It was based on the principle of
reciprocity and most-favoured-nation (MFN) treatment. Member
states also committed themselves to progressive coordination of
their industrialization policies. Special treatment was provided for
agriculture and for the relatively least-developed member
countries.
Liberalization of trade between the member countries was carried
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out initially through negotiation of product-by-product concessions.

In 1967, however, the negotiations failed; they were postponed to
1968, when agreement was reached on a system of across-the-board
automatic tariff reductions similar to those of the EEC. The
eventual aim was that LAFTA be the first step in a process that
would lead to a common Latin American market; but during the
1970s it became apparent that the geographic diversity and varying
levels of economic development exhibited by the member countries
were handicapping the formation of a true common market within
the association's existing framework. In the late 1970s negotiations
were begun to establish a new framework for economic integration,
and in 1980, 20 years after the creation of LAFTA, the Latin
American Integration Association (LAIA; Asociacin
Latino-Americana de Integracin) was formed. Unlike its
predecessor, LAIA adopted an alternative to the concept of a
free-trade area in that it opted for the establishment of bilateral
preference agreements that would take into account the varying
stages of economic development of the member countries. Cuba
was admitted to LAIA in 1986 with observer status and became a
member in 1999. In order to best negotiate bilateral preference
agreements the member nations were divided into three categories.
Although some countries were shifted to different categories over
time, by the beginning of the 21st century the three tiers were:
most-developed countries (Argentina, Brazil, and Mexico);
intermediate-developed countries (Chile, Colombia, Peru, Uruguay,
and Venezuela); and least-developed countries (Bolivia, Cuba,
Ecuador, and Paraguay).
The Andean Group and the Andean Community of Nations
In 1966 Bolivia, Chile, Colombia, Ecuador, Peru, and Venezuelaall
members of the Latin American Free Trade Associationagreed to
form a regional subgroup. The Andean Group began its official
existence in June 1969 without Venezuela, which had withdrawn. By
1973 Venezuela had decided to join, but Chile withdrew in 1976.
The Andean Group began negotiating free-trade agreements with
the Mercado Commn del Sur (also known as the Southern Market,
or Mercosur; a trade community comprising Argentina, Brazil,
Paraguay, and Uruguay) in 1996, and in 1997 the group became
known as the Andean Community of Nations (CAN). Among the
Andean Community's aims are the acceleration of economic
integration between member countries, the coordination of regional
industrial development, the regulation of foreign investment in
member countries, and the standardization of some agricultural and
economic policies.
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The Caribbean Community and Common Market

Established in 1973 by 12 Caribbean countries, the Caribbean
Community and Common Market (Caricom) is the successor to the
Caribbean Free Trade Association (Carifta), which was founded in
1968 by five former British colonies (Antigua, Barbados, Guyana,
Jamaica, and Trinidad and Tobago), all of which joined the new
organization. The organization attempts to encourage economic
integration in the Caribbean region and achieved partial agreement
to a common external tariff and protective policy for the
community in 1978.
Caribbean economic integration had been curtailed between 1976

and 1978, partly because of import restrictions imposed by Jamaica
and Guyana, and partly because of dissatisfaction among the
less-developed countries, which claimed that they were not
receiving their fair share of trading revenues. By 1980 Jamaica and
Guyana had removed their import restrictions, and the Caricom
Council had endorsed several measures to improve the status of the
less-developed countries within Caricom. These countries, however,
remained dissatisfied, and in 1981 the seven former members of the
West Indies Associated States (Antigua and Barbuda, Dominica,
Grenada, Montserrat, Saint Kitts-Nevis, Saint Lucia, and Saint
Vincent and the Grenadines) formed a subregional economic
integration organization, the Organization of Eastern Caribbean
States, though they retained their Caricom membership.
In succeeding years Caricom added new member countries, with the

Bahamas joining in 1983 and Suriname joining in 1995. Joining as
associate members were the Turks and Caicos and the British Virgin
Islands (1991), Anguilla (1998), and the Cayman Islands (2002). Haiti
was asked to join Caricom as a provisional member in 1997, with full
membership to be based on conditions such as trade liberalization.
Ed.
The Association of South East Asia and the Association of

Southeast Asian Nations
The Association of Southeast Asian Nations (ASEAN) originated in 1961
as the Association of South East Asia (ASA), which had been founded by
the Philippines, Thailand, and the Federation of Malaya (now part of
Malaysia). In 1967 ASEAN was established by the governments of
Indonesia, Malaysia, the Philippines, Singapore, and Thailand to
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accelerate economic growth and social development in Southeast Asia.

The end of hostilities in Vietnam brought dynamic economic growth to
the region in the 1970s, and resulting strengths within the organization
enabled ASEAN to adopt a unified response to Vietnam's invasion of
Cambodia in 1979. Brunei joined the association in 1984, followed by
Vietnam in 1995, Laos and Myanmar in 1997, and Cambodia in 1999.
ASEAN's chief projects have centred on economic cooperation and the
promotion of trade, both among ASEAN countries and between ASEAN
members and the rest of the world. The end of the Cold War between
the United States and the Soviet Union at the end of the 1980s allowed
ASEAN countries to exercise greater political independence in the
region, and in the 1990s ASEAN emerged as a leading voice for regional
trade and security issues. In 1992 members reduced intraregional
tariffs and eased restrictions on foreign investment by creating the
ASEAN Free Trade Area.
The North American Free Trade Agreement

In 1992, the North American Free Trade Agreement (NAFTA) was signed
by Canada, Mexico, and the United States. It took effect in 1994 and
created one of the largest free-trade areas in the world.
Inspired by the EEC's success in reducing trade barriers between its
members, NAFTA created the world's largest free-trade area. It
basically extended to Mexico the provisions of a 1988 Canada-U.S.
free-trade agreement that called for elimination of all trade barriers
over a 15-year period and incorporated agreements on labour and the
environment. Other provisions were designed to give U.S. and
Canadian companies greater access to Mexican markets in banking,
insurance, advertising, telecommunications, and trucking.
Regional arrangements and WTO rules

When countries join regional trading groups, they provide preferences
to one another. In the EU, for example, German producers can export
duty-free to France, whereas U.S. or Japanese exporters still have to
pay duties on products shipped to France. In this way German
producers become preferred over U.S. or Japanese suppliers, because
a customs union represents a departure from MFN treatment.
Nevertheless, countries entering a customs union or free-trade
association are not in violation of their commitments under the World
Trade Organization; just as they were permitted under GATT, customs
unions and free-trade associations are still permitted through the
WTO.
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The development of GATT trading rules offers insight into

consequences of regional agreements. GATT article XXIV allowed
countries to grant special treatment to one another by establishing a
customs union or free-trade association, provided that (1) duties and
other trade restrictions would be eliminated on substantially all the
trade among the participants, (2) the elimination of internal barriers
occurred within a reasonable length of time (commonly within 10
years), and (3) duties and other barriers to imports from nonmember
countries would not on the whole be higher or more restrictive than
those preceding the establishment of the customs union or free-trade
association. The third condition was explicitly aimed at protecting the
rights of outside countries.
The first condition disapproved partial preferential arrangements

covering only some products, while accepting broad arrangements
covering (substantially) all products. It was supported on the ground
that large, unrestricted marketsmost notably, that of the United
Statesprovide substantial benefits. Such benefits should also be
available to others. For example, when the GATT articles were being
drafted, consideration was being given to an integration of the nations
of western Europe.
Shortly after article XXIV was written, it received substantial support
in the classic study by Jacob Viner, The Customs Union Issue (1950).
Viner, a Canadian-born U.S. economist, saw efficiency as the main
gain from international trade, since trade encourages production in a
less-costly location (see comparative advantage). He contended that a
customs union works to increase efficiency in one way but decreases it
in another. To explain, Viner drew a distinction between two forces at
work when a customs union is established. As two (or more) countries
cut tariffs on each other's products, new trade is created. Some goods
that were previously bought from domestic producers are now bought
from lower-cost producers in the trading partner nation, whose goods
now come in duty-free, which improves efficiency.
When, however, a country removes tariffs on its partner's goods but
not on the goods of outside countries, the partner has preferred
access. As a result, some purchases are switchedgoods are bought
from the partner nation rather than from the world at large. Such
trade diversion reduces efficiency; purchases are switched from the
efficient outside country to the less-efficient partner nation. A
customs union (or free-trade area) may be predominantly
trade-creating, which is desirable, or it may be predominantly
trade-diverting, which is undesirable.
Viner's book thus introduced a skeptical note into the discussion of
customs unions, which had previously been given broad approval.
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Viner's work also supported the distinctions made in article XXIV of

GATT. Clearly, if barriers on imports from nonmember countries are
kept down, then trade diversion is less likely. Furthermore, the
provision to disapprove partial preferential arrangements covering only
some products, while accepting broad arrangements covering virtually
all products, found support within Viner's framework. Because of the
political dynamics of trade negotiations, partial preferential
arrangements generally cause more trade diversion than trade
creation.
This can be illustrated in a hypothetical situation in which countries
(say, France and Germany) are permitted to get together to make
whatever preferential agreements they wish. A natural way for France
to open negotiations would be to say to Germany, We'll cut tariffs on
your automobiles and buy from you rather than Japan if you will cut
tariffs on our sugar and buy from us rather than from the Caribbean
nations. In other words, negotiators tend to pick and choose those
items previously imported from outside countries; they tend to cut
tariffs where trade diversion is greatest. By requiring a comprehensive
approach, article XXIV ensured that trade-creating tariff cuts would be
made too.
Paul Wonnacott
Patterns of trade
Degrees of national participation

Nations vary considerably in the extent of their foreign trade. As a very
rough generalization, it may be said that the larger a country is in
physical size and population, the less is its involvement in foreign trade,
mainly because of the greater diversity of raw materials available within
its borders and the greater size of its internal market. Thus, the
participation of the United States has been relatively low, as measured
by percentage of gross domestic product (GDP), and that of the former
Soviet Union has been even lower. The U.S. GDP, however, is so immense
by world standards that the United States still ranks as one of the world's
most important trading countries. Some of the smaller countries of
western Europe (such as the Netherlands) have export and import totals
that approximate half of their GDPs.
Trade among developed countries

The greatest volume of trade occurs between the developed, capital-rich
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countries, especially between industrial leaders such as Australia,

Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain,
Sweden, the United Kingdom, and the United States. Generally, as a
country matures economically, its participation in foreign trade grows
more rapidly than its GDP.
The EU affords an impressive example of the gains to be derived from
freer trade between such countries. A major part of the increases in real
income in EU countries is almost certainly attributable to the removal of
trade barriers. The EU's formation cannot, however, be interpreted as
reflecting an unqualified dedication to the free-trade principle, since EU
countries maintain tariffs against goods from outside the Union.
Trade between developed and developing countries

Difficult problems frequently arise out of trade between developed and
developing countries. Most less-developed countries have
agriculture-based economies, and many are tropical, causing them to rely
heavily upon the proceeds from export of one or two crops, such as
coffee, cacao, or sugar. Markets for such goods are highly competitive (in
the sense in which economists use the term competitive)that is, prices
are extremely sensitive to every change in demand or in supply.
Conversely, the prices of manufactured goods, the typical exports of
developed countries, are commonly much more stable. Hence, as the
price of its export commodity fluctuates, the tropical country
experiences large fluctuations in its terms of trade, the ratio of export
prices to import prices, often with painful effects on the domestic
economy. With respect to almost all important primary commodities,
efforts have been made at price stabilization and output control. These
efforts have met with varied success.
Trade between developed and less-developed countries has been the

subject of great controversy. Critics cite exploitation of foreign labour
and of the environment and the abandonment of native labour needs as
multinational corporations from developed countries transport business
to countries with cheaper labour pools and relatively little economic or
political clout. Especially after 1999, when trade talks were disrupted by
globalization protesters during the WTO ministerial conference in Seattle,
the work of the WTO came under increasing scrutiny from its critics.
These critics voiced a number of concerns about the power and scope of
the WTO, with the gravest criticisms clustering around issues such as
environmental impact, health and safety, the rights of domestic workers,
the democratic nature of the WTO, national sovereignty, and the
long-term wisdom of endorsing commercialism and free trade to the
neglect of other values.
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Romney Robinson
Ed.
Additional Reading
General texts
The classic works in the field of international trade are ADAM SMITH, An
Inquiry into the Nature and Causes of the Wealth of Nations, 2 vol.
(1776), available also in many later editions, both complete and in
selections; DAVID RICARDO, On the Principles of Political Economy and
Taxation (1817), available also in modern editions; JOHN STUART MILL,
Principles of Political Economy, 2 vol. (1848, reissued in 1 vol., 1909;
reprinted 1987); GOTTFRIED VON HABERLER, The Theory of International Trade
with Its Applications to Commercial Policy (1936, reprinted 1968;
originally published in German, 1933); and JACOB VINER, Studies in the
Theory of International Trade (1937, reprinted 1975). Useful textbooks
include RICHARD E. CAVES and RONALD W. JONES, World Trade and Payments: An
Introduction, 4th ed. (1985); WILFRED J. ETHIER, Modern International
Economics (1983); PETER B. KENEN, The International Economy (1985); and
PETER H. LINDERT, International Economics, 8th ed. (1986). Surveys of recent
international financial developments may be found in the annual
compiled by the INTERNATIONAL MONETARY FUND, World Economic Outlook.
Surveys of recent advanced work in international economics include
RONALD W. JONES and PETER B. KENEN (eds.), Handbook of International
Economics, vol. 1 (1984); and DAVID GREENAWAY (ed.), Current Issues in
International Trade: Theory and Policy (1985).
Theories of international trade
The Heckscher-Ohlin theory has been the most scrutinized explanation of

trade patterns. The classic work is BERTIL OHLIN, Interregional and
International Trade, rev. ed. (1967). Other surveys are NICHOLAS OWEN,
Economies of Scale, Competitiveness, and Trade Patterns Within the
European Community (1983); and EDWARD E. LEAMER, Sources of
International Comparative Advantage: Theory and Evidence (1984).
Elementary treatments of the theory and practice of tariffs may be found

in standard texts, such as those listed above. Institutional and historical
studies of tariffs include ASHER ISAACS, International Trade, Tariff, and
Commercial Policies (1948); and F.W. TAUSSIG, The Tariff History of the
United States, 8th ed. (1931, reprinted 1967). An analysis of the
economic and political issues in trade policy may be found in BELA BALASSA,
Trade Liberalization Among Industrial Countries: Objectives and
Alternatives (1967); ROBERT E. BALDWIN and ANNE O. KRUEGER (eds.), The
Structure and Evolution of Recent U.S. Trade Policy (1984); JAGDISH N.
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BHAGWATI (ed.), Import Competition and Response (1982); WILLIAM R. CLINE et
al., Trade Negotiations in the Tokyo Round: A Quantitative Assessment

(1978); WILLIAM R. CLINE (ed.), Trade Policy in the 1980s (1983); I.M. DESTLER,
American Trade Politics: System Under Stress (1986); GARY CLYDE HUFBAUER
and HOWARD F. ROSEN, Trade Policy for Troubled Industries (1986); and
ROBERT Z. LAWRENCE and ROBERT E. LITAN, Saving Free Trade: A Pragmatic
Approach (1986). Accounts of the General Agreement on Tariffs and
Trade (GATT) may be found in GERARD CURZON, Multilateral Commercial
Diplomacy (1965); GARDNER PATTERSON, Discrimination in International Trade:
The Policy Issues, 19451965 (1966); and GILBERT R. WINHAM, International
Trade and the Tokyo Round Negotiations (1986). The effects of trade
policies on the developing countries are studied in HARRY G. JOHNSON,
Economic Policies Toward Less Developed Countries (1967).
International trade arrangements
General analyses include F.W. TAUSSIG, Free Trade, the Tariff, and
Reciprocity (1920); LEAGUE OF NATIONS, Commercial Policy in the Interwar
Period: International Proposals and National Policies (1942); JACQUES
LACOUR-GAYET, Histoire du commerce, 6 vol. (195055); and ROBERT SCHNERB,
Libre-change et protectionnisme, 4th rev. ed., edited by MADELEINE SCHNERB
(1977). Economic integration is treated in MAURICE ALLAIS, L'Europe unie:
route de la prosprit (1960); BELA BALASSA, The Theory of Economic
Integration (1961, reprinted 1982); BELA BALASSA et al. (eds.), European
Economic Integration (1975); EUROPEAN FREE TRADE ASSOCIATION, The Effects of
EFTA on the Economies of Member States (1969); JOSEPH GRUNWALD, MIGUEL S.
WIONCZEK, and MARTIN CARNOY, Latin American Economic Integration and U.S.
Policy (1972); MICHAEL HODGES and WILLIAM WALLACE (eds.), Economic
Divergence in the European Community (1981); JAMES E. MEADE, The Theory
of Customs Unions (1955, reprinted 1980); SCOTT R. PEARSON and WILLIAM D.
INGRAM, Economies of Scale, Domestic Divergences, and Potential Gains
from Economic Integration in Ghana and the Ivory Coast, The Journal of
Political Economy, 88:9941009 (October 1980); DENNIS SWANN, The
Economics of the Common Market, 5th ed. (1984); JACOB VINER, The
Customs Union Issue (1950, reprinted 1983); WILLIAM WALLACE (ed.), Britain
in Europe (1980); PAUL WONNACOTT, The United States and Canada: The
Quest for Free Trade (1987); and BRUCE PARROTT (ed.), Trade, Technology,
and Soviet-American Relations (1985).
Paul Wonnacott
To cite this page:
MLA Style: "international trade." Encyclopdia Britannica. Encyclopdia

Britannica Ultimate Reference Suite. Chicago: Encyclopdia Britannica,
2015.
APA Style: international trade. (2015). Encyclopdia Britannica.
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Encyclopdia Britannica Ultimate Reference Suite. Chicago: Encyclopdia

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international trade

the welfare of the nation. It insisted that the acquisition of wealth,

Mercantilism was based on the conviction that national interests are

abandoned all mercantilist policies. Restrictive economic policies were

In the middle of the 19th century, a protective customs policy effectively

The new mercantilism

The theory of international trade

The British school of classical economics began in no small measure as a

a source of increased output, and he treated international trade as a

Simplified theory of comparative advantage

wine (1 unit) 1 hour

cloth (1 unit) 2 hours

As compared with country A, country B is productively inefficient. Its

Country A is said to have an absolute advantage in the production of

The incentive to export and to import can be explained in price terms.

Price of wine per unit $ 5

Price of cloth per unit $10

As soon as the opportunity for exchange between the two countries is

So long as the ratio of prices in country A differs from that in country

earlier, at 1:2 /2), the flow of goods will stabilize.

Amplification of the theory

In this simple example, based on labour costs, the result is complete

noted that even the most elaborate comparative-advantage models

or individual within the country will share in that benefit. Producer

Sources of comparative advantage

Factor endowments: the Heckscher-Ohlin theory

One early study of the Heckscher-Ohlin theory was carried out by

imports. Because his findings were the opposite of those predicted by

Economies of large-scale production

For many products, there are advantages in producing on a large scale;

One important aspect of technology is that it can change rapidly. This

The product cycle

State interference in international trade

Regardless of what comparative-advantage theory may say about the

These interferences may be simply the result of special-interest pleading,

The governments of countries subject to this new investment find

Tariffs may be imposed in different ways, each of which will have a

favoured by industries that find themselves pressed by foreign

The effective rate of protection is a more complex concept:

The same situation may be considered with tariffssay, 20 percent

The effective rate of protection also depends on the share of value

from U.S. competitors, voluntarily limited their exports of

Protectionism in the less-developed countries

Arguments for and against interference

occupationand they press for gradual reduction of import barriers.

Infant-industry tariffs have been disappointing in other ways; the

lower levels of development. (See also economic development.)

those half-submerged feelings that the citizens of the nation share a

The terms-of-trade argument

reason quite different from those thus far discussed: shortage of

If balance-of-payments difficulties arise and persist, a nation's foreign

The problem of reserve shortages became acute for many countries

Contemporary trade policies

Bilateral trade agreements

A bilateral trade agreement usually includes a broad range of

The effect of the MFN clause on customs duties is to amalgamate

which, in a subsequent trade agreement, has negotiated a lower

The coverage of the MFN clause can be considerably reduced by a

The advantages granted under the MFN clause may be conditional or

minimum protection that the negotiating state deems indispensable

Proponents of free trade consider that the unconditional MFN clause

The Conference of Genoa, Italy, in May 1922 and the World

Multilateral agreements after World War II