The U.S. Argument for Limiting MFN
In the communication to the WTO that I mentioned in the last post, the U.S. put forward a critique of the MFN principle:
Most Favored Nation (MFN) Principle
3.1. The MFN principle, which seeks to prevent discriminatory trade practices and promote equal treatment among trade partners, was designed for an era of deepening convergence among trading partners. During that era, countries were expected to adopt open, market-oriented trade policies, as stated by the founding Members of the WTO in the preamble to the Marrakesh Declaration. That expectation was naïve, and that era has passed. It has been replaced by an era of deepening divergence, rooted in some countries' unwillingness to pursue and uphold fair, market-oriented competition, some countries' insistence on maintaining economic systems that that are fundamentally incompatible with WTO principles, and many countries' pursuit of chronic trade surpluses that have adverse economic and political consequences in deficit countries. To face these challenges, trading nations must be able to treat different trading partners differently.
3.2. The MFN principle is not just unsuitable for this era; it prevents countries from optimizing their trade relationships in ways that would benefit each party in that relationship. Put differently, MFN impedes welfare-enhancing liberalization. It pushes Members to engage in one venue—the WTO— and attempt to develop a one-size-fits-all approach. If Country A lowers a tariff for Country B, and Country B lowers a tariff for Country A, both countries have to lower those tariffs for all countries, unless their agreement covers "substantially all the trade" or a waiver or exception applies. This does not actually advance the economic objectives of the organization, and it prevents trading partners otherwise willing to enter into mutually beneficial agreements from doing so. It sets up an impossible requirement of negotiating the same terms with all Members, resulting in an all-or-nothing approach that typically ends in "nothing".
3.3. WTO Members have a long history—dating back to the GATT era—of recognizing the limits of the MFN principle. The 'Enabling Clause' eliminated the MFN principle for Members that claimed developing country status. Particularly given the distinction between developed and developing status is now blurred, it is time to recognize the necessity of allowing all Members to enter into mutually beneficial agreements that may not extend to every Member.
The relevance of MFN has already been substantially diminished in recent decades by the proliferation of FTAs that aim for consistency with GATT Article XXIV (although whether they achieve it is an open question), as well as by the Enabling Clause and other instruments. The U.S. now seems to want to go further in diminishing MFN.
But what exactly is the U.S. proposal here? Is it to amend GATT Article XXIV so as to remove the "substantially all the trade" requirement (or to remove substantive regulation of these issues entirely)? So, instead of customs unions and free trade areas (or interim agreements on their way to these) as the only bilateral/regional/plurilateral exceptions to MFN, there would be no limits on preferential trade arrangements between two or more WTO Members? Countries A and B can just pick any product or products and lower tariffs on them as between themselves?
It's interesting to think about why the U.S. wants this change and how it would play out. The Trump administration has been pursuing bilateral arrangements of a kind that would be covered here (well, the trade parts of these arrangements would be covered at least), so in a sense it is trying to make its current approach consistent with WTO rules. Maybe that's a good sign for U.S. participation in the multilateral trading system? It's looking to build a system that it can comply with?
At the same time, I wonder if the real world result of this change would be to the liking of the Trump administration. The goal here might be to accommodate current U.S. trade policy, but imagine if other governments got on board with it and pursued it themselves. My best guess is that most of them will not, but in today's world of trade disruption, you never know. If the U.S. approach were followed, it could mean that a wide range of other countries begin negotiating these limited bilateral deals with each other in a way that puts U.S. producers at a disadvantage. Thus, I'm not sure the overall impact of this change would be favorable to the U.S., although it must be said that there is a great deal of uncertainty as to how things would play out. The international politics of an MFN-less trading system would be complex, to say the least.
As to whether this change makes sense as a matter of policy, I don't think it would be good for the trading system in terms of the impact on the economy. Generally speaking, preferential arrangements are probably more trade distorting than trade creating, although of course this is hard to quantify. There may be an exception for countries that are neighbors and/or trade a lot with each other, but mostly this approach is likely to reduce economic welfare by distorting the decision-making of companies choosing their production locations, leading them to build in places that are not the most cost-effective. If preferential arrangements start spiraling as a result of a loosening of WTO rules, the negative economic impact could be significant. However, politics seems to be taking precedence over economics these days, so the economic impact might not be the main consideration.