World Trade Organization

Trade Negotiations

The WTO provides a forum for multilateral trade negotiation, which is bolstered by its principles of nondiscrimination and reciprocity. Nondiscrimination hastens trade liberalization by eliminating the need to negotiate the same tariff agreement with each individual country. Nondiscrimination also improves economic efficiency by eliminating the prospects of trade diversion and trade rerouting.

Trade diversion occurs when a country does not import from the lowest-cost exporter because it has high tariffs on exports from that country. For example, say the United States can import portable stereos from Singapore for $70 or from Japan for $80. If the United States has a $25 tariff on all imported stereos, then Americans will buy stereos made in Singapore. However, if the United States eliminates the tariff only on the Japanese-made stereos, then Americans will buy Japanese stereos (because they cost $80 relative to the $95 U.S. consumers must pay for the Singaporean stereos). Americans are no longer buying their stereos from the lowest-cost (most efficient) producers. This is known as the trade diversion effect.

Now suppose that the Singaporean stereo components can be imported into Japan for final assembly and then shipped to the United States. These stereos now cost $75. Since the final product comes from Japan, it is not subject to the tariff on Singaporean stereos. These stereos are cheaper than the purely Japanese-produced stereos, but are more costly to produce than those made completely in Singapore. This process is known as trade rerouting.

Both trade diversion and trade rerouting make international trade less efficient. Nondiscrimination eliminates these possibilities by forcing a member nation to offer the same tariff or quota to all other member nations. In our example, if the United States eliminates the tariff on Japanese stereos, it must do the same for Singaporean stereos. Thus, Americans will import stereos from Singapore, the most efficient stereo producer.

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