Institutions of the International
Economy
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Intellectual arguments for free trade
◦ Adam Smith and David Ricardo
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Free trade emerged gradually as
government policy in Britain, the leading
nation in the 19th century
◦ Repeal of the Corn Laws (1846) allowed free trade in
food
◦ Leading European nations maintained free trade
through late 19th Century to WW I
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Great Depression
◦ US stock market collapse (1929)
 Partial recovery
◦ Congress adopted the Smoot-Hawley tariff (1930)
 Almost every industry had its “made to order tariff”
 Foreign response was to impose own barriers
 Everyone’s exports tumbled
◦ Depression continued almost till World War II
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No one wanted to repeat the mistakes of
the 1930s
Big conference at Bretton Woods, NH, during
WW II
◦ Objective was to liberalize trade by eliminating tariffs,
subsidies, and import quotas
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General Agreement on Tariffs and Trade
(GATT)
◦ multilateral agreement under US leadership
◦ 19 original members grew to 120
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International Monetary Fund
◦ To prevent currency crises
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World Bank
◦ Originally aimed at lending for reconstruction of Europe
◦ Mission expanded in 1950s to supporting ‘developing
countries’
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GATT used ‘rounds of talks’ to reduce
trade barriers gradually
◦ Mutual tariff reductions negotiated
◦ Dispute resolution only if complaints were received
◦ Little permanent machinery
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Uruguay Round GATT 1986-93
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Pressure for greater protectionism in 1980s
due to
◦ Increase in the power of Japan and closed
Japanese markets
◦ US trade deficit
◦ GATT circumvented by many countries
 through use of “voluntary” export restraints
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The WTO was created (1995) during the
Uruguay Round of GATT to police and
enforce GATT rules
Most comprehensive trade agreement in
history

Formation of WTO had an impact on
◦ Agriculture subsidies (stumbling block: US/EU)
◦ Applying GATT rules to
 services and
 intellectual property
◦ Strengthening of monitoring and enforcement
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156 members in 2012
Represents at least 95% of world trade
◦ Russia joined Aug. 22, 2012
◦ This means it agreed to ‘liberalize’ a lot of its
economy
 Must effectively enforce contracts agreed by
foreigners
 Has to allow Hollywood movies, etc.
◦ Will it fulfill promises?

It seems to have contributed to a
liberalization in China’s economy
◦ Many disputes between China, others,
◦ But China mostly follows the rules in settling
them
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9 of 10 WTO disputes satisfactorily settled

Under GATT and WTO
◦ Tariff reduction from average 40% to average
5%
◦ Trade volume of manufactured goods has
increased 20-fold
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196 disputes handled by GATT in its 50
year history
280 disputes brought to WTO between
1995 and 2003
US is biggest WTO user
◦ Big wins: beef, bananas
◦ Big loss: Kodak vs. Fuji Film
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No new tariffs, quotas
Limits on subsidies, especially in developed
countries
Real international rules that guide functioning
of the global marketplace

Telecommunications (1997)
◦ 68 countries - 90% of world telecommunications
revenues
◦ Pledged to open their market to fair competition

Financial Services (1997)
◦ 95% of financial services market
◦ 102 countries would open their markets to varying
degrees
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“Millennium round” was aimed at further
reduction of trade barriers in agriculture and
services
WTO meeting disrupted by
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Human rights groups
Trade unions
Environmentalists
Anti globalization groups
No agreement was reached
◦ WTO still struggling for liberalization today
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Despite criticism, WTO has been the center of
economic evolution
Rapid growth of developing country
economies seems to have undercut critics
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Central banker for world’s central banks
Headquarters Washington DC,
◦ Western Europeans have picked the head
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Intervenes with loans when
◦ currencies crash
◦ nations can’t pay their bills
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Establishes very strict conditions for aid
◦ Radical cuts in government spending required
◦ Countries devalue currencies, so wages decline,
exports increase
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Examples
◦ Iceland, 2008-09 (at least $2 billion)
◦ Korea, Thailand, Indonesia, late 1990s
◦ United Kingdom, 1976
($40 billion)
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Voting is weighted to established nations,
although
China, India, etc. are asked to contribute
more resources than their voting weight
would imply

In a group of nations that shares the same
currency, devaluation is not an option
(unless governments are willing to destroy
the group)
◦ But successful restructurings in the U.S. of New
York City (1976) and Orange County (1995) could
be models
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Originally set up as a lending institution
Is seen as the world’s most important antipoverty agency
◦ Highly respected economists

But gets overwhelming share of revenue from
close-to-market-rate lending
◦ Poor country governments often lack skills to
evaluate projects

If project fails, poor country still has to repay
loan

The world doesn’t have a body that carries
out any really coherent program against
poverty
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While trade was growing freer globally,
some regions focused on reducing barriers
within themselves
◦ “Regional economic integration” refers to agreements
in a geographic region to reduce, and ultimately
remove, tariff and non-tariff barriers for
 goods,
 services, and
 factors of production
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Despite the trend toward freer trade, it is
hard to get the whole world to agree on
changes
Neighbors can often make more
comprehensive agreements
◦ Europe has freedom for banks to operate
freely around Europe
 Rest of world hasn’t been able to develop that
◦ People, capital can move freely around
Europe, too

Levels of integration are much higher in
Europe than in the rest of the world
◦ In many places you can cross borders without
knowing you’ve done so

Europe was in the midst of integration during
the worldwide craze for deregulation in the
late 90s, 2000s
◦ So it wound up with a highly deregulated,
unwatched system
 Incompatible regulations persist inside countries
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In a Free Trade Area all barriers to the trade
of goods and services among member
countries are removed
A Customs Union eliminates trade barriers
between member countries and adopts a
common external trade policy
A Common Market has no barriers to trade
between member countries, includes a
common external trade policy, and allows
factors of production to move freely
between members
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An Economic Union involves the free flow of
products and factors of production between
member countries and the adoption of a
common external trade policy, but it also
requires a common currency, harmonization
of members’ tax rates, and a common
monetary and fiscal policy
A Political Union occurs when centralized
political institutions coordinate economic,
social, and foreign policy of the member
states
Member States of the European Union in 2007
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The North American Free Trade Agreement
(NAFTA) was ratified by the governments of the
United States, Canada, and Mexico in 1993; it
became law January 1, 1994
NAFTA includes
◦ reduced tariffs (99% of goods traded)
◦ removal of most barriers on cross border flow of services
◦ Removal of restrictions on FDI except in certain sectors
 Mexican railway and energy
 US airline and radio communications
 Canadian culture
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A customs union, not full economic union