INTERNATIONAL ECONOMIC LINKS: Cooperation, Conflict, and Bargaining in International Relations. Patricio Fernandez-Urbina. MA International Studies and Diplomacy. September, 1994.

INTERNATIONAL ECONOMIC LINKS: Cooperation, Conflict, and Bargaining in International Relations. Patricio Fernandez-Urbina. MA International Studies and Diplomacy. September, 1994. "This dissertation is submitted in partial fulfilment of the requirements for the degree of MA International Studies and Diplomacy of the University of London", September 1994.

CONTENTS Abstract IV INTRODUCTION Overview 1 Level of analysis and theoretical perspective

2

TRADE 3 Post-war setting 3 The GATT 5 Why cooperate? 7 Has the GATT worked? 8 Protectionism v. free trade 8 Regional trading blocs 12 Winners and losers 15 New issues 17 Are trade rules becoming redundant? 20 INTERDEPENDENCE 23 The domino effect 24 Non-state actors 25 Policy coordination 27 CONCLUSION 29 Bibliography 31

III

ABSTRACT

The dissertation has examined how international economic links affect relations between

states. The first part of the paper explores the area of international trade, and identifies the

presence of contradictory forces in the international system operating simultaneously:

espousal of the principles of free trade against clear neomercantilist tendencies; and

cooperation in international trade regimes whilst circumventing its rules. The retrenchment

into regional trading blocs and consequent threat to an integrated international trading system

is also examined, but on the basis of economic data, it would appear that such moves are the

result of political and geopolitical considerations and, except possibly in one case, do not pose

such a threat. This part also questions the emphasis that states place on residence-based trade

measures in view of the structural changes that have taken place in the world economy, and

the actions of non-state actors.

The second part of the paper refers to the interdependent relations that arise out of economic

links, and extends the enquiry to other issue-areas besides trade. It points to the changing role

of the state in the global economy, and suggests that the challenge to state autonomy posed by

non-state actors, together with a realisation that an unregulated market-based global economy

is ill-equipped to deal with systemic faults, may signal increased interstate cooperation.

IV

1

INTRODUCTION

Overview

This paper, as the title suggests, will examine cooperation, conflict, and bargaining arising in

the international system as a result of economic links. Although the main focus of analysis

will be relations between states, the influence of non-state actors, especially transnational

corporations (TNCs), in the international economy is such that their actions will be discussed

with reference to the effect that they have on the relations between states.

Because of space constraints, I have chosen to examine, principally, the role of trade in

international relations. However, trade cannot occur in the absence of a monetary system

(except in the case of barter trade, and even then a money value is attached to the goods to be

exchanged), nor can trade be easily isolated from other politico-economic issues, and

therefore these related areas will be touched upon where appropriate.

In examining trade, the analysis will point to the contradictory forces at play in the

international system. On the one hand, the espousal of economic liberalism and free trade, and

cooperation in international trade regimes, and, on the other, clear neo-mercantilist tendencies

and attempts to circumvent the rules of the regimes. Also, moves to integrate at the global

level, whilst at the same time, a tendency to retrench into regional and/or geopolitical trading

blocs. Underpinning these forces is economic interdependency and issue-linkages, leading in

some instances to political cooperation, but also to asymmetries and conflict, where

bargaining power is all important.

The examination of the actions of TNCs will discuss how the autonomy of states is challenged

by these transnational non-state actors riding on the back of the structural changes to the

world economy that have taken place in recent decades, especially, the internationalisation of

2

production and the mobility of capital. Where there have been attempts at cooperation

between states to regulate in a given area, they have either clashed with the principles of

economic liberalism and deregulation, or with the power of the market. Conversely, in an

environment characterised by competition between states, the actions of non-state actors may

exacerbate competition to the point of conflict.

Level of analysis and theoretical perspective

Although the paper will focus on the interactions between states and will refer to them as

rational unitary actors in the international system, this shall be only for convenience. It is

recognised that states, especially where economic matters are concerned, are subject to

domestic influence and/or pressures, and analysis at this level will be introduced where

necessary.

As regards to theory, the examination will draw on the various perspectives that are common

in the field of International Political Economy (IPE), since most of them, be it

(Neo)Mercantilism, Liberalism, (Neo)Marxism, or (Neo)Realism and Hegemonic Stability

Theory, provide us with some useful insights in order to understand and conceptualise the

subject.

It should also be pointed out that this is not an "economics" paper per se. The intention is not

to provide empirically testable theories about economic "facts", as for example, about the

benefits or otherwise of free trade, rather, whilst not eschewing the recourse to observable

economic variables, the emphasis will be on the actual behaviour of states and on what they

perceive to be true or false. It is the perception by states of the truthness or falseness of certain

economic "facts" or the interplay of political and economic factors (or forces) that to a large

extent dictate their policies and their relations with other states.

3

TRADE Today, the generally accepted view (at least on the part of most states) is that trade, and

particularly free trade, is good. It enables countries to consume commodities that their

resource endowments might not otherwise permit; maximises global output and economic

growth by the efficient use of resources; and provides gains from a more competitive

domestic economy, whilst also contributing to price stability. Since 1945, the volume of

world trade has increased substantially, to reach US Dollars 3.600 billion in 1993 (excluding

services), and accounts for a significant percentage of world output, albeit unevenly

distributed -developing countries' (including the former Soviet Block) share of world

merchandise exports in 1992 amounted to only 30% of the total. It is therefore not surprising

that countries will vie with each other to obtain as big a share as possible of it, and that those

that gain the most from it (or that would lose the most in circumstances adverse to a stable

trading environment) should place it high in their political agenda, especially in the post-Cold

War era where security issues have receded.

The post-war setting

When representatives of the eventual victors of WWII met at Bretton Woods in 1944 with the

aim of devising how the world economy would be managed after the war, foremost in their

minds

was to avoid a repetition of the mistakes of the 1930's when economic protectionism, by

means of devaluations and the erection of high tariff barriers to trade, had led to a world

economic depression, and in turn, or so many believed, to extreme nationalism and the start of

the war. The way to avoid a repetition of these events was to be the creation of multilateral

international institutions to regulate the post-war world economy. The International Monetary

Fund (IMF) was charged with exchange rate and monetary stability, by regulating a system of

fixed exchange rates, and allowing member-states to draw on the Fund to correct temporary

and structural (long-term) balance of payments deficits (the latter requiring the deficit country

4

to undertake corrective deflationary measures), and the International Bank for Reconstruction

and Development (IBRD), known as the World Bank, to provide funds for the reconstruction

of Europe. The creation of an International Trade Organisation to encourage free trade by the

removal of tariff and non-tariff barriers to trade, however, did not materialise and instead was

replaced by the General Agreement on Tariffs and Trade (GATT), to this date a temporary

agreement. These institutions were to be the pillars of a liberal economic order under the

benevolent leadership of the U.S. An economic order that would deliver the benefits of free

trade and create a system of interdependence that would make wars a thing of the past.

However, the start of the Cold War, the Communist victory in China in 1949, and the start of

the Korean War in 1950, dashed any hopes of a "one world" approach to the management

of the world economy, instead, we see the development of two distinct blocs, one led by the

Soviet Union, the other by the U.S. and it is with the latter that this paper will concern itself.

The liberal economic order in the minds of the planners at Bretton Woods (at least in the mind

of Keynes, the U.K representative) was not of the "laissez-faire" variety, but one where

governments would actively intervene in the economy, a regulated capitalist market economy

where demand management and corporatism would ensure that unemployment would not

reach the unacceptable high levels of the 1930's. A system that would reap the benefits of free

trade to be gained by the international division of labour and comparative advantage,

underpinned by a system of fixed exchange rates and controls on the movement of capital that

was not used to support trade or productive investment (i.e. speculative). However, the

planning was different to the reality and contradictory forces soon began to make themselves

felt. Whilst the American executive, conscious of the strong economic position of the U.S,

favoured a liberal trading regime that would open up markets for its products, especially those

in the British sterling area, U.S businesses where either domestically orientated or sceptical

that foreign trade barriers would be lowered, and Congress too protective of its rights to

legislate on trade issues to allow the President or an international institution to diminish them

5

in any way, as evidenced by the refusal to ratify the Havana Charter of 1948 that would

have established the International Trade Organisation (ITO). On the other hand, Western

European countries were fearful of the short-term domestic consequences of a liberal trading

regime. However, the onset of the Cold War may have served as a catalyst for the U.S

executive to be able to push ahead along a liberalisation path that could satisfy all. Trade

liberalisation could now be wrapped with the mantle of ideology and the very special kind of

American nationalism that Hoffmann1

called "America's exceptionalism" came to the fore,

"...a faith in the singular, unique character of the U.S in its mission as a model

democracy...the lone and shining guardian of certain values and institutions", amongst them

the believe in the quintessential nature of liberal capitalism. Thus, as part of a "policy of

containment" directed towards the avowed enemy of capitalism, a system emerged that whilst

not abandoning the objective of trade liberalisation, which was to be an important foreign

policy instrument, was subject to security considerations. The U.S assumed the role of an

hegemonic power by providing the stability and the economic resources necessary for the

system to function, and allowing, even encouraging, protectionist measures in Western

Europe and Japan.

The GATT

Out of the ashes of the Havana Charter only the chapter on tariffs survived. The GATT,

although it has its own secretariat and headquarters in Geneva, is not an institution (at least

until it is transformed into the World Trading Organisation in January 1995) but, rather, a

regime. As per Krasner's2

1Hoffman, S. Primacy or World Order: American Foreign Policy Since the Cold War, (New York, 1978), P.6

definition: "sets of implicit or explicit principles, norms, rules, and

decision-making procedures around which actors' expectations converge in a given area of

2Krasner, S. Structural Causes and Regime Consequences, in International Organization, Spring 1982, P.186. Quoted in W.Olson, ed., Theory and Practice of International Relations, (New Jersey, 1994, 9th edn), p.272.

6

international relations." The preamble to the agreement lists its objectives as: "...raising

standards of living, ensuring full employment and a large and steadily growing volume of real

income and effective demand, developing the full use of the resources of the world and

expanding the production and exchange of goods..." The achievement of these objectives was

to be accomplished by the gradual reduction of tariffs and the elimination, or at least the

conversion into tariffs, of non-tariff barriers. The regime is underpinned by three principles:

non-discrimination or "most favoured nation treatment" (MFN), or the multilateral

application of bilateral trading concessions; national treatment, whereby imported and

domestic products are treated equally with respect to taxation and regulations; and

elimination of quantitative restrictions, so that quotas or other quantitative restrictions on

trade are prohibited. In addition, it seeks to end unfair trading practices and provides a forum

for dispute settlement. Notwithstanding the above, and in recognition that unrestricted free

trade could be too disruptive in certain circumstances, and that some countries and group of

countries presented certain particularities, a number of exceptions were introduced to the

MFN principle, amongst them, permitting the introduction of import restrictions in situations

of an acute balance of payments deficit; the establishment of customs unions and free trade

areas; and the possibility of introducing emergency safeguards in cases where a sudden

increase in imports would cause serious injury to domestic producers. In 1965, a new part

(Part IV) was added to the agreement granting special provisions for developing countries by

encouraging developed countries to grant more favourable access to their markets without

requiring reciprocity.

Negotiations on tariff reductions and other trade issues are carried out every few years in

meetings, or rounds, between all the Contracting Parties. There have been eight rounds since

GATT's inception in 1947, and they have produced a cut in the average tariff from about 40%

to about 3% once the agreements of the last round (the Uruguay round) are implemented.

7

Why cooperate?

An important characteristic of the GATT negotiations is that decisions are arrived at by

consensus of all the participants (117 at the last count), on a package of measures, and

therefore, whilst countries will try to promote their individual interests, in the end they

have to weigh the overall potential long-term benefits that a successful conclusion of the

negotiations will bring (a study by the OECD and the World Bank3 estimated that the

measures proposed in the Uruguay round would add around US Dollars 213 billion to world

income in 2002 and every year thereafter), against short-term gains or loses. This reflects the

economic liberalism embedded in the system that recognises the interplay of overlapping and

conflicting interests, and that mutual gains can be realised through cooperation. However, the

process of bargaining depends very much on power and leverage. As Keohane4

3Goldin, I. et al. Trade Liberalisation: Global Economic Implications, (Washington, 1993).

has pointed

out: "Contemporary trade regimes do not create harmony, but they do facilitate cooperation

by reducing transaction costs, limiting the legitimate strategies available to actors, and

providing information in a relatively symmetrical fashion. They reduce uncertainty and risk.

Precisely because they lessen discord, however, they may create incentives for actors to be

exorbitantly demanding in their bargaining strategies...". This may be illustrated by, for

example, the confrontation between the U.S and the European Economic Community (EEC)

stemming from the refusal of the latter to bring farm trade under GATT disciplines, that

threatened the successful conclusion of the round. After endless negotiations the matter

appeared to have been resolved by a compromise, known as the Blair House agreement,

concluded in Washington in November 1992, but later, days before the last extension to the

round, and also when the fast track authority of the U.S Congress to the executive to

negotiate it, were due to expire, France, under strong pressure from its farmers, or with that

excuse, reneged on the deal. The matter was only resolved by the U.S agreeing, in exchange

4Keohane, R.O. After Hegemony: Cooperation and Discord in the World Political Economy, (Princeton, 1984), p.214.

8

for France's acquiescence of the deal, to defer negotiations regarding audio-visual trade, and

by undertakings to compensate French farmers from the, by now, European Union (EU)

budget.

Has the GATT worked?

If the above question were to be answered by reference to cuts in tariffs, the resultant increase

in world trade, the creation of rules against unfair trading practices, the extension of

membership from the original 23 signatories (with most of the former communist bloc, either

having acceded or obtained observer status and China seeking to become a founder member

of the WTO), the establishment of an effective dispute settlement mechanism, and the

extension of GATT disciplines to non-manufactured goods and to services, the answer will be

in the affirmative (although with limited success in the last two areas mentioned). However,

in order to answer the question fully, it is necessary to enquire further and ask: Have states

submitted fully to the regime and to global free trade abandoning neomercantilist tendencies

and the resort to exclusive regional trading blocs? Do they resolve differences within the

context of the multilateral setting or do they resort to unilateral retaliatory measures?, and

also, assuming that the liberalisation of trade has been beneficial for global welfare, have

these benefits been evenly distributed throughout?

As has been mentioned at the beginning of this paper, trade cannot be considered in isolation

from other politico-economic factors, and the practice of states of advocating free trade whilst

at the same time engaging in, or allowing and even encouraging, neomercantilist behaviour

illustrates this point. It is no accident, then, that trade policies, to a large extent, reflect

policies in other issue-areas, and that they are remodelled according to what the state's

perception of its interest is at any given time, and are successful depending on the relative

power of states. A proposition that may be tested by examining the negotiations under the

Protectionism v. free trade

9

GATT rounds. We have already referred to the modification of policy of the U.S upon the

onset of the Cold War. Whilst advocating trade liberalisation, despite domestic ambivalence

and some protective practices, the U.S was willing to accept deviations on the part of Western

Europe and Japan and to bear the costs, in order to create strong interdependent economic

links that would underpin a security alliance. This was reflected in the GATT by, for example,

the breach of the MFN principle in order to allow the U.K and France to retain the tariff

preferences granted to their former colonies; by allowing Japan to breach the non-

discrimination rule upon its accession in 1955; and by allowing the use of quotas instead of

tariffs for agricultural products, reflecting the importance of agriculture in these countries

(and for the U.S, that in 1955 obtained a GATT waiver for certain farm products). From

around 1971, however, there is clear evidence of a change in U.S policy that coincides with a

period of détente between the superpowers; strong domestic pressure due to competition of

imports from Europe and Japan (now recovered from the devastation of the war); the

worsening position of the U.S economy (loss of confidence in its ability to sustain the

growing balance of payments deficit and, first ever trade deficit in 1971); and other politico-

economic developments (disagreements between some Western European countries and the

U.S over the latters involvement in Vietnam, and dissatisfaction with the U.S handling of

international monetary issues). The combination of all these factors marked a shift to a more

nationalistic approach whilst at the same time embarking in a quest for the further

liberalisation of the international trade regime. Whilst on monetary issues the U.S acted

unilaterally, in August 1971, by abandoning the gold standard and the system of fixed

exchange rates, that led to a re-alignment of exchange values and, in effect, a devaluation of

the US Dollar, in trade issues it was less inclined to allow deviation from GATT rules by its

trading partners.

The shock to the international economy, and subsequent recession, as a consequence of the

rise in the price of oil by the Organization of Arab Petroleum Exporting Countries (OAPEC)

10

in 1973, exacerbated conflict further, and led to the wide use of protectionist measures by all

leading industrialised countries, and especially non-tariff barriers such as Voluntary Export

Restraints (VERs) and Orderly Marketing Arrangements (OMAs) which although not

prohibited by GATT rules, were certainly not in accordance with the spirit of the regime as

was evident by the introduction of various codes relating to non-tariff barriers during the

Tokyo round (1973-1979). The conclusion of this round, however, coincided with a further

rise in oil prices and continuing recession in the industrialised world. Those industries that

either could not survive in the face of stiff competition from abroad, now also emanating from

the Newly Industrialising Countries (NICs) of East Asia, or that saw their efforts to enter

foreign markets thwarted by barriers, became more and more vociferous in their demands for

protection or bilateral reciprocity that were justified by reference to "fair trade" and "level

playing fields". The principle of non-discrimination was, thus, eroded by discriminatory

measures that provided subsidies of various kinds to support domestic industries, especially

those that suffered from overcapacity in a much more competitive global environment. In the

U.S, the Trade and Competitiveness Act of 1988 enhanced Section 301 of the Trade Act of

1974 by allowing retaliation against trading practices that, in the opinion of the U.S, were

deemed to be unfair (the so-called "super 301"), thus imposing its own standards of fairness

outside of the multilateral setting of the GATT. The U.S due to the size of domestic market,

coveted by foreign suppliers, and the power it can wield in economic and political matters has

been following a dual policy as regards to international trade. On the one hand, it has taken

the lead in launching GATT negotiating rounds and pushing hard for trade liberalisation,

whilst, on the other, under pressure from powerful domestic sectorial interests, has adopted an

aggressive unilateralist approach to resolving trade disputes arising out of the latters

accusations of unfair trading practices against certain countries, and has entered into bilateral

trading agreements on the basis of reciprocity, rather than non-discrimination on a multilateral

basis.

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The Uruguay round (1986-1994) has taken place against the background of dramatic changes

in international relations, most notably, the end of the cold war, the demise of the Soviet

Union, and the fall of its client regimes in Eastern Europe. As these events have unfolded,

security issues have receded, and this has had an effect on economic issues, culminating a

process already underway whereby the latter have entered into the realm of high politics. The

Uruguay round embarked on the ambitious objective of, on the one hand, to strengthen and/or

tighten existing rules and/or introduce new ones in areas such as intellectual property, trade-

related investment measures, subsidies, safeguard provisions and dispute settlement, and on

the other, to remove existing exceptions to textiles, clothing and farm trade, and to extend

GATT disciplines to all types of trade in all sectors, including trade in services (a market that

has an annual cross-border, i.e. excluding domestic, turnover of US Dollars 960 billion). As

regards to market access the aim was to continue trade liberalisation by further cuts in tariffs

and the elimination of NTBs. The round has also been important because of the number of

participants (117) including countries of the former Soviet bloc and China, even if some only

as observers, and the volume of world trade that they represented (90%).

The Uruguay round was heralded by most of the participants, particularly those from the

advanced industrialised countries, as the round that would "make or break" the international

trading system, a point which was reinforced by a high-level agreement between the Group of

Seven (G7) countries at their Tokyo summit in July, 1993 to eliminate tariffs on eight

products, harmonise and reduce tariffs on chemicals, and to effect an across-the-board

reduction of tariffs above 15%. But, notwithstanding this, at the same time, the U.S, in order

to try and resolve the confrontation over its US Dollars 60 billion trade deficit with Japan, was

concluding a "framework agreement" for market opening by the latter to be negotiated on the

basis of "qualitative and quantitative criteria" (offering the "incentive" of super 301

retaliations if not satisfied with the outcome), and the EEC was still reluctant to compromise

on farm trade. Further evidence of self-interest was demonstrated by the alliances that

developed, the U.S and the Cairns Group pressing for the liberalisation of farm trade, the EEC

12

and the U.S willing to consider increased market access to LDCs (especially in agriculture)

and the phasing out of the multifibre arrangement that allowed the use of quotas for textiles,

in exchange for the latters agreement regarding trade-related investment measures, the

extension of GATT disciplines to services, and the protection of intellectual property rights.

After seven years of bargaining the Final Act signed in Marrakech in April 1994 brought farm

trade, services and textiles under GATT disciplines for the first time (although it allows an

implementation period of six years for farm trade and ten years for textiles) and although

short of the initial objectives, achieved progress in most of the headings discussed above, and

was presented as a triumph for multilateral negotiations and for the consolidation of a global

international trade regime. However, in view of the wrangling and the neomercantilist

tendencies shown by the participants, especially by those of the advanced industrialised

world, tendencies which are still apparent, it is difficult to assess whether there exists a

genuine wish to create the liberal trading regime that they advocate. Thus, the best that can be

said about the "contest" between protectionism and free trade is that, unless an alternative to

the existing pattern of international relations is established, the complex atavistic perceptions

of self-interest, underpinned by notions of power and prestige, will continue to be played out

in the international system, albeit curtailed to some extent in the context of cooperation in

institutionalised regimes such as the GATT.

Regional trading blocs

The debate about trading blocs revolves around two issues, the first, is whether distinct

trading blocs have emerged or are emerging (depending on ones point of view) in North

America, Europe and Asia, and the second, is that if they have (or they are), whether they

represent a challenge to free trade and the multilateral trading regime or, on the contrary, they

serve to promote the latter.

J.Schott of the Institute for International Economics in Washington identifies four basic

characteristics for a trade bloc: similar levels of per capita gross national product (GNP),

13

geographic proximity, similar or compatible trading regimes, and political commitment to

regional organisation5 . And concludes that only the EU meets these conditions. We must also

assume that in a definition of "similar or compatible trading regimes", especially as regards to

the EU, the distinction between a "customs union" (common external tariffs) and a "free-trade

area" (each member continues to govern its external trade relations on the basis of bilateral

agreements and/or in the context of the GATT), is taken into account. A look at the figures for

the direction of world trade would seem to support Schott's assertion. In 1989, intra-regional

trade (as a percentage of total regional trade) amounted to 58% for the EU; 35% for North

America (Canada, Mexico and the U.S); and 42% for Asia (Japan, South/South East, and

East/North East Asia). As regards to inter-regional trade, the percentage of trade from North

America to the EU and Asia was of 18% and 29% respectively, from Asia to the EU and

North America of 15% and 30% respectively, and from the EU to North America and Asia of

9% and 7% respectively6

5Quoted in Financial Times World Economic Survey, 24.9.93 p.ix.

. It should also be noted that the U.S depends on outside markets for

around 75% of its exports, and Asia on 45% (although the percentages are much higher for

individual countries as, for example, is the case of Japan with a figure of 49%). In contrast,

the dependence of the EU after deducting exports to the European Free Trade Area (EFTA),

now European Economic Area (EEA), and the signatories to the Lomé Convention, is only of

12.7%. Thus, on the basis of trade figures alone, there appears to be no evidence to support

the view of a world divided into three distinct trading blocs, with the possible exception of the

EU (although this has to be considered in the light of the historical context in which the EU

emerged, and the fact that the motives behind integration were political rather than economic,

however much the latter have underpinned the former). Notwithstanding the above, however,

there is a trend towards greater regional integration, as evidenced by the creation of the North

American Free Trade Agreement (NAFTA) between the U.S, Canada and Mexico that came

6Data from Busch, M. and Milner, H. The Future of the International Trading System: International Firms, Regionalism, and Domestic Politics in Stubbs, R. and Underhill, G., eds, Political Economy and the Changing Global Order, (London, 1994).

14

into force in January 1994. In October 1993, Brazil launched the idea of a South American

Free Trade Area (SAFTA) by merging the existing trade pacts, namely, the Andean Group,

the Central American Common Market, Mercosur, and the G-3. In addition, there is also the

Association of Caribbean States which brings together the Caribbean Community (Caricom),

the G-3, and other Central American countries. Even the eventual formation of a free trade

agreement for the whole continent has been envisaged ("free trade from Alaska to Tierra del

Fuego" in the words of former President Bush7

To be sure, countries do use the threat of retrenchment into regional blocs as leverage in

multilateral negotiations, but what this trend seems to suggest is that the creation of regional

trading blocs, especially in the post-cold war era, is due more to political and geopolitical

considerations rather than purely economic factors, however important the latter might be.

In any event, the test as to whether regional economic integration is gaining ground over

multilateral arrangements depends on whether the creation of the former are compatible with

the GATT, especially as regards to whether they have trade-diverting effects (as per Article

XXIV of the GATT regarding the formation of a customs union or a free trade area).

). In Europe, the EU has already agreed to

extend membership to four members of the EEA and is now looking eastwards for further

enlargement. In Asia, although there is much less formal integration, the only example being

the ASEAN Free Trade Area (AFTA) under which tariff reductions are to be spread over a 15

year period, there has been a proliferation of so-called "growth triangles" that for the moment

are no more than transnational economic zones. On a wider geographical basis the Asia-

Pacific Economic Co-operation forum (APEC) made up of America, Japan, China, South

Korea, Australia, New Zealand, Canada, Hong Kong, Taiwan, and the six ASEAN members,

is put forward by some as the germ that will grow into an Asia-Pacific free trade area, but this

seems very unlikely in view of the different views that the members have as to the aims of the

organisation.

7Quoted in The Economist, "After Nafta, Afta?", 13.8.94

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Bhagwati8, whilst recognising the possible threats to the GATT and proposing a number of

ways to reduce trade-diversion views Article XXIV as: "...permitting a supplemental,

practical route to the universal free trade that the GATT might be said to favour implicitly as

the ultimate goal...". A view that is supported (not altogether surprisingly) by the current

Director General of GATT, Peter Sutherland, when he said9

that: "...they [regional integration

agreements] appear to have had a negligible impact on the structure of world trade, with the

important exception of Western Europe...[where], however, increasing openness...has tended

to offset a higher propensity to trade intra-regionally."

Winners and losers

One of the tenets of liberalism is that free trade will maximise global output, but it says

nothing about how the benefits that will flow from the increased output are to be distributed,

and of who will bear the (short-term) costs of liberalisation. In addition, the structural changes

in the world economy that have taken place over recent decades, combined with the fact

that trade is far from being "free", raises a question mark over the continued emphasis on the

theory of comparative advantage, at least when applied to some less/least developed countries

(LDCs). Having been enticed, if not forced, to open their economies and to engage in

international trade with promises of economic growth, they face, instead, foreign debt,

Structural Adjustment Programmes (SAPs), and increased protectionism on the part of

industrialised countries for the very products that they were encouraged to produce. Although

the original GATT included provisions for LDCs, it was not until the mid to late 1960's, with

the creation of new states in Asia and Africa, that these countries began to press for their

problems to be addressed "seriously" by the developed countries of the industrialised world.

Their vehicle was to be the Group of 77 (G-77), a coalition of developing countries created in

1964 at the first United Nations Conference on Trade and Development (UNCTAD). The

8Bhagwati, J. The Threats to the World Trading System in The World Economy, Vol.15, 1992, pp.443-456, p.452. 9Quoted in GATT News 7.7.94, p.5.

16

efforts of the G-77 were directed, principally, towards linking trade with overall development

and seeking preferences for their exports (mainly primary commodities), and resulted, on the

one hand, in the passing of various resolutions at the United Nations, particularly, the

Declaration on the Establishment of a New International Economic Order in 1974, albeit with

strong reservations on the part of the industrialised countries and it's non-binding character,

and on the other, into concrete concessions, namely, a number of international commodity

agreements (most of them short-lived), the introduction of the generalised system of

preferences (GSP) in 1971, and a number of stabilisation agreements. Nevertheless, their

position today, is not much better, in some cases even worse, than it was then. The

development policies that LDCs have followed, however, have differed considerably, and

have resulted in different outcomes. Whilst the newly industrialising countries (NICs) of East

Asia embarked on export-led economic growth by concentrating on manufacture that has

resulted in growth rates averaging 5-6% p.a. and a 21% share of world merchandise exports,

countries in Sub-Saharan Africa have continued to concentrate on exploiting their primary

commodities for export into a world market where there is either a much reduced demand for

them, or where they have to compete against developed countries producing the same, or

similar commodities, which as is the case with agricultural products, especially in the EU, are

heavily subsidised and protected by high tariffs or quantitative restrictions.

Thus, although special provisions have been introduced into the GATT (especially Part IV in

1965), and a number of instruments have been created to grant preferences to LDCs, market

access has not been as forthcoming as these countries would have wished. The Uruguay

round, whilst addressing the problem, cannot be said to have been a success from these

countries' point of view. The agreements regarding agriculture and textiles have been

disappointing, and those regarding services, if anything, are of little consequence for them

since they do not export services. The same could be said regarding the agreement on

intellectual property rights. The study prepared by the World Bank and the OECD mentioned

above (see note 3) projects that of the US Dollars 213 billion that will be added annually to

17

world income from 2002, the members of the OECD will gain two-thirds, whilst, for example,

Sub-Saharan Africa will suffer a net loss. Admittedly, the marginalisation of some LDCs from

the trading world is just one of the problems with which they are confronted, but it is a further

illustration of the asymmetries embedded in the international system and the importance of

bargaining power.

New issues

Before the ink was dry on the Final Act of the Uruguay Round (in fact, not a single drop had

yet touched the document), some of the advanced industrialised states had begun to complain

about so-called "social dumping", voicing concern about low labour standards and poor

working conditions in some developing countries, and how this could be considered not only

as unfair competition, but also as a violation of basic human rights. Sceptics will be forgiven

for thinking that these concerns are but an excuse for states to introduce what could be termed

as "moral barriers to trade", rather than a genuine one for the fate of workers in developing

countries, especially when examined against the track record of "North/South" relations,

whether economic or political. However, the issue is much more complex than at first

appears, and optimists will hope that in the post-cold war era there really is a genuine concern

for human rights. Some states, notably the U.S and France, have called for the future WTO to

examine how labour standards and poor working conditions affect trade, but the purpose of

such an examination, or the rules that might be proposed as a result, are not clear, as evident

by the comments of Robert Reich, currently America's labour secretary10

10Reich, R. Abrir Mercados a la Democracia in El Pais, (Madrid 1.5.94), p.26. (My translation).

:"What do we expect

to achieve with a policy about international labour standards? It is impossible to say exactly

what will be the mix of motives that will shape our position as regards to international labour

standards, or what form such position will take." The U.S position, nevertheless, does appear

to be one of promoting democracy as an engine of growth in developing countries, hoping

that this will bring about increased standards of living and better working conditions. As

18

regards to their comparative advantage in the meantime, especially in terms of cheap labour,

the view is that it is no match for the competitive advantage of the U.S in terms of levels of

productivity, technology and macroeconomic stability. If, however, the benefits of economic

growth are not shared with the majority of the population, but instead, states continue to

maintain low labour standards and poor working conditions and, thus, obtain what would then

be considered an unfair comparative advantage in trade, the attitude of the U.S, one assumes,

will change from benevolence to retaliation. The position of France, on the other hand, whilst

also condemning the more unsavoury aspects of comparative advantage in terms of labour,

namely, child and prison labour, has more to do with self-interest (or self-preservation) in

view of deteriorating economic conditions including a 12% unemployment rate. The debate

there is about "delocalisation", the relocation of production, especially by TNCs, from France

to developing countries with low labour standards, and the dual negative effect of this process

(unemployment as a result of, both, transferring production to low wage economies and then

importing products from those economies at "dumping" prices).

Whatever the motives, however, the suggestion that the WTO should have a say on how

labour standards and working conditions affect trade, has been opposed from different

quarters. The developing world is obviously not happy with the idea. India's prime minister

has been reported as saying that it would be "an alibi for raising protectionist trade

barriers"11

11Quoted in The Economist 9.4.94, p.13

.In the U.S, opposition is also gathering pace, albeit for different reasons, not only

against giving increased powers to the WTO, but against the GATT deal itself. Whilst

Congress has not yet ratified the Final Act of the Uruguay round, worried amongst other

things about the spending cuts that will have to be made in order to make-up for the US

Dollars 14 billion in lost revenue as a result of tariff cuts, an alliance has been formed

between right and left wingers, unions, environmental groups and some sections of business,

worried about loss of jobs, the declining environmental and health standards they claim will

be imposed through the influence of TNCs and third world countries (reasons also put

19

forward against the signing of NAFTA), and the erosion of American sovereignty that would

result by transferring greater powers of decision and dispute settlement to the WTO. The

danger, then, of including measures against "social dumping" in future multilateral trade

agreements is that the governments of the day might abuse, or give their own interpretation to,

such measures in order to pursue protectionist policies based on perceptions of unfair trade or

under pressure from domestic interests.

A similar scenario might be envisaged as regards to the "new" issue of the environment. The

issues that arise out of threats to the global environment by countries' environmental standards

(or rather the lack of them) are complex and not the subject of this paper, however, when

considered in the context of trade relations, "...commercial friction could arise from

perceptions that environmental standards are to low and thus confer an unfair commercial

advantage, or that they are too high and thus result in the creation of non-tariff barriers to

trade"12

. Again, this is an area where there is scope for domestic industries, in say developed

countries, to call for protectionist measures in the form of anti-dumping duties against

developing countries, and justify same by reference to the increased costs of meeting high

environmental standards. Notwithstanding the above, the environment is one of the areas

where, because of the nature of the problems, there might be considerable scope for

cooperation, despite the incidence of "free riding", and bargaining, especially by the

leverage that can be brought to bear by developing countries. However, trade policies do not

appear to be well suited to deal with environmental problems, if anything because some

countries, unable (however willing) to meet high environmental standards could be

marginalised from the trading world altogether. Trade policies, however, might be useful in

order to encourage participation in broader multilateral regimes.

12Blackhurst, R. and Subramanion, A. Promoting Multilateral Cooperation on the Environment in Anderson, K. and Blackhurst, R. eds, The Greening of World Trade Issues, (Hemel Hempstead, 1992).

20

Are trade rules becoming redundant?

It might appear strange to ask the above question at this stage of the examination, but it is one

that has to be addressed. In an integrated global economy characterised by intense

competition, sometimes the issue is not so much about trade barriers but, rather, about

international investment flows and national competition policies.

The relationship between foreign direct investment (FDI) and trade is a close one. Regardless

of the "logic" for an investment (and we are referring to investments in physical productive

assets), be it to take advantage of lower production costs, or to sell into a market characterised

by high tariffs, the effect is one of export substitution. In both these cases the FDI will have a

negative effect on the trade balance of the home country (if there is one), although it might

have a positive effect for the balance of payments if profits and royalties are remitted back to

it. This scenario will be typical of investment flows between developed and developing

countries. Conflict in these situations will arise if the home state responds to pressures for

protectionist import measures from those domestic interests more at risk from competition,

and from those more likely to suffer job losses as a result of production being transferred

abroad. On the other hand the effect of investment flows between developed countries, and its

consequences for trade, is of a different nature. Here, the conflict that arises between states is

between those that have a relatively open environment for trade (i.e.low tariffs) and

investments (both inward and outward), and those that, whilst maybe having a relatively open

trade policy, have either a closed environment for inward FDI, or a domestic industrial policy

that works in such a way as to make it difficult for foreign firms to enter its markets. This may

be illustrated by reference to the long-running disputes between the U.S and EU with Japan,

and between the U.S and the EU. In the first case, the U.S and EU have accused Japan of

supporting restrictive business practices that make it virtually impossible for foreign firms to

penetrate certain sectors of the Japanese market, and point to the very low level of inward FDI

to support their claim (for 1990 the inward FDI stock amounted to US Dollars 34 billion,

21

whilst outward stock was US Dollars 202 billion). In the second dispute, the US has accused

the EU of protecting certain markets, especially those which are controlled by state

monopolies. Although it is beyond the scope of this paper to examine the full implications of

FDI for the world economy, it is relevant to touch on a couple of points. In terms of

volumes, FDI is fast replacing trade as the "engine of growth" of the world economy, a recent

study by UNCTAD13 calculates that world exports of goods and non-factor services

amounted to US Dollars 4.500 billion in 1991 compared to sales of foreign affiliates of TNCs

of US Dollars 4.800 billion. The same study highlights the influence in terms of output,

employment and demand patterns of the largest 100 TNCs, which controlled global assets of

US Dollars 3.4 trillion in 1992. It is also important to note that intra-firm trade accounts for

around one-third of world exports. In the context of our discussion of the importance that

states afford to their balance of trade, and resulting perceptions of the "national" interest, the

above figures suggest that such traditional measurements may not be accurate. Reich14,

commenting on intra-firm trade concludes that: "...no one knows exactly, at any given time,

whether America's (or any other nation's) international trade is in or out of balance...or what

the significance of such an imbalance might be." Furthermore, Julius15

The internationalisation of production that accompanies FDI, both by transferring production

from high-wage industrial economies to low-wage developing economies (or to the NICs of

East Asia), and by being able to break production from large-scale to high-value, has also had

important consequences for inter-state relations. In what Strange

on the basis of an

ownership-based trade measure, instead of a residence-based one, calculates that the 1986 U.S

trade balance is transformed from a deficit of US Dollars 144 billion to a surplus of US

Dollars 57 billion.

16

13UNCTAD World Investment Report 1994, (Geneva, 1994), p.20.

has called "a new

dimension of diplomacy", the competition between states for world market shares has

14Reich, R. The Work of Nations, (London, 1991), p.114. 15Julius, DeAnne. Global Companies and Public Policy: The Growing Challenge of Foreign Direct Investment, (London, 1990), p.31. 16Strange, S. States, Firms and Diplomacy in International Affairs, Vol.68, (1), 1992a, pp.1-15.

22

intensified and has led them to bargain with TNCs to locate operations within their territories,

and to try and convince "national" firms not to leave. This competition has developed into

conflict when a TNC moves production from one state to another, or as in the case of the U.K,

opting-out from the Social Chapter of the Treaty on European Union, in order to maintain a

"competitive edge".

23

INTERDEPENDENCE

Although the examination thus far has already pointed to this feature of international

relations, this section will explore the theme further, and in so doing, three points should be

kept in mind. The first, concerns the close links between domestic and foreign policies. The

choice of a domestic policy by one state may have implications (positive or negative) for the

domestic policies of another, and if the influence is negative, the latter will seek to remedy the

situation by adopting measures that may, in turn, affect the domestic policies of the former.

Conversely, in this situation, states may decide that it is in both their interests to seek

accommodation and cooperate to achieve mutual gains, as Rosecrance17 points out: " In

international society where government does not exist, nations will have power conflicts

unless they can work out a system of interdependence to satisfy their needs. Only the

reciprocal exchange and division of labour represented by the trading world can prevent

conflict in such an anarchic environment." The second, concerns the question of choice. To

talk about choice implies the ability to select freely, and after consideration, to decide on a

given course of action. The proposition is that economic interdependence places certain

constraints, voluntary or otherwise, on the ability of states to choose or to determine policies.

The third, concerns issue-linkages and their direction, a point discussed above when

examining the linkage between economic and security issues during the cold war. In addition,

we must not lose sight of the importance of power or influence as a major force in

interdependent relationships, especially when asymmetrical relationships are considered, as

Keohane and Nye18

17Rosecrance, R. The Rise of the Trading State: Commerce and Conquest in the Modern World, (New York, 1986), p.25.

have pointed out: "We must also be careful not to define interdependence

entirely in terms of situations of evenly balanced mutual dependence. It is asymmetries in

dependence that are most likely to provide sources of influence for actors in their dealings

18Keohane, R.O. and Nye, J.S. Power and Interdependence: World Politics in Transition, (Boston, 1977).

24

with one another. Less dependent actors can often use the interdependent relationship as a

source of power in bargaining over an issue and perhaps to affect other issues".

The domino effect

The one event that probably best illustrates the degree to which states have become

inextricably intertwined in a complex web of economic and political interactions was the oil

crisis that followed the Middle East War of October, 1973. As a result of that war, OAPEC

cut off the supply of oil whilst at the same time raising the price fourfold and, placing an

embargo on the sale of oil to the U.S and Holland for their support of Israel. The oil price rise

caused inflationary pressures in industrialised countries, heavily dependent on Middle Eastern

oil supplies, which in turn led to the introduction of deflationary measures and a consequent

rise in unemployment levels. The economic recession that ensued resulted in declining rates

of growth and trade and the introduction of protectionist measures in the form of NTBs to

trade.

For developing countries, particularly in Latin America, the negative effect was twofold.

Having embarked on the road to industrialisation importing capital equipment, partly financed

by their exports of primary commodities, they faced a much decreased demand for their

products as a result of the recession in the West, and rising prices for their imports from both

oil producing and industrialised countries. The resulting balance of payments deficits where

then financed, not by exclusive resort to the IMF and its strict conditionality, but instead, by

borrowing heavily from Western banks, flushed with the surplus oil revenues of OAPEC -the

so-called Petrodollars. A further hike in the price of oil in 1979, this time as a result of the war

between Iraq and Iran, accompanied by high interest rates (US Dollar rates increased from 9%

in 1973 to 17% in 1981), led to the debt crisis of 1982, when first Mexico and then a string of

other indebted countries, defaulted on their debt repayments, bringing the world financial

system to the brink of collapse. The initial action of OAPEC in 1973, besides highlighting

25

what Keohane and Nye19

have identified as two dimensions of interdependence, namely

sensitivity and vulnerability, also had other consequences for international relations. On the

one hand, and for the first time, a group of developing countries had been able to exploit

economic links for political purposes, and by means of such leverage to influence the foreign

policies of a number of advanced industrialised countries, as evidenced by the open support

that some Western European countries began to give to the Arab cause. On the other, it was

instrumental in changing the role of the IMF as the main provider of funds to correct

international payment imbalances, and was to affect monetary relations for decades to come.

The switch in 1971 from fixed to floating rates of exchange was supposed to lead to automatic

adjustment of payments imbalances, although countries could still have recourse to the IMF,

now, a number of countries, if they wished, could circumvent the system altogether by

financing deficits with recycled petrodollars originating from the unregulated financial

markets.

Non-state actors

A salient feature of the global economy, especially since the late 1970's, has been the growing

importance attached to the market, rather than to the state, as regulator of economic activity.

The shortcomings of Keynesian economic policies and the distorting effects on the economy

of high inflation rates, ushered in a revival of classical economic theory, which coincided with

the election of conservative governments in the U.S and Britain, with an emphasis on supply-

side economic management (rather than demand management) and on monetary policies to

combat inflation. Added to this was the belief that government should interfere as little as

possible in the workings of the market (implying deregulation), which left to its own devices

would ensure the efficient allocation of resources. One of the consequences of this was that, to

a very large extent, economic relations between states were to be conducted through the

intermediation of the market. To be sure, states had given a fillip to this process by the

19ibid.

26

abandonment of fixed exchange rates between 1971 and 1973 which fostered the growth of

the foreign exchange markets, an increase in international financial flows, and the continued

growth of the Eurodollar market. However, this appears to have been due more to U.S

perceptions that a more liberal financial environment would be better suited to the retention of

its hegemonic power in the global economy, which had been bruised by the challenge from

Japan and Western Europe, rather than to a concerted effort towards global financial

liberalisation. By the late 1970's and early 1980's, however, the hold of the "new" economic

orthodoxy, promoted by economists, business interests, and policy-makers in the

bureaucracies of government and multilateral organisations, underpinned by the pace of the

structural changes taking place in the world economy was such that few governments could

ignore it, especially when confronted with another recession in 1979. In the U.S and Britain it

fitted-in with the political creed of the new conservative governments, whilst in other states a

new wave of more pragmatic left-of-centre governments, disillusioned with Keynesianism,

were willing to consider an alternative. The result was a drive towards the removal of capital

controls and the deregulation of global financial markets, with states retaining responsibility

for the stability of the system. However, having shifted the emphasis from external to internal

adjustment measures (monetary and fiscal policies), states have found it increasingly difficult

to retain a systemic policing role and, instead, their role in those occasions when the system

has cracked has been one of crisis-management, acting as lender of last resort, rather than

crisis-prevention, as became

evident in the wake of the debt crisis of 1982, which was the result, in part, of irresponsible

bank lending. The shift from Keynesian to neo-liberal economic policies and from external to

internal methods of adjustment, together with liberalisation and deregulation of financial

markets, have had serious implications for the global political economy as some non-state

actors have pursued their own narrow interests defined on the basis of short-term speculative

profit motives, rather than on the basis of economic fundamentals, that has resulted, on the

one hand, in events such as the stock exchange crash of October 1987, evidencing the

27

inability of the market to cope with systemic faults, and, on the other, the speculative attack

on some of the currencies of the European Exchange Rate Mechanism (ERM) in September

1992, which represented a calculated strategy to change state policies.

As interdependent relations have become more complex, states have sought to coordinate

their policies in an attempt to maintain stability in the system and, it could also be argued, in

order to protect their autonomy (or sovereignty) in the face of the actions of non-state actors.

Cooperation, however, does not imply harmony, as has been mentioned elsewhere in this

paper, and states whilst engaging in cooperation, continue to promote their perceived

interests. Nevertheless, the pervasiveness of economic links in the global economy and the

Policy coordination

depth of integration between national economies, has had important consequences for, on the

one hand, the role of the state, what Cox20

20Cox, R.W. Global Restructuring: Making Sense of the Changing International Political Economy in Stubbs, R. and Underhill, G. Political Economy and the Changing Global Order, (London, 1994), p.49.

has referred to as the "internationalizing" of the

state whereby it is converted into "...an agency for adjusting national economic practices and

policies to the perceived exigencies of the global economy" and, on the other, the structure of

international relations, in the sense that it is becoming increasingly difficult to view the

international system as a collection of autonomous sovereign states answering to no one but

their domestic constituents. Granted that states are, for the time-being, the only legal

constructs that can exercise sovereignty in the international system, however, the exigencies

of cooperation requires that a degree of sovereignty is given up in order to pursue the benefits

that policy coordination will bring. Such coordination, though, does not come easy, as

evidenced by the debates that signal the start of the annual summit meetings of the G7 leaders,

as it will invariably involve one or more states giving-up domestic goals and sole control over

monetary and fiscal policies, still very much considered as core attributes of economic

sovereignty. Since states seem unable (or for political and ideological reasons unwilling) to

control the financial markets and their currencies exchange rates, as has been evident during

28

the recent turmoil in the foreign exchange and bond markets, which did not even get a

mention in the final communiqué of the last G7 meeting held in Naples last July, they are

restricted to bargaining over contraction or expansion of demand, budget deficits, and the

level of interest rates (and even this last area is dependent, to a certain degree, on the actions

of non-state actors). However, faced with systemic instability, economic recession, the serious

problem of structural unemployment (especially in Europe), and what is perceived as an

erosion of the social fabric, it would appear that states are in the process of considering a

return to the "ideals" of Bretton Woods if the likely recommendations of the commission of

the same name are adopted21

.

21Quoted in The Guardian, "Call for rethink on exchange rates", 13.6.94.

29

CONCLUSION

The foregoing examination has highlighted the complexity of inter-state relations arising out

of international economic links. This complexity is illustrated by state behaviour that is

characterised by the simultaneous interplay of cooperation, conflict and bargaining, which is

not surprising considering the many issue-areas in which states interact, and the many

domestic conflicting demands that states (at least in pluralist societies) must try to

accommodate. This leads to the proposition that there is, to say the least, a very close link

between economics and politics, and between the international and the domestic systems,

notwithstanding that, if these were thought of as elements of a matrix, at any one time a

particular combination will take precedence over another, depending on states' perception of a

particular conjuncture when considered against policy aims, and complex atavistic

conceptions of self interest, power and prestige. However, the discussion has also questioned

whether states' perceptions of national interest are relevant in today's interdependent global

economy, especially when their autonomy to dictate policy is being challenged by

transnational non-state actors riding on the back of the structural changes that have taken

place in the world economy over recent decades. In this scenario, the national/territorial

model of the state, clashes with the transnational/non-territorial model of non-state actors.

This dichotomy becomes apparent by, for example, comparing

residence-based trade measures against those that are based on ownership. Having said this,

however, it is also the case that economic interdependence between states has, in part, eroded

the national/territorial conception of the individual self-centred state, in favour of institutional

arrangements, or regimes, based on the principle that despite overlapping and conflicting

interests, mutual gains can be realised through cooperation. Since interdependence, to a large

extent, has been mediated through the market, such arrangements could also be viewed as a

means by which states try and protect their autonomy, in the face of the market based actions

of non-state actors, and following also from the realisation that an unregulated market

30

economy is unable to cope with systemic faults, or if it does, that the automatic adjustment

mechanism used to do so places undue burdens on states and limits their ability to pursue

policy objectives.

31

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