B. An economic perspective on the use of non-tariff measures

World TrAde reporT 2012

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Governments use non-tariff measures and services measures for a growing number of reasons. This section examines what these are and how they may affect trade. It also analyses the choices available to governments among a variety of policy instruments, from a theoretical and an empirical perspective. The section ends with case studies on non-tariff measures in the context of the recent financial crisis, climate change and food safety.

B. An economic perspective on the use of non-tariff measures

II – TRADE AND PUBLIC POLICIES: A CLOSER LOOk AT NON-TARIFF MEASURES IN THE 21ST CENTURY

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Contents 1 Reasonsforgovernmentinterventionandtypesofmeasures 50

2 ThechoiceofNTMsinlightofdomesticandinternationalconstraints 63

3 Measuresaffectingtradeinservices 73

4 NTMsinthe21stcentury 79

5 Summaryandconclusions 87

Some key facts and findings

• Non-tariff measures (NTMs) are often first-best policies to correct

market failures. However, as the same NTM used to pursue a public

policy objective may also be employed to distort international trade,

it can be difficult to distinguish “legitimate” from protectionist

motivations for NTMs.

• Neither the declared aim of a non-tariff measure nor its effect on

trade provides conclusive evidence of whether it is innocuous

from a trade perspective. However, analysing the nature of these

measures – their opaqueness, efficiency and effect on various

groups in society – and their political and economic context can

provide important insights.

• Non-tariff measures, including behind-the-border measures,

may take the place of tariffs and border NTMs that are disciplined

in trade agreements. This raises important questions regarding

the regulation of NTMs at international level.

• Similar issues arise in relation to services measures, which have

become increasingly significant in light of the international

fragmentation of production processes.

• Developments such as the recent financial crisis, current debates

on climate change and heightened concerns about food safety

have led to the increased use of NTMs and services measures in

the 21st century, illustrating the difficulties involved in dealing with

public policy measures and their impact on international trade.


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Trade agreements are meant to discipline policiesthat distort trade without constraining governmentsin their pursuit of other legitimate public policyobjectives, such as consumer health and safetyprotection – even if these happen to affect trade.Thus,whilecertainnon-tariffmeasures(NTMs)entailtrade costs, these costs can be justified for otherreasons. This section seeks to shed light on theimportance of making this distinction and on how itcanbemade,akeyquestionfromtheperspectiveoftheWTO.

Section B.1 introduces different types of non-tariffmeasures and discusses how they are employed toachievearangeofpolicyobjectives. Inanalysingthewelfare and trade effects of NTMs in more detail, itbecomes clear that usually more than one measurecanbeusedtopursueagivenpolicygoal, inamoreor less efficient manner. While a specific NTM canrepresent the first-bestpolicy topursuea legitimatepublicpolicyobjective,thesamemeasurecanalsobeusedforprotectionistpurposesorcreateunnecessarytradecosts.Makingthisdistinctionisnotalwayseasyand represents a major challenge for tradeagreements that target the latter, while seeking nottointerferewiththeformer.

Section B.2 identifies situations in whichgovernments may be prone to employ non-tariffmeasures for trade competitiveness reasons, evenif the stated policy rationale is a different one,or implement an inefficient instrument that mayaffect trade more than necessary to achieve agiven objective. From this analysis, a number offactors relating to the choice of NTMs andthe sectors and political context in which theyareappliedcanhelpdistinguishbetween“legitimate”and “protectionist” (or excessively trade-restrictive)use. Another reason why governments may turn toNTMs relates to “policy substitution” – that is, theuse of certain NTMs when tariffs or other NTMsare effectively regulated in international tradeagreements.

Thespecialcharacteristicsofservicestrade,notablythe intangibility of services and the different modesoftrade,makeitnecessarytoask, inSectionB.3,towhatextentthepreviousanalysisappliestoservicesaswell.

The penultimate part (Section B.4) examines casestudies on the rise of non-tariff measures duringthe recent financial crisis, in the context ofclimate change and in relation to food safety.The objective of this sub-section is to illustratehow recent developments have led to an increaseduse of NTMs and to what extent the measurestaken may pose a challenge for internationaltrade. Finally, the main results are summarizedinSectionB.5.

1. Reasonsforgovernmentinterventionandtypesofmeasures

(a) ClassifyingNTMsandgovernmentmotives

There are various ways to categorize both non-tariffmeasuresandthereasonswhygovernmentsusethem.Theclassificationsdiscussedinthissectionprovideausefulwaytoconsidermanyoftheissuesraisedinthisreport.

The trade literature typically distinguishes betweeninterventionsaimedatincreasingnationalwelfareandthose motivated by “political economy” goals. Theformerincludesinterventionstocorrectmarketfailuresandtoexploitacountry’sorafirm’smarketpower(bymanipulating the terms of trade and shifting profits).One key point is that interventions to exploit marketpower come at the expense of one’s trade partners(beggar-thy-neighbour practices), whereas thosefocused on correcting market failures have tradeeffects that are unintended consequences of thepolicy.

Political economy motives reflect the response ofpoliticalincumbentstospecialinterestgroups,usuallyassumed to be organized producer groups. Althoughtheeconomicliteraturegenerallyassumesconsumersaretoonumerousanddiversetocoordinateeffectively,theycanputeffectivepressureonpoliticiansonissuesthat involve consumer health and safety. In addition,civilsocietyandnon-governmentalorganizationshavebecome powerful advocates for issues such as theenvironment. Political economy motives are likely tolead to policies that shelter favoured producers andreducetradeflowsattheexpenseofnationalwelfare.Thissuggestsafurtherdistinctionbetweennon-tariffmeasures motivated by public policy objectives andthose motivated by competitiveness concerns. Thisdoesnotmeanthatpublicpolicyandcompetitivenessconcerns cannot overlap – for example, whenprotecting an infant industry whose expansion canincreasenationalwelfare.However, thereare likely tobemanymore instanceswherepromotingadomesticproducer’s interests comes at the expense of thesocial good. Lastly, motives can be distinguishedaccording to their intended distributional effects –specifically, whether they benefit consumers orproducers.

So far, the discussion has focused on the economicmotives of governments for employing non-tariffmeasures.However,nationalwelfareandpublicpolicyobjectivesmayembracefarmorethanpurelyeconomicissues.Governmentsareresponsibleforsafeguardingnational security. Governments may wish to firmlyuphold certain moral and religious tenets. Where asociety is made up of different ethnic or religiousgroups, a high value will be placed upon the


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preservation of social cohesion. These goals may becompromised if certain goods are freely available inthecountry,requiringgovernmentstouseNTMssoastorestricttheirsupplyviainternationaltrade.

The classification and quantification of non-tariffmeasuresisalong-standingareaofresearch(apartiallistingincludesBaldwin,1970;LairdandYeats,1990;DeardorffandStern,1997;DeeandFerrantino,2005).ThisresearchhasprovidedtheconceptualframeworkforthevariousNTMdatabases–includingtheWTO’s– that will be relied on extensively in this report,especiallyinSectionC.

Following Staiger (2012), non-tariff measures can beclassifiedaccordingtowhethertheyareappliedattheborder, to exports (e.g. export taxes, quotas or bans)and imports (e.g. importquota, importban),orbehindthe border. This latter category can be further sub-dividedaccording towhether theNTMsaredomestictaxes, other charges, and subsidies, or whether theyare regulatory. The distinction between border andbehind-the-border NTMs appears frequently in theeconomic literature. In one sense, it is a distinctionbasedonwherethemeasuresareapplied.However,inanother sense, it involves a distinction betweenmeasuresappliedtoforeigngoodsonly(attheborder)and those applied equally to domestic and foreigngoods. This raises a key question about behind-the-border measures – i.e. whether, intentionally or de facto,theytreatdomesticandforeigngoodsdifferently.

What is common about the interventions collectivelycalled non-tariff measures, irrespective of their

motives, is that they have trade effects (either liberalorrestrictive).Sometimesthetradeeffectsaresimplythe by-product of pursuing a particular public policyobjective. Other times, the trade effects are theprimary goal. Since governments usually claim thattheir policies have laudable objectives, declaredintentions may offer little insight into the motivesbehind interventions. Instead, motives can best bededucedfromthetypeofNTMchosen,fromthesectorto which it is applied, from its design andimplementation, and from its impact – i.e. whetherconsumers or producers benefit and whether foreigngoodsarediscriminatedagainstornot.

For the purpose of later analysis of the trade andwelfare effects of non-tariff measures, a distinctionwill also be made between NTMs that are price,quantityor“quality”focused.Apricemeasure(suchasasubsidy)operatesbychangingrelativepriceswhileaquantity measure (such as a quota) works by directlylimitingthequantityofsomeactivity.Qualitymeasures(such as a technical barrier to trade measure or asanitary and phytosanitary measure) change somefeatures of a product or the process by which it isproduced. This categorization helps to simplify theanalysisof the tradeandwelfareeffectsofNTMsbyusingexamplestakenfromeachcategoryratherthanbyexaminingexhaustivelyallNTMs.

Anotherimportantthemeintheliterature–andinthisreport – is the transparency of non-tariff measures.Although there is no agreed definition of whatconstitutesatransparentNTM,BoxB.1discusseshowtheissuemightbeapproachedandconceptualized.

BoxB.1: Defining transparency in non-tariff measures

Criteriaforassessingthetransparencyofnon-tariffmeasuresarenotreadilyavailableinthetradeliterature,so the following analysis draws on several papers that address public policy transparency more broadly.TheseincludeGeraats(2002)whichdefinestransparencyincentralbankingandintheconductofmonetarypolicy,Wolfe(2003)whichdiscussestransparencyrequirementsfoundinWTOagreements,Collins-WilliamsandWolfe(2010)whichdevelopswhat theauthorsdescribeasan“analyticframework” for thinkingaboutWTO transparency provisions and Helble et al. (2009) which discusses the transparency of the tradingenvironmentandconcludesthatitexertsanindependentimpactontradeflows.1Noneprovideadefinitionoftransparencythatcanbetaken“off-the-shelf”andapplieddirectlytoNTMs.However,thepapersdoprovideanumberofusefulideasforapproachingthetaskofassessingthetransparencyofNTMs.

First,ataconceptuallevel,transparencycanbedefinedastheabsenceofinformationasymmetry,asituationwherepolicymakersandrelevanteconomicagentshavethesameinformation(Geraats,2002).Informationasymmetry generates uncertainty for the agents with less information. Those with access to privateinformationmaytrytomanipulatethebeliefsofothersandtherebyindirectlyaltereconomicbehaviour.Thus,economicefficiency requires informationbemadepubliclyavailable. In thecaseofnon-tariffmeasures, itmay be important to distinguish between different economic agents – the private sector and othergovernments–becauseeach is likelytobeconcernedwithdifferentaspectsof information.Governmentsarelikelytowantinformationthatallowsthemtobetterevaluatewhethertheirtradepartnersareabidingbyinternational commitments. The private sector is likely to be more concerned with information asymmetrythathampersitsabilitytotakeadvantageofcommerciallyprofitableopportunities.

Secondly,giventherangeanddiversityofnon-tariffmeasures,removinginformationasymmetrymayrequiredevotingmoreefforttosomemeasuresthanothers.


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Any discussion of the motives and impacts of non-tariff measures needs to take into account theincreasingfragmentationandoffshoringofproduction.Unfortunately, there is very little literature about howfragmentation affects government motives to employNTMs so what can be said is rather limited andconjectural.

The international fragmentation of production acrossmanypartsof theworld iswelldocumented in recentempiricalresearch.Hansonetal.(2005) illustratetheextent of US multinationals’ trade in intermediateinputsbetweenparentfirmsandtheirforeignaffiliates.Hummels et al. (2001) demonstrate the degree ofvertical specialization among ten OECD and fouremerging countries. Kimura and Ando (2005) show

the extent of international production/distributionnetworks in East Asia. Theoretical research into thefragmentationofproductionhasalsogrownintandemwith this expanding empirical work (see the recentsurveybyBaldwinandRobert-Nicoud,2007).

The economic theory of fragmentation (Jones andKierzkowski, 1990; 2000) contends that increasedmarketsizemakesitprofitabletosplituptheprocessof production and allow specialization to reduce perunitcost.3Thisdivisionoflabourcantakeplacewithina country, but if countries differ in their comparativeadvantages, greater cost savings from specializationcanbeobtainedbyoffshoringproduction.Thisprocessoffragmentationrequiresfirmstobeabletocoordinatebetween production locations and to move parts and

Regulations involvinghumanhealth, foodsafetyor theenvironmentusually requirespecializedknowledgeandwillbeintrinsicallymorecomplexthananad valoremtariff.AsCollins-WilliamsandWolfe(2010)putit,tradingpartnerscannotseewhatisgoingon“behindtheborder”withouthelp.Thismeansthatmechanismsto achieve regulatory transparency may have to be designed or structured differently than other types ofnon-tariffmeasuresgiventheirgreatercomplexity.

Thirdly,amoresystemicviewoftransparencyisneededwhichtakesintoaccountthepolicy-makingprocessasawhole.Oneofthekeydifficultiesisdistinguishingwhetheranon-tariffmeasureisputinplacebecauseofpublicpolicyconcernsoradesiretoprotectdomesticproducers.Itismucheasiertoresolvethisquestionif onehasknowledgeof thedecision-orpolicy-makingprocessasawhole, and isnot limited todrawinginferencessolelyfromtheNTM’sdesignoritsimplementation.

Fourthly, in this connection, it may be possible to take the stages of policy-making identified in Geraats(2002)andadaptthemtoatradeorNTMcontext.Thepaperdistinguishesbetweendifferentstagesofthepolicy-makingprocess–political,economic,procedural,policyandoperational–andmakesthepointthattransparencywillneedtoapplytoeachofthesestagesandthatitmaycallfordifferentrequirementsateachstage.2 In the NTM context, political transparency refers to openness about policy objectives and theimportanceassignedto them.Scientificor technical transparencymeansmakingavailable the informationused as the basis for implementing a measure, including the underlying data, expert opinion and riskassessment.Proceduraltransparencydescribesthewaypolicydecisionsaretaken,includingthescopeforpublicconsultationsandaccesstoindependentadjudication.Italsoincludesthepublicationandnotificationof measures and the establishment of enquiry points. Operational transparency concerns the design andimplementationoftheNTM.BycomparingthetransparencyofNTMsinthis“systemic”way,thewholepolicy-makingprocesscouldbetakenintoaccount,orjustoneparticularstageofit.

Fifthly,thepapersbyHelbleetal.(2009)andWolfe(2003)associatetransparencywithpredictabilityandsimplicity.Predictabilityreducesthecoststemmingfrompolicyuncertaintywhilesimplificationreducestheinformationcostsfromanoverlycomplextradingenvironmentthatmayhindereconomicagents.A“bound”import tariff is more transparent than an unbound tariff because the tariff binding creates greaterpredictability for exporters to that country. These papers suggest that predictability and simplicity areimportantdimensionsof transparencyandprovideanotherwayofcomparingthetransparencyofdifferentnon-tariffmeasures.At theoperationalstage forexample, the transparencyofanNTMmaybe judgedbywhethertradersfinditsdesignorimplementationtobesimpleandpredictable.

Finally,anunstatedassumptioninallthesepapersisthataggregatewelfareshouldincreasewithenhancedtransparency.Whilethisislikelytobethecase,noteveryonewouldnecessarilybebetteroffiftradepartnersbecome more transparent with one another. Some import-competing firms may lose out if, as a result ofgreatertransparencyofthehomecountry’snon-tariffmeasures,foreigncompetitorsexportmorebecauseofthereductioninuncertainty.AswillbeexplainedinSectionB.2,somepolicy-makersmayhavenointerestintransparencybecauseopaquenessallowsthemtorewardpoliticalbackerswithoutpayingapoliticalprice.This may explain why introducing more transparency in NTMs is likely to be a difficult undertaking, notnecessarily because of the technical challenges involved, but because there are interests that will beopposedtoit.


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componentsacrossnationalborders.Thisunderscoresthe crucial role of services, particularlytelecommunications and transport, in connectingfragmentedproductionblocks.

Production fragmentation has an impact on whygovernments use non-tariff measures and how theyinfluence trade. First, where global supply chains areprevalent,itisnotpossibletodisentanglemerchandisetradefromservicestradeandforeigndirectinvestment(FDI).ThismeansthatNTMs,whichaffectmerchandisetrade,arealsolikelytohaveanimpactonservicesandFDI flows. Conversely, services and investmentregulations are likely to impact merchandise trade aswell. Secondly, while governments’ usual motives foremploying NTMs remain – i.e. to address marketfailures, to exploit market power or to respond topolitical economy pressures – productionfragmentation makes some motives more pressingthan others. For instance, governments may seeinformation asymmetry as more critical given thatproducts are now made from parts and componentscoming from distant and multiple sources (see thecase study of food supply chains in Section B.4).Clearly, the role of NTMs in a world of increasinglyfragmented production is a fertile area for futureresearch.

(b) Howdonon-tariffmeasuresachievepolicyobjectives?

The discussion here illustrates how non-tariffmeasurescanbeusedtoachievepublicpolicyaswellas political economy objectives. Although it is not anexhaustive discussion of all possible governmentmotivesforusingNTMs,twobroaderobservationscanbemade.First,morethanoneNTMcanfrequentlybeused to pursue the same policy objective. From the

standpoint of economic efficiency, governmentsshouldusetheNTMthatmaximizesnationalwelfare–i.e. the first-best NTM (see Box B.2 which discusseshow this decision-making process is akin to cost-benefit analysis). Secondly, NTMs used to pursuelegitimate policy objectives can also be used forprotectionist purposes, underlining the difficulty ofdistinguishing “legitimate” from “protectionist”governmentmotives.This sectionbeginswithseveralcasesofmarketfailures,looksatinstancesofbeggar-thy-neighbourpolicies, touchesonequitymotivations,andendswithpoliticaleconomyexamples.

(i) Correcting market failures

Health and safety of consumers and consumer choice

AsdiscussedinBoxB.1,informationasymmetryrefersto a situation where one set of agents involved in aneconomictransactionorexchangehasaninformationaladvantageoverotherparties.Anexampleisthesellerof a used car who has better information about thestate of the car than the potential buyer (Akerlof,1970). Another example is the job seeker who hasbetter informationabouthisproductivityandaptitudefor work than the potential employer (Spence, 1973).Athirdexample isthecaseofaproducerwhosellsasub-standard product which can compromise thehealthandsafetyofunwittingconsumers.

Theexistenceofinformationasymmetrycanleadtoanumberofinefficienciesinthemarket.Intheusedcarexample, since buyers know that they are at aninformationdisadvantagetheywillonlybewillingtobida low price – with the result that owners of good-qualityusedcarsdonotbothertoputtheircarsupforsale, and the used car market ends up being

BoxB.2: Choice of NTMs and cost-benefit analysis

There are a number of methods that governments can follow in choosing non-tariff measures. Trachtman(2008)providesarelativelycomprehensivelistingofthesemethods(e.g.balancing,means-endsrationality,proportionality). Theeconomically coherentway to thinkaboutgovernment interventionand thechoiceofNTMsisinthecontextofacost-benefitanalysis(BownandTrachtman,2009).Inbroadterms,acost-benefitanalysis involvescalculating thenetgains tonationalwelfareby implementingonemeasure relative toanalternative. (Note that the Bown and Trachtman paper goes one step further than this by including thechange in the welfare of the trade partner as well because they are concerned with global and not justnationalwelfare.)

Thepresumptionisthatnon-tariffmeasureswillvaryintheirabilitytoachievethepolicygoalandthattheywillalsodifferintheircosts.Governmentswillthereforeneedtoevaluatethebenefitfromachievingagivenpolicyobjective (e.g. thewelfaregain from reducingpollution), thecontribution that aparticularNTMcanmake to achieving the policy goal, and the cost incurred in applying the NTM. The outcome of the cost-benefit analysis determines not only whether government intervention is called for in the first place (thebenefitmustexceedthecost)butalsoprovidesarankingoftheNTMs.Inparticular,themethodshouldbeabletoidentifythefirst-bestmeasure–thatwhichproducesthelargestdifferentialinbenefitovercost.Itislikely thatacost-benefitanalysiswouldbemore information-intensiveandtechnicallychallengingtoapplythansomeofthesimplermethodsmentionedabove.Benefitsandcostsneedtobequantifiedandmonetaryvalues assigned to them. Informational and resource constraints may explain, at least partly, why somegovernmentsdonotmakemoreextensiveuseofcost-benefitanalysisindecision-makingonNTMs.


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overwhelmedby low-qualitycars, i.e. there isadverseselection. In the job-seeking example, informationasymmetry may lead the job seeker to expendresources to “signal” his productivity to the potentialemployer (e.g. attend a more expensive school) eventhough that decision will not necessarily increase hisproductivity. In thecaseof the sub-standardproduct,saleoftheproductcancauseinjuriesorevenfatalities.Astheseexamplesshow,marketswillnotnecessarilydeliver the most efficient outcomes, and this failureprovidesarationaleforpublicaction.Thisexplains,forexample,whyawiderangeofconsumergoods–food,drugs,vehicles,electricalappliances,safetyequipment– facemany typesof requirements, fromdesign (e.g.toys) to ingredients (e.g.chemicals) to theprocessofmanufactureorproduction(e.g.pasteurizationofmilk)and to performance (e.g. helmets) (World TradeOrganization (WTO), 2005a). What these measuresare designed to do is to weed out those products,whetherdomesticorforeign,thatwillcompromisethehealthorsafetyofconsumers.

Informationasymmetryisalsorelevanttointernationaltrade. Suppose that countries differ in the safety orqualityofthegoodsthattheyproduce,withthehomecountry specializing in high-quality products and theforeign country specializing in low-quality ones.Imaginethatconsumersinbothcountriesdifferintheirpreference for quality, with some willing to pay morefor high-quality products, and others unwilling to paymore. In this scenario, consumers are also unable totell the difference between high-quality and low-quality products because these goods are notdistinguished by origin. Under these circumstances,Bond(1984)shows that thecountrywithhigh-qualityproducts may lose if it trades with the countryproducing low-quality products. This arises becausetrade reduces theaveragequalityofproducts sold inthe market of the high-quality producing country,whichspillsover toaffect theexpectedwelfareofallconsumersintheimportingcountry.

Thefirst-bestpolicyislabellingtoallowconsumerstodistinguish between home (high-quality) and foreign(low-quality) products.4 Consumers with a taste forhigh-quality goods will purchase home goods andconsumers satisfied with low-quality goods willpurchaseforeigngoods,resultinginatwo-waytradeinequilibrium.Eachproductwill sell for the “right”price– high-quality goods at higher prices and low-qualitygoods at lower prices. The ability to distinguishbetween home and foreign products leaves bothcountries better off as a result of trade because itexpandsthevarietyofproductsavailabletoconsumers,andleadstoabettermatchbetweenconsumertastesandproducts.AsimilarresultisestablishedinPienaar(2005) where requiring foreign goods to be labelledaccordingtotheircountryoforigingivestheconsumerall the necessary information, and unambiguouslyimprovesthewelfareoftheimportingcountry.

Under certain circumstances, export subsidies canalso help reduce or eliminate information asymmetry(Bagwell and Staiger, 1989). Consumers in theimportingcountrydifferintheirtasteforquality.Someconsumers like high-quality goods and are willing topayahigherpriceforthem;otherswouldratherpayalowerpriceforthelow-qualitygood.Unfortunately,thegroupsareunabletotellthedifferencebetweenhigh-quality and low-quality products until they make thepurchase, i.e. these are “experience goods” (Nelson,1970).5

Producers in the exporting country, who make thehigh-qualityproduct,incurahighercostofproductionthanproducersintheimportingcountry,whomakethelow-quality good. If both goods circulate in theimportingcountry,consumerswillbeunabletotellthedifferenceandthepricewillreflecttheaveragequalityofthesegoods.Atsuchaprice,high-qualityproducerswill notbeable toexport theirgoodssince itwill notcovertheircostofproduction.6Ifthehigh-qualityfirmsare aided by an export subsidy, they can sell theirgoods at the average price and still earn a profit.Having been introduced to the high-quality product,consumers preferring high-quality goods will be abletomakerepeatpurchases,payingapricethatreflectsthe quality of the good. At this later stage, the high-quality producer receivesaprice that covershis costof production, and the government can withdraw theexportsubsidies.Consumerssatisfiedwithlow-qualitygoods benefit as well since they can now identifythesegoodsandpayalowerpriceforthem.7

Pollution and the environment

Another type of market failure that can justifygovernment action is a negative externality such aspollution.Negativeexternalitiesarisewhenanagent’seconomic activity generates costs to others that theagent does not fully absorb. Hence, the scale of hisactivityexceedsthesociallyoptimalamount.Inrecentdecades, the public and policy-makers have becomeincreasinglyawareoftheenvironmentalconsequencesof certain economic activities. Much of the economicliterature focuses on the use of taxes to correctnegative externalities – the so-called Pigouvian tax.Nevertheless, many governments have chosen topursue environmental objectives using non-pricemeasures, such as performance standards, emissionquotas,andmandatedtechnologies.8

One drawback of trying to reduce pollution throughgovernment-mandated technologies is that theincentivetofindlesscostlywaystoachievethesameenvironmental objective is removed. Nevertheless,governments may prefer these measures fordistributional or competitive reasons, because ofuncertaintyaboutthecostsandbenefitsofabatement,or to avoid the cost of monitoring and enforcement(Bovenberg and Goulder, 2002). Regardingdistributional or competitiveness concerns, for


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example, governments may be sensitive to the factthatapollutiontaxrequiresfirmstopayforeachunitof emission while an emission quota does not. Whileboth instruments might lead the firm to curtailemissions by the same amount, the tax saddles thefirm with an additional liability that it does not facewithaquota. Ifpolicy-makersareuncertainaboutthetruecostofmitigatingenvironmentaldamage,butarecertain that passing beyond a threshold level ofenvironmental damage would be catastrophic,quantity-based measures will be preferred to price-basedmeasures.9

Some of the more complicated and contentiousenvironmental issues involve cross-borderexternalities. One type of cross-border externalityinvolvescountrieswhoseeconomicactivitypollutesorreduces a common resource, damaging all countries.A notable example of this is global warming (see thediscussion in Section B.4). Another type of cross-border externality is where the activity occurs in onejurisdiction,buttheadverseimpactsarepartlyorfullyfeltinanotherjurisdiction.

Cross-border externalities are often compounded bydifferencesincountries’ incomelevels,or institutionaland environmental capacities. Since adoptingenvironment-friendlyproductionmethodsoftenentailshighercosts, thiscanleadtodisagreementsbetweencountries about the distribution of the costs andbenefits of correcting the externality. A number ofGATT/WTO disputes – tuna-dolphin10 and shrimp-turtle11–appeartofallwithinthiscategory.Whilesuchdifferencesmake itdifficult forcountries to reachanagreement, markets could play a role in mitigating oreliminating a cross-border externality. Assuming thatcredible informationabout theenvironmentalcostsofproducingagoodwereavailable,consumersmightbewilling topaymore for theproduct if itwasproducedwithout causing environmental harm. Higher priceswouldprovidean incentive forproducers toswitch tomore environment-friendly methods, thereby reducingpressureontheenvironment.

However, products made by environmentally-friendlyprocesses may not be distinguishable from thosemadebylessenvironmentally-friendlyprocesses.Tunacaught by fishing methods which leave dolphinsunharmedtastesthesameastunacaughtbymethodslethal to dolphins. This introduces a second marketfailure–informationasymmetry(seediscussionabove)–totheoriginalproblemofacross-borderexternality.Beaulieu and Gaisford (2002) analyse the effects ofattemptingtoaddresstheseproblemsthroughvariousnon-tariffmeasures–fromoutrightbanstolabelling.

Given the existence of market failures, open trade isnotnecessarilyoptimal.Dependingonthestrengthofconsumer preferences for the environment-friendlygood, an outright ban of imports from countries thatarethesourceoftheenvironmentalexternalitymaybe

evenbetterthanopentrade.Therationaleisthatabanimproves consumer confidence in the products sincetheyknowthatonlyenvironment-friendlygoodscanbesold.Thisleadstoanincreaseindemand,i.e.ashiftinthe demand curve, and to greater consumer surplus.For the importingcountry, thedrawbackof an importban is that some consumers may be indifferent toenvironment-friendly and environment-unfriendlyproducts, and unwilling to pay a premium for theformer.Thebanadverselyaffects themsince it limitstheir choice to the expensive, environment-friendlygood.

While there are good reasons to question theadvantagesofimportbans,therearenotableexamplesof products whose trade the international communityhas banned for environmental reasons, includingendangeredspecies(bannedundertheConventiononInternational Trade in Endangered Species of WildFauna and Flora) and ozone-depleting substances(banned under the Montreal Protocol).12 Of course,consumer confidence can also be enhanced by alabellingschemethatcorrectlydistinguishesbetweengoodsmadewith littleornoharmto theenvironmentandthosethatimposeanenvironmentalcost.Effectivelabellingwouldbesuperior toabansince it improvesconsumer confidence without artificially restrictingimports.Consumersunwillingtopayapremiumfortheenvironment-friendly good are still able to purchasetheir preferred (low-price) environmentally-unfriendlygood.

Infant industry protection

Insomecases,anagent’seconomicactivitygeneratesbenefits for others that the agent does not fullycapture. These “positive externalities” represent animportantclassofmarketfailurethatcanjustifypublicinterventionsincethescaleofactivityislessthanthesociallyoptimalamount.Oneexampleisinfantindustryprotection.

Suppose the conditions for supporting an infantindustry exist.13 The home country has a high-costindustry that finds it difficult to compete with foreigngoods,buttherearedynamiclearningeffectsthatareexternal tothefirmandbeneficial tothecountry.Theexperience that domestic firms accumulate byproducing the good will reduce their costs over time.Furthermore, these learning effects cannot becontained within the firm but are also of benefit tootherfirmsintheindustry.Thisspill-overeffectmeansthatafirmdoesnotfullyinternalizethegainsfromitslearning,andsotheprospectoflaterprofitmaynotbesufficiently attractive to warrant absorbing lossesduring the initial learning period. This situationprovides the necessary justification for extendingtemporarygovernmentsupport to the industry.Underthese conditions, the first-best solution is forgovernmentstouseaproductionsubsidyratherthanatariff to assist the infant industry (Bhagwati and


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Ramaswami, 1963). It directly targets the source ofthe market failure by supporting learning in thedomesticindustrywithoutpenalizingconsumerswithahigherpricefortheproduct,theprincipaldrawbackofusingatariff.

Ideally, the support extended to the infant industryshould decline as learning takes place. However,information about the pace of learning may not beknown with certainty by the policy-maker. Applying afixedsubsidyratemeansthattheprotectionextendedtotheinfantindustrywillbebelowtheoptimumlevelatthestartoftheleaningperiodandtoohighattheend.Under these circumstances, Melitz (2005) proposesusing a quota instead of a subsidy, noting that it willallow the level of infant-industry protection to adjustautomatically as the industry’s costs decline.14 Overtime, the quota will become less distortive as thedomesticindustry’scompetitivenessimproves.

Network effects/externalities

Certain products or services are more valuable to abuyerwhenmoreconsumersusethesameproductorservice. For example, the greater the number ofsubscribers toa telephonesystem, themorevaluablethatnetworkwillbetopotentialsubscribers.Likewise,Facebook, Twitter or LinkedIn accounts are morevaluablethemore“friends”,“followers”,orprofessionalcontactsaredrawnintothesesocialnetworkingsites.Such products or services are subject to what havebeen called “network effects/externalities” (Katz andShapiro,1985).15

Potentially there is a market failure associated withthesenetworks.Anindividualdecidestojoinanetworkbecause of the benefits he or she will obtain, notbecause of the benefits existing members will derivefrom him or her joining. As a result, the size of thenetwork is smaller than the socially desirable size. Ifthere are competing networks, each one of which isowned by a different firm, one way the problem ofnetwork size can be resolved is by making themcompatiblesothatclientsofonenetworkareconnectedto the clients of all other networks (Katz and Shapiro,1986). Given that each user’s utility increases as thesize of the network expands, compatibility amongnetworksincreasessocialwelfare.

Compatibility can be achieved through adoption ofcommonstandards.Thekeyquestioniswhetherfirmshave enough incentives to develop compatibilitystandards on their own without governmentintervention.Onereasontobescepticalofgovernmentinterventionisthatgovernmentsareunlikelytohaveasignificant informational advantage relative to privateparties when emerging technologies are concerned,andsocannotbepresumedtoknowwhichstandardistheoptimalone(KatzandShapiro,1994).Ontheotherhand, because of the network effects, a product’scompatibilityincreasesitsvaluetoconsumerswhowill

thenbewillingtopaymoreforitthanforacompetingbutincompatibleproduct.Theremayalsobeamarket-mediated effect, as when a complementary good(spare parts, servicing, software) becomes cheaperandmorereadilyavailablethegreaterthecompatibilityof markets (Farrell and Saloner, 1985). Based onevidence from the United States, these incentivesappear tobesufficiently large to induceanumberofprivate institutions–from lumbercompanies toLocalArea Networks – to get involved in standardizationactivity (Farrell andSaloner,1988).BoxB.3providesotherexamplesofthedevelopmentanduseofprivatestandardsbyindustrygroups.

Monopoly power

Imperfectcompetition representsanother instanceofmarket failure which occasions various forms ofgovernment intervention. Typically though, suchmeasures are directed at the behaviour of firms andnot at the products or services they produce.Competition rules will prevent a firm from colludingwith others, limit its merger and acquisition activity,andguardagainstabuseofadominantposition.

A specific example illustrates the role of non-tariffmeasures in addressing this particularmarket failure.

A small country is only able to source a specificproduct from a foreign monopolist because it is notproduced domestically. The importing government’sobjectiveistoexpandimportsandreducetheartificialscarcityresultingfromtheforeignmonopolist’scontrolof the domestic market. Instead of NTMs being usedtorestricttrade, inthiscaseNTMswillbeusedtotryto expand trade and/or reduce the price charged bythemonopolist.Theoptimalpolicyisapriceceilingonthe imported product set equal to the monopolist’smarginal cost of production (Helpman and Krugman,1989). In other words, the foreign monopolist will beallowed to sell to thehomecountryonly if it caps itsprice at the ceiling established by the importingcountry.(Ifthemonopolisthadbeenadomesticfirm,acompetition authority would have adopted a similarpolicy of marginal-cost pricing.) More elaborateexamples are discussed in Helpman and Krugman(1989)involvingtheuseofotherNTMs,suchasimportsubsidies and minimum import volume requirements,to induce foreign firms with market power to supplymoretotheimportingcountry.

(ii) Beggar-thy-neighbour policies

Acountrywithmarketpowerininternationaltradecanincrease national welfare by improving its terms oftrade (the ratio of export to import prices). If firmscompeting in international tradehavemarketpower–sothatonefirm’sactionshaveaneffectontheprofitsof its rival(s) – then government actions can shiftprofitsfromtheforeignfirmtothehomefirm,resultingin a gain in national welfare. In both instances, non-tariff measures can be used by the home country to


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pocket terms-of-tradeandprofit-shiftinggains.Thesewelfare gains will come at the expense of othercountries – i.e. these are beggar-thy-neighbourpolicies. Unlike the motives discussed before, wherethetradeeffectsmaybeunintendedconsequencesofthe policy, in this instance the trade effects are theintended aim of the policy. They are the means bywhich the country appropriates gains at the expenseofitspartner.

Manipulating the terms of trade with NTMs

Muchof the literatureonhow the termsof tradecanbe shiftedby trade policy has focused on the role ofimport tariffs (Johnson, 1954, Mayer, 1981; Bagwelland Staiger, 1999). An import tariff reduces thedemand for imports, so for a large country this willhave the effect of reducing the world price of itsimports relative to the price for its exports. However,

an export tax can have a similar effect on a largecountry’s termsof tradesincethereducedavailabilityof a country’s export good in world markets shouldleadtoariseinitspricerelativetotheimportproduct.16It turns out that an export subsidy can also shift theterms of trade in favour of the exporting countryprovided that it has another good that it exports andtherearedifferencesinconsumptionpatternsbetweenthe importing and exporting countries (Feenstra,1986).17

If a country is not constrained in its use of thesemeasures, such as by international agreements, theywouldbewidelyusedtomanipulatethetermsoftrade.Regulatory instruments, such as technical barriers totrade (TBT) and sanitary and phytosanitary (SPS)measures, would be used to correct market failuresand would be set at their socially optimal levels(BagwellandStaiger,2001;StaigerandSykes,2011).

BoxB.3: Network effects/externalities and private standards

Where network effects/externalities exist, private standard-setting is a common outcome. Indeed,compatibility and integration are paramount to exploit such externalities. The following two examplesillustrate the huge incentive to develop and implement private standards in industries characterized bynetworkexternalities.

Oneexampleise-business.TheInternethasbecomeanincreasinglyimportantcommercialmarketplaceinrecent decades, thanks tomass Internet connectivity, and the expansion of web browsers and interactivewebsites(PantandRavichandran,2001).

Itisreasonabletoassumethatthevalueofane-businessinformationsystemincreaseswiththenumberofpeople, IT products, and networks interacting through it – and in general, systems of e-business thatconstructglobal communitiesof customers, suppliers andbusinesspartners achieveahigher value (Pantand Ravichandran, 2001). However, in order to function and to provide customers with timely informationaboutproducts,e-businesssystemsneedtobeintegratedwithcompanies’ internalsystemsandsuppliers’informationsystems.Suchintegrationcanbeeffectivelyachievedthroughstandardizationactivities(Chen,2003).E-businessstandardsallowaspecificationofbusinessobjects,dataandprocessesinvolvedinweb-based commerce. Therefore, their adoption represents a step towards compatibility and inter-operabilityamongcompanies,generatinganenhancedvalueforthefirmsinvolvedandtheindustryasawhole(Zhaoetal.,2007).

Electroniccardpayments(ElectronicFundsTransferatPointofSaleor“EFTPOS”)provideasecondexampleoftheincentivetodevelopstandardsincontextscharacterizedbynetworkexternalities(Guibourg,2001).Inthelastdecades,theEFTPOSmarkethasdevelopedinmanyindustrializedcountries,evolvingfrompaper-based instruments to debit and credit card payments. Usually, these payments are used for face-to-facetransactions,andrepresentmoreefficientalternativestocashastheyallowareduction inbothcostsandrisks related to such payments. Network externalities are evident in this context. The usefulness to thecardholderincreasesastheacceptanceofthecardasameansofpaymentgrowsbroaderandthenumberofcompatibleterminalsincreases.

Inorderforelectronicpaymentstotakeplace,andfornetworkexternalitiestocometofullrealization,someconditions must apply. Complementarities between users need to be in place. Indeed, the utility of anindividualinanEFTPOSmarketiszeroifnoretaileracceptselectronicpayments.However,thepresenceofcomplementaritiesisnotawhollysufficientcondition.Fornetworkexternalitiestoplayarole,compatibilityamongproductsisalsocrucial.Thefinaltransferisbasedonanexchangeofinformationtoauthenticateandauthorizethepayment,andretailersneedtoownaterminalthatallowscommunicationwiththecustomer’sbankwhichinturnauthorizesthetransfer.Thisrequiresatelecommunicationsinfrastructurethatconnectstheretailer’sterminalwithboththeretailer’sandthecustomer’sbank.Inter-operabilityisthereforeparamounttoexploit networkexternalities, and it canbeachieved throughcommon rules, operational standardsandformats(Guibourg,2001).


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However, this result may not necessarily hold in aworld where production is increasingly offshored andinternationaltradeflowsaredominatedbyintermediateinputs,manyofwhichappear tobehighlyspecializedto their intendeduse (Staiger,2012).SectionB.2willprovideamoredetaileddiscussionofthisresult.

Profit-shifting non-tariff measures

Non-tariff measures can also be used to shift profitsfrom the foreign to the home country. This is mostrelevant in imperfectly competitive markets wherefirms have market power, and can effectively useNTMs, suchas subsidies, export taxesandTBT/SPSmeasures,totakemarketshareandprofitsawayfromforeignrivals.

Suppose that two firms, the home and foreign firm,compete in selling to a third market. Competitionbetween them can take many forms but for thepurpose of this discussion two types of competitionareexamined–throughtheirchoiceofoutput(Cournotcompetition)orthroughtheirchoiceofprice(Bertrandcompetition).

Under Cournot competition, Brander and Spencer(1985)demonstratethatagovernmentcanuseexportsubsidiestohelpthehomefirmexpandoutput,therebyforcing its foreign rival to contract production andconcedemarket share. Thesubsidyhas theeffectofcommitting the domestic firm to a more aggressivestrategy which in turn induces the foreign firm toproduce less.18 From the point of view of the homecountry, even though the subsidy payment is just atransfer from the government to the home firm, theprofit-shiftingeffectresultsinthefirm’sprofitrisingbymore than the amount of the subsidy, creating a netgaintothehomecountry.Notethattheexportsubsidycreatesaterms-of-tradelossforthedomesticcountry,butthisismorethanmadeupforbytheprofit-shiftingeffectofthepolicy(Brander,1995).

Iffirmscompeteinprices,EatonandGrossman(1986)show that the optimal policy will be an export taxrather than an export subsidy. Under Bertrandcompetition, both firms would like to charge a higherprice but if only one firm does so it will face lowerexportdemand.However,apricehikewouldnotprovedetrimental to thehomefirm if its rival followswithapriceincreaseof itsown.Bothfirmswillearnpositiveprofits as a result. By imposing an export tax on itsfirm,thehomegovernmentineffectcommitsthehomefirmtochargeahigherpriceforanygivenpricechosenby the rival. Thispersuades the foreignfirm to followsuit – match the home firm’s higher price – whichbenefitsitandthehomefirmaswell.19

Domestic subsidies in the form of research anddevelopment(R&D)subsidiescanalsobeusedtoshiftprofitsfromforeignrivalstodomesticfirms.Thispolicyturns out to be optimal regardless of whether firms

engageinBertrandorCournotcompetition.Basically,the R&D subsidy provides an incentive to the homefirm to increase its R&D investments, therebygenerating cost-reducing innovation.20 If the foreignfirmisnotsubsidizedinturnbyitsgovernment,onlyasmall level of R&D spending will be optimal withunfavourableconsequences for itsability togeneratecost-reducing innovation. The home government’ssubsidy forcesacontraction in theoptimalamountofR&Dspendingbytherivalfirm,therebyshiftingprofitsfromtheforeignfirmtothehomefirm.

Although such subsidies dominate discussion in theprofit-shifting literature, other non-tariff measures,such as TBT/SPS measures, can play a similar role(Fischer and Serra, 2000). Consider a situation inwhich home and foreign firms are competing in thehome market. The home government can impose anewTBT/SPSmeasurewhichraisesbothfirms’costs.This measure also burdens consumers, as both firmstrytopassontheadditionalcostintheformofhigherprices.Despite this, thehomegovernmentmayfind itworthwhile to impose the measure if, as aconsequence, the foreign firm is forced to exit thehome market, leaving the home firm free to earnmonopoly profits, and if the resulting gains outweighthe loss in consumer surplus. The reason that theTBT/SPSmeasureweighsmoreheavilyontheforeignfirm is because it must re-organize production toconform with two different sets of regulations – oneforproductssoldinthehomemarket,andtheotherforproductsdestinedfortheforeignmarket.

(iii) Equity

Governments are not only concerned with increasingnational incomebutalsowithdistributingincomemoreequitably. This type of motive could be hard todistinguishfromtheprotectionforsalemotivediscussedbelow. First-best policies for income redistribution arenottariffsornon-tariffmeasures.Inadvancedcountries,thefiscalsystem–bothonthetaxandexpenditureside–isusedtoalterthedistributionofincome.Particularlyin least-developed countries (LDCs), where fiscalsystemsarelessdevelopedandsocialsafetynetsoftennon-existent, governments appear to use trade policyinstrumentsandNTMs inparticular toachieve incomedistributiongoals.21

Kalenga (2012) provides evidence that import andexportbansandquotarestrictionsoncommoditytradecontinuetomakeupasignificantpartofNTMsinsub-Saharan Africa. The use of export restrictions by anumber of emerging economies when commoditypricesspikedin2008wasmotivatedinparttoalleviatethe pressure of high food prices on the mostdisadvantaged (Organisation for Economic Co-operationandDevelopment (OECD),2009a).SectionB.3andBoxB.7provideotherexamplesofmeasuresin the services sector whose underlying motive isequityandincomeredistribution.


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(iv) Political economy (protection for sale)

Allthemotivationsdiscussedaboveinvolveincreasingsocialwelfarebyusingnon-tariffmeasurestocorrectmarketfailuresortotakeadvantageofacountry’sorafirm’s international market power. However, politicalleadersmayhaveothermotivationsbeyondthewelfareofcitizens.Forexample,theymaydependonfinancialcontributionsfromspecialinterestgroupswhowantasay in tradepolicy (GrossmanandHelpman,1994).22

In these cases, trade protection is “for sale” to thehighest bidder. If policies are being influenced byspecialinterestgroups,itshouldbeapparentfromthestructure of the protection being offered andthenatureofthelobbyingbehindit.This isdiscussedingreaterdetailinBoxB.4.

The original study by Grossman and Helpman onlyconsidered the use of trade taxes – tariffs, importsubsidies, export taxes and export subsidies – by“captive”policy-makersunder the influenceofspecial-interest groups. The subsequent protection for saleliteratureextendstheanalysistocoverothernon-tariffmeasures. Maggi and Rodríguez-Clare (2000), forinstance, consider a situation where importers makecontributionstothepoliticalincumbent.Theinterestsofimportersareopposedtothoseofdomesticproducerswho benefit from import restrictions. However, ifprotection is to be given anyway, importers will preferthatittakestheformofimportquotasratherthantariffsbecausetheywillbeabletoobtainthequotarents(i.e.theincomegeneratedbyimportswithinthequotalimit).Rather than being motivated by some public policy

objective,theuseofquotassimplyreflectstheinfluenceof importers’ interests on policy-makers. Maggi andRodríguez-Clare point out that political contributionsmay be made by foreign exporters as well. This couldexplain the use of voluntary export restraints (VERs)sincethequotarentsaccruetoforeignexportersratherthanhome-countryimporters.

Politicianscaptive to special interestsmight alsouseTBT/SPS measures or customs procedures as ameans of transferring profits to their benefactors(Abel-Koch,2010).Oneofthe“stylized”findingsfromthe“newnew”tradetheory(Melitz,2003;Helpmanetal., 2004; Chaney, 2008) is that only the mostproductivefirms inacountryareengaged inexports.Thisstylizedfactisexplainedbyfirms’widelydifferingproductivity(“firmheterogeneity”)andtheexistenceoffixed costs to exporting. These are costs that areincurredbyfirmsonlyonceinordertoaccessaforeignmarket,suchasmarket informationcosts, thecostofsetting up a distribution system, or the cost ofcomplyingwithforeigntechnicalregulations.Thefixedcostofexportingturnsouttobecriticalindeterminingwhichfirmswillbeabletoaccessforeignmarketsandwhichfirmswillfailtodoso.

SupposethattheimportingcountryrequiresallforeigngoodstocomplywithitsnationalTBT/SPSmeasures.Since this increases the fixed cost of exporting, lessproductivefirmscannotgenerateenoughrevenuestocover thehigher fixedcostsof accessing the foreignmarketandthereforeexit it.Thisreducescompetitionin the importing country and increases the market

BoxB.4: Is it possible to identify disguised protectionism in NTMs?

Asnotedat thestartof thissection,non-tariffmeasures thatareused toachievepublicpolicygoalsmayalsobeusedtopursueillegitimateends.ThismakesitdifficulttoascertainwhatmotivatesagovernmenttoapplyaparticularNTM.Withoutunderestimatingthechallengethisposes,theeconomicliteratureidentifiesanumberofbenchmarksthatcouldbeusedtoanswerthequestion.Tocomplementthisanalysis,asetoflegaltoolstoidentifydisguisedprotectionismbasedonWTOjurisprudenceisdiscussedinSectionE.3.

The “protection for sale” literature predicts that organized or lobbying sectors would be favoured. Withinorganized groups, the import-competing members typically obtain protection while exporting membersreceiveanexportsubsidy.GrossmanandHelpmanalsopredict thatunorganizedsectorswillbepenalized,with import-competingproducers facingan importsubsidyandexportingsectorspenalizedwithanexporttax.23Sectorswithlowelasticitiesofimportdemand(exportsupply)willenjoyhigherlevelsofprotectionorsupport. The rationale for this is that thegovernmentwill prefer to raise contributions from thosesectorswhereincreasedprotectioncreatestheleastlossestosociety.

Finally, sectorswhere import penetration is low will enjoy greater protection.24This is because in sectorswithlargedomesticoutput,producershavemuchtogainfromanincreaseinthedomesticprice,whiletheeconomy has relatively little to lose from protection when the volume of imports is low. Using US data, anumberofempiricalpapershavebeenabletoconfirmthattheobservedpatternofprotectionandlobbyingisconsistentwiththepredictionsoftheprotectionforsalemodel(GoldbergandMaggi,1999;GawandeandBandyopadhyay,2000;Facchinietal.,2005;Bombardini,2008).

The lack of transparency of a measure may also be a tell-tale sign of lurking protectionism. Politicalincumbentshaveaninterestincamouflagingthetransferofincometospecialinterests.Thelesstransparentthemeasures,thegreaterleewayincumbentshavetoservetheirprincipals.


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share and profits of domestic firms. A governmentcaptive to domestic producers can use compliancewith TBT/SPS measures as a way of increasing theprofitsoftheseproducers.

In theprotectionforsale literature, it isassumedthatnon-tariff measures are more widely used nowbecause trade agreements and multilateral rulesincreasinglyconstraintheuseoftariffs.However,thismay not be the only reason why NTMs are used bypolitical incumbents. As is explained in Section B.2,political leaders might prefer to use TBT/SPSmeasuresbecause theirgreateropaqueness reducestheelectoralriskposedbytheiruse(CoateandMorris,1995;Kono,2006;Sturm,2006).

(c) WhatarethetradeandwelfareeffectsofNTMs?

The previous discussion established that, apart frompolitical economy motives, governments use non-tariffmeasurestoincreasenationalwelfare.Thismeansthattrade and welfare effects need not move in the samedirection.TheapplicationofanNTMmayreducetradeand yet increase the welfare of the NTM-applyingcountry.Theeffectslargelydependonthenatureofthemarketfailure,thetypeofNTMused,andothermarket-specificcircumstances.Nevertheless,thetradeeffectsofthespecificmeasuresarehighlyrelevant.

Thetradeeffectsofnon-tariffmeasurescanbelargein a world of deepening economic integration andshaped by complex cross-border production in theform of global supply chains. Using NTMs to pursuebeggar-thy-neighbour policies – to manipulate acountry’stermsoftradeortostealprofitsfromforeignenterprises – is a game that can be played by everycountry. A government tempted to employ suchmeasures, but concerned about national welfare, willneed toworryabout thepossibilityof similarbeggar-thy-neighbour NTMs being used against it by tradepartners.Themagnitudeofthepossiblewelfarelossesfrom others’ opportunistic actions is linked with thesizeof the tradeeffects.This issue,and the role thatinternational cooperation can play in addressing it, isthefocusofSectionE.

Even in the absence of explicit beggar-thy-neighbourpolicies, and where non-tariff measures are onlytargetedatgenuinemarketfailures,themeasuresmaybe opaque, poorly designed, or badly implemented,thus increasing uncertainty and trade costs. Anycountry – whether the home country or its tradingpartner–canbeguiltyofthesefailings,whichwillendupreducingtradeandthepotentialwelfaregainsthattheNTMswere intended toachieve in thefirstplace.One area that illustrates the potential problem isconformityassessment.25

Conformity assessment procedures are technicalprocedures—suchastesting,verification,inspection

andcertification—whichconfirm thatproducts fulfilthe requirements laid down in regulations andstandards. Generally, exporters bear the cost, if any,oftheseprocedures.Ideally,attestationofconformityshould be carried out only once in the most cost-effective manner and, subsequently, be recognizedeverywhere. However, in many instances, authoritiesin the importing country are not willing to rely onforeign manufacturers’ own declarations orreports/certificationsbythirdpartiesthattherequiredspecificationshavebeenmet.WhatevertheTBT/SPSmeasure may be, assurance of compliance will besoughtfromdomesticbodiesintheimportingcountry.This will unnecessarily raise trade costs if foreignconformity assessment bodies already possess thecompetence to assure them that products meet therequirements of the importing country. See SectionC.2 and Section D.2 for evidence about conformityassessmentproceduresandestimatesofthecosts.

Sinceitisimpossibletoanalysethetradeandwelfareeffect of every non-tariff measure, the followingsectionfocusesonexamplesregardingquantity,priceandqualitymeasures.

(i) Quantity measures

Theclassicexampleofaquantitative restriction isanimport quota which fixes trade flows at a given level.Sincethetradeimpactofaquotaisunambiguous,theinteresting issue is its effects on other economicvariables. Section B.1(b) highlighted instances whenan import quota was an instrument used to transferincome (quota rent) to special interest groups andwhen a government might use an import quota toachieveapublicpolicygoal.

If the level of infant industry protection needs todecline over time, and policy-makers lack reliableinformationabout the requiredpolicy setting, aquotamayservebetter thanasubsidy (Melitz,2005). If thesafety of foreign products cannot be assured andthere isnowayforconsumerstodistinguishbetweensafe and unsafe products, an import ban might bewarranted. However, a careful consideration of theselatter instances suggests that extenuatingcircumstances in the form of high information costswere required to justify the use of import quotas. Inalmost all other circumstances, other non-tariffmeasureswouldbepreferabletoquotas.Forexample,in the case of infant industry protection, a subsidy issuperior to an import quota. Likewise, TBT/SPSmeasuresorlabellingschemesworkbetterthanabanin addressing all but the most extreme forms ofinformation asymmetry. The following discussionaddresses other issues related to the effects of aquota.

In principle, it is possible to calculate an ad valoremtariffratethat, ifappliedinplaceofaquota,willhavethesametradeeffect.Eventhoughimportlevelswould


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be identical, there are critical differences betweentariffs and quotas that have an important bearing onwelfare. If demand expands because of income orpopulation growth, for example, imports will growunder a tariff but not under a quota. A quota alsogenerates income (quota rent) for importers whereastariffsgenerate revenues forgovernment. Inaddition,the existence of quota rent can lead to an unhealthystruggleamonginterestgroupstoacquiretheserents,abehaviourknownas “rent-seeking” (Krueger,1974),whichcaneitherbelegalorillegal(e.g.takingtheformof bribery or corruption of officials). Since competinggroups expend resources to capture the quota rent,rent-seeking adds to the welfare losses orinefficienciesunderquantitativerestrictionthatdonotexistundertariffs.

Ifdomesticproducershavemarketpower,aquotaalsogives them greater scope to restrict imports than atariff(Bhagwati,1968).Whiletotalimportsremainthesameasunderatariff,domesticproducersareabletochargeconsumersapricegreaterthantheworldpriceplus the tariff equivalent of the quota. This effect isdemonstratedmostclearly inthecaseofamonopoly.Underatariff,thedomesticmonopolistcannotchargeanypriceabovetheworldpriceplusthetariffwithoutimports flooding in. However, a quota insulates thedomesticmarketfromtradeonceagiventhresholdofimports isreached,allowingthemonopolisttochargethe monopoly price because there is no offsettinginflowofimports.

Thecasewheretheimport-competingindustryismadeup of an oligopoly (i.e. a market dominated by a smallnumber of sellers) is more complicated. If theoligopolistscompetewithoneanother,itwillstillbetruethataquotagivesthedomesticfirmsgreaterscopetoexercise market power. The domestic price ends upbeingabovetheworldpriceplusthetariffequivalentofthe quota but less than the monopoly price (Helpmanand Krugman, 1989).26 If the oligopolists collude, itturns out paradoxically that the cartel may charge alowerpriceunderaquotathanunderatariff(Rotembergand Saloner, 1988) because cartels are subject todefectionbymembers.Thehigherthepricechargedbythe cartel, the greater the temptation for any singlemembertocheatbysellingmorethanitsallottedshareof total output. Thisopportunisticbehaviour is rationalfor a cartel member even if it risks breaking up thecartel, so long as the additional profit made fromcheating is greater than the present value of thereduction in future profits resulting from the cartel’scollapse.27Given thepossibilityofabreakdownof thecartel and the lower profits it implies, cartel membersmaychoosetochargealowerpricewhichisjustenoughtopreventdefections.

(ii) Price measures

InSectionB.1(b),severalexamplesofpricemeasures(a domestic tax, a production subsidy, and an export

subsidy) were examined, as well as their use inaddressing market failures (such as externalities andinformationasymmetry)and inshifting termsof tradeandprofits.

Sinceexternalities involvea failure to incorporate thebenefitorharmcausedbyacertaineconomicactivityinto market prices, price measures should be thepreferred tool to address this type of market failure.Such measures can result in either an expansion orcontractionoftradeflows.Ifthereisalegitimatecaseforinfantindustryprotection,forexample,aproductionsubsidy reduces imports but also improves economicefficiencybygivingdomesticfirmstimetoaccumulateexperience, whose learning in turn benefits theindustryasawhole.Ineffect,thereis“toomuch”tradesince the market fails to price in domestic firms’capacitytolearnandbenefitotherfirmsintheindustry.A different pattern will result if a Pigouvian tax isappliedtocorrectpollutionathomeandthedomesticindustry is import-competing. Domestic outputexceeds the socially optimal amount and “too little”trade is being generated because the market fails toprice in the environmental harm created by domesticproducers. In this case, the Pigouvian tax results inboth the imports and the welfare of the importingcountryrising.

Byitsnature,anexportsubsidyisintendedtoincreasethe subsidizing country’s trade. Leaving aside theexamplediscussedbyFeenstra(1986), ifmarketsareperfectly competitive, an export subsidy moves theterms of trade against the subsidizing country andreducesitswelfare.Tradeandwelfarethereforemovein opposite directions. Despite the loss in socialwelfare, this may well be the chosen trade policy ifpolicy-makers are beholden to producer groups. Asnotedabove, oneof thepredictionsof theprotectionforsaleliteratureisthatorganizedgroupsintheexportsector will be supported with export subsidies. Ifmarkets are oligopolistic, and firms compete inquantity, an export subsidy will move profits to thesubsidizing country and increase its welfare. In thiscase, both trade and welfare move in the samedirection. If firms compete in price, an export tax willbe required to shift profits from the foreign to thehome firm. Since an export tax reduces trade, tradeand welfare of the country applying the non-tariffmeasuremoveinoppositedirections.

Althoughwedonotnormallythinkofpricemeasureswhen confronted with problems of informationasymmetry, we saw an example of how an exportsubsidycouldbeusedtoovercomethatmarketfailureinSectionB.1(b).Uncertaintyintheimportingcountryabout thequalityof foreigngoodsacts likeamarketbarrier. The export subsidy allows the foreignproducer with the high-quality good to introduce itsproduct to consumers in the importing country byselling at a lower price. If enough consumers therehaveatasteforthehigh-qualitygood,tradeexpansion


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willbecoupledwithawelfaregain for the importingcountry.

(iii) Quality measures

As explained above, a quality measure will requirechangestothetechnicalfeaturesofimportedproductswhich can be either an obstacle to or a catalyst fortrade.Requiringexporterstocomplywiththeimportingcountry’sTBT/SPSmeasurescanincreasetradecostsanddiminishtheirexportprospects.Ontheotherhand,if compliance with the TBT/SPS measure resolvesuncertaintyaboutthequalityorsafetyoftheimportedproduct, greater consumer confidence can increasethedemandfortheitemandincreasetrade.Thetradeand welfare effects of a quality measure depend onwhether it addresses genuine market failures. If themeasureisappliedonlytoprotectdomesticproducers,both trade and welfare in the importing countrydecrease. If,on theotherhand, themeasurecorrectsanexistingmarketfailure,welfareis likelytoincreasewithambiguouseffectsontrade.

Take the extreme case where there are no marketfailures but where the importing country requires allimportedproductstocomplywithanewly introducedTBT/SPSmeasure.28 It ispossible todistinguish twotypes of trade costs that would be increased by therequirement to comply with the importing country’sregulation.Compliancecanincreasethevariablecostof exporting, with each unit of export incurring anadditional cost. Alternatively, compliance can requiretheexportingfirmtorevampitsproductionprocessorupgrade its technology. In this case, irrespective ofthe volume of exports, the firm will incur a fixedamountofexpenditureifitwantstoaccesstheforeignmarket.

Anincreaseineitherfixedorvariablecostswillhavetwo effects. First, it will decrease the volume ofexports of those firms who continue to serve theexport market. This is sometimes referred to as theintensive margin of trade. Secondly, the leastefficient exporters will no longer be able to covertheirfixedcostsofexportingandsowouldbeforcedto quit exporting altogether, sometimes referred toastheextensivemarginof trade.29WhereTBT/SPSmeasures are imposed in the absence of a marketfailure, social welfare will fall in the importingcountry.Consumersintheimportingcountryloseoutboth because the variety of goods is reduced, assomeexportersexit themarket,andbecausepricesrise as the volume of trade declines. This is not tosay that there will be no winners in the importingcountry. Domestic firms stand to gain because thewithdrawal of some exporters and lower sales fromremaining exporters reduces competition in thehomemarket.

However, suppose that there is a genuine marketfailure involving informationasymmetry.Consumers intheimportingcountryareuncertainaboutthesafetyofthe foreign good. Firms in the exporting country maybe newcomers to global trade and have little or noreputationtobuildon.Foreignproducersknowiftheirproductissafeornot,butconsumersintheimportingcountry have no reason to trust their claims. Underthesecircumstances,theremaystillbedemandfortheforeign product, but it is likely to be low. Requiringforeignproductstocomplywiththeimportingcountry’sTBT/SPSmeasurescanresolvethisuncertaintyinthemindofconsumers.Compliance,however,addstotheexportingfirms’costofproduction.

Under these conditions, the regulation will have twoopposingeffectsontrade(seeBoxB.5).Theneedtoconform to the new regulation raises the cost of theimportedgoodwhichwill tend to lower thevolumeoftrade.However,enhancedconsumerconfidenceinthesafetyoftheforeignproductwill increasedemandforit. While it is possible that the increased compliancecosts will force some exporters to exit the market,otherswillusetheircompliancewiththeregulationasa competitive advantage and increase their marketshare. In the context of food safety regulations, forinstance, Jaffee and Henson (2004) note that morestringent SPS measures in rich importing countrieshave different impacts on the competitive position ofdeveloping countries, exposing the weaknesses ofsome producers but accentuating the underlyingsupply-chainstrengthsofothers.

Furthermore, some countries use high-quality andsafetyregulationstosuccessfullypositionthemselvesinglobalmarkets.Like trade, theeffectonwelfare isambiguous and depends on the relative strengths ofthe forces acting on consumers and domesticproducers. The increased cost incurred by foreignexporterstocomplywiththemeasureshouldincreaseoutput and revenues for domestic producers. Forconsumers,therearetwoopposingeffects–ahigherprice for the product which needs to be weighedagainst the improvement in the product’s safety orquality.

Finally, while Box B.5 seems to suggest that anincrease (decrease) in trade leads to an increase(decrease) in welfare, this does not necessarily holdundermoregeneralconditions.ThisisshowninDisdierand Marette (2010) for example, where despite areduction in trade, welfare improves when theapplicationofaTBT/SPSmeasurecorrectsanexistingmarket imperfection.Thisresult isconsistentwiththeargument that sometimes theadverse tradeeffect ofa non-tariff measure is a by-product of pursuing alegitimatepublicpolicygoal.


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2. ThechoiceofNTMsinlightofdomesticandinternationalconstraints

In theprevious sub-section itwasshown that inmanyinstances,non-tariffmeasures,eventhoughtheyaffecttrade, are first-best policies to address a legitimatepublic policy objective, such as consumer health andsafety protection. However, the same measures canalso be employed in a way that distorts internationaltrade.InordertodecideinsuchcaseswhetheranNTMis innocuous, it is useful to determine whether themeasure is likely to be pursued for competitivenessreasonsratherthanthestatedpublicpolicyrationaleorwhether itmayaffect trademore than isnecessary toachieveitspolicyaim.30SectionB.2(a)exploresarangeof scenarios in the domestic political and economiccontextinwhichgovernmentsmaybeinclinedtomisuseNTMsinthismanner.SectionB.2(b)considershowfarsub-optimalpolicychoicesreflectgovernment-imposedconstraints on alternative options. The question ofpossible “policy substitution” may arise wheninternational trade agreements limit the use of tariffs

and certain types of NTMs but regulate other, lessefficientoptionslesseffectively.

(a) UseofNTMsanddomesticpolicyconsiderations

An important reasonwhygovernmentsmaychoose topursue trade policy objectives by applying non-tariffmeasuresassociatedwithotherpublicpolicygoals,or,more generally, may not choose the most efficientmeasure for this purpose relates to the lack oftransparency of certain NTMs regarding their ultimateeffectandpurpose.This“opaqueness”maymakesuchmeasures more attractive for politically motivatedinterventions where beneficiaries and the size of theeffectsarenoteasily identified.Otherexplanationsforsuchpolicychoicesemphasize institutionalconstraintsthat entice politicians to choose NTMs with certaincharacteristicsevenifthesemeasuresareeconomicallywastefulcomparedwithalternativemeans.

The fact that some NTMs entail a fixed rather thanvariablecost isanotherfactor thatmayexplainwhyagovernmentsubjecttopressurefromparticulargroups

BoxB.5: Effect of TBT/SPS measures on trade and welfare

AssumethatacountrydoesnotproducethegoodXandmeetsallitsconsumptionthroughimports.Theseimported goods differ widely in quality and consumers are unable to tell them apart. Because of thisuncertainty,demandislow(givenbythelineBDinFiguresB.1(a)and(b))andpriceisequaltoOW.ImportsareequaltoOA.Thegovernmentoftheimportingcountryrequiresforeignproducerstocomplywithaqualityassuranceprogramme;otherwisetheirgoodswillnotbeallowedtobesoldinthecountry.ComplianceraisesthecostsofforeignproducerssothatthepricetheychargerisesfromOWtoOW’.However,consumersarenow assured that only high-quality products are being sold in the market which leads to a shift in theirdemandtoBD’.OnepossibleoutcomeisthattotalimportsrisetoOA’inspiteofthehighercostofimportedgoods (see Figure B.1(a)). Some consumer surplus is lost, given by the area labelled WW’EF, as aconsequence of the cost of compliance. However, the increased confidence in the higher-quality importsresultsinagainequaltothearealabelledBEC.Overall,therehasbeenanincreaseinconsumerwelfaresoin thiscasebothsocietalwelfareandtrade increaseat thesametime.Anotherpossibleoutcome involvesimportsdeclining(seeFigureB.1(b)).Theincreaseinconsumerconfidenceisnotsufficienttoovercomethehighercostofcompliance. Inthissecondexample,bothtrade(fallingfromOAtoOA’)andsocietalwelfaredecline(thelossofWW’EFoutweighsthegainofBEC).

Figure B.1(a): Effect of TBT/SPS measures on trade and welfare: both increase

O A A’ Imports

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FigureB.1(b):Effect of TBT/SPS measures on trade and welfare: both decrease

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may favour NTMs over tariff protection. Finally, theexistence of market power in a context of offshoring(andthepossibilityofextractingprofitsfromexporters)mayexplainwhytradeconcernscanleadbothwelfare-and politically oriented governments to tamper withdomestic policies rather than border policies alone.Eachoftheseexplanationsisdiscussedinturn.31

(i) Transparency

Although it has been argued that in competitivepolitical systems, politicians who favour specificinterestgroupsinaninefficientmannerwouldbevotedout of office (Stigler, 1971), the political economyliteraturehasincreasinglypaidattentiontotheformofgovernment intervention.Onebranchof the literaturepresumes that citizens are poorly informed as to theeffects of various policies and the extent to whichdifferentpoliticiansmaybereceptiveto lobbying. It isnot unrealistic to assume that politicians have betterinformationthancitizensaboutwhethertheconditionsforawelfare-improvingpolicyinterventionareactuallysatisfied.32 In addition, it may be true that citizensremain unsure after a policy is implemented whetherthe government has acted in the national interest orsimplycateredtoorganizedinterests.

Inparticular,asTullock(1983)observes,policiesmaybechosenthatbenefitorganized interestgroupsand,at the same time, are justifiable on other widelyaccepted grounds, such as environmental protection,and, hence, may affect positively the government’sreputation with the public at large. This mismatch ininformation between citizens and the governmentabout both policies and politicians’ motivations canlead to the implementation of “inefficient ‘sneaky’methods of redistribution over more transparentefficient methods” (Coate and Morris 1995: 1212),evenwhenthelatterareavailable.

Inthefieldoftradepolicy,non-tariffmeasuresmaybeameanstoincreasetheincomeofproducerlobbieswhileconcealing the associated costs and/or the truebenefits of the alleged policy objective (e.g. health,environment)tothepublicatlarge.33Ratherthantariffsthatarestraightforwardintheirpriceimpactandcosttoconsumers,an“opaque”NTM,suchasanenvironmentalregulation, may shelter an import-competing sectorfrom foreign competition and, at the same time, beperceivedasbeinginthepublicinterest,eventhoughapropercost-benefitanalysismaynotshowanetwelfaregain.Uncertaintyaboutthejustificationfor,andimpactof,differentpoliciescannotexplainon itsowntheuseof opaque non-tariff measures, as competition amongpoliticians would allow voters to sanction thosepoliticiansthatpursuelessefficientpolicies.

However, this changes when the possibility of“government failures” is taken intoaccount.CoateandMorris (1995) describe a situation where different“types”ofpoliticiansarecompetingforofficeandvoters

areunsureastothetruenatureofpoliticians’intentions.Insuchacase,reputationmatters.“Bad”politicians,i.e.those who wish to increase the income received byspecial interest groups at the expense of the generalpublic, may have an incentive to implement a “public”policy that indirectly benefits the preferred interestgroup, even though it is not warranted on grounds ofnational welfare, because open favouritism to certaingroupswouldentailagreaterreputationaldamage.34

In other words, by increasing the income of specialinterest groups through “opaque” rather than directmeans,thesepoliticianslimitthenegativereputationalimpact. This is because voters cannot be sure that agivenpublicpolicyisbeingmisusedby“bad”politicians,as “good” politicians would pursue the same policy,albeitonly if it resulted inanoverallnetwelfaregain.As noted above, this presupposes that citizens areunable todetermine theoverall costs/benefits of thepublicpolicyinquestionwithanydegreeofconfidenceboth before and after it is implemented. This is aplausible assumption for policy decisions in manyareas(CoateandMorris,1995).35

Theauthorsspecificallycitetheexampleoftemporaryinfant industry production subsidies pursued toencouragelearningbydoing.Whetherthesesubsidiesbenefit the public or not ultimately depends on theamountoflearningbydoingtheyengender,anditwillbedifficultforcitizenstoverifywhethersuchsubsidieswereintheirinterest.Sturm(2006)citesanumberofrecent trade disputes over environmental or healthregulations to construct a similar model, in whichuncertaintyabouttheoptimallevelofregulationallowspoliticianstoprovidedisguisedprotectiontothe localindustry and, hence, to limit possible negativeconsequences in future elections.36 Like Coate andMorris(1995),Sturm(2006)characterizessuch“greenprotectionism”(i.e.theunwarrantedimplementationofa product regulation in view of the limitedenvironmentalrisk)asapoliticalfailure,aspreferableinstrumentsfromawelfareperspectiveareavailable–in this case, direct subsidies to local producers.However, these are not chosen by “bad” politiciansowing to their potentially negative impact on thepoliticians’re-electionprospects.

In an interesting extension to the Coate and Morris(1995)set-up,Sturm(2006)alsoconsidersthepoliticalconditions in the exporting country. It is assumed thattheforeigncountryhasacomparativeadvantageintheproductinquestionandthatitwouldbemorecostlyforforeign producers to comply with an environmentalregulation than for domestic producers. Politicians inthe exporting country (both “good”, i.e. solely socialwelfare-oriented, and “bad”) would therefore opposethe product regulation for its negative impact on thecountry’s terms of trade. However, due to the samepoliticalfailuredescribedabove,“bad”foreignpoliticianswould oppose compliance with a product regulationeven if the environmental risk was sufficiently high to


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affect welfare of consumers in their own country. Inotherwords, althoughadherence to theenvironmentalregulation would increase welfare in the exportingcountry as well, bad politicians would continue tooppose it to the benefit of their constituency in theexportsector,asituationtheauthorcalls“environmentaldumping”.

A situation where politicians in the importing countryimplement the product regulation, while politicians inthe exporting country do not (i.e. a potential face-offonthetradeimpactofenvironmentalpolicy),canhaveimplicationsfortheirreputationsinanyoneofthetwocountries. While voters may be unable to distinguishwhether theforeignenvironmentalpolicy is too laxorthedomesticregulationtoohigh,theyknowthatsuchdisagreement over the appropriate environmentalpolicy implies that at least one of the two incumbentgovernmentsisofthe“bad”type,i.e.pronetoinfluencefromproducerlobbies.

In other words, the “politician who is distorting theenvironmentalpolicy…imposesanegativereputationalexternalityontheotherincumbent”(Sturm2006:576),and, by implication, disagreement over the appropriatepolicy with a respectable politician in another countrycan entail a reputational damage for a domesticincumbent. In practice, this implies that transparencyandthefreeflowofinformationonpoliciesandpoliticalprocesses across countries can help to constrainspecial interest-oriented policy choices.37 Section Ediscusses further the rationales for cooperation ongovernment regulations, for example in the fields ofSPSmeasuresandTBT,andothertypesofNTMsandhighlightstheimportanceoftransparency.

(ii) Institutional constraints

Institutional constraints can make economically lessefficientnon-tariffmeasuresbetterfortheinterestsofpoliticians or social groups that hold political power.First, governments may be limited in their ability todirect benefits to important constituents. They maylack the information necessary to target resourcestowardstheirsupporters,orthecredibilitytomaintainthose policies, without an otherwise inefficient non-tariffmeasure.

Secondly, if the public elects a new government, theinterest groups that support the incumbent may loseinfluence. Inconsistency problems between thegovernmentanditssupportersleadpoliticianstotrytoenact policies that are difficult to reverse. CertainNTMs may be less exposed to the winds of politicalchange.Finally,governmentpolicy isnota “monolith”,but rather reflects the interests of parochialdepartments, bureaucrats and legislators. Intra-governmentalconflictcancreatefrictionsthat leadtothe implementationof inefficientNTMsfavouringoneparticularinterestoveranother.

Targeting political supporters

Some non-tariff measures that are comparativelyinefficient, such as a market-distorting regulation, canhelp the government to target policies towards theirfavoured constituency. Concretely, a government maypreferapolicythatislessefficientifitsoutcomeismorepredictable. In order to illustratewhy such distortionarypolicies persist, Mitchell and Moro (2006) describe acase in which removing an inefficient trade measurecreates winners and losers in society.38 The authorspresume that the NTM in question is “informationally”efficient, as compensating those that would lose fromtrade opening requires knowing the extent to whichforeign market competition actually causes the harm,while keeping the NTM in place requires no suchadditional knowledge. It is assumed that informationabout actual losses is private, i.e. “losers” from tradeopeninghavetheincentivetoover-reporttheirlosses.

If the government worries about excessive spendingon compensation policy, it may prefer to sustain theNTM rather than make decisions about how much tocompensate.39 Here, a key assumption is that theeffectsofanNTMareeasiertoverifythantheeffectsoftradeopening.Thisargumentislessplausibleifthecostsofover-compensationareloworthegovernmentis equally informed (or equally ignorant) about theeffects of an NTM compared with a more efficientredistributivepolicy.

Acemoglu and Robinson (2001) address a similarproblem in the following example. If farmers holdsignificantpoliticalsway,thegovernmentmayconsiderproviding either a lump-sum transfer (i.e. incomesupport) or price support in order to maintain favourwiththisgroup.Pricesupportrepresentsalessefficientinstrument because of its effects on product markets,andfromanationalwelfareperspective,thegovernmentshouldpreferalump-sumtransfer.However,despiteitsnegativeeffectsonconsumersandtrade,governmentsmaypreferpricesupport,whichefficientlytargetsthosewho are genuinely farmers in the short-run, as farmoutput is a prerequisite for receiving the subsidy.Conversely, lump-sum payments might go to a largernumberofbeneficiarieswhomerelyclaimorpretendtobefarmers(Stigler,1971).

In addition, Acemoglu and Robinson (2001) highlightthat price support increases the returns to farmingand, inthelongrun,encouragesmoreentry intofarmactivities, which further entrenches farmers’ politicalpower. Hence, for the government the distortiveeffects of the price support policy are potentiallyoutweighedby thebenefitsof solidifying thepoliticalpowerofitsfavouredconstituency.

Policy reversals

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perspectiveofaninterestgroup,relativelymoreefficientpolicymeasuressuchasaone-timesubsidyora tariffmayhavethedisadvantageofbeingsubjecttoreviewbynew legislaturesorotherelectedofficials.Bycontrast,certainnon-tariffmeasures,suchasproductregulations,maybedefinedandimplementedbyregulatoryagenciesunaffectedbypoliticalchangeandmaynotbesubjectto a regular renewal process. Rubin (1975) notes thatsuch long-lived but inefficient policies can benefitpoliticiansbyincreasinginterestgroupsupport.

Politicianswhoareunsureabouttheirownre-electionprospectsreceivelessfromlobbyistsforashort-term,reversiblepolicy.However,politiciansmaynonethelessreceive benefits from special interests if they put inplacemeasures, suchasproduct regulationsand therelated bureaucratic apparatus that last beyond theirexpectedcareers.InefficientNTMswhichlackregularoversight also call upon fewer resources to influencethepoliticalprocessand, thus,are lessexpensive forlobbyistswithsufficientlylong-termhorizons.40

Intra-governmental conflict

Even if legislators do have regular oversight ofregulatorypolicymeasures, thebargainingnecessaryto pass legislation can distort policy decisions. Eachlegislator must decide how to allocate resourcestowards policies that benefit the whole country andthose that primarily benefit their local constituency.Politiciansmaybewilling topassapolicyof nationalinterest only if, for example, a subsidy is given to anindustrylocatedintheirhomedistrict.Asalllegislatorsmay need to cater to special interests, inefficientpoliciescanproliferate(Weingastetal.,1981).41

Further inefficiencies can arise if each legislatorrepresents a number of constituents with conflictinginterests.Dixitetal. (1997)developamodel inwhichinterest groups spend resources on lobbying forgovernment policy. As with the farming case above,lump-sum cash transfer policies by the governmentwould be more efficient from a welfare perspective,buttheauthorsdemonstratethatcompetitionbetweenindividual interestgroups formore transferscan leadto an inefficient allocation of resources to lobbying.Thiscanexplainwhythe interestgroupsmayseektoagree on a comparatively less efficient non-tariffmeasure that may not require them to lobby. Whilesuch an NTM reduces overall efficiency, it ultimatelychannelsmoreresourcestothegroups.

Theoversightproblemalsoarisesbecauseofalackofcoordination within governments and across agenciesthatproduceandregulatenon-tariffmeasures.Becauseagency jurisdiction is often allocated according to afunction,agivenkindofNTMcanbetheresponsibilityofanumberofoverlappingdepartmentsorcommitteeswithin a government. Efficient policy-making requiresthe contribution and cooperation of a number ofagencieswithdifferentinstitutionalinterests,butthese

agenciesmaynotvaluetheoverallpolicygoalasmuchas a parochial interest. As a result, intra-departmentmiscommunication or competition can producepersistently inefficient policies. This implies thatreforming NTMs that involve a range of domestic andpossibly sub-national regulatory agencies may requirebroaderattentiontothepotentialbureaucraticfrictionsthatpreventcooperation(Gulotty,2011).

(iii) Firm preferences for trade measures inducing fixed costs

Recent economic research on the diverse nature offirmswithinaparticularsectorintermsofproductivityand size has led to another rationale why tradeprotection may come in the form of “behind-the-border” non-tariff measures rather than borderprotection. A range of NTMs, such as TBT/SPSmeasures,haveanimportantfixedcostcomponent,ascostly production adjustments have to be made, butperunitcostssubsequentlydeclineasmoreoutput issoldintherespectivemarket.42

Owingtoproductivityandsizedifferencesamongfirms,fixed cost increases affect firms differently, unlikevariableleviesthatraisecostsforeveryfirmbythesamepercentage.43 Hence, although a technical productregulationaffectsbothdomesticand foreignfirms, thefixed costs it entails represent a higher burden forsmallerandlessproductivefirmsinbothcountries.Asaconsequence, the least efficient firms will cease to becompetitive and exit the market, while the moreproductiveandlargerfirmsbothdomesticallyandabroadwill see their profits and market shares increase.Ultimately,behind-the-bordernon-tariffmeasuresofthissortonlybenefitthecountryintroducingthemeasureasa whole if the ratio of very efficient to very inefficientfirms is larger at home than in the exporting country(Rebeyrol andVauday,2009;Abel-Koch,2010).44Thisisincontrasttobordermeasures,whichalwayspenalizeforeignfirmstothebenefitofdomesticproducers.

Underwhatcircumstances, then,wouldabehind-the-border non-tariff measure rather than borderprotection be introduced? Of course, like bordermeasures, distortionary behind-the-border measuresmayalsohaveanegativeimpactonconsumerwelfare.However,asdiscussedintheprevioussub-sections,apolitically-oriented government may yield to lobbypressurefromdomesticproducers.Assumingthatonlythelargestandmostefficientfirmshavethemeanstolobbythegovernment,45theymaygainmorefromtheintroduction of a behind-the-border NTM at theexpense of small, less productive producers at home(evenifsomeofthegainsalsogotomoreproductivecompetitors abroad) than from border protection thatshieldsalldomesticfirms(includingthosethatdonotlobby)fromforeigncompetition.

Lobbying foramoredemandingproduct regulation ismore likely the less the government is concerned


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about social welfare and the fewer foreign firms areactiveinthedomesticmarket.Thereasonforthelatteris that when trade is already low (e.g. due to largelyinefficient foreignfirmsorexistingborderprotection),an increase in behind-the-border non-tariff measureshas a relatively more important effect on domesticcompetition.Tosomeextent,thisiscounter-intuitivetothe idea of policy substitution, i.e. the increase ofbehind-the-border NTMs when border measures areliberalized.Thisisfurtherdiscussedinthesub-sectionthat follows, where empirical evidence in support ofpolicysubstitutionisalsopresented.

At higher levels of regulation, the marginal gain frombehind-the-border non-tariff measures declines (andhence the political contributions lobbying firms arewilling to make) and at some point becomes smallerthan the marginal loss in social welfare (despite thelargerweightgiventoorganizedproducerinterest).Asaresult,behind-the-borderNTMsmaybesetatsome“intermediate”level.

Conversely,forbordermeasurestargetedexclusivelyatforeign producers, the domestic producer lobby’smarginal gain in profits (and related politicalcontributions) do not decrease with higher levels ofprotection and lobbies who gain a lot from keepingforeigncompetitionoutandgovernmentsthatcarelittlefor social welfare may implement a prohibitive level ofborderprotection,orvice-versa,noneatall(Abel-Koch,2010). In sum, although the author formally does notconsider lobbyingforbehind-the-borderasopposedtobordermeasuressimultaneously,itisinterestingtonotethatwhenbehind-the-borderNTMsareintroduced,theconflictofinterestbetweendomesticproducerspittinganorganizedlobbyofproductivefirmsagainsttherestmay lead to less restrictive measures than if borderprotectionwerepursued.

(iv) Offshoring and bilateral bargaining

Theincreasedroleofinternationalproductionnetworksintoday’sglobaleconomyandthefragmentationoftheproduction process across borders have required afresh look at the impact of non-tariff measures andservices measures on international trade and at theincentivesforgovernmentintervention.InSectionB.1,itwas noted that international production sharing mayadd to market imperfections, such as informationasymmetries(KimuraandAndo,2005)thatcanprovokeregulatoryintervention,forinstanceinrelationtosafetyand quality control. In their seminal work, Jones andKierzkowski (1990; 2000) emphasize the effects thatgovernmental measures in “services links” connectingfragmented production blocs can have on trade inintermediates,whilesuchmeasuresplay lessofa rolewhen the production of goods is integrated and tradetakesplaceinfinalproducts.

In regard to political economy rationales, Grossmanand Helpman (1994) mention that the protection for

sale framework can easily be extended to allow forimported intermediates, without changes to itsfundamental outcomes. Protection would still beprovidedtopoliticallyorganizedfinalgoodsproducersrather thanproducersof intermediates,as the formerwouldlobbyagainstprotectionforthelatter.46

While the fragmentation of the supply chain affectsgovernments’motivationstointerveneandenlargetheambit of relevant policy areas, as established inSection B.1, it may also involve new constraints andconsiderations in the choice of policy measures. In arecent set of papers, Staiger (2012) and Antràs andStaiger(2008)formalizeanovel,explicitmechanisminrelation to the international fragmentation of thesupply chain that could lead to an increased use ofnon-tariffmeasures. In their frameworkofoffshoring,thedeterminationofinternationalpriceschangesfromonegovernedbymarket clearingmechanisms toonecharacterized by bilateral bargaining between foreignsuppliers and domestic buyers. As noted in SectionB.1,insuchasituation,governmentscanbeexpectedtousetariffsasa“first-best”instrumentforextractingprofits from foreign exporters.47 However, withinternational offshoring, even though the governmentmay be free to use tariffs, other policies, includingbehind-the-border NTMs,mayalsobeused, resultinginadistortionoftheirefficientlevels.

The key feature in international offshoring emphasizedbytheauthorsistherelationship-specificnatureoftradebetween importers and their specialized suppliersabroad. Owing to the specificity of the input, foreignsuppliers hold some market power over the importingproducer.Atthesametime,oncetheinput isproducedbytheexporteraccordingtotheimporter’sspecificationsand the related investment is sunk, the importer canwield its bargaining power to obtain a share of theforeignsupplier’sprofits.Asaresult,internationalpricesare determined by bilateral bargaining rather thanmarket clearing. This phenomenon, which has becomeknown as the “hold-up” problem in the economicsliterature,leadstothesituationof“under-investment”byforeign suppliers and, hence, an insufficient supply ofinputstodomesticproducers.48

The domestic government now faces a tension in itsobjectivetomaximizenationalwelfare:itmustprovideincentives to foreign input suppliers to produce moreand,atthesametime,itmusthelpdomesticproducersimportingtheseinputstoappropriatemaximumprofitsinthebilateralbargainingwiththeforeignsupplier.

In order to pursue these different objectives in itsforeigntraderelationship,thegovernmentwillnotonlyadjust its tariff policy on inputs, but also employmeasures in regard to final products. It will do theformertoincreasethesupplyofforeigninputsandthelatter in order to affect prices received by producersand, hence, profits all along the supply chain.Concretely,AntràsandStaiger(2008)seektodevelop


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a realistic scenario, where a politically motivatedgovernment (i.e.one thatattachesahigherweight toproducer benefits) may reduce tariffs on importedinputs(whichhasapositiveeffectonsupply),butseekto increase the price of the final product, e.g. via animport tariff or an export subsidy. A disproportionatepart of the costs of these distortions is borne byconsumers, but a government that is sufficientlyinfluenced by organized producer interests may bewillingtoallowthistohappeninordertohelpdomesticproducersto increasetheirprofits,eventhoughsomeof these profits may also be dissipated along thesupplychaintoforeigninputproviders.

Buildingonthisapproach,Staiger(2012)constructsamodel in which the government applies non-tariffmeasuresontopoftariffstothesameproductinordertomaximizenationalwelfare inasituationofbilateralbargainingwithforeignproducers.49 Inhisset-up, theconsumption of a good that is subject to bilateralbargaining when imported and also domesticallyproducedentailsanadverseeffectontheenvironment.Aconsumptiontax is imposed inorderto“internalize”thisenvironmentalexternality– that is, to reduce theover-consumptionof theproduct inquestionowingtothe lack of consideration by consumers of theenvironmentalharmimposedonothers.Itcanthenbeshownthatthelevelofthedomesticconsumptiontaxused to address the environmental externality wouldbe set “inefficiently”, as part of the costs of the taxwouldbebornebytheforeigninputsupplier.

Concretely, under certain conditions, the importingcountrycanbemadebetteroffwhenimporttariffsontheproductarereducedandthedomesticconsumptiontaxisincreased.ThereasonforthisisthatinStaiger’smodel, lower tariffs directly affect the pricing andproductiondecisionsof exportingfirms.On theotherhand, because consumers experience diminishing“utility”fromhigherlevelsofconsumptionofthesameproduct,thetaxdoesnotalterconsumerbehaviour inalinearfashion.

While the tax partially induces consumers to cutconsumption,someoftheburdenofthetaxisimposedontheforeignproducersbyloweringproducerprices.50Through this mechanism, the government is able toensureagivensupplyofthegoodinquestionbyloweringtariffs,whileatthesametimereducingforeignprofitstothe benefit of domestic importers. This adjustment iseventually stopped when the distortion of domesticdemand, taking into account the marginal costs andbenefits of containing the environmental externality,becomestoohighintermsofnationalwelfare.Whilethegovernment’s motivation to use non-tariff measures insuch a situation is discussed in relation to a domesticconsumption tax (as a targeted product-specific anddetailedpriceinstrument),Staiger(2012)brieflyexplainsthattheunderlyinglogiccouldalsoapplytootherformsof“behind-the-border”NTMs,suchasTBTmeasures.Inparticular, the author asserts that in practice

governmentstendtoapplyuniformsalesorvalue-addedtaxesacrosswiderangesofproductsratherthanlevyingdifferentiatedtaxeson individualgoods.Heshowsthatwhere product-level domestic taxes are unavailable ordifficulttoimplement,offshoringandbilateralbargainingcanleadtoasituationinwhichproductregulationsaresettobeinefficientlyhigh.

(b) UseofNTMsandinternationalconstraints

Governments can use multiple policies to achieve agiven objective. In the case of a market failure, the“first-best”policytoaddressasingledistortion isonethat offsets the source of the distortion directly. Forinstance,ifthedomesticproductionofacertaingoodis associated with positive externalities for aneconomy,aproductionsubsidyisthe“first-best”policy– it is welfare-superior to an import tariff. What thenhappens in a situation where an economy faces adomestic distortion, an externality for example, butalsohasmonopolypowerintradeinthat itcanaffectthe world price of the given product? In a non-cooperativeframework,agovernmentwouldintroducetwo “first-best” or most efficient policies – a non-distortionary non-tariff measure to tackle the formerand a suitable tariff for the latter (Bhagwati andRamaswami, 1963). However, the “first-best” or mostefficient measures may not always be used bygovernments.

The previous section showed that governments maychoose to pursue trade policy objectives using non-tariffmeasuresratherthantariffsevenwhenthelatter,more efficient, measure is available to them. Itattributed this to institutional factors, the lack oftransparency of certain NTMs, the fact that someNTMsentail afixed rather than variablecostand theexistenceofmarketpower inacontextofoffshoring.However, it may also be the case that the moreefficient measures are not always available togovernments.ThissectiondiscussestheuseofNTMsin light of constraints imposed by international tradeagreements–bothmultilateralandregional.

(i) International constraints

Under the auspices of the GATT/WTO, the last60yearshaveseenadramaticmultilateralreduction intariffbarriersowingtoagreementsthatrequiremembersto respect the negotiated tariff bindings – ceilings onappliedtariffs.Ifmemberssettariffsabovethatbinding,they may be subject to a costly dispute initiated byanother member. Similar constraints also affect othertrade policy measures – for example, non-tariffmeasuressuchas importandexportquotasaswellasexportsubsidiesaregenerallyprohibited,althoughtheiruseisallowedfor“legitimate”reasonsinspecificcases.Eveninpreferentialtradeagreements(PTAs),countriesagreetopreferentialtariffsbetweenthemselvesand,in


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customsunions,tosetacommonexternaltariff,wherebynon-enforcementof these tariffscouldgeneratecostlyretaliationbyotherPTAmembers.

Unlike border measures, disciplining behind-the-border non-tariff measures explicitly under themultilateral trading system, for instance, is morechallenging for the following reasons. First, they aretypically less transparent. Secondly, as alluded to inSection A, NTMs are often highly complex andcountry-specific. This means that the formulation ofgeneral rules to discipline them is likely to involvedifferentauthoritieswhoarenotusedtocoordinatingwith others. Thirdly, while NTMs may have adversetrade effects, some of them are associated withlegitimate public policy objectives. Despite thesedifficulties, NTMs are not left entirely unregulatedbecause members of a trade agreement couldotherwise undo any negotiated tariff restrictions by,for instance, imposing different sales taxes forimported and domestic products (Horn, 2006). Ofcourse, to theextent thatcountriescanuseNTMs inimport-competing sectors as a means of reducingtrade flows, they can undermine commitmentspreviously made with respect to trade policy (BajonaandEderington,2009).

(ii) Policy substitution

It is likely thatascountriessignsuccessiveroundsoftradeagreementsthatconstraintheirabilitytopursuetrade goals through trade policy (tariffs and certainborder non-tariff measures), other NTMs, includingthose behind the border, become attractive tools forterms-of-trade manipulation that shifts costs ontoforeign exporters. In other words, there will beincentivesforgovernmentstodistort theirNTMsasasecondary means of protecting import-competingindustries(Copeland,1990;Ederington,2001;Bagwelland Staiger, 2001; Bajona and Ederington, 2009). Inthis context, it isevenargued that there is a “LawofConstantProtection”(Bhagwati,1988).

According to Anderson and Schmitt (2003), whentariffsareconstrainedcooperatively,quotaswouldbethepreferredmeasureamongthesetofborderNTMsfor governments looking for alternative measures.Anti-dumpingpoliciesare likely tobeusedonlywhenthe use of quotas is also sufficiently constrained byinternationalagreements.51

Similarly, if a government cannot respond tocompetitivepressuresabroadbyunilaterallyrestrictingmarketaccesswithan increase in its tariff, itmaybedrawn into imposing a behind-the-border NTM. Forexample, it may be tempted to improve the relativecostpositionofadomesticfirmby relaxing technicalregulations in its import-competing industry, therebyrestricting access to foreign suppliers. Some foreignsuppliers who export to these markets may actuallylowertheirpricestoremaincompetitivewithdomestic

producers.52 However, even such terms-of-trademovementleadstoforeignproducersabsorbingsomeof the costs of the weakening of domestic technicalregulations (Bagwell et al., 2002). Hence, in light offallingtradebarriers,thisregulatorycostshiftingcouldresult in a “race-to-the-bottom” problem wheregovernments might be tempted to relax technicalregulations that apply to import-competing industriesin the name of international competitiveness – thoserelating to labour and the environment are prominentexamples (Bagwell and Staiger, 2001; Bagwell et al.,2002).

AccordingtoBagwelletal.(2002),thetruesourceofthe “race-to-the-bottom problem” is not that weakforeign technical regulations generate competitivepressures that induce inefficiently low domestictechnicalregulations.Rather,itistheimperfectionsinproperty rights over market access commitments intradeagreements–agovernmentisnotfreetoadjustitspolicymixsolongasitmaintainsitsmarketaccesscommitment. For instance, if a government increasestechnical requirements in its import-competingindustry,thisindustrywouldbesubjectedtoincreasedcompetitive pressure from abroad. However, becausetrade policy is constrained by an internationalagreement,thegovernmentwouldnotbeabletoraiseits tariff (without a penalty) and maintain its marketaccesscommitment.

Itisworthnotingthatinsteadofa“race-to-the-bottom”problem, it may even be the case that increasedconstraints on tariff policy imposed by internationalagreements are accompanied by rising technicalregulations. The international cost-shifting incentivedescribed above may instead create a tendency forgovernments to impose more stringent domestictechnicalregulationsifthedomesticfirminanimport-competingindustryfindsiteasiertocomplywiththem,i.e. if the technical regulation improves the relativecostpositionofthedomesticfirm(StaigerandSykes,2011). However, even when a technical regulationincreasesthecostsofproductionmorefortheforeignfirm than the domestic firm, the substitution oftechnicalregulationsfortariffswhichareconstrainedby an international agreement is far fromstraightforward.

In a recent study, Essaji (2010) considers twoscenarios.First,whentariffsareprohibitiveandhencewhen a small tariff reduction enables minimalparticipation by the foreign firm, governments arelikelytohaveanincentivetoraisetechnicalregulations.This is because the tariff cut increases the marginalbenefit of the regulation – because imports becomecheaper,theregulationbecomestheinstrumentwhichcan improve thedomesticfirm’s relativecostpositionandhence itsprofits.At thesametime,byworseningthe foreign firm’s production costs, and reducingimports, the technical regulation reduces tariffrevenues.Hence, ifthegovernmentcaresabouttariff


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revenues,itsoptimalregulatoryresponsetotariffcutsis less clear. However, prohibitive tariffs areincreasinglyrare.

Secondly, in the case where the foreign firm alreadyhas a significant market presence, the relationshipbetweentariffcuts–thatdeepenforeignpenetrationevenfurther–andrisingtechnicalregulationsismoretenuous. Technical regulations reduce consumersurplus.However,areductionintariffsdiminishestheregulation’s marginal impact on consumer surplusbecause it lowers prices faced by consumers.Similarly,whileregulationsshiftprofitstothedomesticfirm, tariff cuts – by making imports cheaper –diminish theregulation’smarginaleffectondomesticfirmprofits.

Given theabove, if thegovernmentonlycaresaboutconsumer surplus and the domestic firm’s profits, itwould respond to tariff cuts by relaxing technicalregulations. This suggests that because constraintson the use of tariffs weaken the effectiveness of atechnical regulation as an instrument, tariffs andtechnical regulations are actually complements. Itunderscoresthatwhatmattersforpolicysubstitutionis not the direct effects of measures, but how theweakening of one measure affects the marginaleffectiveness of the other. The government’sresponse is more ambiguous when it also worriesabout tariff revenues and negative consumptionexternalities.

A reduction in tariffs, bound by an internationalagreement,enhances the regulation’smarginaleffectontheconsumptionexternalitybecauseitremainstheonly instrument to reduce demand in the economy.Similarly, tariff reduction enhances the regulation’smarginaleffectonraisingtariffrevenues–constraintson increasing tariffs imply that altering technicalregulations is the only way in which the governmentcaninfluenceimportsandhencetariffrevenue.Hence,if the impact of the regulation on the consumptionexternality is large and/or if the initial tariff rate ishigh, the improvement in the regulation’s capacity toreducetheexternalityandraisetariffrevenues,onthemargin,mayoffsetthereductionofitsmarginaleffectsondomesticprofitsand theconsumersurplus. In thissituation, governments may respond to tariffreductions by technical requirements, i.e. policysubstitution.

The findings of Essaji (2010) suggest that theproliferation of technical regulations in recent yearsmay not be driven by a desire to protect domesticfirms’ profits when tariffs are constrained by aninternational agreement, but rather it may reflect agrowing awareness of consumption externalities.Governments will have an incentive to increasetechnicalregulationsonlyifthenetmarginalbenefitoftheregulationincreaseswithfallingtariffs.

(iii) What does the evidence suggest?

There is an empirical literature which uses formalstatistical methods to analyse whether or notconstraints imposedby internationalorbilateral tradeagreementsongovernments’ability toset tariffsmayinducesomecountriestoreplacethemwithnon-tariffmeasures. Usingdata fromColombiaduring themid-1980s (and early 1990s), Goldberg and Pavcnik(2005) find that tariffs and NTMs were positivelycorrelated, i.e. tariffs were reduced, not simply to bereplacedbyNTMs.

Analysing data for a large cross-section of countries(91) for a more recent time period (the early 2000s),Kee et al. (2009) find that the average ad valoremequivalent (AVE) of non-tariff measures appears toincreasewithGDPpercapita.However,theyalsofindthattheoveralllevelofprotectiondecreaseswithGDPper capita, mainly driven by average tariff levels thattend to be significantly lower as countries becomericher. It suggests that, in general, tariffs may besubstituted by NTMs. This is reinforced by theirfindings at the tariff line level, where tariffs arenegativelycorrelatedwiththeAVEsofNTMs.Similarly,Brodaetal. (2008)showthatafterGATT/WTOtariffcommitments constrained the United States in itsability touse tariffs for thepurposeof terms-of-trademanipulation, the country set significantly higherNTMs in import-competing sectors where it hadgreaterabilitytoaffectforeignexporterprices.

Inamorerecentstudy,usingdataontariffsandnon-tariff measures for about 5,000 products, Limao andTovar (2011) exploit the variation in tariff constraintsgenerated by the two most common commitmentdevices – multilateral and preferential tradeagreements(PTAs). Importantly, theauthorsestablisha causal impact of the resulting tariff constraints ontheuseofNTMs–notmerelyacorrelationwhichmaybeinfluencedbyotherfactors.Considerthefollowing.Differences in the size of member states in a PTA,whichisacustomsunion,leadtothecommonexternaltariff being determined by the tariffs of the largerpartner.Thiscangeneratealargechangeintariffsforthe smaller partner that is likely to be “exogenous” –that is, independentofotherdeterminantsof itstradepolicy.

The aforementioned argument is relevant for theanalysisinLimaoandTovar(2011)becausetheyfocuson a single country, Turkey, which had to adopt pre-existingEUtariffsinalargenumberofproducts.SoifthecommonEUtariffconstrainedTurkey in its tariff-setting, this could have had a causal impact onprotection via non-tariff measures on non-EUexporters. Limao and Tovar (2011) find evidence ofpolicy substitution – tariff commitments imposed viathe WTO and the PTA with the European Unionincrease the probability of Turkish NTMs. They alsofind that the likelihood and restrictiveness of Turkish


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NTMs increase with the stringency of those tariffcommitments.Furthermore, it isworthnotingthat theauthors find imperfect policy substitution, therebyimplying that tariff commitments – while partiallyoffset by higher NTMs – may have still reduced totalprotection.

The studies discussed above analyse a broad set ofnon-tariff measures, including domestic productstandards, technical regulations and voluntary exportrestraints. There is also a literature which analyses apossible substitution effect between tariffs and aparticular class of NTMs – anti-dumping (AD)initiations. Evaluating data for 24 countries(17developingandsevendevelopedcountries)duringtheperiodfrom1996to2003,FeinbergandReynolds(2007)find that tradeopeningcommitmentsmade intheUruguayRound–measuredbychanges inboundtariffs – have a statistically significant, albeit small,positive effect on the likelihood53 of a WTO memberusingADprotection.Inaddition,theyuseasimulationexercise to show that had tariffs not been reducedby the Uruguay Round, there would have been23percentfewerADcasesfrom1996to2003.Whenonly considering the AD cases brought by thedeveloping countries in their sample, Feinberg andReynolds(2007)findamuchlargerpositiveeffectofapromised reduction in tariffs under the UruguayRound.ThisholdstruebothforthelikelihoodofaWTOmemberusingADprotectionand the totalnumberofADpetitionsfiledbyWTOmembers.

To view the above as evidence of policy substitution,however, onemustbecautious.Developingcountriesdid not reduce in the Uruguay Round the tariffs thatthey actually applied. Their commitments were toreduce the gap between the bound (i.e. the upperceiling)andtheappliedrates(the“tariffoverhang”)bypledging to keep within the lower bound rates.However, what firms actually face in practice are theappliedtariffs,whichareverydifferentfromtheboundrates,especiallyindevelopingeconomies.

Forthedevelopedcountriesintheirsample,FeinbergandReynolds(2007)findthatcommitmentstoreducetariffsunder theUruguayRoundareassociatedwithless frequent AD activity. According to the authors,this surprising result may reflect a move towardsalternative measures of protection, such as TBT andSPSmeasures.Itmayalsobeattributabletoahostofomittedvariables, suchas the increasing importanceof services and FDI, which could have diverted theattentionof firms in theseeconomies away from theADinstrument(FeinbergandReynolds,2007).Giventhe limitations of the study described above, it isdifficult to identifyacausal impactoftariffreductioncommitments under the Uruguay Round on ADactivity.

More recently, using data for 35 countries(29developingandsixdevelopedcountries)over the

periodfrom1991to2002,MooreandZanardi(2011)also examine the relationship between sectoral tradeopening and subsequent AD initiations.54 UnlikeFeinberg and Reynolds (2007), however, the authorsanalyseappliedratherthanboundtariffs.Furthermore,theytakeaccountofadditionalfactorsthatmayaffectAD initiations, include a larger set of importing andexporting countries. They also cover a longer timespan,workwithmoredisaggregatedindustrialsectorsanduseamorecompleteADdatabase.

In general, Moore and Zanardi (2011) find thatreductions in applied tariffs do not lead to a higherprobabilityofADpetitions.However,forasmallgroupofdevelopingcountriesthathavebecomeheavyusersofAD in recentyears, theydofindevidenceofpolicysubstitution–astatisticallysignificantimpactoftradeopeningon theprobabilityofADfilings.For thissub-sample, a one standard deviation increase in tariffliberalizationresultsinabouta25percentincreaseinthe probability of observing an AD initiation. Theabsence of a statistically significant “substitutioneffect” for other developing countries or for the sixdevelopedcountries in thesamplemaybedue to thefactthattheformerinitiatedrelativelyfewADpetitionswhile the latter already had very low tariff rates overtheentireperiodcoveredintheanalysis.

TheresultsofMooreandZanardi(2011)arereinforcedby the recentworkbyBownandTovar (2011)on thetradereformsundertakenbyIndia inthe1990s.Theyfind that taking other factors into account, productsthatunderwentlargertariffcutsasaconsequenceofthe tradereformwere,by theearly2000s,subject toanincreaseintheuseofsafeguardsandADmeasures.Inparticular,theyshowthattheprobabilityofinitiatingan AD investigation and safeguard proceeding is50 per cent higher as a result of a one standarddeviationincreaseintradeopening.

The Specific Trade Concerns (STCs) databasescreatedbytheWTOSecretariat(discussedindetailinSection C.1) have been used to shed new light onwhether applied tariffs and TBT/SPS measuresmay have been used as substitutes over the period1995-2010.55Applyingananalysissimilar inspirit toKee et al. (2009) – who seek to identify a “clean”correlation between tariffs and their estimated ad valorem equivalent of non-tariff measures,56 ratherthan identifying a causal link – the results indicatesome evidence that TBT measures may have beenused to take the place of tariffs, but there is verylimited evidence of substitution between tariffs andSPSmeasures(seeBoxB.6).Thisresultisinlinewithexpectations:SPSmeasurescoverarelativelynarrowareaofhealthandsafetythatisoftendirectlyrelatedtoconsumerprotectionandmayoffer lessscope forpolicy substitution than the wider set of TBTmeasures.


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In conclusion, the use of less efficient non-tariffmeasures instead of tariffs is facilitated by the factthat while bindings on import tariffs are rigid, theexplicit disciplining of NTMs within the framework ofinternational trade agreements is more difficultbecausetheyarelesstransparent.Inaddition,certainNTMs can be used to address a legitimate publicpolicyconcern(health, theenvironment,etc.), therebymakingitpossibletoconcealapotentiallyprotectionistintentbehindthemeasure.However,isitthecasethatgovernments choose to exclude NTMs from suchinternationalagreements?And,ifso,whatdeterminesthischoice?

Thetradeliteraturesuggestsanumberofpossibilities.Thedecisiontoexcludemaysimplyreflectthecostsofwritingandenforcinganagreementthatcoversawiderangeofbehind-the-bordernon-tariffmeasures(Horn,2006;Hornetal.,2010).Itmayalsobeattributabletouncertainty about the circumstances that will prevailduringthelifetimeoftheagreement,therebymakingit

difficulttoforeseeallregulatoryneedsthatmayarise(Battigalli and Maggi, 2003). There are furtherpossibleexplanations.

Thenon-explicitregulationofnon-tariffmeasuresmayrepresent “escape clauses” for members of theagreements – providing them with the flexibilityrequired to maintain a self-enforcing agreement in avolatileworld(BagwellandStaiger,1990).Itmayevenbe the case that governments can improve theirbargaining power vis-à-vis special interest groups bycommitting to constrain tariffs through internationalagreements, and then using less efficient NTMsinstead(LimaoandTovar,2011).Finally,countriesmaywant to retainpolicyspace in issues theyconsider tobe “too important” to be subject to trade rules, e.g.nationalsecurity.Ananalysisofsuchfactorsthatmayexplain the “endogenous determination” of thecoverageofNTMsininternationaltradeagreementsiscarriedoutinSectionE.

BoxB.6: Policy substitution – evidence from specific trade concerns

FromtheSpecificTradeConcerns(STCs)databases,coverageratio(theamountoftradecoveredbyanSPSorTBTmeasure)andfrequencyratio(theshareofproduct linescovered)havebeencomputed.Frequencyandcoverageratiosareinventory-basedmeasuresthatdonotnecessarilycapturethetraderestrictivenessof a measure. However, they indicate how much trade is affected by it.57 These measures have beencomputedforeachcombinationofmaintainingcountry (thecountry thatmaintains themeasuresubject tothe specific trade concern), HS2 sector (a two-digit classification in the Harmonized System) and year.ToanalysewhetherthereisevidenceofsubstitutionbetweentariffsandSPSorTBTmeasures,thefollowingeconometricmodelhasbeenestimated:

From the Specific Trade Concerns (STCs) databases, coverage ratio (the amount of trade covered by an SPS or TBT measure) and frequency ratio (the share of product lines covered) have been computed. Frequency and coverage ratios are inventory-based measures that do not necessarily capture the trade restrictiveness of a measure. However, they indicate how much trade is affected by it.1 These measures have been computed for each combination of maintaining country (the country that maintains the measure subject to the specific trade concern), HS2 sector (a two-digit classification in the Harmonized System) and year. To analyse whether there is evidence of substitution between tariffs and SPS or TBT measures, the following econometric model has been estimated: 𝑦𝑦!"# = 𝛽𝛽!ln (𝑡𝑡𝑡𝑡𝑡𝑡)!"# + 𝜀𝜀!"# where y is the (log of ) the coverage ratio (or the frequency index) of the maintaining country i in HS2 sector j in year t, and tar is the (log) average applied tariff in sector j. Year, country, sector and country-sector fixed effects have then been progressively added to this baseline model.

1 Details about the construction of frequency index and coverage ratio can be found in Section C

(Box C.1).

whereyisthe(logof)thecoverageratio(orthefrequencyindex)ofthemaintainingcountryiinHS2sectorjinyeart,andtaristhe(log)averageappliedtariffinsectorj.Year,country,sectorandcountry-sectorfixedeffectshavethenbeenprogressivelyaddedtothisbaselinemodel.

Asarguedinthemaintext,theestimatedregressiondoesnotpurporttoidentifyacausallink,butrathera“clean”correlationbetweentariffsandTBTorSPSmeasures.ItissimilartotheoneestimatedbyKeeetal.(2009), who find evidence of substitution between tariffs and non-tariff measures when considering thevariationwithincountryandwithin sector. Incontrast toKeeetal., there isalso timevariation in theSTCdatabases,allowingtheuser to identifyvariationwithincountry-sectorandtimeusingarichersetoffixedeffectsthanKeeetal.(2009).

Table B.1 reports the results of the regressions. In columns (1) (for the coverage ratio) and (5) (for thefrequencyindex),nofixedeffectisincluded.Incolumns(2)and(6),countryandtimefixedeffectsareadded.In columns (3) and (7), sector fixed effects are added. Finally, in columns (4) and (8), there are time andcountry-sectorfixedeffects.

TheupperpanelofthetablepresentsresultsfortheSPSspecifictradeconcerns.Thecoefficientonthetariffisnegative(asitwouldbeifSPSmeasuresandtariffsaresubstitutes)butnotalwayssignificant.Inparticular,itisnot significant for thecoverage ratio in thepreferredspecificationwith the timeandsector-countryfixedeffects(column(4)).Overall,thereislittleevidencethattariffsandSPSmeasuressubstituteeachother.

TheresultsoftheregressionswithTBTconcerns,however,revealaclearerpatternofsubstitutionbetweentariffsandTBTmeasures(seebottompanelofTableB.1).AsinKeeetal.(2009),thecoefficientturnsfrompositivetonegativeasmorefixedeffectsareincluded.Itisnegativeandstatisticallysignificant–bothintheregressionusingthecoverageratioandintheregressionusingthefrequencyindexasdependentvariable–whentimeandcountry-sectorfixedeffectsareincluded(seecolumns(4)and(8)).


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3. Measuresaffectingtradeinservices

(a) Whyaseparatediscussion?

Cross-border delivery alone does not fully captureinternationalservicestransactions.Theintangibleandnon-storable nature of many services implies thatsuppliersandconsumersoftenhave tobe inphysicalproximity for servicesprovision to takeplace. Indeed,trade in services takes place through four different“modesofsupply”:beyondthetraditionalcross-bordermode,itencompassestheconsumptionofaserviceina foreign territory and the movement of the supplierabroad,eithertoestablishacommercialpresenceorinperson.Asaresult,capitalandlabourmobilityisofteninextricablylinkedtoservicestrade.

Against this background, measures affecting trade inservices warrant a separate discussion for at leastthree,relatedreasons.

First, the feasibility of applying a tariff, and an ad valoremtariffinparticular,totheinternationalprovisionofservicesisremote.Inmostinstances,itwillbenexttoimpossible for customs officials to observe a service“crossingaborder”,andthevalue(volume)ofaservicestransactionwillonlybeknownaftertherelevantservicehasbeenproducedorconsumed(HoekmanandPrimoBraga, 1997). Trade protection in services is thusessentially in the form of regulatory measures.58 In aliteral sense, all limitations to services trade are “non-tariff”.Thus,itmakesnosensetodiscusswhynon-tariffmeasuresareusedand toanalyse theireconomicandtradeeffectsinjuxtapositionwithtariffsas,inthecaseofservices,tariffsarenotstrictlyavailable.

Secondly,ananalysisbasedonwhethermeasuresareappliedatorbehind theborderisalsolargelyunhelpful.Many services transactions involve the presence ofeitherthesupplierortheconsumerinsidetheterritoryofthe“importing”country.Hence,servicesrestrictionsmostlyapply“behind-the-border”.

TableB.1:Coverage ratio and frequency index of STCs and tariffsSPS

Dependent variable Coverage ratio (ln) Frequency index (ln)

(1) (2) (3) (4) (5) (6) (7) (8)

Tariff (ln) -0.00847 -0.0250 -0.0911*** -0.0256 -0.0444*** -0.0125 -0.0906*** -0.0598***

(0.00886) (0.0159) (0.0143) (0.0242) (0.00909) (0.0155) (0.0139) (0.0193)

Fixed effects:

Country No Yes Yes Yes No Yes Yes Yes

Sector No No Yes Yes No No Yes Yes

Time No No Yes Yes No No Yes Yes

Country*sector No No No Yes No No No Yes

Observations 3,259 3,259 3,259 3,259 3,259 3,259 3,259 3,259

R-squared 0.000 0.160 0.337 0.279 0.006 0.223 0.431 0.330

Number of id 223 223

TBT

Dependent variable Coverage ratio (ln) Frequency index (ln)

(1) (2) (3) (4) (5) (6) (7) (8)

Tariff (ln) 0.0215*** 0.00642 -0.0126*** -0.0439*** 0.0234*** 0.0150*** -0.00512 -0.0394***

(0.00308) (0.00417) (0.00453) (0.0113) (0.00334) (0.00425) (0.00460) (0.0123)

Fixed effects:

Country No Yes Yes Yes No Yes Yes Yes

Sector No No Yes Yes No No Yes Yes

Time No No Yes Yes No No Yes Yes

Country*sector No No No Yes No No No Yes

Observations 9,788 9,788 9,788 9,788 9,788 9,788 9,788 9,788

R-squared 0.005 0.084 0.170 0.107 0.005 0.100 0.185 0.108

Number of id 657 657

Notes:Robuststandarderrorsinparentheses;***p<0.01;columns(4)and(8):withinestimation,idvariable:country-sector.

Source:WTOSecretariatestimates.


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Thirdly, given the modal definition of services trade,theanalysisneedsto includemeasuresapplyingbothto the product (i.e. the service) and to the producer(i.e. the services supplier). Furthermore, the producermay be physically present in the territory of theimporting country. While in the case of goods, factormovement represents a substitute for cross-bordertrade, with many services it is a precondition, or animportantcomplement,foranytradetotakeplace.Allmeasuresthatgovernhowservicesareproducedandconsumed in an economy are thus potentiallymeasures affecting services trade. This is whymeasures discussed here that might appear to gobeyond traditional “trade” instruments need to befactoredinwhenconsideringservicestrade.

While it would be impracticable to lump together adiscussion of services measures and non-tariffmeasures, this does not imply, however, that servicesandgoods trade,and the respective trade limitations,shouldbeconsideredinisolation.Notonlyaretradeingoodsandtradeinservicesmutuallysupportive,59butalso many services trade restrictions affect goodstrade,andviceversa.

Services play a key role in supporting productionnetworks. Transport and logistics services areobviously the most important direct services input tointernational goods trade, but communication,insuranceandbankingarealsokeyenablingservices.Aprominent role isadditionallyplayedbydistribution,businessandotherafter-salesservicessuchasrepairandmaintenance.

Measures that restrict trade and competition inservices markets thus affect not only the economicperformance of the sector concerned, but may,particularly with infrastructural services, also havespillover effects on the economic and exportperformance of goods and other services industries(seediscussioninBoxD.3).60

Restrictionson trade incertaingoodsmay impair theefficiency and export competitiveness of servicessuppliers that rely on those particular products asinputs. Restrictions on the importation of certainmedicalequipmentmayraisecostsforhospitalswhenproviding related medical services to national andforeign patients, for instance. Measures raising thecost of imported consumer goods would likewisenegatively affect retailers, and particularly foreignretailers sourcing many of their products from theirhomecountry.

Suchcross-effectsareespeciallyimportantinlightofthe growing fragmentation of production processesacross countries. As much as three-quarters ofservicestradeisinintermediateinputs(Miroudotetal.,2009),whileintra-firmtradeaccountsfor22percentofUSservicesimportsand26percentofitsservicesexports (Lanz and Miroudot, 2011).61 Together, these

datado indeed paint a picture of services tradeas aprominent, though probably still underestimated,componentofglobalorregionalvaluechains.62Inlightof their spillover effects beyond the industryconcerned,restrictionstotradeinsuch“intermediate”services can be argued to be of even greatersignificance.

Similartotheanalysisofnon-tariffmeasuresforgoodstrade,thissectionwillfirstdiscussthemotivationsforgovernments’ intervention in services markets. It willthen try to categorize the main forms of interventionused and, to the extent possible, examine theireconomicandtradeeffects.

(b) Whydogovernmentsinterveneinservicesmarkets?

This section discusses why governments mayintervene in services markets. To a large extent,the analysis in sections B.1(a) and 1(b)(ii) aboveremains pertinent. A number of services-specificcharacteristics,however,needtobefactoredin.

(i) Public interest considerations

From a public interest theory standpoint, governmentintervention in services markets may be justified onefficiencygrounds,aswellasonequityconsiderations.Efficiencyconcernsrelateprimarilytotheexistence,inmanyservicesindustriesofinstancesofmarketfailure,suchasasymmetric information (i.e.onepartyhavingmore information than the other), imperfectcompetition and externalities (see below).63 Whilethese failures also appear in goods industries, theyseemtobemorepervasiveinthecaseofservices.Thediscussionthatfollowsislargelyillustrative.

Instances of asymmetric information in services arefrequent.Thisis,essentially,becauseoftheintangiblenature of many services. Immateriality implies thatconsumers cannot easily assess the quality of aservicebeforeconsumingit.Producerswilltendtobebetter informed. However, they might not have anincentivetosupplymoreinformationtoconsumers,asthismightbecostlytoprovide,orretaininginformationmayaffordacommercialadvantage.Atthesametime,consumersmay lack theexpertise required toassessmuch of the technical information they receive. As aresult, consumer choice is insufficiently informed forcompetition to function effectively. This problem isaccentuatedbythefactthatrepeatpurchasesmaynotalwaysbeanavenuetodisciplineproducerbehaviour.Services,bytheirnature,tendtobemuchmorediversethangoods.Consumersmaynotbewilling,orable,tocontinuallypurchaseidenticalservices.

Though market-based solutions could see producerssignalling a commitment to quality, for instance byinvesting in reputation,customerservice,brandnameor easily accessible complaint procedures, they are


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unlikely to be sufficient for high-risk activities(Pelkmans, 2006). Governments thus often intervenetocurb services suppliers fromexploiting informationasymmetries. As it is generally impossible to impose,verify and ensure compliance with performancerequirements by focusing exclusively on the service,governments frequently intervene at the level of thesupplier. They may, for instance, require producers todisclose certain information to consumers, or imposequalification or licensing requirements that seek toensure the competence of the services supplier andthusthequalityoftheservicesprovided.

Information asymmetries may also be problematic forproducers where consumers possess privateinformation, for example about their health status. Alack of generally available information may alsoengender situations of “moral hazard”. For example.wheresomeoneotherthantheconsumerbearsthefullresponsibility and consequences of his actions,excessiveconsumptionmayresult. Insurancemarketsareacaseinpoint.

Imperfect competition is another market failure oftenencounteredinservices industries.Manyservicesaresupplied through networks: telecommunications,postal services, electricity distribution, environmentaland rail transport services are prominent examples.Standardized services provided over suchinfrastructure or distribution networks often exhibitsuchlargeeconomiesofscalethattherelevantmarketcan be served most cheaply by a single or smallnumber of firms, i.e. they are often naturallymonopolistic/oligopolistic. Unchecked, these marketsresult in under-supply and prices set above marginalcost. Government intervention is thus warranted, andmay imply instituting price controls or enablingcompetition (e.g. through unbundling services,regulating access to essential facilities, franchisingandconcessions).

Finally, both negative and positive externalities occurin service markets when the price of a service doesnot reflect the true cost or benefit to society ofproducing that service. This results, respectively, inexcessive or insufficient consumption. Theenvironmental consequences of heavy road transportor intensive tourism are instances of negativeexternalities. Network expansion intelecommunicationsservices, increased investment ineducation or vaccination programmes, on the otherhand,areexamplesofpositiveexternalities.

Government intervention in services industries mayalsobedrivenbyequityconsiderations.Manyservicesare inputs into human capital development and, assuch, they underpin governments’ social objectives.Health and education services are typical examples,but similar considerations may also play a role insectors such as audio-visual, telecommunications,transport, energy and water services. Unfettered

markets would leave certain geographical areas orgroups of consumers without affordable prices oradequatesupply.Theimpositionof“universalservicesobligations” has been one government response tocountertheseproblems.

Box B.7 provides some sector-specific examples ofservices measures that governments may use toaddressefficiencyandequityconcerns.

(ii) Political economy considerations

According to the economic theory of regulation,government intervention is not driven exclusively bythe pursuit of the “public interest”, but rather, oradditionally,bytheconcernsofspecialinterestgroups.Governments may therefore intervene irrespective ofthe existence of a market failure. Even whenintervention is warranted on public policy grounds,governmentsmaystill,indecidingwhichinstrumenttoemploy, be “bought” into relying on those measuresthatbenefitmoreorganizedgroups,generallydomestic(orincumbent)producers.

WhilethediscussioninSectionB.1remainspertinent,whenitcomestoservicesindustries,politicaleconomyconsiderations are particularly significant in at leastfourrespects.

First and foremost, the most transparent form ofinterventionwhenitcomestotradepolicy, i.e.atariff,is not available in services markets. By definition,governments need to resort to other, often moreopaqueinstruments.Thisoffersgreaterscopetomaskany private interest motivations, and thus potentiallyreducestheriskofelectoralpunishment.

Secondly, much less scientific evidence exists onwhich services intervention might be based and itseffectiveness tested. The diverse nature of manyservices,theirintangiblenature,andthefrequentneedto regulate at the producer level all imply thatregulationtendstobenotonlycomplex,butalsomuchmoredifficult toassesson thebasisofexact criteriaappliedattheproductlevel.Thismay,onceagain,helpcamouflagegovernments’trueintentions.

Thirdly, the complexity of much services regulationimplies that regulators who are less experienced orless resourced might be more easily “captured” byspecial interest groups even if they intend to act inpursuitofthe“publicinterest”.Givensuchinformationasymmetries, protection might not even need to be“bought”.

Fourthly,giventheequityandsocialconcernsattachedtomanyservices, consumersmightactually sidewithdomesticproducers.Consumersmaymisguidedlyfearthat, if the interests of domestic producers are nolongerupheld,servicequalitywillsufferand/orpriceswillincrease(Hoekmanetal.,2007).


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BoxB.7: Examples of services-specific measures to pursue public policy objectives

Equitable access

In the transport or telecommunications sectors, governments often want remote regions to be served bysuchservicesregardlessofprofitability.Basicequityobjectivesalsopromptgovernmentstoensurethatallcitizenshaveaccesstoeducationandessentialhealthcareatloworzerocosts.

Measuresincludecross-subsidizationschemestoensurethatrevenuesinprofitableareasarereinvestedinfavour of under-developed regions or persons in financial need and licensing conditions which includeuniversalservicesobligations(forexample,commercialhospitalsarerequiredtotreatacertainpercentageofpatientsfreeofcharge).

Consumer protection

Withregardtoprofessional,financialorhealthservices,thecomplexityoftheservicethatisprovidedmakesit verydifficult forconsumers toappreciatequalityor safetyprior toconsumption.Servicessuppliersmayexploitsuchinformationasymmetries.

Measures include prudential and other technical standards to be complied with by services suppliers;publicationrequirementsoncosts,risks,side-effects,etc.,soastoenabletheconsumertomakeinformeddecisions;educationandtrainingrequirementstoensurecompetence;andmandatoryprofessional liabilityinsurance.

Reduction of environmental impacts and other negative externalities

Roadandairtransportcausepollutionandnoise;tourismcouldputtheenvironmentunderstressanddisturbnaturalhabitats,etc.

Measuresincludetrafficrestrictionsoverweekends,duringnighthoursorinsensitiveareas;zoninglawsandbuildingcodes;tax/subsidyschemestomobilizefundsforthepreservationofculturalheritage.

Macroeconomic stability

Financial institutions may engage in imprudent lending or design complex financial instruments that areinsufficiently understood. As a consequence, depositors may lose confidence and withdraw their money,inter-banklendingmaysuffer,creditsupplytotherealeconomymaybehampered,andsoforth.

Toensurestability,financialinstitutionsmustcomplywithmeasuressuchasminimumcapitalrequirementsandhighercapitalreserveswhennewfinancialinstrumentsareprovided.Theymustalsodiversifyassetstolimitexposuretoindividualclients,reportontheiractivities,orputlimitsonremunerationofmanagement.

Avoidance of market dominance and anti-competitive conduct

Concernsaboutanti-competitiveconductariseinsectorspronetomarketconcentration(includingserviceswithnetworkeffectsandinterconnectionneeds,suchastransportandtelecommunications,andliberalizedformermonopolies).

Measures include limitationsonmarketshares, introductionofpricesurveillanceormandatorypricecaps,interconnection guarantees, and government-mandated technical standards to replace company-specificrequirements.

Source:WorldTradeOrganization(WTO)(2005a)

(iii) Pervasiveness of government intervention

Services industries exhibit hugely differentcharacteristicsandmarketstructures.Thereisabroad

rangeofsectorsinwhichgovernmentsplaynospecificrole. Nonetheless, it is widely acknowledged that,giventhegreaterlikelihoodofmarketfailuresandthepotentially bigger role played by private interestconsiderations, government intervention in services


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markets as a whole is more prominent than in goodsmarkets.

The formof this interventionhaschangedover time,however.Historically,severalinfrastructuralandsocialservices, especially those provided to the generalpublic (traditionally called “public services”), weredirectly supplied by government entities, usually inmonopoly situations. Recent decades have seen amove away from state ownership towards morerelianceonprivatemarketstoprovidetheseservices.Governments progressively moved back from theirroleof suppliersand increasingly tookon the roleofregulators. Once such services were no longerpublicly financed and provided, governments wereforced to introduce new measures, with the statedobjective of promoting economic and social welfare.Indeed, regulation of these services markets hasexpanded at the same time as the industriesconcerned have been privatized and opened up tocompetition.64

(c) Howdogovernmentsinterveneinservicesmarkets?

Thissectionhighlights themain typesofgovernmentmeasures that have an effect on trade in services. Itonlysketchesbroadcontours.Giventhatthedefinitionoftradeinservicesincludesservicesthatareproducedlocallyintheimportingcountry,thescopeofmeasurespotentially impacting such trade is vast, ranging fromcorporate taxation to labour laws, to consumersubsidies,tolandownershipprovisions,andsoon.Thelist is much longer than in the case of measuresclassified as non-tariff measures in a goods tradecontext.

The fact that a measure negatively affects trade inservicesdoesnotimplythatitshouldbeautomaticallyviewedasprotectionist.Onthecontrary,asdiscussedabove, governments often intervene in servicesmarkets in pursuit of a variety of public policyobjectives that are unrelated to trade policyconsiderations.Theirinterventionsmightneverthelessraisethecostforservicessupplierstoenter/establishoroperateinamarket.

Thissectionpresentsatypologyofservicesmeasuresand draws on the (limited) available literature todiscuss to what extent such measures may beconsideredastraderestrictions.

(i) Types of services measures

As highlighted, the concept of “border” is notnecessarilyahelpfulcriterionwhentryingtocategorizeservices measures. Francois and Hoekman (2010)classify services interventions according to whetherthey affect domestic and foreign services andservices suppliers differently, i.e. are discriminatory,and whether they affect the ability of firms toenter/establish ina foreignmarketorhavean impactontheiroperations(seeTableB.2).

Suchaclassification,which isbasedon theeffectofthe measures, captures virtually all forms ofgovernment intervention in services markets. It isalso helpful in that it enables a rough distinctionbetweenmeasures thatusually reducethenumberofsuppliers in a market (i.e. those related to marketentry/establishment),andthusthequantitysuppliedata given price, and measures that raise costs once amarket is entered into (i.e. those that impactoperations) and result in a given quantity beingsuppliedatahigherprice.

It also helps to highlight that services interventionscomprisemeasuresthataffectinthesamewayforeignand domestic producers seeking access to thedomestic market. Measures impacting either entry orestablishment in a non-discriminatory fashion mayprotect national, or incumbent, suppliers, at theexpenseof foreignornewdomestic suppliers. In thisregard, some of the measures under discussion mayactuallybe restrictive tocompetitiongenerally, ratherthanto“foreigncompetition”,i.e.trade.

Thus, what matters for services trade is not just theremoval of discriminatory measures but thecontestabilityofthemarket.Eveninasituationwhereall discriminatory measures were removed, a sectorwould still remain highly restricted if only a fixednumber of suppliers were permitted to operate.Though there would be no discrimination in favour ofnationals,theentryofanynewsuppliertothemarket,betheyforeignordomestic,wouldstillbeconstrained.

Alternative classifications have also been proposed.Theyfocusmoreonthetypeofinstrumentbeingused,rather than its effects. Hoekman and Primo Braga(1997), for instance, distinguish between four maincategories: (i)quotasand localcontent requirements;(ii) price-based instruments; (iii) standards, licensingand procurement; and (iv) discriminatory access to

TableB.2:Typology of measures affecting services trade

Measures impacting entry/establishment Measures impacting operations

Non-discriminatory Restrictiononthenumberoflicencesforpharmacies,forexample

Reserverequirementforbanks,forexample

Discriminatory Alimitonthenumberofforeignarchitects,forexample

Higherportdutieschargedonforeign-flaggedvessels,forexample

Source:WTOSecretariat,basedonFrancoisandHoekman(2010).


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distribution networks. Copeland and Mattoo (2008)propose a fairly similar classification. Theseclassifications,whicharemoreakintothoseemployedtoclassifynon-tariffmeasuresapplyingtogoodstrade(seeSectionB.1),appearbettersuitedtoanalysetheeconomic effects of the various measures, preciselybecause available literature borrows heavily fromtraditional(i.e.goods)internationaltradetheory.65

Oneinstancethatisnotcapturedbyeitherclassificationis when trade is affected by the absence, rather thanthepresence,ofameasure.Forexample,asdiscussedfor non-tariff measures, when there is significantuncertainty about the quality of a service, demand for(andtradeof)theserviceconcernedmightonlyincreaseifcertificationrequirementsforsuppliersareintroducedasthesehelpraiseconsumerconfidence. Instancesofnaturalmonopoliesoroligopoliesprovideafurthercasein point. Unless pro-competitive measures areintroduced,dominant incumbentsupplierscan,throughtheir control of essential facilities, obstruct access tothemarket(MattooandSauvé,2003).

(ii) When is a measure a trade restriction?

Much services regulation pursues public policyobjectives. Nevertheless, such regulation mayunintentionallyalsohavetrade-restrictiveeffects.Or,atthesametimeasaimingatdomesticefficiencyorsocialequity objectives, it might be captured by specialinterest groups to protect domestic suppliers at theexpenseofconsumers.Economicpolicyconsiderationsmay also lead to services measures being usedexclusivelyforprotectionistpurposes.Theymayfurtheraffect the choice, among all possible alternatives, ofparticularlyinefficientpolicyinstruments.

Giventhepervasivenessofservicesregulationanditscomminglingwithtradeprotectionaclearidentificationof which measures are trade restrictions, or a neatseparation of the protective component in suchmeasures, is fraught with difficulty. As Copeland andMattoo(2008)observe,thetrade-relatedimplicationsof services measures depend on the specificcharacteristicsoftheserviceindustryinquestion,andparticularly on the market imperfections suchmeasuresaredesignedtocorrectorequityobjectivesthey are pursuing. Market structures differ widelyamong services sectors (Francois and Hoekman,2010). Services trade includes transactions in highlycontestable sectors as well as network industriescharacterizedbylargefixedcostsofentry,forinstance.The trade effects of services measures can thus beexpected to be different in these two types ofindustries.66

Indeed,atthesectorallevel,agreatdealofliteratureisavailablethatassessestherelativeefficiencyofdifferentregulatory measures in attaining specific public policygoals. Though rarely explicitly trade-oriented, manyfindings lead to trade-relevant policy conclusions. At a

generallevel,however,verylittleanalysisseemstohavebeen undertaken on the relative efficiency of servicesmeasures. Nevertheless, the limited literature that isavailable does point to some broad observations. Thefollowingdiscussionisorganizedaroundthetypologyofservices measures in Francois and Hoekman (2010),complementedbyan instrument-basedclassification. Itaddressesfirstdiscriminatorymeasures,and thennon-discriminatoryones.

First, discriminatory measures that impact eitherentry/establishment or operations place foreignservices and suppliers at a competitive disadvantagerelative to domestic services and suppliers. They canbe considered trade restrictions almost by definition.They include “traditional” trade measures, such asquantitative restrictions, that impact foreignentry/establishment, and discriminatory taxes orsubsidies that affect the cost of foreign suppliers’operations.

International trade theory suggests a ranking of suchinstruments of protection for goods trade (seeSectionB.1).Iftheobjectiveofapolicyistoexpandtheoutputofanimport-competingindustry,outputsubsidiescanbeshowntobeasuperiorinstrumenttotariffs,andtariffs normally superior to quotas. As Hindley (1988)indicates,thisrankingshould,inprinciplebeasvalidforservices as it is for goods. Nonetheless, applying asimilaranalysis toservices tradepresentsanumberofchallenges,asMattoo(2003)highlights.First,tariffsarenotnecessarilyafeasibleoptionforservices.Secondly,measures that may have tariff-like effects in terms ofraisingforeigncostsperunitofoutputarenottariff-likewhenitcomestogeneratingrevenue.Thirdly,andmostsignificantly, the modal definition of services tradeimplies the possibility that trade restrictions will bringabout mode-switching and that factor movements willdirectlyaffectmarketstructures.

Tariff-likemeasures thatdonotproduceany revenuewould imply a much greater loss in national welfarethanastraight tariff if incomefromquotas (i.e.quotarents) does not accrue domestically.67 Generallyspeaking,quotarentsaccruetotheownersoftherighttoimporttheproductinthedomesticeconomy.Inthecaseofservices, foreignsuppliersgenerallysell theirservice directly to domestic consumers, so they aremuchmorelikelytocollectthequotarentsthaninthecase of goods. Additionally, quotas are oftenassociated with wasteful administration and rent-seeking activities, including corrupt practices, thatpush their social cost above that of tariffs. Inimperfectlycompetitivemarkets,quotasareshowntobeevenmorewasteful(CopelandandMattoo,2008).

Iftradeispossiblethroughonlyonemode,alimitationonthatmodemayrender theserviceconcernednon-tradable.Ifmodescanbesubstitutedforeachother,aprohibitiverestrictionmaynothavemucheffect iftheunconstrainedmodeisthemostefficientone(Francois


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andHoekman,2010).If,however,itisnotthefirst-bestoption,theswitchtothealternativemodemayresultindeadweightlossesinducedbytradediversion(thoughpossibly moderated by lower price increases than inthe case where this mode-switching option was notavailable). Thus, any benefits resulting from themultiplemodesofservicesprovisionatthedisposalofsuppliers faced with a trade restriction need to beweighed against the additional cost to the importingeconomyofacquiringtheservicethorougharelativelyinefficientmode(CopelandandMattoo,2008).

For thoseserviceswherecross-borderdelivery isnotfeasible, limitations to entry on foreign investmentimply that the price and quality of the servicesconcernedaredeterminedexclusivelybythedomesticmarket structure. These restrictions on foreign directinvestment (FDI) generally take the form of eitherentry quotas and/or restrictions on foreign equityparticipation.Whilethe latterrestrictionsmaypreventtransfers of technology, skills and know-how, theformerhavebeenshowntobemoresociallywasteful.Foreign FDI might be attracted by returns toinvestment that have been artificially raised byrestrictions on competition and the true socialproductivityoftheinvestmentmaythusbelowerthanthereturnstotheinvestor(Mattoo,2003).68

Asfornon-discriminatorymeasures,limitedtheoreticaland empirical work has been undertaken on thesemeasures at a general level on the part of tradeeconomists. This is most probably a consequence oftheir primarily domestic nature. Literature relating totheeconomiceffectsofnon-discriminatoryrestrictionstoentry in individualsectors ismorereadilyavailable,but a review of this literature would be beyond thescopeofthisreport.

Nevertheless, it is possible to point to some generalobservations. First, non-discriminatory measuresaffecting entry/establishment, most notablyquantitative restrictions,wouldseem tobedifficult tojustify on efficiency grounds, as Hindley (1988) andCopeland and Mattoo (2008) argue. By protectingincumbent suppliers from competition, such entrylimitationsreducemarketcontestability.Theyhaveonoccasion been defended for infant-industry typereasons and the fulfillment of universal servicesobligations through cross-subsidization. However,alternative means have been shown to achieve thesame objectives without the need to restrictcompetition, so that entry limitations are at bestsecondorthird-rankingalternatives.

Secondly, non-discriminatory measures that impactsuppliers’ operations would seem to be the servicesmeasures furthest removed from protectionistpurposes. Even when they are pursuing public policygoals, however, they may, intentionally or otherwise,havespillovereffectsontrade.Forinstance,Copelandand Mattoo (2008) observe that, though responding

primarily to problems of asymmetric information,certificationrequirementsforprofessionalshavetradeand welfare effects that may vary depending on thescreening mechanisms chosen. Moreover, suchmeasures might yet again affect supply patterns byinducing suppliers to switch to alternative modes oftradingservices(Delimatsis,2008).

Assuch,acrucialchallengeposedbythesemeasuresis how to distinguish between when they are usedexclusively for public policy objectives and when theyare also being used for protectionist purposes(see Section E.2). Mattoo and Sauvé (2003) argue infavour of a “necessity test”. Such a test would enablegovernmentstoattaintheirchoseneconomicandsocialobjectives, but to do so in a manner that does not“unnecessarily”restricttrade.Theycontendthatsuchatestwouldencouragetheuseofthemosteconomicallyefficient measure among those available to remedy amarketimperfectionandpursuenon-economicgoals.

The ranking of instruments of protection in servicestradethatemergesfromeconomictheoryis,toalargeextent,reflectedintheGeneralAgreementonTradeinServices(GATS).Bydesign,andasdiscussedinmoredetail in Section E, the GATS distinguishes broadlybetweenthreetypesofservicesmeasures:thosethatrestrictentry/establishment,whetherdiscriminatoryornot; measures that are discriminatory, modifying theconditionsofcompetitioninfavourofnationalservicesand services suppliers; and measures that are non-discriminatoryandnon-quantitativeinnature.Thefirsttwotypesofmeasures(essentiallymarketaccessandnational treatment limitations as defined in GATSArticles XVI and XVII, respectively) are subject tonegotiationstoprogressivelyeliminatethem.Thethirdtype of measures (“domestic regulation”) are notconsidered trade restrictions as such, but the GATSacknowledgesthattheymayneverthelesshavetrade-restrictiveeffectsandmandatestheestablishmentofrelevantdisciplinesunderArticleVI:4.

4. NTMsinthe21stcentury

This section describes how recent or foreseeablechanges in the trading environment have affected ormay affect governments’ use of non-tariff measuresandservicesmeasures.Thisallowsustoillustratethepracticaldifficultiesinvolvedindealingwithmeasurespursuedforpublicpolicyreasonsandthetradeimpactof suchmeasures.Examples includemeasures takeninthecontextoftherecentfinancialcrisis,policies inrelation to climate change and measures addressingfoodsafetyconcerns.

(a) NTMs,servicesmeasuresandtherecentfinancialcrisis

Economiccrisestypicallyresult intheimplementationof economic stimulus measures by governments.


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Theuseofnon-tariffmeasuresisapartofsuchcrisis-inducedgovernment intervention.Therecentfinancialcrisis,whichhashadanimpactontheuseofNTMsbygovernments worldwide, is a case in point. In thissection, an analysis of the NTMs implemented in thewake of the crisis will enable us to illustrate thepracticaldifficultiesinvolvedindistinguishingbetweenmeasures taken for public policy reasons and thosethat constitute disguised protectionism. This sectionwill also discuss how recent changes in the tradingenvironmentbroughtaboutby thefinancialcrisismayaffect governments’ use of NTMs in the future. Itemphasizes that better monitoring of non-tariffmeasures,whichensuresgreatertransparencyintheiruse, is imperative in preserving consumer interestsand preventing a proliferation of protectionistmeasures. Italsoalludes to the fact that insituationswhere governments have a preference to protectdomestic industry, a monitoring mechanism needs tobe accompanied by legally enforceable rules (thatenable retaliation if an agreement is violated) to limittheuseoftrade-distortingNTMs.

(i) The recent financial crisis: attributing motive to the use of NTMs and services measures

It is well-established that the origin of the recentfinancialcrisiscanbetracedtoinstitutionalfailuresinthe regulationoffinancial systemsatanational level.Its effects were then transmitted across manycountries through international trade and financelinkages. In response to the crisis, subsidies, in theform of direct funding, special loans and guarantees,were provided to bail out a number of financialinstitutions in various advanced economies (Baldwinand Evenett, 2010). These “emergency” measures inthefinancialsectorwereassociatedwithpublicpolicyobjectives; they were deemed necessary to stem thespread of systemic damage and help restore thenormal functioning of financial markets – critical forbothconsumersandproducersacrosstheworld.

A number of countries also introduced subsidies toencourage consumers to buy specific productsthrough, for instance, refunding a certain amount ofthe purchase price. For example, the ConsumerAssistance toRecycleandSave(CARS)Actof2009in the United States – referred to as the “cash-for-clunkers”programme–providedcreditstoconsumerswhotradedinold,fuel-inefficientvehicleswhenbuyingor leasing new, more fuel-efficient vehicles(Congressional Quarterly, 2009). Such consumersubsidy schemes, implemented in a number of otheradvanced economies including Germany, France andthe United Kingdom, were used as measures tostimulate domestic demand – once again, a publicpolicy objective. Moreover, they were non-discriminatoryinternationally.

Intimesofeconomicrecession,however,highlevelsofunemploymentcanresult ingovernmentsresortingtonon-tariff measures and services measures thatdiscriminate against imports competing with “like”domestic products. Hence, as highlighted earlier, itoften becomes difficult to distinguish practicallybetween measures taken for public policy reasons(although their imposition may have adverse tradeeffects) and those that constitute disguisedprotectionism.Thisambiguityingovernmentmotivationisfurthercomplicatedbytheincreasedimportanceofintermediate goods trade in global supply chains(Hummels et al., 2001; Koopman et al., 2010). Forinstance, consider the industry-specific subsidiesintroduced by a number of developed economies toassisttheirstrugglingautomotiveindustriesduringtherecentcrisis.Thisispotentiallytrade-distortingforthefinal product market in the short-run. However, it ispossible that by disrupting an established globalsupply chain, their collapse would have led to asubstantialdecline inworld intermediategoodstrade,therebyresultinginsignificantjoblossamongseveralcountriesoverthemedium-run.

Identifyingthemotivebehindnon-tariffmeasuresandservicesmeasuresbecomesespecially important inacrisis situation because it can easily lead to beggar-thy-neighbour policies, i.e. trade-restrictive actionstaken by one country can trigger similar actions byother countries, leading to a spiral of ever morethreatening restrictions. Consider, for example,subsidies to financial institutions. If bailout funds areconditional on financial service firms redirectinglendingtowardsthehomemarket,thismaybeseenasdiscriminatory despite the apparent prudentialconcerns. The same holds true if subsidies areconditionalonthepurchaseofadomesticallyproducedproduct.

(ii) Impact of the recent crisis on future use of NTMs and services measures

Monitoring and coordination

The recentcrisismayaffectgovernments’useofnon-tariff measures and services measures in the future.Earlier in the section, we argued that the increasedincidence of NTMs may be linked, in part, to the factthat they are less transparent than border measuressuch as tariffs, and hence harder to discipline underinternational agreements. An outcome of the recentcrisis was the revival of the WTO’s trade monitoringmechanism in October 2008 (see Section C.1).69TherevivalofthismonitoringmechanismrepresentsanadvanceinaddressingtransparencyintheuseofNTMsandservicesmeasures. Itcanactasacommunicationdevice to solve a coordination problem that leads toexcessiveprotectionism,viatheuseofsuchmeasures.Inthefollowinghypotheticalexampleofhowthismightwork,itisassumedthatgovernmentspreferopentradepoliciestoprotectionism(seeTableB.3).


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Giventhepayoffsspecifiedfortwotradingpartnersinthe above table, there are two equilibria. If country 1resistsprotectionismthroughnon-tariffmeasures, forinstance, country 2’s best response is also not torestricttrade(andviceversa).If,however,country1isimposingtraderestrictions,country2’sbestresponseis also to impose similar restrictions (and vice versa).This reflects a beggar-thy-neighbour policy – if, forexample, country 1’s exporters cannot compete on alevel playing field in country 2, the government ofcountry 1 would not want the country’s firms to alsolose out on domestic market share to importcompetition from country 2. For both countries, thefirst equilibrium outcome is preferable to the second.But if the two are unable to communicate andcoordinatetheiractions,theymayendupwiththelesspreferred equilibrium outcome. Hence, by improvingthe transparency of NTMs, WTO’s monitoringmechanism can guide members to a better welfare(“Pareto-superior”)outcome.

Ofcourse,itmaybethecasethatgovernmentspreferto protect their domestic industry. If so, the strategicinteraction between governments is not simply acoordination game – the payoffs presented in theprevioushypotheticalexamplewouldchange.Supposeone country chooses “no protectionism”, the otherwouldwant to choose “protectionism”as itwouldgetfull market access to the former without having toopen up to competition itself. Table B.4 reflects thisargumentwithrelevantpayoffsforthetwocountries.Itshows that the situation is representative of what isknown as a prisoner’s dilemma game, whereby bothparties are motivated by the fear of what the othermightdo.

Giventhepayoffsspecifiedfortwotradingpartnersinthe above table, the equilibrium is both countrieschoosing the strategy of protectionism. Unlike thecoordinationgame,however,amonitoringmechanismthat helps the countries to communicate with eachotherwouldnotbesufficienttoguidethemtoabetterwelfareoutcomewherebothchoosethestrategyofnoprotectionism. This is because despite thecommunication,eachcountrywouldhaveanincentivetodefectfromtheiragreeduponstrategy,fearingthattheothermightdoso.Hence,alongwithamonitoringmechanism, legally enforceable rules – that enableretaliation in the event either country violates anagreementofchoosing“noprotectionism”–wouldberequired to control the use of trade-distorting non-tariff measures and services measures. It is worthnoting,however,thatduringtherecentfinancialcrisis,

governments of both advanced and developingeconomieshavereaffirmedtheirfaithinthemultilateraltradingsystemwithrepeatedpledgestoguardagainstprotectionistpolicies.

Measures in the financial services sector

Given that the origin of this economic crisis lay in afinancialcrisis,itislikelytoaffectgovernments’futureuseofmeasuresinthefinancialservicessector,whichmayaffect internationalmarketaccess.The literatureidentifiestheheterogeneityofregulatorypracticesasa major constraint on services trade (see Section D).Therecentfinancialcrisismayaffectthemotivationofgovernmentstopursueregulatoryconvergence inthefinancial services sector due to the reasons outlinedbelow.

First, the recent crisis was anchored in advancedindustrialized nations – those perceived to haverelatively sophisticated regulatory regimes. In fact,certain developing economies may associate theactivitiesofsomeforeignfinancialoperatorswithwhatthey perceive to be legitimate macro-prudentialconcerns. Secondly, unlike several developedeconomieswhichareassociatedwithhighly liberalizedcapital accounts, those which maintained greaterrestrictions on capital transactions and took a stricterstanceonfinancialleverageappeartohaveweatheredthestormbetter (DelimatsisandSauvé,2010).Thirdly,global liquidity growth, induced by expansionarymacroeconomicpoliciesimplementedacrosstheglobeduring the recent crisis, resulted in a surge of capitalflows to emerging economies. This has compoundedconcerns about the intrinsic volatility of short-termcapital flows, thereby giving developing countries anadditionalreasontoring-fencetheireconomiesagainstasuddenreversal(Sidaouietal.,2011).

(b) NTMsandclimatechange

(i) The future scenario

TheDurbanClimateChangeConferenceinDecember2011endedwithacommitment(“DurbanPlatformforEnhancedAction”)toworktowardsanewglobaltreatytoreplacetheKyotoProtocolby2015atthelatestandto establish a new climate fund (the “Green ClimateFund”)tohelppoorcountriesbothmitigateandadaptto climate change. Two years earlier, the UN ClimateChange Conference in Copenhagen established atargettokeeptheincreaseinglobaltemperaturefrompre-industrial times below 2 degrees Celsius.

TableB.3:Coordination game

Country 1

Country 2

Noprotectionism Protectionism

Noprotectionism (2,2) (0,0)

Protectionism (0,0) (1,1)

TableB.4:Prisoner’s dilemma game

Country 1

Country 2

Noprotectionism Protectionism

Noprotectionism (2,2) (0,3)

Protectionism (3,0) (1,1)


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A number of observers (Houser, 2010; Bodansky,2010)saw that targetunder theCopenhagenAccordasasignificantstepforwardsfortheglobalcommunitysince the lack of an explicit long-term goal meantcountries had no clear direction for national andinternational policy.70 Furthermore, under the Accordboth developed and developing countries notifiedemission reduction targets to the United NationsFramework Convention on Climate Change(UNFCCC).71

Nevertheless,bothmeetingsfellshortofexpectationsthat they would produce binding mitigationcommitments from both developed and developingcountries.Withoutprejudgingtheoutcome,shouldthenegotiations on a post-Kyoto agreement proveprotracted,whatwilllikelyemergeintheneartermisapatchwork of regional and national climate changeregimeswithsomecountriesimplementingfairlystrictmitigation measures, others taking no meaningfulaction,andafairnumberofcountrieswithpoliciesthatlie somewhere in between. This may lead toenvironmentalandeconomicoutcomesthatcountrieswouldthentrytomanagethroughtheuseofnon-tariffmeasures.

(ii) Carbon leakage and concerns about loss of competitiveness

Two related concerns are likely to deepen if nointernational agreement emerges about the specificactionsthatallcountriesneedtotaketotackleclimatechange.One is “carbon leakage”and theother is thepossible loss incompetitivenessoffirmsor industriesin countries which take more stringent mitigationmeasures.

Carbon leakage refers to a situation in whichreductionsofgreenhousegasemissionsbyonesetofcountries (“constrained” countries) are offset byincreased emissions in countries which do not takemitigationactions(“unconstrained”countries).Muchofthe discussion of carbon leakage has taken place inthe context of the Kyoto Protocol where so-calledAnnexIcountries(predominantlydevelopedcountries)hadcommitmentstocutbackontheiremissionswhilenon-AnnexIcountries(developingcountries)didnot.72

Theleakagecanoccurthroughanumberofchannelsinvolvingchangesininternationalpricesofenergyandenergy-intensive goods as well as the relocation ofproduction. Basically, the mitigation measures inconstrained countries reduce the production ofenergy-intensive goods and raise their internationalprices.Thedecreaseinproductionofenergy-intensivegoods also reduces the demand for fossil fuels andleadstoadropintheirprices.Unconstrainedcountriesexpand their production of energy-intensive goods inresponsetotheirhigherinternationalprices.Thelowerprice of fossil fuels will also induce unconstrainedcountriestousemoreofit,thusincreasingemissions.

Finally, energy-intensive industries may relocate fromconstrainedcountriestounconstrainedcountries.

However,therearealsooffsettingeffectswhichneedto be considered. The first one is the income effectfrom the increase in the price of energy-intensivegoods (Copeland and Taylor, 2005). The same pricechange which drives unconstrained countries toincrease production of energy-intensive goodsincreases their income. Assuming that environmentalquality is a normal good, this income effect will prodthem to take measures to mitigate emissions. Thesecond effect that can counteract carbon leakage isinnovation towards more energy-efficient means ofproduction(DiMariaandWerf,2008).Thesamepricechange responsible for carbon leakage also inducesfirmstodevotemoreoftheirresearchanddevelopment(R&D) resources to find energy-efficient means ofproduction. This is similar to the argument made byPorterandvanderLinde(1995)thatproperlydesignedenvironmental regulations can spur innovation thatmay partially or more than fully offset the costs ofcomplyingwiththem.

Because of these possible offsetting effects,estimates of the magnitude of carbon leakage varyconsiderably although it is always greater than zero.The standard method of measuring carbon leakageexpressesitasaratiooftheincreaseinCO2emissionsof unconstrained countries and the reduction in theemissions of constrained countries. Most of theestimates of the global rate of carbon leakage varybetween5percentand20percent(Sijmetal.,2004).However, much higher estimates reaching up to130 per cent have been calculated (Babiker, 2005).Estimatesofcarbonleakageabove100percentimplythat mitigation policies in the constrained countriesare actually counter-productive since they lead tohigher global emissions as production shifts tounconstrained countries that employ more emission-intensivetechnologies.73

Unlikecarbonleakage,thereisnoprecisedefinitionofcompetitiveness in the climate change literature. Itmight refer to the impact of the mitigation measureson firms’ or industries’ cost of production, profits,output,employment,ormarketshare.Theseindicatorshavebeenvariouslyemployed inanumberofstudiestomeasurelossofcompetitiveness.74Notwithstandingthis imprecision, the shift in production of energy-intensive goods from constrained to unconstrainedcountries, which is what makes leakage possible,capturestheessenceofthiscompetitivenessconcern.

(iii) Measures to address climate change, carbon leakage and loss of competitiveness

The need to mitigate climate change will spur manycountries to take unilateral mitigation measures,


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manyofthemfalling inthe listofnon-tariffmeasuresthat have been discussed in this report. However,carbon leakage introduces a strategic dimension toconstrained countries’ mitigation efforts since theymayconsider itnecessary to take intoaccount “free-riding”byunconstrainedcountrieswhichcandiluteorreversetheeffectoftheirmitigationactions.Thefree-riding refers to the argument that unconstrainedcountries bear no cost of mitigation efforts, yetassuming carbon leakage is less than 100 per centthey benefit from the reduction in global emissionsdue to the mitigation activity of the constrainedcountries. It is argued that trade measures provide awayforconstrainedcountriestoaltertheincentivestofree-rideontheirendeavours.

Theoretical work exists on the effect of linkinginternational environmental cooperation with trade(Barrett, 1994; Barrett, 1997; Botteon and Carraro,1998).Thebasicinsightfromthesestudiesisthatthenumber of cooperating countries in an environmentalaccordwouldbelargerandtheagreementmorestable(e.g. self-enforcing) if there are provisions for tradesanctionsagainstnon-members.Inotherwords,usingtrade measures against non-cooperating countriescan be an effective way of increasing the number ofcooperating countries and of guarding againstdefectionbycurrentlyconstrainedcountries.Asnotedpreviously (in Section B.1), a number of internationalenvironmentalagreements,namelytheConventiononInternational Trade in Endangered Species of WildFauna and Flora (CITES) and the Montreal Protocol,included provisions allowing for the use of trademeasures.

Non-tariff measures that might be taken to mitigateclimatechangeaswell as tocounter carbon leakageor to reducethe lossof internationalcompetitivenessbycountrieswith stringentmitigationpolicies includeborder tax adjustments, subsidies, and regulatorymeasures (includingTBT/SPSmeasures).There isbynowalonglistofpapersthathaveexaminedtheWTOconsistencyofthesetypesofmeasuresinthecontextof climate change. A partial list includes Bordoff(2009),Lowetal.(2011),Pauwelyn(2007),andWorldTrade Organization (WTO) and United NationsEnvironmental Programme (UNEP) (2009). Thefollowing discussion will focus on the economicaspects rather than the legality or WTO-consistencyofthemeasures.

Border adjustment measures

Border adjustment measures would impose costs onimports of emission-intensive goods commensuratewiththecostsofcompliancewithdomesticemissionsregulations. On the import side, border adjustmentscantaketheformofataxonimportedproducts,ortoa requirement for importers to purchase emissionpermitsorallowances for those foreignproducts thatthey are importing. On the export side, border

adjustments can take the form of an export rebate,where exporters shipping items to unconstrainedcountries are compensated for the cost of complyingwith emission requirements. This discussion focuseson a domestic tax on imports since that has drawnmoreinterest.

Whenconstrainedcountriessettheiroptimalpolicies,theywillneedtotakecarbonleakageintoaccount,i.e.theywill have to act strategically.Hoel (1996) showsthat the first-best policy of constrained countries willbetoimposeatariffontheemission-intensiveimportandapplyauniformcarbontaxonbothdomesticandforeign emission-intensive goods.75 The import tariffwill be set so as to (i) shift the terms of trade in theimportingcountry’s favourand (ii) reducedemand foremission-intensiveforeigngoods.Thissecondelementreflectstheconstrainedcountry’sstrategicrecognitionofcarbonleakageandtheneedtorespondtoit.

Ifacountrycannotfreelyadjustitstariffs,thesecond-bestpolicywillrequireanon-uniformcarbontax,sinceitnotonlyneedstoreflectthesocialcostofemissionsbut also shift demand away from emission-intensiveforeign goods.76 There are two main challenges toimplementingsuchabordertaxadjustment.Thefirstisthe administrative difficulty of implementing such ascheme given the enormous amount of informationrequired to determine the emissions of foreign-producedgoods.77Thesecond is theriskthatonceasystemofbordertaxadjustmentsisputinplace,itwillbe captured by protectionist interests. Moore (2010)observes that the carbon-intensive sectors that arelikelytobeatthecentreoftheissue–steel,chemicals,paper,cement,andaluminium–areintensiveusersofanti-dumping measures, suggesting that they will beaggressive in their attempts to use border taxadjustments as a means of limiting internationalcompetition.

Subsidies

Asdiscussed inSectionB.1, theexistenceofpositiveeffects can provide a legitimate reason forgovernmentstousesubsidiestosupportaneconomicactivitywithsocietalbenefits thatarenot reflected inmarket prices. In the case of climate change, thereare strong reasons to believe that technologicalchange offers the main avenue for reducing futureemissions and achieving the eventual stabilization ofatmospheric concentrations of greenhouse gasemissions. The Intergovernmental Panel on ClimateChange (IPCC) identifies several reasons why R&Dsubsidies are warranted, particularly in the energysector(Metzetal.,2007).

ThebenefitsofR&Dmaynotberealizedfordecades,which is beyond the planning horizons of even themost forward-looking firms. Industry can onlyappropriate a fraction of the benefits of R&Dinvestmentsandasaresult,firmsunder-investinR&D.


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Moreover,firmsfacedifficultiesinevaluatingintangibleR&D outputs and regulatory interventions can capprofitsinthecaseofpath-breakingresearchsuccess.Finally, given that the agricultural sector is a majorsource of emissions, there is also a potential role forsubsidies to facilitate the adoption of “climate smart”agriculturaltechnologies.

Ontheotherhand,itisalsotruethatsubsidiesprovidegovernmentswithameansofsupportingcompetitivelychallenged domestic firms and industries. One areawhere the role of subsidies has gained increasedattention is in biofuels. Thereareno readily availabledata on the amount of these subsidies at the globallevel. However, a recent study by Steenblik (2007)using informationonfiveOECDmembers–Australia,Canada, the European Union, Switzerland and theUnited States – provides an estimate of biofuelsubsidiesofaboutUS$11billionayear.Ajointreportby several international organizations including theWTO(FoodandAgriculturalOrganization(FAO)etal.,2011) estimates that during the 2007-09 period,biofuelsaccountedforasignificantshareoftheglobaluse of several crops – 20 per cent for sugar cane,9 per cent for vegetable oil and coarse grains and4percentforsugarbeet.

Thepoliticaleconomyofsubsidieshasbeenraisedinthe context of biofuel subsidies, where it is claimedthat a primary objective of some countries’ biofuelpolicyistoincreasefarmers’andlandowners’incomes(Rubinetal.,2008).Anumberofconcerns,economic,environmentalandsocial,havealsobeenraisedaboutthe wisdom of large biofuel subsidies. Some biofuelsemit more greenhouse gases than they save. Anyexpansion of biofuel production will have indirecteffects on greenhouse gas emissions through landuse expansion.Subsidies for biofuels have also beenimplicated in the recent spike in commodity priceswhich has been particularly detrimental to food-importingdevelopingcountries(Mitchell,2008).

Regulatory measures

AsnotedinSectionB.1,regulationsarewidelyusedtodealwithenvironmentalproblems.Thediscussiontherealso suggested that governments may prefer thesemeasuresfordistributionalorcompetitivenessreasons,uncertaintyaboutthecostsandbenefitsofabatement,andthedifficultyofmonitoringandenforcement.

In the field of climate change, it is possible todistinguish between technology standards thatmandatespecificpollutionabatementtechnologiesorproductionmethods, andperformancestandards thatmandate specificenvironmental outcomesperunit ofproduction (Sathaye et al., 2007). An example of atechnology standard is a regulation that requires theuseofspecificCO2captureandstoragemethodsonapowerplant;anexampleofaperformancestandardisonethatlimitsemissionstoacertainnumberofgrams

of CO2 per kilowatt-hour of electricity generated(Sathaye et al., 2007). Beyond these types ofregulations,somehavealsopointedtotheprospectofmore sanitary and phytosanitary measures beingtakenbycountriesgiventhatclimatechangewillalterthe impactofpestsanddiseases (Jackson,2008). Inthe face of greater uncertainty about pestinvasiveness,countriescouldbecomemoreriskaverseand use emergency trade restrictions as a way ofmanagingthoseuncertainties.

Assumingforeignproducershavehigheremissionsortheir products are less energy efficient, requiringforeign producers to comply with more stringentdomestic requirements can reduce carbon leakage.Foreignproductionofthegoods,andtheirsale inthehome country can continue, but it will be employingtechnology or standards that are as environmentallyfriendly as those in the home country. Since therequirements also raise the trade costs of foreignproducers, domestic firms are able to secure someadvantageandtheoveralleffectmaybeareductionofimportsbythehomecountry.

(iv) Conclusions

Nothing speaks to the intertwining of public policygoalsanddomesticproducer interestsmore than theissue of carbon leakage and competitiveness. Thecloselinkbetweenthesetwoissuesconfrontsuswithone of the main themes of this report: distinguishingbetween the pursuits of public policy goals and ofdomesticproducer interests.There isclearlyaglobalinterestinreducingcarbonleakageandcountriescanhave strong environmental reasons for using trademeasurestopreventfree-riding.Theothersideofthecoin, however, is that the same trade measure alsohelpscompetitivelychallengeddomesticproducerssothat the risk of regulatory capture cannot be easilydismissed. We may see increasing use of non-tariffmeasures in the future to deal with carbon leakageand competitiveness concerns as well asdisagreementsabouttheunderlyingmotivationbehindthosemeasuresandtheirtradeeffects.

(c) Foodsafetymeasures

This section discusses why food safety measures78

appear to have become more and more important inrecent times and what the challenges are thatcountries face regarding their impacton internationaltrade. It concludes that more transparency is neededto ensure the pursuit of consumer interests and topreventprotectionistabuse.

(i) Increased importance of food safety measures

Thegrowinginterestofconsumersworldwideinsafetyand quality attributes of food has drawn a lot of


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attention to the role of food safety and qualitymeasures in international trade, both governmentaland private (Henson and Caswell, 1999). On the onehand, governments intervene in food markets asmarkets alone fail to provide the socially desirablelevelofqualityandsafety(Smith,2009).Ontheotherhand, agri-food enterprises employ private standardsasatoolforproductdifferentiationandquality-basedcompetition(HensonandReardon,2005).Hence,thewidespread incidence of both governmental andprivate measures in the agri-food sector relates todevelopmentsonboththedemandandthesupplysideoftheagri-foodsystem,withclear linkagesand inter-dependencies.

Demand-driven developments

Technological, social and economic developmentshavetransformedconsumerdemand,andrecentfoodsafety incidents have amplified this trend. A renewedfocus on consumer awareness has resulted in agrowing demand for higher levels of regulation andcommunication, and appears to have shifted foodmarkets from price-based towards quality-basedcompetition.

Growing attention by consumers to quality and safety attributes

Demographicandsocialtrends–suchasurbanizationand the evolving role of women in the workplace –have modified eating habits and patterns of fooddemand (Reardon and Barrett, 2000). At the sametime, increasing levels of income, technologicaladvances, more sophisticated information about theinfluenceofdietonhealthanditsmasscommunicationhave influenced consumer attitudes towards foodattributes, increasing their awareness of risks andopportunitiesrelatedtoeatingbehaviour(CaswellandMojduszka, 1996; Kalaitzandonakes et al., 2004;Grunert, 2005). This change in focus has ledconsumerstoconsideraspectsoffoodthatcannotbeverified at the time of consumption (Caswell andMojduszka,1996). Inaddition, scientificprogresshasfacilitatedamorepreciseidentificationofhealthrisks,thus allowing consumers to increase their evaluationstandards(Mafraetal.,2007).

Moreover, when assessing food quality, consumersappearincreasinglytopayattentiontoabroaderrangeof product and process characteristics, such as theimpactoffoodproductionontheenvironment,workerwelfare and global poverty (Henson and Reardon,2005). These developments, which are increasinglyprominentalsoindevelopingcountries(Reardonetal.,2001), have led to a market for quality and safetycharacterizedbyimperfectinformationandsubstantialtransaction costs in obtaining and using information(Caswell and Mojduszka, 1996). Governments andprivatesectoractorshaveintervenedtocorrecttheseinefficiencies, introducing governmental measures

thatregulatefoodproductsandproductionprocessesanddevelopingprivatestandards,respectively.

Food safety scares

A number of high-profile food safety scandals haveheightened public and private attention to foodattributesevenfurther.Thedioxincrisis inthepoultrysector in the Netherlands in 2006, the bovinespongiform encephalopathy (BSE) in the beef sectorinvariousEuropeancountriesoveranumberofyearsand the Chinese melamine-adulterated milkcontamination in 2008 are prominent examples(Latouche et al., 1998; Marucheck et al., 2011).Considerable media attention towards these crisesamplifiedtheireffectsonconsumerattitudes,andthisprocess of “social amplification” has resulted in animportant decrease in consumer trust in relation topublicandprivateassurances regarding thesafetyoffood(Latoucheetal.,1998).

The subsequent need to restore confidence in publicauthoritiesandfoodproducershasledtoanincreaseintransparency in regard to the operation of the supplychain(BöckerandHanf,2000;Mazzocchietal.,2008),and governmental and private food safety measureshave proliferated as tools to guarantee such levels oftransparency (Henson and Humphrey, 2010). Whilepublic actors have tightened existing measures andinstituted new measures for emerging and previouslyunregulatedissues,foodcompanieshavefelttheneedtocontrol reputationalandcommercial risks related tofoodsafety(HensonandReardon,2005).

Supply-driven developments

Besides demand-driven changes, developments onthesupplysideoffoodmarketshavecontributedtoanincrease in both governmental and private measuresrelatedtofoodsafetyandquality.Thestructureofthesupply chain has evolved towards increasedfragmentation across multiple enterprises andintegration intoglobalmarkets.Thisdevelopmenthasbeendrivenby technologicalchangeswhichhave ledtoare-organizationoffarmactivitiesandanincreasedprovisionofgoodsandservicesbyoff-farmenterprises(Reardon and Barrett, 2000). The large number ofplayers involved in the supply chain has heightenedthe need for both coordination among firms andgovernmentassuranceofqualityandsafetyinrelationtofoodproductsandproductionprocesses.Theglobalreach of today’s agri-food supply chains, driven byadvances in communication, distribution andtransportation systems, has further amplified thechallenge to ensure traceability and compatibilityamongfoodsafetymeasuresindifferentjurisdictions.

Coordination costs and global supply chains

Fragmented supply chains face coordination andmonitoring challenges. Agri-food supply chains may


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involve a high number of supplier-buyer relationshipsacross which the quality and safety of the final foodproduct needs to be ensured (Henson and Reardon,2005). Coordination and monitoring efforts increasetransaction costs and are further complicated bydifferent levels of information between buyers andsuppliers(Gereffietal.,2005;Hammoudietal.,2009).This has led firms to adopt “hands-on” forms ofcoordination or even to strive for complete verticalintegration. Alternatively, coordination costs andinformationproblemsat the inter-firm levelhavebeenmanaged at arm’s length via product and productionstandards (Ponte and Gibbon, 2005; Gereffi et al.,2005).Asagri-foodchainsbecomeglobalandinvolvedifferent regulatory environments, the role of theseinstruments in the coordination of supply chains andthe standardization of product requirements amongsuppliersbecomesofgreaterimportance(HensonandReardon,2005;Maruchecketal.,2011).

Importance of, and challenges related to, traceability

Allowing for the precise tracking of food productsalongthesupplychain, traceabilitysystemsrepresentimportant instruments to assure food quality andsafetyinagri-foodsupplychains.Theirprincipalaimisto collect the necessary information for theidentificationand theeventual recall of products thatrepresent a risk to consumers (Meuwissen et al.,2003).Theadoptionoftraceabilitysystemsisrelatedto the broader phenomena of increased consumerattention to food safety and quality, technologicalprogress and the global extension of food supplychains.Thesafetyscandalspreviouslyreferredtohaveincreased the interest of consumers in theseinstruments (Souza-Monteiro and Caswell, 2004;Dickinson and Bailey, 2002). In order to functionadequately, traceability systems must allow for theidentification of all partners in the supply chain, andgrant complete information transfers. The trendtowards an increased internationalization of supplychains has posed considerable challenges to theaccomplishment of these requirements, and led to agrowing need for regulation and cooperation(Meuwissenetal.,2003).

(ii) Trade impacts of food safety measures and mitigation strategies

Given the important role that food safety measuresplay on both the supply and demand side of food,thesemeasuresareboundtoaffectinternationaltradein these products.79 This part describes some of theprincipal ways in which food safety measures affectproducer strategies and considers mechanisms formitigatingpossiblenegativetradeimpacts.

Trade impact

Foodsafetymeasurescancreatebothchallengesandopportunities for producers. Some of the main

challengesrelatetothecostsassociatedwithdiverserequirements.By investing in thecapacity toproduceproducts that achieve higher safety requirements,producers may also benefit from accessing higher-valuemarkets.Producersmayalsoinvestindevelopingtheirownstandardsasamarketingstrategyandasameans of managing product quality along the value-chain.

Compliance costs and loss of economies of scale

Costs of compliance can result in the loss ofeconomies of scale for foreign producers if differentrequirements apply in different export destinations.These costs will be a function of the exporters’administrative and technical capacity for managingdiverse requirements (Henson and Mitullah, 2004;Mathewsetal.2003;Otsukietal.,2001). Inaddition,foodsafetymeasuresusually includebothaspecifiedlevel for particular substances and systemicrequirements associated with record-keeping andconformity assessment. Therefore, when they areconsidered cumulatively, regardless of whether thelevelofthesefoodsafetymeasuresisthesame,iftheconformityassessmentproceduresaredifferent,costsmayincreaseduetoduplicativetestingrequirements.

Increase in value-added

Food safety/quality measures may also embodyadvanced regulatory “technology” and help increasevalue-added in the exporting country. Some analystsstress that rising food safety requirements cancatalysetrade,creatingincentiveforfirmstoinvest inorder to re-position themselves in competitive globalmarkets (Jaffee and Henson, 2004; Swinnen andMaertens, 2009). Of course, food safety measuresimpactthecompetitivepositionofindividualcountriesanddistinctmarketparticipantsdifferentlydependingon their strengths and weaknesses.80 Highrequirements typically are associated with high-valuetrade,whichmeansproducersparticipatinginthistypeof trade will be able to receive higher returns. In asupportive policy environment, poor producers maybenefitdirectlythroughcontractedparticipationinthevaluechain(see,forexample,Jaffeeetal.,2011).

Private standards and market power

Privatesectorfoodsafetystandardsplayanimportant,and increasing, role indetermining international tradeoutcomes,addinganadditional layerofcomplexity tounderstandingtradeinfoodproducts.81Whenretailershave buying power, such standards can become de facto market entry barriers for certain producers(Henson and Humphrey, 2009; World TradeOrganization (WTO), 2005b). This is particularly thecasefordevelopingcountrieswhichactas“standard-takers” rather than “standard-makers”. Researchindicatesthatinmanycases,developingcountriesarestandard-takers because developing their own


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standards ismorecostly thanadopting thestandardsoftheirmajormarkets(Stephenson,1997).

Increasingly, private companies or groups of retailershavecreatedtheirownstandardstosatisfyconsumerdemandforparticularproductcharacteristicsandasatool to segment markets. For example, the UKsupermarket chain Tesco has a standard that all itssuppliers of fresh fruits, vegetables and salads mustmeet (García Martinez and Poole, 2004). Privatestandards often go beyond food quality and safetyspecifications and include ethical and environmentalconsiderationsaswell(SwinnenandMaertens,2009).The implications for themultilateral tradingsystem inregard to private standards as well as furtherchallenges in regard to multilateral cooperation onfoodsafetymeasuresmoregenerallyarediscussedinSectionE.

Mitigation of negative trade impacts

Several approaches are available to mitigate thepossiblenegativeimpactsoffoodsafetymeasuresontrade. Countries may seek to harmonize their foodsafetymeasurestoaparticularbenchmark.Theymayalso negotiate an agreement to recognize othernational food safety systems as achieving thenecessary levelof foodsafety.CountriesalsocommittoacommonsetofrulesembeddedintheWTO’sSPSAgreementthatseektolimitthepotentialuseoffoodsafetymeasuresforprotectionistpurposes.

Harmonization and equivalence

While protectionist incentives may contribute toregulatory diversity in food safety regulations, thisdiversity persists for a variety of other reasons. Riskperceptionsandpreferencesandtheinterpretationofscientific evidence may vary among countries. Thesedifferencesmayleadtotheadoptionofdifferentlevelsof food safety regulations. Food safety measures,however, are typically more complex than aspecification of a particular level for content of riskymaterial. A large proportion of food safety measuresare process requirements which define particularapproaches for achieving specified levels of foodsafety.Since the conditionswithineachcountry vary,the optimal approach for achieving the same level ofsafety may also vary. There are various collectiveapproaches for reducing the potential negative tradeimpactsassociatedwiththisdiversity.

One approach would be for countries to seek toharmonize foodsafetymeasures toasinglestandardor standards system. Harmonization can take manyforms and the impact of harmonization will dependupon what level is chosen as the benchmark. WTOrules in relation to food safety encourageharmonization towards international standards set bythe Codex Alimentarius Committee. Thisintergovernmental body collectively decides on

standards, guidelines and recommendations in theareaoffoodsafetyand,inprinciple,shouldincorporatethe preferences of all countries participating in thestandard-setting (for more detailed discussion,seeEngleretal.,2012;Hooker,1999;Sykes,1999).

Another approach for addressing regulatory diversityamong countries is for countries to recognize foodsafety measures of trading partners as equivalenteven if these measures differ from their own.82 Thisapproach would enable countries to develop foodsafetysystemstofittheirspecificcontext,ratherthanforcing a one-size-fits-all approach to achieving aparticular level of safety (Josling et al., 2005).Equivalence is particularly important in the case ofprocess requirements due to their complexity. Bycontrast, product requirements are typically definedalong fewer dimensions and are thus more easilycompared. Inpractice,thedeterminationofwhetherasystem of food safety requirements achieves areasonable level of safety may be administrativelyburdensome because it requires an evaluation of thesystem of risk management interventions, includinginfrastructure,programmeimplementationandspecifictechnicalrequirements.

Other means to prevent trade distortions

Asfoodsafetymeasurecanbeabusedforprotectionistpurposes,83 countries can commit to a range ofdisciplines that constrain such behaviour. Someprincipal obligations contained in the WTO SPSAgreementinthisregardareoutlinedbelow.

First, the right to implement trade-distorting foodsafetymeasuresislinkedtoascientificjustificationofthe measure, specifically that the measure be basedonscientificassessmentoffoodsafetyrisks.Anotheraspect of the rules emphasizes that the level of risksought within countries should be consistent indifferent situations. Of course, as noted above, whilefood safety measures will include a target level forcontent of risky material, the measures usually alsoinclude other dimensions. Some analysts havequestioned whether consistency is a realisticexpectationgiven thecomplexsystemof factors thatcontribute to the development of regulations (Sykes,2006).Finally,theWTOrulesforfoodsafetyexplicitlystate that food safety measures should be “not moretrade restrictive than required to achieve theirappropriate level of sanitary or phytosanitaryprotection”. As in the case of recognition ofequivalence across countries, this requirementrecognizes that there may be alternative approachesthatcouldbetakentoreachdesiredlevelsofsafety.

5. Summaryandconclusions

This section has introduced different categories ofnon-tariff measures and measures affecting trade in


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services,analysedtheirpolicyrationalesandeconomiceffects and elucidated the difficulties involved inidentifying possible protectionist abuses. In SectionB.1, reasons for government intervention have beenreviewed,ashave thepolicies implemented inpursuitofthesegoalsthatmayaffecttrade.Thishasresultedinthefindingsoutlinedbelow.

National welfare-maximizing policies that seek tomanipulate the terms of trade or shift profits fromforeigntodomesticfirmsareexplicitlytrade-oriented.Measures affecting foreign producers may also betakeninordertoprivilegespecificindustrylobbiesforpolitical economy motives. Other policies addresspublic policy concerns, such as environmentalprotection or consumer health. As such, they are nottargeted at distorting trade, but may neverthelessaffecttradeinordertoreachtheirobjective.84

A range of instruments are available to pursue thesepolicies.Tradeobjectivescanbepursuedusingtariffsoropenlytrade-distortingnon-tariffmeasures,suchasquotas, export taxes or subsidies. For many publicpolicy objectives, non-discriminatory NTMs, such asregulatory measures or product taxes, are first-bestpolicies. However, governments can also implementorigin-neutral measures in ways that de factodiscriminate against foreign producers or employNTMs that are inefficiently reducing trade more thannecessarytofulfillapublicpolicygoal.85

Whileagovernmentmaydeclareitsintentiontopursueapublicpolicyobjective,suchasconsumerprotection,it may employ a non-tariff measure in a way thatcreates an artificial advantage for domestic overforeignproducers.Behind-the-bordermeasuresofthissort pose a particular challenge to trade cooperationbecause their effects and motivations are often lessclearthanbordermeasures. Ingeneral, thecostsandbenefits of regulatory measures are more difficult toevaluate than classical price and quantityinstruments,86 which is why the remainder of thisreport putsaparticular focusonTBT/SPSmeasuresanddomesticregulationinservices.

Section B.2 has discussed a number of situations inwhich governments may be inclined to use certainnon-tariff measures rather than more efficientinstruments. Under certain conditions, governmentsmayspecificallyprefer“opaque”measuresintermsofboth their cause and effect or choose NTMs thatincrease fixed rather than variable costs. Politicalmotives and institutional constraints can explain thepersistence of inefficient NTMs more generally. Therecent phenomenon of offshoring, where businessrelations are characterized by bilateral bargainingrather than market clearing, provides another reasonwhy, also from a national welfare perspective,governmentsmaydistortNTMs, includingbehind-the-borderpolicyinstrumentssuchasTBT/SPSmeasures,inadditiontotariffsinordertoinfluencetrade.Finally,

SectionB.2hashighlightedthatgovernmentsemployNTMs that are not effectively regulated at theinternational level anduse these to take theplaceoftariffs or other NTMs that are constrained by tradeagreements.

Oneofthemaininsightsfromthisdiscussionhasbeenthatneitherthedeclaredaimofapolicynoritseffectontrade,whichmaybecoincidentalinthepursuitofa“legitimate”publicpolicyobjective,inandofitselfcanoffer a conclusive answer to the question whether anon-tariff measure is innocuous from a tradeperspective or not. A number of factors have beenidentified in Sections B.1 and B.2 that can beexaminedinordertoassesswhetheranNTMmaybeemployed for competitiveness reasons despitestatements to the contrary or may otherwise undulyinfluence trade. These include an analysis of theefficiency of the measure in achieving its objectivecompared with alternative means as well as of itsincidence – that is the distribution of costs andbenefits among producers and consumers bothdomestically and abroad. An examination of sectorcharacteristics,suchas thedegreeoforganizationorextentofbilateralbargainingininternationalbusinessrelations, and the wider political context in terms ofinstitutions, political processes, information problemsand the like also informs this assessment. Theseissues are further elaborated in Section E.4, wherechallengesfacedby themultilateral tradingsystem inrelation to NTMs and possible ways forward arediscussed.

SectionB.3hasbrieflypresentedthespecificfeaturesof services trade, the types of services measuresencountered and the principal reasons whygovernments intervene in services markets. Despitethepeculiaritiesofservices trade, thediscussionhasrevealed the same fundamental difficulty indistinguishing situations when services measurespursueexclusivelylegitimateobjectivesfrominstancesin which they also have a trade-related purpose.Section E.2 provides a more detailed account of theprogress made and challenges faced in regulatingservicesmeasuresattheinternationallevel.

Finally,thecasestudiescontainedinSectionB.4havehighlightedtheprominenceofnon-tariffmeasuresinanumber of current high-profile areas of governmentactivityandtheneedforabetterunderstandingofthetypesofNTMsused,theirobjectivesandeffects.Therecentfinancial crisishasgiven rise toahostofnewNTMs taken for “emergency” reasons. However, theglobalextentof thecrisishasquicklyheightened theneedforwidespreadmonitoringofthemeasurestakeninordertoforestalltemptationstopursuebeggar-thy-neighbour policies or to engage in such practices inretaliationforperceivedprotectionism.

The issue of carbon leakage and competitiveness inthecontextofclimatechangepolicyhasgivenriseto


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extensive debates about the use of non-tariffmeasures in this regard and provides a powerfulexample of the difficulties involved in distinguishingbetween the pursuit of legitimate public policyconcernsandtheabilitytoservesector-specifictradeinterests. The lack of progress in climate changenegotiations and the desire by certain countries toforge ahead unilaterally have the potential to lead toan increased use of NTMs and trade rows over theirtruepurposeandimpact.

Lastbutnotleast,economic,socialandtechnologicaldevelopments have fuelled the rise of food safetymeasures as an important tool in supply chainmanagement and consumer protection. Food safetymeasures offer opportunities and pose challenges toproducers, and efforts to mitigate negative impactshave received renewed attention, not least with thecreation of the Standards and Trade DevelopmentFacility (STDF), an inter-organizational initiative forenhancingdevelopingcountries’capacitytomeetSPSrequirements.

All of these concerns have in common the need forappropriate data, and the challenges faced inimproving transparency through notifications,monitoringandothertechniquesarefurtherdiscussedin Section E.4. Section C takes stock of the existinginformation base on non-tariff measures, which formanytypesofmeasuresisfoundtobewanting.Widegaps in thecoverageandcontentof thedatamake itdifficulttogaugetheextenttowhichtheuseofNTMsintheareasdescribedabove(andmoregenerally)hasindeed increased over time and whether this hasresulted in additional impediments to internationaltrade,aswillbefurtherdescribedbelow.

1 Wolfemakesasimilarargumentaboutthepositiveeffectoftransparencyontrade,pointingtotheroleoftheWTO’smonitoringmechanisminreducingtheincidenceofprotectionismduringtheglobaleconomiccrisis.

2 Inthepaper,politicaltransparencyreferstoopennessaboutpolicyobjectivesandinstitutionalarrangementsthatclarifythemotivesofmonetarypolicy-makers.Thiscouldincludeexplicitinflationtargets,centralbankindependenceandcontracts.Economictransparencyfocusesontheeconomicinformationthatisusedformonetarypolicy,includingeconomicdata,policymodelsandcentralbankforecasts.Proceduraltransparencydescribesthewaymonetarypolicydecisionsaretaken.Thisincludesthemonetarypolicystrategyandanaccountofpolicydeliberations,typicallythroughminutesandvotingrecords.Policytransparencymeansapromptannouncementandexplanationofpolicydecisions,andanindicationoflikelyfuturepolicyactionsintheformofapolicyinclination.Operationaltransparencyconcernstheimplementationofmonetarypolicyactions,includingadiscussionofcontrolerrorsfortheoperatinginstrumentandmacroeconomictransmissiondisturbances.

3 ThisisanideaasoldasAdamSmithintheWealth of Nations:“Asitisthepowerofexchangingthatgivesoccasiontothedivisionoflabour,sotheextentofthisdivisionmustalwaysbelimitedbytheextentofthatpower,or,inotherwords,bytheextentofthemarket”.

4 Alabellingrequirementmaynotbeapanaceaifforexampleitrequiredadetailedbreakdownoftheoriginofeachcomponentpartasthisinformationcouldbedifficultandcostlytotrackdown.

5 Wherethereislessthanperfectinformationaboutgoods,economistsgenerallydistinguishbetweensearch,experienceandcredencegoods.Searchgoods(e.g.clothes)needtobeinspectedbeforebuyinginordertoobservetheircharacteristics.Experiencegoods(e.g.wine)haveunknowncharacteristics,buttheseattributesarerevealedafterbuyingorconsumingthem.Credencegoodshavethecharacteristicthatthoughconsumerscanobservetheutilitytheyderivefromthegood(orservice)ex post,theycannotjudgewhetherthetypeorqualitytheyhavereceivedistheex anteneededone.SeeDullecketal.(2011).Anexampleofacredencegood(orservice)isadoctor’sadviceaboutmedicaltreatment.Thepatientmayrealizethatheorsheisgettingbetterfromthetreatmentbutdoesnotknowifheorsheisbeingover-treated–beingprescribeddrugsandtherapiesthatarenotstrictlyrequiredoraremorecostly.

6 BagwellandStaigerrecognizethatthefactconsumerslearnaboutthequalityofthegoodsafterpurchasingopensthedoorforthehigh-qualityfirmtoofferalowintroductorypriceatwhichitsuffersalossbutenticeenoughconsumerstopurchaseitandlearnaboutitstruequality.Thus,therecouldbecircumstanceswhereexportsubsidieswillnotbeneededtoovercomethebarrierposedbyinformationasymmetry.

7 AsBagwellandStaiger(1989)note,exportsubsidiesinthissituationimprovethewelfareofboththeexportingandimportingcountriesanddonothavethebeggar-thy-neighboureffectsusuallyassociatedwiththeiruse.

8 ThereareonlyafewexamplesofenvironmentaltaxesintheUnitedStates,notablytaxesongasoline,motorfuels,oilspillsandchemicalfeedstocks.SeeBovenbergandGoulder(2002).

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9 TheclassicdiscussionofpriceversusquantitymeasuresunderpolicyuncertaintyisfoundinWeitzman(1974).

10 TheUS-tunacaseisaGATT-eradisputebetweenMexicoandtheUnitedStatesconcerningthelatter’sbanonimportsoftunacaughtusingfishingmethodsthatresultedinratesofaccidentalkillorinjuryofdolphinsexceedingUSrequirements.

11 TheUS-shrimpcaseinvolvedadisputebetweenanumberofdevelopingcountrycomplainants(India,Malaysia,PakistanandThailand)andtheUnitedStates.ItconcernedaUSprohibitionofimportsofshrimpandshrimpproductsfromcountriesthatdidnotuseaparticulartypeofnetincatchingshrimp,anetthatwouldallowendangeredturtlesthatwereaccidentallycaughttoescapeandavoiddrowning.

12 TheMontrealProtocolbannedthetradeofozone-depletingsubstancesandrequiredthephasingoutoftheirproduction.

13 Thesearespecifiedmoreformallyin,forexample,Meade(1952),Kemp(1960)andCorden(1974).

14 Anaturalchoiceofquotalevelisthepolicy-maker’sforecastofthelong-runlevelofimportswhenthedomesticindustryachievesfullmaturity.Therestrictivenessofthisquotadeclinesastheindustry’sexperienceaccumulatesuntilthequotanolongerbindswhenlearningiscomplete.

15 AlthoughKatzandShapiro(1985)originallyappliedtheterm“networkexternalities”fortheseeffects,LiebowitzandMargolis(1994)disputedwhetherthesewerereallyexternalities.InlaterworkbyKatzandShapiro(1994),theyswitchedtotheterm“networkeffects”suggestedbyLiebowitzandMargolis(1994).Seealsothediscussionofnetworkeffects/externalitiesinWorldTradeOrganization(WTO)(2005b).

16 ThissymmetrybetweenimportandexporttaxeswasfirstformallyarticulatedbyLerner(1936).

17 Thereasonforthisresultisasfollows.Anexportsubsidygivenbythehomecountrytoitsexportgood1wouldleadtoafallinthatgood’sworldpriceandanincreaseinitspriceathome.Totaldemand(foreignplushomeconsumers)forthecountry’sotherexportgood2willincreaseifthetwoproductsarecomplementsabroadandsubstitutesathome.Undercertainconditions,theincreaseddemandforgood2willleadtoaterms-of-tradeimprovementinthatproduct,whichwillmorethanoffsettheterms-of-tradelossingood1.

18 UnderCournotcompetition,outputdecisionsare“strategicsubstitutes”.Theincreaseintheoutputofthehomefirminducesareductionintheoutputoftheforeignfirm.Strategiesaresaidtobestrategicsubstitutesiftheoptimalresponsebyonefirmtomore(less)aggressiveplaybyanotherfirmistobeless(more)aggressive(Bulowetal.,1986).

19 UnderBertrandcompetition,pricesare“strategiccomplements”.Anincreaseinthepricechargedbythehomefirminducesanincreaseinthepricechargedbytheforeignfirm.Strategiesaresaidtobestrategiccomplementsiftheoptimalresponsebyonefirmtomore(less)aggressiveplaybyanotherfirmistobemore(less)aggressive(Bulowetal.,1986).

20 Thisistobedistinguishedfrom“product”ordemand-enhancinginnovation.SeeAtheyandSchmutzler(1995).

21 Forlessresource-strappeddevelopingcountries,conditionalcashtransferprogrammeswhichprovidemoneytopoorfamiliescontingentoncertainbehaviour,usuallyinvestmentsinhumancapitalsuchassendingchildrentoschool,havebecomemorewidelyemployedgiventheirapparentsuccess(FiszbeinandSchady,2009).

22 However,seeLevy(2003)foracritiqueoftheGrossman-Helpmanapproach.Inhisview,theGrossman-Helpmanapproachpositsfully-informedrationalactorswhodivideupasurplus.Thiswouldnotexplaintheuseofavoluntaryexportrestraint(VER),whichisaninefficientmeansoftransferringincometospecialinterestssincethecountryincursaterms-of-tradeloss.

23 Thisisbecauselobbiesalsohaveconsumerinterestsandtheybenefitfromlowerprotectioninsectorsotherthantheirown.

24 Onthislastpoint,oneshouldnotethattheempiricalstudybyMaggiandRodríguez-Clare(2000)arrivesattheoppositeconclusion.Theyfindthattheprotectionlevelincreaseswithimportpenetration,bothinsectorsthatareprotectedwithtariffsandinsectorsthatareprotectedwithquantitativerestrictions.

25 SeethediscussionofconformityassessmentintheWorld Trade Report 2005(WorldTradeOrganization(WTO),2005b).

26 ThisassumesthattheoligopolistsareCournotcompetitors.Thismeansthateacholigopolistusesthelevelofitsoutput,ratherthansaythepriceitchargesforitsgood,astheinstrumenttocompeteagainstitsrivals.Ifitwantstobemoreaggressivetowardsitsrivals,itexpandsthevolumeofitsproduction.Ifitwantstobemorepassive,itreducesthelevelofitsoutputorcapacity.

27 Itisassumedthatcartelmembersfollowa“grimtrigger”strategy.Theycooperatewithothercartelmemberssolongaseveryoneelseiscooperating.Theyceasetocooperateandpursuethatpathforeveratthefirstinstanceofamembercheating.

28 Alternatively,onecanassumethatthemeasureappliestobothdomesticallyproducedandforeign-madegoods,butcompliancewiththeregulationraisesthecostsofforeignproducersmorethandomesticproducers.Abel-Koch(2010)andRebeyrolandVauday(2009)discussthecasewherecompliancecostsareidenticalfordomesticandforeignfirmsbutwherefirmshavedifferentproductivities.

29 Animportantparameterthataffectsthesetradeadjustmentsisthedegreeofsubstitutabilityoftheproducts,ormorepreciselytheelasticityofsubstitution(Chaney,2008).Thedegreeofproductsubstitutabilityhasoppositeeffectsoneachmargin.Ahigherelasticitymakestheintensivemarginmoresensitivetochangesintradecosts,whileitmakestheextensivemarginlesssensitive.ChaneyisabletoshowthatiftheproductivityoffirmsfollowsaParetodistribution,adjustmentalongtheextensivemarginwilldominate.

30 Here,itisgenerallyassumedthatgovernments,whenenactingpolicy,onlytakeintoaccountnational,notglobalwelfare.Or,inthecaseofpoliticaleconomy,governmentsonlyconsidertheinterestsofdomestic,notforeignfirmsand,hence,actdifferentlythantheywouldifallproducerswerelocateddomestically.See,forinstance,FischerandSerra(2000)orMaretteandBeghin(2010)foraformalizationofthisapproach.Thesepapersaskmoregenerallywhenprotectionismoccurs,whilethefocusofthissub-sectionisspecificallythechoiceofpolicyinstruments,i.e.ontheconditionsunderwhichspecifictypesofNTMsarechosenratherthanotherpolicyoptions.

31 Thereisnonarrowlydefinedliteratureineconomicsonthissubjectandsomeofthestudiesreviewedherebelongrathertoapoliticalscienceliterature.Thelistofexplanationsprovidedhereregardinggovernments’constraintsinthechoiceofpolicyinstruments,whileimportant,isnotnecessarilyexhaustive.


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32 Inexaminingthedegreeof“welfare-mindedness”ofgovernmentsacrossalargesampleofcountries,Gawandeetal.(2005)showempiricallythatthemoreinformedcitizensare,thegreaterisgovernments’concernwithaggregatewelfareratherthanspecialinterestsinshapingtradepolicy.

33 Asnotedintheprevioussub-section,inourconsiderationsofpoliticaleconomy,wemainlypresumeproducerstobeorganizedandconsumerstobeunorganized.Formanypolicyissues,thishasfoundtobeareasonableassumption.However,whereconsumerorganizationsexist,theymayhaveconsiderablepoliticalinfluenceaswell,forexampleintheareaoffoodsafety(SwinnenandVandemoortele,2011).GulatiandRoy(2007)showthatpoliticallinksarecreatedbetweendifferentpolicyinstrumentswhengovernmentsneedtotakeintoaccountbothproducerandconsumerinterestgroups.Suchlinksmayenhanceorcushionthetradeimpactofrelevantpolicies.Inturn,suchlinkagesalsoimplythatwhentradeagreementsdealwithbehind-the-borderissuesthathavetraditionallybeenseenasbeingofpurelydomesticconcern,specialinterestgroupsthatpreviouslyhavenotengagedintradepolicymaybegintotakeanactiveinterestinthisdomain.SectionEdealswithinternationalcooperationonNTMsandwilltouchfurtherontheseissuesandtheimplicationsthattheymaygiveriseto,forinstanceinregardtotransparency.

34 Asimilarargumentfortheuseofpublicpolicymeasuresasdisguisedprotectionistdevicesariseswhenseveralinterestgroupslobbyforprotectionbutthegovernmentcannotprovideprotectiontoeveryonethroughtariffs(becauseofsomeexternalconstraint,e.g.intheformofaninternationaltradeagreementlimitingtheoverallleveloftariffprotection).Inthiscase,thegovernmentcouldprotectoneindustrywithanNTM,e.g.aregulatorymeasure,assumingthatinterestedparties(competitors,consumers)areunabletoverifyitsrealprotectionistimpact.AgovernmentmayalsopreferacomparativelyopaqueNTMifithasspecifictieswithcertaininterestgroups(e.g.ofanethnicorculturalnature),butseekstohideitsdiscriminatorytreatmentamonglobbies(RobinsonandTorvik,2005).Inaseminalpaper,LaffontandTirole(1991)showthatinterestgroupsthemselvesmayhaveaninterestininefficientregulationsiftheyareprivytorelevantinformationaboutpoliciesthatisnotavailabletopolicy-makersandthissituationmayaffordthemadditionalpoliticalinfluence.

35 Theauthorshighlightthatforquestionsofpublicpolicyitisrationalforanindividualtoremainignorant,whentheexpectedbenefitsaresmallrelativetothecostsofacquiringthenecessaryinformation.

36 Theauthorexplainsquitesuccinctlythat,allelsebeingequal,a“bad”politicianwouldprefertoprovideadirectsubsidytoproducers,“sinceimplementingtheproductstandardisdistortionaryinthelow-riskstate[i.e.notoptimalonwelfaregrounds]andevenbadincumbentscareaboutwelfare”(Sturm2006:575).However,there-electionperspectivecandominatethiseffect,i.e.“bad”incumbentswhoattachlowimportancetosocialwelfareandforwhomre-electionissufficientlybeneficialprefertodistorttheenvironmentalpolicyinordertomakeanindirecttransfertolocalproducersratherthantoprovideasubsidythatwouldsignaltheir“bad”politicalbehaviourtovotersandentailelectoraldefeatwithcertainty.

37 SeealsoYu(2000)whodevelopsaparsimoniousmodelinwhichchangesinthedegreeoftransparencyofanNTM,inthiscaseavoluntaryexportrestraint(VER),comparedtoatariffandtherelativemarketdistortionsthattheseinstrumentsentailhaveanimpactongovernmentsintheirchoiceofsubstitutinganNTMforatariff.

38 Thisisdifferentfromastrandinthetradeliteraturethathasexplainedtheexistenceoftradepoliciesmoregenerallywhentheidentityofwinnersandlosersfromtradeopeningisuncertain.See,forexample,FeenstraandLewis(1991).

39 Ineconomicterms,thismeansthatthecostsofanexcessiveoverpaymentmustbetradedoffagainstthe“deadweight”lossassociatedwithadistortionarypolicy.

40 Asimilarresultholdsiflegislatorsaremotivatedbypolicyratherthanlobbyingcontributions,solongasthelegislatorcaresaboutthepolicieschosenafterleavingoffice(Martimort,2001).

41 Therelationshipbetweenpoliciesinthenationalinterestandpoliciesorientedtowardsindividualconstituenciescanbecomplex.Somenationalpolicies,suchasanation-wideeducationprogramme,canhavelong-lastingimpacts.BattagliniandCoate(2007)warnthatoncesuchapolicyisinplace,futurelegislatorscanleveragethegainsfromtheinvestmenttodivertresourcestowardslessefficientmeasuresthatfavourtheirconstituency.Anticipatingthedistortionaryeffectsofasurplusofpublicgoods,theauthorsnotethatinsomecaseslegislatorsmaydobetterbypartiallylimitinginvestmentinpublicgoodstodiscourageinefficientNTMs.

42 Ofcourse,conformityassessmentforindividualshipmentsstillentailssomeformofvariablecostrelatedtothemeasure.

43 SeealsoSchmittandYu(2001)andJorgensenandSchroder(2008)foraperspectiveonthewelfareeffectsoftariffsinthepresenceoffixedexportingcosts.

44 Tobemoreprecise,unlikeinRebeyrolandVauday(2009),Abel-Koch(2010)showsthatevenifforeignfirmsaremoreproductiveonaverage(and,consequently,importpenetrationishigh),theintroductionofabehind-the-borderNTMmaystillshiftprofitstowardsdomesticfirmsifinthelattertheParetodistributionoffirmproductivitiesislessskewedthanabroad.Insuchcase,theratioofhighlyefficientfirmstoratherinefficientfirmsandhencetheratioofwinnerstolosersfrombehind-the-bordermeasuresishigherfordomesticthanforeignfirms,and,overall,profitsareshiftedfromabroadtowardsthecountryintroducingthemeasure.ThispropositionmaybeseenasapossiblecontradictiontothepredictionbyGrossmanandHelpman(1994)thatthelevelofprotectionvariesinverselywithimportpenetration.However,aswillbediscussedfurtherbelow,itisstillgenerallytrue,albeitfordifferentreasons,thatthelevelofe.g.aregulatorymeasurewillbehigherthefewerforeignfirmsareactiveinthedomesticmarket,asinsuchsituationscompetitionamongdomesticfirmsandthepotentialfordomesticprofit-shiftingarerelativelymoreimportant.

45 Bombardini(2008)showsthatwhenthechannelingofpoliticalcontributionsentailsfixedcosts,thelargestfirmsinasectorwillformaninterestgroup.Theauthorgoesontoconfirmempiricallythatsectorswithahighershareoflargefirmsexhibitahigherlevelofpoliticalactivity.

46 ForanempiricalconfirmationseeYi(2003).

47 SeealsoFischerandSerra(2000),forexample,fortheapplicationofanenvironmentalmeasureinaninternationalduopolysituationwheretheregulationissetinefficientlyhighinordertoshiftrentsfromtheforeigntothedomesticproducerandimposepartofthecostsofreducingtheexternalityontheforeignproducer.Theauthorsonlyshowthatenvironmentalmeasurescanbeusedasaprotectionistdevice,theydonotseektoexplainwhythegovernmentwoulduseaninstrumentthatappliestodomesticand


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foreignproducersalike(butimposesahighercostonthelatterwhoareassumedtoproduceforseveralmarketsaccordingtodifferentrequirements)ratherthantradetaxes.

48 See,forinstance,Antràs(2011)forarecentoverviewofthisliterature.

49 UnlikeAntràsandStaiger(2008),Staiger(2012)obtains“realistic”policypredictions,i.e.policiesofincreasedprotectionfromimportsviaNTMs,alsoinamodelwithoutpoliticaleconomyconsiderations.Intheformerpaper,thebasicmodelpredictsasubsidizationofimportsofintermediatesbythehomegovernmentandataxationofintermediatesbythegovernmentintheexportingcountry.Whilethissituationisnotunrealisticperse,itmaybemorerelevantinregardtotradeinnaturalresourcesandotherrawmaterials,whereescalatingprotection(and,hence,ahighereffectiverateofprotectionforfinalproducts)aswellascounteractingexportpolicieshavebeenobserved,ratherthaninregardtotradeinmanufacturedinputs.SeealsoWorldTradeOrganization(WTO)(2010).

50 Inotherwords,pricesfacedbyconsumerswillincreaselessforagivenreductioninquantityequaltotheincreaseinquantityinresponsetothemarginaldecreaseintheimporttariff,aspartofthetaxincidencefallsonproducers.

51 AndersonandSchmitt(2003)alsoarguethatwhencompetitionwithinanindustryislower,tariffliberalizationislower,andtheendogenousresponseofimposingNTMs,suchasquotasandanti-dumpingduties,isgenerallymoremodest.

52 Thisappliesifa“large”countryreducestherequirementsappliedtodomestically-producedgoods.

53 DefinedastheprobabilityofacountryfilinganADpetition.

54 Thedatadonotdistinguishbetweentariffliberalizationthatwasunilateralordrivenbyaninternationalagreement–multilateralorregional.

55 Appliedratherthanboundtariffsareusedintheanalysisbecauseinthepresenceofbindingoverhang,areductionintheboundtariffmaynothaveanyeffectontheappliedtariff,thereforeitwouldnotcreateanyincentiveforpolicysubstitution.

56 Detailsoftheestimationofad valoremequivalentofNTMscanbefoundinSectionD.1.

57 DetailsabouttheconstructionoffrequencyindexandcoverageratiocanbefoundinSectionC(BoxC.1).

58 Inanarrowconnotation,theterm“regulation”maydesignatethepromulgationofabindingsetofrules(Baldwinetal.,2012).Inabroadersense,itcanbeusedtodefineallstateactionsdesignedtoinfluenceeconomicorsocialbehaviour,referringbothtolegislativeactsandfiscalmeasures.IntheterminologyoftheGATS,thecorrespondingnotionisthatof“measures”,asintheAgreement“regulation”referstoaspecifictypeoflegislativeact(see,forinstance,GATSArticleXXVIII).

59 Lennon(2009),forinstance,arguesthat“tradeingoodsandinothercommercialservicesreinforceeachother.Bilateraltradeingoodsexplainsbilateraltradeinservices:theresultingestimatedelasticityiscloseto1.Reciprocally,bilateraltradeinservicespositivelyaffectsbilateraltradeingoods:a10%increaseintradeinservicesraisestradedgoodsby4.6%”.

60 Two-ormulti-sidedplatforms(i.e.platformsthatservetwoormoredistinctgroupsofcustomerswhovalueeachother’sparticipation,suchasmediaplatformsthatselladvertisingtoonegroupofcustomersandcontenttoanother)or

clustersofhorizontallycomplementaryorverticallyintegratedservices(e.g.telecommunications,audio-visualandrecreationalservices,orverticallyintegratedretailersprovidingwholesale,warehousingandlogisticsservices)areexamplesofsomeoftheinterrelationsbetweendifferentservicesectors.

61 TheUnitedStatesisoneofthefewcountriesthatprovideinformationonintra-firmtrade.

62 Theroleofservicesininternationalproductionmaybesignificantlyunderestimatedintradedata,becauseservicesaretoamuchlargerextentthangoodstradedindirectly,embodiedingoodsandotherservices.Thus,itisestimatedthatlocalmanufacturingvalueaddedembodiedinexportsaccountsforlessthan50percentofthegrossvalueofmanufacturingexports,whilelocalservicesvalueaddedaccountfor150percentofgrossvalueofservicesexports(JohnsonandNoguera,2012).TheauthorscalculatedtradeinvalueusingtheGTAP7.1.databasefor94countriesand57sectors.Asharehigherthanoneispossiblewhendirectexportsofservicesislow,butlocalservicesareembodiedinmanufacturedexports.

63 Themanipulationofthetermsoftradetoincreasenationalwelfareisnotconsideredarelevantjustificationinthecaseofservicestrade,essentiallybecauseoftheoft-associatedfactormovement(FrancoisandHoekman,2010;MarchettiandMavroidis,2011).

64 Theshiftawayfromstateownershipandresponsibilityfortheprovisionofaservicetoprivateownershipandprivateprovisionwithenhancedstateregulationhasbeendescribedastheriseofthe“regulatorystate”(Majone,1994).

65 Foradiscussionoftheapplicabilityoftraditionaltheoreticalmodelstoservicestradesee,forexample,WorldTradeOrganization(WTO)(2008).Foralternativeviews,seeWhalleyandChia(1997),forinstance.

66 Forinstance,measuresthatraisethecostofforeignfirmswhentheysellinthedomesticmarketaremoretraderestrictiveinthepresenceofincumbentdomesticmonopolyoroligopolythanunderperfectcompetition(seeDeardorffandStern,2008andHelpmanandKrugman,1989).FrancoisandWooton(2001)showthat,inthepresenceofanimperfectlycompetitivedomesticindustry,aforeigncompetitormightchoosewhethertojointhehomecartelorcompetewithitdependingontheextentofrestrictionstocross-bordertrade.

67 Tariff-likeinstrumentscouldbeapplicableincertainsectorsforgivenmodes.Onemightconceive,forinstance,ofataxperpassengerorpervolumeofcargoincross-bordertransportservices,giventhataphysical,visibleentityisassociatedwiththeservicebeingsupplied.Alternatively,entry,outputandprofittaxescouldbeapplicabletolocallyestablishedforeignfirms(seeCopelandandMattoo,2008).

68 However,Laffont(1999)showsthat,inthepresenceofweakdemocraticinstitutions,stimulatingcompetitionmightnotalwaysbewelfareenhancing.

69 TheGlobalTradeAlert,asimilarprivateinitiativethatprovidesinformationonstatemeasurestakenduringtherecenteconomicdownturn,wasestablishedin2009.

70 SeeCorfee-MorlotandHohne(2003)forexample.

71 Theseemissionreductiontargets,whichareconditionalonothersmeetingtheirs,canbefoundintheUNFCCCwebsite:http://unfccc.int.


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72 UnderArticle3oftheKyotoProtocol,countrieslistedunderAnnexIoftheUnitedNationsFrameworkConventiononClimateChangeweretoreducetheiroverallemissionsofgreenhousegasesbyatleast5percentbelow1990levelsinthecommitmentperiod2008to2012.

73 SeeCopelandandTaylor(1994)foradiscussionofhowdifferencesinthestringencyofenvironmentalregulationsbetweenhigh-incomeandlow-incomecountriesleadstheformertospecializeincleanindustriesandthelattertospecializeinpollutingindustries.Furthermore,theyestablishthattheresultingincreaseinpollutionlevelsinlow-incomecountriesmorethanoffsetsthedeclineinhigh-incomecountries.

74 Togetasenseofthediversityoftheindicatorsused,weexaminedarandomsetofstudies.DemaillyandQuirion(2006)usechangesinprofitsandoutputasindicatorsofthechangeincompetitiveness;ZhangandBaranzini(2004)usetheincreaseincostofproduction;Reinaud(2008)usesprofitsandmarketshare;theSternReview(Stern,2007)usesthechangeinproducercostandthepassthroughtoconsumerprices.

75 Markusen(1976)derivessimilarresultsinamodeloftradewithtransboundarypollution.

76 ThereisaninterestingpaperbyLockwoodandWhalley(2008)whichrelatesthecurrentdebateoncompetitivenessandbordertaxadjustmentstoa1960sdebateontheValueAddedTax(VAT)andbordertaxadjustmentsintheEU.Astheymakeclear,theacademicliteratureofthetimeshowedthatachangebetweenoriginanddestinationbasisintheVATwouldbeneutralandhencetheuseofabordertaxadjustmentintheEUtoaccompanytheVATofferednotradeadvantagetoEurope.However,thatargumentrestsontheneutralityoftheVAT–relativepricesintheEUareleftunchangedbytheVAT.Thiswillnotbethecasewithcarbontaxessincetheintentofthemitigationmeasuresistoincreasetherelativepriceofcarbon-intensivegoodstoreflecttheirsocialcost.

77 SeeMattooetal.(2009),though,forhowthismaybesimplifiedbyassumingforeigngoodshavethesamecarbonfootprintasdomesticgoods.SeeIsmerandNeuhoff(2007)foraproposalonhowtosimplifyandmakeWTO-consistentaborderadjustmentschemeinvolvingpurchasesofemissionpermits.

78 Forthesakeofbrevity,thediscussionhereprincipallyreferstofoodsafetymeasures,butalsomentionsrelevantaspectsofmeasuresrelatingtoqualityandbroaderattributes,suchasenvironmentalimplicationsoffoodproduction.SwinnenandVandemoortele(2009)emphasizetheextenttowhichthenatureofsuchmeasuresaffectstheirpoliticallyoptimallevelandthelikelihoodoftradeconflicts,pointingoutimportantdifferencesinthisregard.Thisdiscussionisbeyondthescopeofthepresentsub-section.

79 SwinnenandVandemoortele(2011)buildamodeltoillustratethatfoodsafetymeasures(almost)alwaysaffecttradeand,inapoliticaleconomycontext,derivetheconditionsunderwhichsuchmeasuresactasacatalystorbarriertointernationaltrade.AsnotedinSectionB.1,theauthorsalsoshowthatapossiblenegativeeffectontradeflowsdoesnotautomaticallyrelatetoproducerprotectionism.

80 Mangelsdorfetal.(2012),forinstance,findapositiveimpactofvoluntarystandardsandmandatoryrequirementsonChinesefoodandagriculturalexports,withthebenefitsoutweighingincreasedcompliancecosts.

81 Foranextensiveliteraturereviewonprivatestandards,seeInternationalTradeCentre(ITC)atwww.standardsmap.org,lastvisitedon9March2012,aswellasOrganisationforEconomicCo-operationandDevelopment(OECD)(2006)andrelatedpublications.

82 ArecentexampleistheagreementonorganicfoodproductssignedbetweentheEuropeanUnionandUnitedStatescomingintoeffectinJune2012.AgenceFrance-Presse(AFP)reportsthatbeforethedeal,companieshadtoconformtotwodifferentsetsofrequirementsonbothsidesoftheAtlantic.

83 Theliteratureonthissubjectisratherlimited.Foletti(2011)examinesthevariationinmaximumresiduelimits(MRLs)forvariouspesticidesandproductsinarangeofcountries.Analysingtherelativecontributionof“consumerprotection”(atthepesticidelevel)and“producerprotection”(attheproductlevel),shefindsthatwhilehealthmotivesexplainasignificantamountofthevariationinMRLs,protectionistmotivescanexplainuptoonethirdofthevariation.AsfarasMRLlevelsareconcerned,shefindsthathigherlevelsoftoxicityresultinstricterregulation,aswastobeexpected.However,whetherapesticideisproduceddomesticallyalsoplaysarole,resultinginmorelenientregulatorythresholds.

84 InSectionE.1theincentiveforcountriestocooperateisestablishedinordertoavoidbeggar-thy-neighbourpoliciesorprovideacrediblecommitmentdevicethathelpstocontainpressurefromdomesticinterestgroups.Butcountriesmayalsocooperateonpublicpolicyobjectivesinordertopursuethemostefficientpolicynotonlyfromanational,butglobalwelfareperspective,oriftheyshareacommonpublicpolicygoal.

85 Although,atfacevalue,therequirementsofameasuremaybethesamefordomesticandforeignproducers,certainaspectsinitsapplicationmaybeinherentlymoredifficulttofulfillbyforeignthanbydomesticmanufacturers.Forconceptualworkonthisissue,seeSwinnenandVandemoortele(2009;2011).Awell-knownexampleistheobligationforimportstobetestedfortheirconformitywithtechnicalrequirementsinspecificlaboratoriesentailinghigheraccesscostsforforeignersthanfordomesticproducers.Anotherexamplerelatestoproducttaxes,wherethresholdsaresetsuchthatcompetingforeignproductsfallinthehighertaxbracket.

86 Cost-benefitanalysiswasbrieflyintroducedinBoxB.2.Forthedevelopmentofacost-benefitframeworktoassessregulatorymeasuresanditsapplicationtoTBT/SPS,seeVanTongerenetal.(2009;2010).

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B. An economic perspective on the use of non-tariff measures