APPLICABILITY OF MFN PRINCIPLE: NEGATIVE DIMENSION, DOWNTRODDEN IMPACT ON INTERNATIONAL TRADE
Author: Drishti Sharma, IV year of B.A.,LL.B.(H) from Amity Law School, Amity University Rajasthan
This article talks about what Most-Favored-Nation (MFN) are and what are the disadvantages of the same. Many articles have been published which talk about their advantages but this specifically gives you an insight as to what MFN means and its downtrodden impact on International Trade. There has been a short note on China’s new MFN Status as it has been adversely been affected by the COVID 19 situation, like the rest of the countries. Emphasis has been given to the MFN status in the context of India and Pakistan and I’ve assessed the effects of most favoured nation clauses as well as the exceptions to the Most Favoured Nation Principle.
WHAT IS MFN?
Most-favored-nation (MFN) status is an economic position within which a country enjoys the most effective trade terms given by its trading partner. That means it receives all-time low tariffs, the fewest trade barriers, and also the highest import quotas (or none at all). In short, we can say that all the members or all the trade partners of the MFN should be treated in a nondiscriminatory way.
The most-favoured-nation clause in two countries' free trade agreements confers that status. That clause is additionally utilized in loan agreements and commercial transactions. In the former, it implies that interest rates on a subsequent loan won't be less than on the primary one. In the latter, it means the seller won't offer an improved deal to a different buyer.[i]
In the U.S., it's more common to hear the term "permanent normal trade relations." This is simply another way to refer to a country with MFN status.
BACKGROUND OF MOST FAVORED NATION STATUS
All 164 members of the WTO receive most-favoured-nation status.[ii] That means all of them to receive similar trade benefits as all other members.[iii] The only exceptions are developing countries, regional trade areas, and customs unions.[iv]
Developing countries get preferential treatment knowing that they do not have to reciprocate the same, so their economies can grow. Developed economies benefit within the long run—as economies grow in developing economies, so too do their demand for imports. That provides a much bigger marketplace for the developed countries' products.
The United States of America has reciprocal most-favoured-nation status with all WTO members. The General Agreement on Trade and Tariffs was the primary multilateral trade agreement to bestow the most-favoured-nation status.
The downside of MFN status is that the country must also grant similar trade benefits to all or any other members of the agreement or the World Trade Organization. This means they can't protect their country's industries from cheaper goods produced by foreign countries. Some industries get exhausted because they simply can't compete. It’s one of the many disadvantages of trade agreements.
Countries sometimes subsidize their domestic industries. So this makes it easier for subsidized companies to export at incredibly cheap prices. This unfair practice will put companies out of business within the trade partner's country. Once that happens, the country reduces the subsidy, prices rise, but now there is a monopoly—no other companies remain within the industry so that the prices competitive. This practice is known as dumping. This can get a country in trouble with the WTO.[v]
Many countries within the past were excited to induce MNF status and wanted to start cheaply exporting goods to the U.S., only to search out they lost their local agricultural industry. Local farmers couldn't compete with subsidized food from the U.S. and European Union. Many farmers had to shift to the cities to seek out jobs. Then, when food prices escalated, there have been food riots.
GATT members recognized in essence that the "most favoured nation" rule should be relaxed to accommodate the requirements of developing countries, and therefore the UN Conference on Trade and Development (established in 1964) had thought of extending the preferential treatment to the developing countries exports.
Another challenge to the "most favoured nation" principle has been posed by regional trade blocs like the EU and also the North American Free Trade Agreement (NAFTA), which have lowered[vi] or eliminated tariffs among the members while maintaining tariff walls between member nations and therefore the rest of the world. Trade agreements usually give exceptions to permit for regional economic integration.
CHINA'S MFN STATUS
The United Nations of America gave China permanent MFN status in 2001, in the very year that China became a WTO member. U.S. companies wanted to sell to the biggest population within the world. As China's GDP grew, they thought, so would its consumer spending.
Despite the friendly start to the 21st century, the 2 countries have since become locked in an ongoing trade dispute. Citing unfair trade practices, including intellectual theft, the Trump administration began imposing tariffs on Chinese imports in 2018. China soon introduced tariffs in retaliation. More rounds of tariffs from each side followed throughout 2018 and 2019.[vii]
In January 2020, the U.S. and China signed a "Phase One" trade agreement, citing multiple structural reforms to China's trade practices. As part of the agreement, China committed to purchasing an additional $200 billion in American products over 2017 levels in four sectors: manufactured goods, services, agricultural products, and energy. In turn, the United States conceded in lowering tariffs from 15% to 7.5%.[viii]
IN CONTEXT OF INDIA AND PAKISTAN
In response to the dastardly terror attack against a Central Reserve Police Force (CRPF) convoy in south Kashmir’s Pulwama district, India announced that it would revoke the most favoured nation (MFN) status given to Pakistan.
The MFN provision, given in Article I of the General Agreement on Tariffs and Trade (GATT) could be a principle of non-discrimination, which prohibits WTO member countries from discriminating between their trading partners subject to certain exceptions. It makes it compulsory for all the member countries of WTO to treat all the other member countries in a non-discriminatory manner or simpler words as equal as “the most favoured” trading partners. India without any doubt has held the honour of its MFN obligation towards Pakistan since 1996 i.e. after the formation of the WTO. However, Pakistan has not done so.
Pakistan allowed only 1,946 items to be imported from India, till 2011. All other items were prohibited. After 2011, Pakistan moved from a ‘positive list’ to a ‘negative list’ approach where it permitted all imports from India barring 1,209 items that remained on the banned list. While this was a leap forward in normalizing trade relations, it still fell in need of fully honouring MFN's obligation towards India because Pakistan doesn't impose such restrictions on imports from other countries.
Though revocation of MFN status is frowned upon by WTO, within the instant case the grace is that the non-reciprocal posture by Pakistan in terms of granting MFN status to India. Reportedly, India’s decision is going to be sort of a death knell to Pakistan’s exports to India, currently standing at around $490 million, which seems to be exaggerated. The trade volume between the two countries is worth about $2.30 billion, which is a smaller amount than 0.40 per cent of India’s total volume of trade.
Further, just in case of any retaliatory tariffs on Indian goods or expansion of its negative list prohibiting imports from India, it'll certainly have a negative impact on Indian exports which is near worth $2 billion. Realistically speaking, this can cause way more harm to India than to Pakistan. Further, the recent decision by India could affect the goodwill and business reputation of India in world trade. This measure also will impact our relationship with SAFTA countries where Pakistan is additionally an important member.
ASSESSING THE EFFECTS OF MOST-FAVORED NATION CLAUSES
When analyzing the concentration of the market, it is important to note that increased concentration may improve consumer welfare. While consumers may not get the benefit of aggressive price competition when fewer firms are present, that loss may be more than offset by the benefit of belonging to a large network.
In health insurance, for example, consumers may enjoy a larger selection of hospitals and doctors that can treat them if they sign up with a large insurer. MFN agreements can also affect innovation in the market.
Even if it is determined that the MFN had a negative effect on prices and market concentration (fewer firms charging higher prices), it is still possible that the presence of an MFN increased the rate of innovation. Economists have studied the connection between market concentration and rate of innovation extensively and have identified several reasons why higher market concentration may increase innovation. Joseph Schumpeter argued in 1942 that large firms have advantages in productive capacity, marketing, and financial flexibility that enable them to exploit new technologies at large scales.
Technological progress has tangible benefits for consumers, whether it is the introduction of an online payment and information portal by an insurer or the introduction of high-definition programming by a cable network. The rate of innovation is significantly more difficult to quantify within the context of MFNrelated litigation than the price and concentration factors. Even if it is quantifiable, it may not be straightforward to measure the economic benefits from innovation. Yet, these benefits may be tangible and should be considered in a serious evaluation of an MFN agreement.
And finally, MFN agreements allow the parties to reduce their negotiating costs. The MFN provides a safeguard against a major shift in market conditions (due to an economic cycle or a technological innovation) that would change the pricing structure in that market. When a buyer of a product or service receives an MFN from the seller, the buyer is willing to sign a long-term contract.
Otherwise, that buyer might be concerned that three years into an eight-year supply contract, a dramatic change in prices would allow its competitors to obtain these products or services at substantially lower costs and render it non-competitive. Besides saving money and resources on the negotiating sessions themselves (for both the buyer and the seller), long-term contracts reduce the risk of supply interruptions for the consumers.
For example, in recent years various cable and satellite networks went through blackout periods over disputes with content providers (e.g., DISH dropped Disney HD programming). Some of these disputes are unavoidable and negotiations will break down. However, having long-term contracts and the MFN protection limits the frequency with which such situations arise.
EXCEPTIONS TO THE MOST FAVOURED NATION PRINCIPLE
The GATT provides, sure enough, exceptions to the Most-Favoured-Nation rule. Regional Trading Agreements (Gatt Article XXIV).
Regional Trade Agreements (RTAs) have become in recent years a very prominent feature of the Multilateral Trading System (MTS). The surge in RTA has continued unabated since the early 1990s. Some 380 RTAs are notified to the GATT/WTO up to July 2007. Regional integration therefore may cause results that are contrary to the Most-Favoured-Nation principle because countries inside and out of doors the region are treated differently. This may have a negative effect on countries outside the region and thus cause results contrary to the liberalization of trade.
Regional integration, thus, has a great impact on the world economy today and is the subject of frequent debate in a variety of forums, including the WTO Committee on Regional Trade Agreements. One of the foremost commonly asked questions is whether or not these regional groups help or hinder the WTO's multilateral trading system.
The WTO Committee on Regional Trade Agreements is keeping an eye on the development. The regional trading groups such as the European Union (EU), the North America Free Trade Agreement (NAFTA), the Association of Southeast Asian Nations (ASEAN), the South Asian Association for Regional Cooperation (SAARC), the Southern Common Market (MERCOSUR), the Common Market of Eastern and Southern Africa ( COMESA), etc have posed a great challenge to the Most Favoured Nation principle which have lowered or eliminated tariffs among the members while maintaining tariff walls between member nations and therefore the remainder of the planet. The groupings that are important for the WTO are those that abolish or reduce barriers to trade within the group.
Normally, fixing a customs union or free trade area would violate the WTO's principle of equal treatment for all trading partners (most-favoured-nation). But GATT's Article 24 allows regional trading arrangements to come upon as a special exception, provided certain strict criteria are met (as mentioned above). In particular, the arrangements should help trade flow more freely among the countries within the group without barriers being raised on trade with the surface world.
Article 24 of the GATT says that if a free trade area or customs union is formed, duties and other trade barriers should be reduced or removed on substantially all sectors of trade in the group. Non-members shouldn't find a trade with the group any longer restrictive than before the group was created. Its purpose is to look at regional groups and to assess whether or not they are according to WTO rules.
The committee is also examining how regional arrangements might affect the multilateral trading system, and what the relationship between regional and multilateral arrangements might be.
Member countries of the General Agreement on Tariffs and Trade (GATT) of the World Trade Organization (WTO) have to treat one another as favoured trading partners in terms of imposing customs duties on goods. India granted the MFN status to Pakistan way back in 1996, but Pakistan has not yet reciprocated, though both of them are signatories to GATT. A country that provides MFN status to another has to give preference to that country in trade agreements. MFN is just a non-discriminator trade policy to discourage exclusive trading privileges among WTO countries. So MFN status doesn't mean other countries would be the ally even though it would sound like that.
[i] World Trade Organization. "Principles of the Trading System." Accessed Aug. 15, 2020
[ii] World Trade Organization. “Members and Observers.” Accessed Aug.15, 2020
[iii] World Trade Organization. “The General Agreement on Tariffs and Trade (GATT 1947).” Accessed Aug.15, 2020
[iv] World Trade Organization. “The WTO Agreements Series 2, General Agreement on Tariffs and Trade,” Page 3. Accessed Aug. 15, 2020.
[v] World Trade Organization. “Anti-Dumping, Subsidies, Safeguards: Contingencies, Etc.” Accessed Aug. 15, 2020
[vi]Handbook at WTO official website. (Note that the document's printed folio numbers do not match the pdf page numbers.) https://www.wto.org/english/thewto_e/whatis_e/tif_e/understanding_e.pdf
[vii] Tax Foundation. “Tracking the Economic Impact of U.S. Tariffs and Retaliatory Actions.” Accessed Aug. 15, 2020.
[viii] U.S.-China Economic and Security Review Commission. "The U.S.-China 'Phase One' Deal: A Backgrounder." Accessed Aug. 15, 2020
Drishti Sharma is going to be a 2022 graduate of Amity Law School, Amity University Rajasthan, with B.A.,LL.B. (H) with specialization in Criminal Law. She is an Editor at Pro Bono Solicitors, and is keen on exploring various fields of law, writing articles for her is a way to bring out her ongoing thoughts on screen for everyone. When she isn't making law firms look their best while interning. Drishti can be found traveling around India or petting dogs.