WTO and Challenges

UNIT 23 WTO AND CHALLENGES of New Trading and

Financial Systems
OF NEW TRADING AND
FINANCIAL SYSTEMS
Structure

23.0 Objectives
23.1 Introduction
23.2 World Trade Organisation (WTO)
23.2.1 Objectives of the WTO
23.2.2 Principles of the WTO
23.2.3 Functions of the WTO
23.2.4 Structure of the WTO
23.2.5 WTO Agreements
23.3 Dispute Settlement Mechanism (DSM) of WTO
23.4 Evaluation of WTO
23.4.1 Achievements of WTO
23.4.2 Limitations of WTO
23.5 Doha Round of Negotiations
23.5.1 India’s Response
23.6 New International Financial Architecture
23.6.1 Need for a New International Financial Architecture
23.6.2 Suggestions for a New International Financial Architecture
23.7 Let Us Sum Up
23.8 Key Words
23.9 Some Useful Books
23.10 Answers or Hints to Check Your Progress Exercises

23.0 OBJECTIVES
After reading this unit you will be able to:

l explain the different international economic institutions that have

moulded international economic relations during the last six decades
since 1950;

l outline the background in which the World Trade Organisation came

to be set up;

l state the objectives, principles and functions of the WTO;

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External Sector l describe the principal agreements in trade in goods, services etc.
that the WTO administers;

l review the functions of WTO as it has evolved over the last fourteen
years;

l identify the factors due to which a new international financial

institution capable of responding to the changing international
economic environment is needed; and

l suggest a new international financial architecture.

23.1 INTRODUCTION
In the wake of the unprecedented destruction caused to the global
economic structure by the Second World War, and the accompanying
instabilities and uncertainties that arose in the economies world over, a
group of nations met at Bretton-woods for a conference in 1944. Their
principal objective was to prepare a framework for economic co-
operation and co-ordination between sovereign nations having the right
to pursue independent policies. The Bretton-woods conference, as it has
since come to be known as, addressed itself to three broad issues of
interest in international economic relations, viz. (i) trade in goods, (ii)
flow of capital for development, and (iii) stability of exchange rates and
provision for assistance to members who get confronted with short-
term imbalance in their balance of payments. In seeking to find a solution
to the problems arising out of these, the Bretton-woods conference
reached an agreement to set up three multilateral institutions, viz. (a)
International Monetary Fund, (b) International Bank for Reconstruction
and Development (IBRD), and (c) International Trade Organisation (ITO).

The two institutions, IMF and the IBRD which were set up and started
functioning since 1946 came to be identified as Bretton-woods twins.
While the IMF was entrusted with the task of ensuring exchange rate
stability and providing short term financial assistance to member countries
faced with balance of payments difficulties, the IBRD was to arrange
long-term finance for developmental programmes in member nations.
The agreement relating to the setting up of the ITO was not ratified by
the US and hence the ITO could not be established. Instead, the US, UK
and a few other countries, set up in 1947 an interim organisation called
General Agreement on Tariffs and Trade (GATT). The GATT, in its
functioning, was biased in favour of the developed countries and hence
began to be informally dubbed as the ‘rich men’s club’.

Owing to the persistent insistence of the developing countries for setting

up the ITO, which move was continually opposed by the US, the United
Nations (UN) appointed a committee in 1963 to resolve the issue. The
committee recommended the alternative of setting up a United Nations
Conference on Trade and Development (UNCTAD). The UNCTAD was
80 thus set up in 1964 with its principal functions outlined as follows:
l promote international trade with a view to accelerate economic WTO and Challenges
of New Trading and
development; Financial Systems

l formulate principles and policies on international trade and related

problems of economic development;

l assist developing countries in the negotiations in the international fora

and facilitate market access for the goods of developing countries and
encourage technology transfer to them;

l assist developing countries to improve their terms of trade vis-à-vis

the developed countries;

l negotiate multilateral trade agreements; and

l make proposals for putting its principles and policies into effect.

The UNCTAD could manage to get some concessions for the developing
countries, more important among which was the General System of
Preferences (GSP). GSP provided for preferential access to markets in
the developed countries for the manufacturing goods originating from
the developing countries. Having functioned for many years in its
originally charted out functions as outlined above, the vision and structure
of UNCTAD began experiencing the need for a significant change in the
1990s. This was triggered mainly, once again, by the decision of the
developed world to de-link the UNCTAD from the discussions of the
Uruguay round of negotiations on GATT. The Uruguay round thus became
controversial as it sought to expand the scope of GATT by including
under its purview areas like services, investment and intellectual property
rights (IPR). The Uruguay round proposals were accepted by all the
members of the GATT in December 1993 at the official level and in
March 1994 at the ministerial level. This set the ground for the setting
up of what came to be later known as the World Trade Organisation
(WTO).

23.2 WORLD TRADE ORGANISATION (WTO)

The Uruguay round of agreement provided for the setting up of an
international trade organisation by the name of World Trade Organisation
(WTO). The WTO started functioning from January 1, 1995. At present,
the WTO has 153 countries as its members.

23.2.1 Objectives of the WTO

The agreement establishing WTO reiterated the objectives of the GATT.
More specifically, the WTO outlined its objectives to include the
following under its scope.

a) Raise standard of living and incomes by ensuring: (i) full employment,

(ii) expanding production and trade, and (iii) optimal use of world’s
resources; 81
External Sector b) Adopt the idea of sustainable development in relation to the optimal
use of world’s resources i.e. reinforce the need to protect and preserve
the environment in a manner consistent with the various levels of
national economic development; and

c) Recognise the need for positive efforts to ensure that developing

countries secure a better share of growth in international trade.

23.2.2 Principles of the WTO

In its broad perspective, the WTO was to strive at creating a liberal and
open trading environment by which business enterprises could trade under
conditions of fair and undistorted competition. Towards the achievement
of this, the four principles that were laid down to guide the trading rules
of its members are as follows:

1. Most Favoured Nation (MFN) Treatment: The principle of MFN

treatment laid that tariffs and regulations must be applied to imports
or exports without discrimination among members. In other words,
no member country was to be accorded a treatment of ‘a favoured
nation’;

2. National Treatment: It prevents discrimination between imported

products and equivalent domestically produced goods, especially in
levying internal taxes and domestic regulations;

3. Protection Through Tariffs: While advocating liberal trade, the

WTO recognises that some members may need to protect their
domestic production against foreign competition. The underlying
principle was, however, that such protections through tariffs must be
kept at low levels in what was called as ‘bound tariff framework’;

4. Bound Tariffs: The principle of ‘bound tariff’ advises the member

countries to reduce and gradually eliminate protection to domestic
production. By seeking to reduce tariffs and eliminating non-tariff
barriers, the principle requires the member countries to commit in
their respective national schedules against further increase of tariff
levels at later points of time. In other words, the reduction and
ultimate phase-outs of tariffs was meant to provide the cushion time
required for gaining competitive strength and the tariffs were to be
phased out firmly in a committed time frame.

23.2.3 Functions of the WTO

The WTO is meant to perform the following functions:

1. Administer through various councils and committees, the 29

agreements contained in the final Act of the Uruguay round of world
trade talks, plus a number of plurilateral agreements, including those
on government procurement;
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2. Oversee the implementation of the significant tariff cuts (average 40 WTO and Challenges
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percent) and reduction of non-tariff measures agreed to in the trade Financial Systems
negotiations;

3. Act as a watchdog of international trade by regularly examining the

trade regimes of individual members;

4. Ensure that members notify in detail various trade measures and

statistics, which are to be maintained by the WTO in a large database;

5. Provide several conciliatory mechanisms for arriving at an amicable

solution to trade conflicts among members;

6. Resolve trade disputes that cannot be solved through bilateral talks

by adjudication in the WTO dispute settlement court;

7. Act as a management consultant for world trade by having its

economists keep a close watch on the pulse of the global economy
and provide inputs to WTO by studies conducted on the main issues
of the day; and

8. Assist developing countries through its secretariat to implement the

Uruguay round agreements through a newly-established development
division and a technical co-operation and training division.

The WTO is, thus, a forum where countries continuously negotiate the
exchange of trade concessions and trade restrictions all over the world.
The WTO has a substantial agenda for further negotiations in many areas,
notably certain services sectors.

23.2.4 Structure of the WTO

The WTO secretariat is headed by a Director General with a three-tier
system of decision making. The decisions are made at three levels: (i)
Ministerial Conference, (ii) General Council and other councils, and
(iii) Heads of Delegations. The principal decision-making body is thus
the ministerial conference which can take decisions on all matters under
any of the multilateral trade agreements. It meets once in two years.

In the intervening period, the General Council of the WTO, together

with the other councils for Trade in Goods, Trade in Services and
Intellectual Property, performs the WTO functions. These councils are
responsible for overseeing the implementation of the WTO agreements
in their respective areas of specialisation.

The third-tier of decision-making, at the Heads of Delegation level, is

most effective in overcoming inherent impediments for reaching
consensus on a trade-related issue. This level is usually represented by
different sets of people depending on the need of the hour with the
required expertise and experience. The usual process is to hold a meeting
in which select countries are interested in participating in a particular 83
issue. Such meetings are termed as Green Room meetings.
External Sector 23.2.5 WTO Agreements
WTO administers a set of agreements, among which the more important
are the following:

1. GATT 1994

The cornerstone of trade relations is the area of goods. Differential and

most favoured treatment (MFT) to UDCs and LDCs is permitted under
the 1979 enabling clause with respect to tariffs and non-tariff measures.
This is notwithstanding the MFN treatment principle which prohibits
such favoured treatment to any country as a rule.

2. Agreement on Agriculture (AOA)

The approach adopted here is to encourage gradual reduction of trade

distorting subsidies. The AOA specifically deals with: (i) providing
market access, (ii) containing of export subsidies, and (iii) regulating
domestic support.

i) Market Access: The AOA requires tariffication of all NTBs, and a

reduction of those tariffs by an average of 36 percent for developed
countries and 24 percent for UDCs. Developed countries were given
6 years to bring about these reductions, while developing countries
are given 10 years. The time counting has begun from 1995.

ii) Export Subsidies : Export subsidies have to be reduced by 36 percent

in budgetary terms and 21 percent in volume over a six-year period.
The developing countries have been given lower reduction targets of
24 and 14 percent respectively over a longer period of 10 years.

iii) Domestic Support: A distinction has been made between subsidies

that did not distort trade and those that do. Only the trade distorting
subsidies have to be reduced, if they are above the permissible level.
The following have been exempted from this provision.

l Green Box: Subsidies with no, or minimally trade distorting, effect

have been put in this box. These are not subject to any reduction
commitments. It includes all government service programmes.

l Blue Box: It contains those subsidies whose continuation is subject

to a limitation on production.

l White Box: It includes such subsidy practices in developing

countries like investment subsidies, agricultural input subsidies
available to low-income or resource-poor farmers and measures
to encourage diversification from growing illicit narcotic crops.

All other domestic support measures are subject to reduction

commitment.
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3. Agreement on Sanitary and Phyto-Sanitary (SPS) Measures WTO and Challenges
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SPS measures are those applied to protect human, animal or plant life
from certain risks. These risks are those arising from the entry,
establishment or spread of pests, diseases and disease-carrying or diseases
causing organisms. The risks also include risks arising from additives,
contaminants or toxins. Disease causing organisms in food, beverages
and foodstuffs and from risks arising from diseases carried by animals,
plants and products are also covered under this agreement.

SPS measures include all relevant laws, decrees, regulations, requirements

and procedures, including end-product criteria, processes and production
methods, testing, inspection, certification and approval procedures,
quarantine treatments, provisions on relevant statistical methods, sampling
procedures and methods of risk assessment, packaging and labelling
requirements directly related to food safety.

SPS measures must be based on international standards, guidelines or

recommendations where they exist. It is open to a country to adopt a
level of SPS protection higher than that of the relevant international
standards, if there is a scientific justification or if it is needed by the
appropriate level of SPS protection in that country.

Members are allowed to provisionally adopt such SPS measures which,

on the basis of available pertinent information and relevant scientific
evidence are the best possible measures at the current juncture, although
they fall short of the standards set by the WTO. Such provisional
measures need to be reviewed within ‘a reasonable period of time’.

4. Agreement on Anti-Dumping (ADA)

The objective of this agreement is to provide the right to the contracting

parties to apply anti-dumping measures. These are measures against
imports of a product if such imports cause injury to a domestic industry
in the territory of the contracting party.

The ADA allows member-nations to apply anti-dumping measures on a

unilateral basis after elaborate investigations. The anti-dumping
investigation determines whether:

l an imported product has been dumped;

l it has caused material injury to the domestic industry of a like product;

and

l there is a causal link between dumped imports and the injury.

If the investigations establish these three factors, the government is

allowed to levy anti-dumping duty on imports. This duty could be levied
on imports either from a specific country or a group of countries.
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External Sector The ADA provides that all countervailing duties should be terminated
within five years of their imposition unless a review determines
otherwise.

5. Agreement on Technical Barriers to Trade (TBT)

The objective of this agreement is to ensure that mandatory product

standards should not be so applied to countries as to cause ‘unnecessary
obstacles to international trade’. It visualises that mandatory product
standards do not create such barriers if based on internationally agreed
standards. It also recognises that countries have a right to establish
protection, at levels they consider appropriate (concerning the human,
animal or plant life or health of the environment), and that countries
should not be prevented from taking such measures as are necessary to
ensure that those levels of protection are met.

Technical regulations and standards cover product characteristics, process

and production characteristics, terminology and symbols and packaging
and labelling requirements as they apply to the products.

The TBT encourages countries to use international standards where

appropriate, but does not require change in the level of protection as a
result of standardisation.

It recognises right of member countries to adopt technical regulations

and standards as well as conformity assessment procedures for the
purpose of: (i) national security requirements, (ii) prevention of deceptive
practices, (iii) protection of human health or safety, animal or plant life
or health of the environment.

6. Agreement on Trade-Related Investment Measures (TRIMs)

Beginning 1995, GATT’s inconsistent agreement on TRIMs were required

to be notified and eliminated within a transition period of two years (for
developed countries), five years (for developing countries) or seven
years (for least-developed countries). A further extension may be
requested by developing and least-developed countries. The agreement
on safeguards prohibits the use of ‘grey-area measures’ such as voluntary
restrains or orderly marketing arrangements, and requires that such
measures are both notified and eliminated within a time frame.

7. Agreement on Textiles and Clothing

This provides for the eventual elimination of the multi-fibre arrangement

(MFA) after a ten-year transition period. In place since 1973, The MFA
has since been terminated with effect from January 1, 2005.

8. General Agreement on Trade in Services (GATS)

It is the first multilateral agreement on trade that has as its objective the
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progressive liberalisation of trade in services. The GATS covers trade
in all service sectors and the supply of service in all forms. Every WTO and Challenges
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member is bound to open up its service sector, with exceptions only in Financial Systems
(i) non-commercial services like health-care and education, (ii) measures
affecting air-traffic rights and services, and (iii) other services for which
a country has sought partial or full exemption before signing the treaty
(for example, India sought exemptions for legal and accounting services).

9. Agreement on Trade-Related Intellectual Property Rights

(TRIPs)

The main features of this agreement are as follows:

l minimum standards of protection to be provided by each member;

l domestic procedures and remedies for the enforcement of intellectual

property rights to be evolved and put in place;

l dispute settlement mechanisms for the WTO member countries to be

instituted.

TRIPs agreements cover the following areas: copyright and related rights,
trademarks including service marks, geographical indications including
appellations of origin, industrial designs, patents including the protection
of new varieties of plants, the lay-out designs of integrated circuits and
undisclosed knowledge including trade secrets and test dates.

10. Agreement on Government Procurement (GPA)

The GPA provides a vehicle for the progressive opening of markets to

international competition through legally enforceable provisions of non-
discrimination which apply to procurements ‘covered’ by the agreement.
In addition, various provisions of the agreement relating to the provision
of information to potential suppliers, contract awards, qualification of
suppliers and other elements of the procurement process aim at ensuring
transparency and non-discriminatory conditions of competition among
suppliers. India, as yet is not a signatory to GPA, although other major
developing countries such as China and Saudi Arabia have made
commitments to eventually seek accession to it.

Check Your Progress 1

1. State in brief the objectives of the WTO.

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External Sector 2. What are the principles on which the WTO has been set up?
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3. State in brief the functions of the WTO.

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4. Outline in brief the structure of the WTO.

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5. State in brief the features of the WTO agreement on agriculture.

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6. What are TRIPs and TRIMs ?

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7. State in brief the features of GATS.

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23.3 DISPUTE SETTLEMENT MECHANISM

(DSM) OF WTO
The Dispute Settlement Mechanism (DSM) of the WTO is a central
element in providing security and predictability to the multilateral trading
system. WTO members have committed themselves not to take unilateral
actions against perceived violations of the trade rules. In fact, they have
pledged to take recourse to the DSM, and abide by its rules and
procedures.

Under the WTO, there is a dispute settlement body (DSB) which is the
custodian of the DSM. The DSB has been empowered to establish
panels which are bodies set up for a specific investigation. The DSB is
also empowered to constitute appellate bodies and exercise surveillance
for compliance of rules and recommendations. It can also authorise
retaliatory measures in cases of non-implementation of
recommendations.

Stages in Dispute Settlement

The settlement of disputes passes through different stages as follows:

The first stage of settling disputes is the holding of consultations between

the members concerned. Such consultations aim at evolving a solution
of the dispute in a mutually acceptable manner.

If no solution is found, in the second stage, the complainant can ask the
DSB to establish a panel. The panel is set up by the DSB in consultation
with the disputing parties. The panel examines the complaint. Its report
contains findings and recommendations. The DSB adopts the panel
report after its submission.

In the third stage, any party to the dispute can appeal a panel’s decision
to the WTO appellate body. A standing appellate body (SAB) is set up
by the DSB to hear all appeals. Prompt compliance with
recommendations or ruling of the DSB is essential in order to ensure
effective resolution of disputes to the benefit of all members. Members
are given time to implement the recommendations but if a member fails
to act, it is obliged to enter into compensation negotiations with the
complainant. If no satisfactory compensation is agreed, the complainant
may request authorisation from the DSB to suspend concessions or
obligations against the other party. The suspension of concession is thus
the last resort which an aggrieved member can call upon in retaliation.

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External Sector WTO and GATT

DSM of the WTO is a significant improvement over GATT. Under GATT,

dispute settlement was fragmented between the council and various
committees. Under the WTO, there is one DSB which has the sole
authority to establish panels and appellate bodies.

Besides, under the WTO, there has to be consensus against the

establishment of panels or for the adoption of panel reports, whereas
the opposite was true for the GATT. Thus, parties to the dispute in the
present system can no longer block these decisions. Another new
feature is the possibility of appeal against panel decisions to a SAB. And
in line with the integrated nature of the WTO mechanism, complainants
may take retaliatory action as a last resort against a nation which has not
implemented the adopted panel recommendations.

23.4 EVALUATION OF WTO

WTO has been in operation for about a decade and a half now. During
this short time, the WTO has proved that it is very different from its
predecessor, GATT. For instance:

l While GATT was toothless, WTO with its DSM is able to bring to book
even the mighty US in several cases.

l GATT’s negotiating rounds took place once in a decade or so. But,

at Singapore, just two years after the conclusion of the Uruguay
round, the WTO virtually concluded an Information Technology
Agreement, and launched studies on investment, competition policy,
transparency in government procurement and trade facilitation. There
is enormous pressure to compress into next five years what used to
take decades to complete before.

l WTO is democratic in the sense that one country-one vote principle

is adopted;

l For enforcing trade liberalisation, WTO has brought into its

framework, many new areas, such as agriculture, textiles, technology
and investment; and

l Induction of services, in the agenda of liberalisation, has been an

extremely important feature of WTO.

23.4.1 Achievements of WTO

In the short period the WTO has been in existence it is being credited
with the following achievements:

i) Greater market orientation has become the general rule;

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ii) Tariff-based protection has become the norm rather than the WTO and Challenges
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exception; Financial Systems

iii) Use of restrictive measures for BOP problems has declined

markedly;

iv) Services trade has been brought into the multilateral system and
many countries, as in goods, are opening their markets for trade and
investment either unilaterally or through regional or multilateral
negotiations;

v) Many UDCs have undertaken radical trade, exchange and domestic

reforms which have improved the efficiency of resource use, opened
up new investment opportunities, and, thus, promoted economic
growth;

vi) Bilateralism has been, to a great extent, placed under control by the
extension of WTO provisions to services, TRIPs and TRIMs.
Further, under the unified DSM, the possibility of any country
unilaterally blocking the adoption of panel decisions no longer exists;

vii) The trade policy review mechanism has created a process of

continuous monitoring of trade policy developments. Also, by
promoting greater transparency, it has assisted the process of
liberalisation and reform;

viii) It has been agreed to reduce import tariffs on industrial goods,

based on Swiss Formula. A Swiss formula is a non-linear formula
where tariff-cuts are proportionally higher for tariff which are
initially higher. For instance, a country which has an initial tariff of
30% on a product will have to undertake proportionally higher cuts
than a country which has an initial tariff of 20% on the same product.

23.4.2 Limitations of WTO

The WTO, however, has still to make any progress or become more
sensitive on the following issues:

i) The trade reform process is incomplete in many countries. For

instance, some high tariffs still remain on which negotiations are still
proceeding at various levels, notably in the areas of basic
telecommunications and financial services;

ii) There appears to have been at least some reversals in the overall
liberalisation process in some developing countries. Examples are
of increasing anti-dumping measures, selective tariff increases and
investment related measures. The developed countries are also
blocking the process of liberalisation by adopting many neo-
protectionist measures;

iii) Concerns have been raised that the combination of globalisation 91

External Sector and technological change creates a premium on high-skill as against
low-skill with growing social divisions;

iv) The major share of the benefits of the WTO has gone to the countries
of the North. The WTO has opened up the world economy more
rapidly in areas that benefit the developed world. Where the benefits
of free trade accrue primarily to the UDCs, progress has been much
slower;

v) The WTO has also not been sensitive enough to the development of
non-tariff barriers to imports from the UDCs, such as anti-dumping
duties;

vi) The multilateral trade rules are increasingly becoming a codification

of the policies, perceptions, laws and regulations of the industrialised
countries. The policies and rules appropriate or advantageous to the
industrialised world are getting established as common rules to be
obeyed by the developing world as well. As a result a ‘one size fits
all’ approach is increasingly getting embedded in the WTO rules
and disciplines;

vii) The interests of international trade, which are primarily the intrests
of transnational corporations, take precedence over local concerns
and policies even if such a course exposes the local population to
serious health and security risks;

viii) The implementation-related issues are becoming a source of serious

concern. These issues cover a whole range of demand to correct
while asymmetries in TRIPS, TRIMS, anti-dumping, movement of
people, etc. remain. Other issues requiring WTO attention relate to
agriculture, textiles, industrial tariffs including peak tariffs, and
services. In addition, there are what are described as Singapore
issues. These relate to: (i) rules to protect investments, (ii)
competition policy, (iii) transparency in government procurement,
and (iv) trade facilitation.

WTO has now become a forum for perpetual negotiations on newer and
newer subjects and for using trade rules to establish standards and enforce
compliance even in non-trade areas. Everything now seems to require
the hand of WTO, be it foreign investment, environmental or labour
standards, child labour, good governance, or human rights.

However, a word of caution need to be sounded. WTO should not be

expanded into a sort of world government, covering every economic
subject under the sun, and then using the threat of trade sanctions to
bring about a new world order.

23.5 DOHA ROUND OF NEGOTIATIONS

92 At the ministerial meeting at Doha (Qatar, UAE), in November 2001,
the WTO held a new round of trade negotiations. This round has been WTO and Challenges
of New Trading and
temporarily named as the Doha Development Round. This round began Financial Systems
in January 2002 and was expected to end by January 1, 2007. It has,
however, not concluded till January, 2009.

The Doha round of trade negotiations mandated negotiations on

agriculture, industrial products, services, intellectual property, WTO rules,
trade and environment. The negotiations at WTO reached a dead-end in
July 2006 and were temporarily suspended. Since then, some attempts
have been made to revive them, but these have not been successful.

Due to unrelenting pressure by the developed countries, the Doha

negotiations veered from their proclaimed ‘development-orientation’
towards a ‘market access’ direction in which developing countries are
pressurised to open up their agricultural, industrial and service sectors.
In short, developed countries are out to seek exclusive benefits for
themselves, alone. This goes against the spirit of bilateralism. The demise
of multi-lateralism will set in a two-pronged movement towards increased
bilateralism and regionalism. This will mean short-term gains for the
vested interests, and medium and long-term welfare losses for everyone.

23.5.1 India’s Response

India has a strong interest in a successful conclusion of the Doha round
and should aim at the successful ending of negotiations even if the
impasse may need to be prolonged to accomplish such an outcome.
India should not be deterred by the fear that the trend towards regional
arrangements would strengthen and trade conflicts would intensify. The
geographical dynamics which drives regional arrangements will remain
unaltered as it is. There is no doubt a distinct possibility of increased
trade disputes, especially in agriculture after the demise of the peace
clause, remains. But, India should not be daunted as the major subsidising
countries are likely to face disputes and trade friction which could
eventually prove to be a tonic for the trading system. In other words,
it might help create a sense of urgency among the major players and a
required political will to emerge effecting deep reforms in agriculture.

Check Your Progress 2

1. Enumerate in brief the major achievements of the WTO.

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2. Enumerate in brief the major limitations of the WTO.

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3. What is Doha round of negotiations?

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23.6 NEW INTERNATIONAL FINANCIAL

ARCHITECTURE
The global economy has entered a new phase during the first decade of
the twenty-first century. Momentous changes have been taking place,
whose pace and force have both been unprecedented. Among these
changes, a few important ones can be enumerated as follows:

1. Emergence of China, etc.: Emergence of China, India and others as

economic powers has been a major factor of the present international
economic dispensation. The global economy had witnessed the all-
powerful hold of US and Europe for preceding close to two centuries
or so. These economies served as the locomotive for the global
economy. Twenty-first century is a witness to a tilt in this power-
balance. Growth rate in China have been stupendous; India and other
Asian nations have been fast catching up with this trend. This cannot
leave the global economy unaffected. Already China is being touted as
the locomotive economy for the world.

2. Groups of Developing Economies: Fast emerging developing

economies have already tasted the flavour of their strength and ability
to dictate their demands to the developed world. They have
successfully stopped the developed world in their mission at Doha
round of negotiations. They have presented a voice of unity in the
form of groups of nations, like G20. India and other fast emerging
economies have provided leadership to such efforts.

3. Capital Flows: Unprecedented capital flows, in different forms of

investment, has taken place throughout the globe. Aided by advances
in technology, both the developed and developing nations have gained
from these flows.

4. Growing Uncertainties and Instabilities: While mushrooming

94
foreign capital flows lubricated the growth engine throughout the
 globe, it suffered from in built weaknesses of growing uncertainties WTO and Challenges
of New Trading and
and instabilities. These flows have been fickle and have demonstrated Financial Systems
keenness to take flight at the first sign of trouble.

That these instabilities can cause trouble throughout the world, and there
is no system in place to check and regulate them, became clear when the
whole of the globe got engulfed in what came to be known as the ‘sub-
prime crisis’ that originated in US (see Unit 28 on this). Even earlier,
the Latin American Crisis of 1987-88 and the East Asian and South East
Asian Crisis had sounded the warning bubbles which were not adequately
heeded. In wake of sub-prime crisis, however, the all-powerful, steel-
strengthened, highly robust and the energetic financial structure of the
US came down like a house of cards, putting the whole economy in a
state of recession. This turmoil soon spread throughout the globe,
bringing distress and misery for the masses.

23.6.1 Need for a New International Financial Architecture

The world now (2009) needs a new international financial architecture,
including a new global economic institution for several reasons. These
are:

One, the existing international financial institutions have been inefficient

in dealing with the present economic crisis. They were set up in a
different political and economic context from what prevails today. The
IMF was set up with a view to maintaining an international monetary
system that would promote exchange rate stability. The World Bank was
set up to help build war ravaged nations. The prevailing global economic
conditions have little or no similarity to the conditions at that time.

Two, prospects for enhancing the effectiveness of the existing

international financial institutions are bleak. There is little or no indication
thus far that these institutions have been able to gear themselves
adequately for the magnitude of the task that the world economy currently
faces, be it in the developed or the developing world. On the contrary,
there have been indications of delays and failures, not to talk of the role
with respect to ‘surveillance’ that the IMF is mandated to perform.

Three, in the wake of the international financial crisis in 2008, at the

G-20 Summit towards the end of 2008, an Action Plan has been
formulated to meet the situation. The plan consists of both short-term
and medium term measures. It, however, appears unlikely that either the
IMF or the World Bank is geared to perform this task.

Four, a new international financial architecture, including a new global

economic institution is required to enable the global economy to become
more fair and equitable, and thereby also more sustainable. Present day
globalisation has created tremendous potential for creating prosperity
and for reducing global inequalities with growth rates of developing
countries far outpacing those of the developed world. However, 95
External Sector globalisation has been accompanied by accentuation of income
inequalities across nations and within nations. This has happened because
globalisation, as reflected in flows of finance, investment, capital, and
knowledge between nations, has taken place across a less than level
playing field, thereby enabling the already prosperous nations to get
greater benefits, and become even more prosperous, while others have
been partly or totally left out of the growth process.

In short, action to build a fair and inclusive globalisation through a new

financial architecture is urgently required.

23.6.2 Suggestions for a New International Financial

Architecture
As stated above, it is imperative to design a new international financial
architecture. For this purpose, a few suggestions can be advanced as
follows.

1. The process and institutional design that the new architecture

develops must be inclusive: The new institution should give adequate
attention and support to both industrial and developing countries, and
to both large and small countries. Its governance system must be based
on representative institutions, not on any adhoc grouping of countries
(e.g. a G-8, a G-13 or a G-20). There is a need for a deeper involvement
of the United Nations (UN) in any reform process, as it is the most
representative of global institutions.

2. The regulatory deficit of global finance must be corrected: The

crisis in the international financial system is closely associated with
inadequate regulation and supervision of financial activities. Since
the Asian crisis of the 1990s, it became an established criterion that
financial liberalisation must be accompanied by stronger prudential
regulation and supervision. This principle has been applied in many
parts of the developing world but was entirely disregarded in the US,
where further liberalisation was accompanied by deregulation and
weak supervision of financial inter-mediation.

It is important, in this context, to follow the following basic regulatory

principles.

One, regulations must be comprehensive, to avoid the massive loopholes

through non-banking inter-mediation that led to the 2008 turmoil. This
will include regulating the types of transactions that led to this crisis,
particularly securitisation and derivatives, and force all the markets to
be open and transparent thus limiting the over-the-counter operations.

Two, regulations should have strong counter-cyclical focus which would

avoid excessive indebtedness and force the accumulation of increasing
capital and provisions during booms.
96
Three, when pricing assets according to their market value to maintain WTO and Challenges
of New Trading and
transparency, the system must have mechanisms to avoid asset price Financial Systems
bubbles from feeding into the credit expansion, and asset price busts
from feeding into the credit squeeze.

Four, reliance on the internal models of financial institutions should be

discarded. It has already shown how perilous it can be, and how the use
of similar risk models by financial institutions can lead to greater
instability. The new models should focus on: restricting monopoly power,
encouraging diversification and avoiding unsafe financial products.

Five, any system that is designed in this area should be based on a well-
functioning network of national and regional authorities and include truly
international supervision of financial institutions with a global reach.
The IMF should not be at the centre of the regulatory system. The Bank
of International Settlements and the Basle Committee are better placed,
but this will require a fundamental reform to broaden their membership
and avoid the two major problems that the Basle Committee faced in
recent years viz. (i) the lack of representation of developing countries,
and (ii) excessive influence over regulation by large international banks.
Alternatively, building on these institutions, a new ‘Global Financial
Regulatory Authority’ could be considered.

3. The IMF should be revamped: Four essential reforms of the IMF

should be part of the reform agenda.

The first is the creation of a meaningful and truly global reserve

currency, which could be based on the IMF special drawing rights.
This would overcome both the inequities and the instability that is
inherent in a global reserve system based on a national currency.

The second issue is the need to place the IMF at the centre of global
macroeconomic co-ordination, not the G-7 or in fact any group. This
is the only way to give developing countries a voice on the issue.

The third issue is the need for the IMF to lend during BOP crisis
rapidly and without overburdening conditionalities, particularly when
the sources of the crisis are a rapid reversal of capital flows and a
sharp deterioration in the terms of trade. This means putting in place
a preventive credit line for capital account crises and making active
use of the Compensatory Financing Facility and of the Poverty
Reduction and Growth Facility to manage the adverse terms of trade
shocks faced by low income countries. This implies that the IMF
would act more like a central bank, providing liquidity in an agile
way, the way central banks have actually been providing funds in
industrial countries on a massive scale in recent months.

As a fourth issue, the IMF should encourage and advice countries on

what regulations to impose under given circumstances. Indeed, the
regulatory structure that must be developed to manage financial
97
External Sector stability in the global era should include provisions that apply to
cross-border capital movements such as: generalised reserve
requirements on cross-border flows, minimum stay periods, and
prohibitions to lend in foreign currencies to economic agents that
do not have revenues in those currencies.

4. A co-ordinated global macro-economic policy package must be

urgently adopted: Both developed and developing countries should
form part of such an effort.

5. An international debt count must be created: The lack of a

regulatory institutional framework to manage debt (i.e. a court similar
to those created to manage bankruptcies in national economies, the
decisions of which are legally binding) is one of the major
deficiencies of the current international financial architecture. The
system has relied in the past on ad-hoc mechanisms, or on traumatic
individual debt renegotiations. The problem of all these mechanisms
has been that they generally come too late, after high indebtedness
has had devastating effects on countries. Conditionalities have also
been a significant source of problem for several poor countries and
must be immediately lifted to allow these countries to benefit from
these initiatives. The new international financial architecture should
solve these problems by creating an international debt court, which
would serve both as mediator and eventual arbitrator of both public
and private sector international loans.

6. The system must rely more broadly on regional institutions: In

all areas of reform, the IMF should make more active use of regional
institutions and support their creation in other parts of the developing
world. Indeed, the IMF of the future should be seen as the apex of
a network of regional reserve funds.

The developing countries are in an excellent position to contribute to

this task, given their large foreign exchange reserves. Using those
reserves more actively for swap arrangements among central banks,
pooling them in reserve funds, or using them to support the development
of regional bond markets are all mechanisms to be used in expanding
the scope to plan the new financial architecture. These reserves and
existing sovereign wealth funds could also be used for creating the
multilateral development banks owned by developing countries, and by
investing in the capital bonds issued by such institutions.

Check Your Progress 3

1. Mention the factors which indicates the need for a new international
financial architecture.

....................................................................................................................
....................................................................................................................
98
 .................................................................................................................... WTO and Challenges
of New Trading and
.................................................................................................................... Financial Systems

....................................................................................................................

2. State the essential features (by way of suggestions) for a new

international financial architecture.

....................................................................................................................
....................................................................................................................
....................................................................................................................
....................................................................................................................
....................................................................................................................

3. Mention the lines (by way of your suggestions) on which a revamping

of the International Monetary Fund is called for.

....................................................................................................................
....................................................................................................................
....................................................................................................................
....................................................................................................................
....................................................................................................................

23.7 LET US SUM UP

Bretton-woods conference, 1944, gave birth to two international
institutions, viz. the IMF and the IBRD. Interim arrangements were made
to regulate trade in goods through an institutional structure called GATT.
GATT, however, did not live up to the expectations and requirements of
newly developing countries. The continuous pressure exerted by these
countries resulted in the setting up of the UNCTAD. The Uruguay round
of negotiations on GATT culminated in the setting up of the WTO, which
became operational from January 1, 1995. During the period since the
WTO has been in existence, it has broadly lived up to the expectations
of majority of countries.

However, the response of the WTO to the fast changing global situation
has also been found inadequate. This can be seen from the slow progress
made by the Doha round of negotiations. Simultaneously, international
financial system has come under deep stress with the turmoil having its
origins in the US and in the highly volatile large capital movements
across the globe. This has brought out the need for a new international
financial architecture.

99
External Sector
23.8 KEY WORDS
Bretton-woods : Refers to the two institutions of IMF and
Institutions World Bank following their establishment
as a result of a conference held in a place
called Bretton-woods in 1944 as a sequel to
the need felt for extending economic support
following the end of II World War.

General Agreement on : An organisation set up by the rich developed

Tariffs and Trade countries in 1947. It was biased in favour
(GATT) of the rich countries and hence was dubbed
as the ‘rich men’s club’.

World Trade : An international organisation set up in 1995.

Organisation (WTO) This organisation too came up as a result of
the initiative and support of the members of
GATT. However, its functioning was more
democratic mainly in view of the change in
the economic atmosphere which had seen
the coming up of many newly industrially
advanced countries since GATT.

Most Favoured Nation : One of the four principles of WTO, which

(MFN) Treatment advocates no preferential treatment be given
to any country. However, the other two
principles of the remaining three provisions
for such a treatment to some countries by
‘protection through tariffs’ based on the
‘bound tariffs’ approach.

TRIPs and TRIMs : Two agreements under WTO for protection

of ‘intellectual properties’ and ‘trade related
investment measures’.

Doha Round : An inconclusive and continuing round which

became controversial in view of its agenda
on items like agriculture, services,
environment, and other issues in which the
views and situation of developing countries
are different from those of developed
countries.

23.9 SOME USEFUL BOOKS

Kaushik Basu (ed.), The Oxford Companion to Economics in India, Oxford
University Press (OUP), New Delhi, 2008.

Ishwar C. Dhingra, The Indian Economy, Environment and Policy, Sultan

100 Chand, New Delhi, 2009.
Ashwini Deshpande (ed.), Globalisation and Development, OUP, New WTO and Challenges
of New Trading and
Delhi, 2007. Financial Systems

Basudeb Guha (ed.), The WTO, Developing Countries and the Doha
Development Agenda, Palgrave, New York, 2004.

K.S. Jomo (ed.), Globalisation Under Hegemony, Uneven Development

and Global Inequality, OUP, New Delhi, 2005.

23.10 ANSWERS OR HINTS TO CHECK

YOUR PROGRESS EXERCISES
Check Your Progress 1

1. See Section 23.2.1 and answer.

2. See Section 23.2.2 and answer.

3. See Section 23.2.3 and answer.

4. See Section 23.2.4 and answer.

5. See Section 23.2.5 and answer.

6. See Section 23.2.5 and answer.

7. See Section 23.2.5 and answer.

Check Your Progress 2

1. See Section 23.4.1 and answer.

2. See Section 23.4.2 and answer.

3. See Section 23.5 and answer.

Check Your Progress 3

1. See Section 23.6.1 and answer.

2. See Section 23.6.2 and answer.

3. See Section 23.6.2 and answer.

101