The WTO credibility decked global supply chains and investments resulting in a laundry list of impacts

The WTO has noted that trade scepticism among policymakers and trade policy tensions over supply chains are manifesting themselves in even more fragmented and concentrated supply chains. This column develops a model to show how trade policy uncertainty deters the investment needed to facilitate integration into global value chains, and demonstrates how WTO agreements, by acting as a commitment device, lower this uncertainty and thus encourage investment and integration. Any erosion of the WTO’s credibility or destabilistion in the global trading environment can have long-term implications for global supply chains. US-China trade tensions, the COVID-19 pandemic, and national security concerns have exposed several risks in current global supply chains (Freeman and Baldwin 2022, Alfaro and Chor 2023). The response from governments and firms worldwide has focused on investments to make these supply chains more ‘resilient.’ 1 Another approach is directly targeting the policy shocks, for example by renewing cooperation in trade policy and mitigating systemic uncertainty about future policies. Cooperation via the WTO has, until recently, successfully reduced trade policy uncertainty (TPU), which has been an important source of export growth (Handley and Limão 2022). However, the credibility and enforcement of commitments in the WTO are currently diminished (see, for example, Wolff 2022 on dispute settlement). The WTO itself notes that trade scepticism among policymakers and trade policy tensions over supply chains are manifesting themselves in even more fragmented and concentrated supply chains (WTO 2023). Before abandoning hope of renewed cooperation in this area we must answer the following. What is the value of WTO commitments along the global supply chain? In a new paper (Handley et al. forthcoming), we start to address this question. Specifically, we model and estimate firm input sourcing decisions under TPU and use the framework to estimate the value of WTO commitments made by China upon accession. The reduction in TPU increased investments in new imported inputs within firms and made them more responsive to future trade liberalisation. This translated into higher final sales. These impacts from lower TPU – a more responsive demand for prices and diversified supplier portfolio – are in line with the rhetoric of policymakers and firms but undermined by the tensions in the WTO and in some regional agreements. TPU can be challenging to measure systematically over long periods. A useful descriptive tool is an index such as the one in Figure 1, constructed with the measure by Davis et al. (2019) of the frequency of Chinese language newspapers about TPU. We note a couple of features to provide context and illustrate the current importance of TPU. First, there is a reduction in this index after China’s WTO accession, which included its commitment to previous tariff reductions. Second, there is an increase in the 2008 crisis, which eventually subsided but at a higher level than before. The index rises again during Donald Trump’s presidential campaign and spikes with his entry into office and successive threats and implementation of tariffs on Chinese intermediates and subsequent retaliation. Since 2021, TPU has subsided relative to those peaks but remains elevated. China started its process of trade liberalisation in 1992 with the introduction of the ‘Social Market Economy’ concept and the signing of the US-China memorandum of understanding on market access. Tariffs placed by China on intermediate goods quickly fell following these events. Figure 2 shows China’s average most favoured nation (MFN) rate declined from 35% in 1992 to around 12% in December 2001, when it entered the WTO, and was below 10% in 2006. The substantial liberalisation pre-WTO was not reflected in higher intermediate import shares relative to GDP, which fell between 1992 and 1998. This share did increase in a significant and sustained form after WTO entry, even though the tariff cuts were smaller in that period. One hypothesis for these facts is that Chinese importers believed the tariffs between 1992-1998 could be changed in the future without commitment through an agreement such as the WTO. The resulting tariff uncertainty lowered their investment in imported inputs. Under this hypothesis, the WTO accession lent credibility to the earlier liberalisation and thus spurred Chinese firm imports. We find that a significant fraction of the WTO impact on Chinese imports is due to this commitment mechanism, rather than the reduction of Chinese tariffs between 2000-2006, which many other studies emphasise.