II – C ECONOMICS, DISCIPLINES AND PRACTICES C ECONOMICS, DISCIPLINES AND PRACTICES While Section B discussed the rationale for the credibly the use of safeguards in the context of a existence of contingent trade policies in a trade trade agreement is a key condition for governments agreement, this section analyzes in more detail to prevent moral hazard3 and to be able to achieve some of the key features of different types of the intended objectives. This premise provides a measures. This includes both an economic and natural lead into sub-section (b), which presents a legal analysis. For safeguards, anti-dumping the main provisions contained in the Agreement on measures and countervailing (“anti-subsidy”) duties Safeguards (SGA) and their interpretation through as well as the various other actions that can be WTO case law. It will also describe to what extent used as contingent measures, each sub-section the underlying economic logic of how and when to will highlight the specific economic aspects that apply safeguards is reflected in these disciplines, and are relevant for a full appreciation of the possible how economists have sometimes struggled with the economic consequences of the use of any particular implementation of certain legal requirements. measure. Some of the principal WTO disciplines applying to each type of measure are discussed (a) Economic arguments for along with their interpretation through dispute disciplining the use of safeguards settlement. In Section B.1, it was demonstrated that countries The sub-sections discussing legal elements of need the flexibility to temporarily defect from safeguards, anti-dumping and countervailing duties their obligations under an international trade are organized in a similar manner in order to agreement in order to be ready to commit to a facilitate a comparison among these measures. higher level of liberalization commitments. At the The structure consists of a discussion of: (i) the time that a trade agreement is concluded, countries respective “trigger” for contingent measures are unable to foresee all future events that may 1 (increased imports, dumping, subsidization); lead to an intensification of competitive pressure (ii) the definition/involvement of the “domestic from foreign imports. This may make contingent industry”; (iii) the existence of (serious or material) measures desirable for certain industries, be it as 2 injury to the domestic industry; (iv) the cause of insurance against income loss, to facilitate industry the injury; and (v) various conditions that need to adjustment to competition or for political reasons. be respected in the application of the respective measures, such as timeframes. Where applicable, Section B.2 elaborated on the different types of selective reference is made to national practices circumstances in which governments may wish to as well as to comments, notably by economists, use such flexibilities. It was recalled that, from an regarding the implementation of these disciplines economic point of view, government intervention and their compatibility with the economic rationale may help to improve national welfare in the presence underlying contingent measures. The section of market failures. For example, if imports increase concludes with a number of observations regarding and domestic production in a particular sector regulatory factors, both domestic and international, decreases while, at the same time, labour markets that may influence a government’s preference for do not adapt, workers might become unemployed. one contingent trade policy over another in a given Ideally, the problem is addressed at its source, i.e. in situation. this case, via labour market policies, since trade is not the origin of the problem. However, according to the 1. SAFEGUARDS theory of “second-best”, a governmental measure in one market, that would be considered an unwanted In previous sections of this Report, the term distortion of incentives in a perfectly functioning “safeguards” has often been used in a generic market environment, may in fact counterbalance the sense to denote the existence of flexibility in trade effect of a market failure elsewhere. If, for example, agreements to temporarily employ trade measures in the case of rigidities in the labour market, the in response to an increase in import competition. preferred policy, such as reducing job search costs, By briefly reviewing this discussion, sub-section (a) is for some reason not possible, a tariff may act as will highlight the fact that disciplining and limiting a “second-best” instrument reducing the costs of 47 WORLD TRADE REPORT 2009 adjustment associated with the transfer of workers a (socially optimal) higher level of investment.6 from a declining industry into an expanding export The tariff has the effect of increasing the effective sector and thereby improving the situation to at costs to foreign industry and allows domestic least some extent (Krugman and Obstfeld, 2006). firms to reap higher profits from innovation in the meantime.7 The authors emphasize that in order In Section B.2, it was demonstrated that rather than to fulfil their purpose, safeguards must be strictly maximizing national welfare, governments may time-limited, since the benefits of protection vanish give in to demands for trade protection by well- once the innovation has taken place. organized pressure groups to gain political support or to use trade measures to redistribute or stabilize It is crucial that governments can credibly commit income in the pursuit of broader social objectives.4 to a specific period, after which protection will Taking into account these political economy be removed. If the industry thinks there is a considerations, the greatest challenge in using possibility of a renewal of safeguard measures if it temporary trade protection becomes the avoidance has not successfully innovated, it has an incentive of moral hazard. Once trade measures are in place, to delay innovation. As discussed in Section B.1, incentives to adjust to new circumstances decline for the threat of retaliation under a trade agreement the protected industry. Brainard and Verdier (1997) can provide a credible “commitment device” that describe the vicious cycle of more lobbying leading safeguard measures will not be extended beyond to a greater level of protection and less industry the authorized date. By the same token, industry adjustment, with the latter increasing in turn the also needs the assurance that early successes in industry’s pay-off from lobbying for an extension of research and development (R&D) do not lead to protection. In addition, as explained in Section B.1, a premature withdrawal of protection. Otherwise, firms anticipate that it is not in the government’s the expectation of lower profits might prompt the interest to remove trade protection if industry domestic industry to invest less. This seems to adjustment has been inadequate. Since government imply that a clear delineation of governments’ rights lacks the credibility to remove protection at the pre- in a trade agreement to use temporary protection is specified date, firms under-invest in the adjustment equally important, since countries should not come process (Staiger and Tabellini, 1987; Matsuyama, under pressure from trading partners to remove 1990). protection earlier than initially planned. The distinguishing feature of safeguards, taken As mentioned above, several papers have noted that in the context of a trade agreement as opposed to protectionist measures might be employed in order any protectionist measure pursued following the to slow down an industry’s decline until it ceases to second-best argument, becomes the credible threat exist (Hillman, 1982; Brainard and Verdier, 1997; of their being removed after a defined period of Magee, 2002). These papers seek to explain the time. A number of recent papers have specifically political economy processes that lead governments to examined the question as to what extent the provide import protection to declining industries.8 temporary nature of safeguard measures (for fear However, some recent literature has gone further, of retaliation)5 allows governments to reach the emphasizing that if the costs of quickly scaling back objectives pursued. It is assumed that competition production are high, slowing down an industry’s from abroad rises unexpectedly and that temporary decline via temporary safeguards may improve a safeguards are used in order to either provide the country’s overall welfare. Protracting an industry’s opportunity to the domestic import-competing demise, of course, also entails welfare costs, as it industry to catch up technologically or to allow slows down the reallocation of resources to more for an orderly exit from the market if a quick productive sectors. contraction of the industry may be associated with long-term welfare losses. Davidson and Matusz (2004) assume the existence of “congestion” in the labour market, i.e. it becomes Crowley (2006) and Miyagiwa and Ohno (1999) harder to find a job when the market is “crowded”. look at a foreign productivity “shock”, i.e. a situation A temporary safeguard tariff can be beneficial by in which the domestic industry (unexpectedly) lags reducing the number of unemployed at a given behind its foreign competitor in terms of technology. moment in time and keeping them at work in the In such a situation, the government can put in import-competing sector. This reduces congestion place trade measures, such as tariffs, to stimulate and improves the chances of those looking for 48 II – C ECONOMICS, DISCIPLINES AND PRACTICES a job to find a new occupation in expanding described in which governments may wish to resort sectors. Since older workers have less time to to trade remedies, including safeguards, as second- find re-employment, this approach can specifically best instruments, a multilateral trade agreement explain why governments concerned with the is likely to contain provisions that seek to ensure welfare of this segment of the population might that the interests of other countries are taken into have an extra incentive to provide temporary trade account in this decision.