The chapter explores the role of the World Trade Organization (WTO) in promoting business cooperation between countries. There are two theoretical explanations of why the WTO exists. One argues that the formation of the WTO was a direct result of the formation of the General Agreement on Tariffs and Trade (GATT) that was reached after the Second World War. The other asserts that the main reason why the WTO was formed is to promote trade cooperation between countries, which is difficult to achieve without a control body. One reason why cooperation is difficult to achieve is the desire of some countries to take advantage of others. Also, the fear of being taken advantage of makes some countries reluctant to liberalize trade.
Why is international trade necessary? Why can’t all countries produce what they need? The chapter maintains that countries gain more by specializing in the production of specific products and importing others. Countries have a comparative advantage over others in the production of certain products. For example, the United States can gain more by producing electronics and importing clothes from China, rather than producing both clothes and electronics. In other words, every country gains by specializing in the production of what they are good at.
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The root of comparative advantage is the uneven distribution of factors of production such as labor and capital; For example, some countries have more labor than others. The supply of the factors of production determines their prices. In turn, the cost of the factors of production affects the prices of the final products. Countries specialize in the production of products whose factors of production they have in abundance. For example, the United States has a high supply of capital while China has a high supply of labor. This means the United States will do well in the production of capital-intensive products while China will thrive in the production of labor-intensive products. With that, it will be cheaper for the United States to import the labor-intensive product from China than produce it locally.
Countries do not decide to liberalize their trade individually. Instead, they open their markets to select countries that must reciprocate by opening their markets. In other words, most trade liberalization is achieved when countries exchange trade commitments. Though bilateral trade agreements benefit both parties, the benefits are not equally distributed, and one party may gain more. The party with the higher bargaining power is likely to get more benefits since they are in a position to choose the market access they need from the other parties. A country’s bargaining power is determined by its level of patience, how much information it can hide from the other party, and whether the country has an outside option. Patience in trade negotiations is a measure of how long a party is able or willing to hold out for a better deal. If a government has an outside option in a trade negotiation, it means it can get the trade commitments it is seeking elsewhere.
For trade agreements to work, there must be an enforcement mechanism, a way of ensuring that governments fulfill their trade commitments. Unlike in domestic trade where there is a political authority that enforces fair trade practices, the international trade system does not have a political mechanism to enforce trade agreements. Trade agreements are likely to be followed when the parties expect to strike other deals in future and when the parties employ reciprocity strategies.Tit-for-tat is a typical reciprocity strategy. The WTO promotes international trade cooperation by creating an expectation of future trade deals and availing the information necessary to play reciprocity strategies. When two WTO members enter a trade deal, they are likely to fulfill their commitments since they frequently interact. Further, the WTO resolves trade disputes between members and punishes governments that violate its rules.
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