The WTO as a Systemic Regulator?

The term “systemic risk” entered the global lexicon last year — and quickly became the newest addition to the list of vital things we did not know we did not know about.

With astonishing speed, the world of finance came apart and took the rest of the global economy with it. Precisely the kind of risk that Alan Greenspan used to tell the banks they need not worry about now hangs like a cloud over the global economy.

In the process, national regulators or colleges of regulators have emerged. Their job is nothing short of predicting and preventing the sum of the parts taking down the whole — thus replacing the theory that markets are essentially self-regulating.

At the international level, we see new institutions like the G-20, a revitalized Financial Stability Forum and calls for reform of the IMF, while we all start to wonder if we are living in a Bretton Woods bubble.

Indeed, the Bretton Woods institutions have been turned on their heads and the presumed weak pillar, namely the WTO, is emerging as the tent pole that is holding up the entire system.

How on earth could that be possible? Isn't the WTO a virtual catastrophe for failing to complete the Doha Development Round? Didn't Paul Blustein just publish a brilliant book about the WTO subtitled: "Clashing egos, inflated ambitions, and the great shambles of the world trading system"? Could anyone in his right mind really suggest that the WTO be considered the most successful global systemic regulator in the history of mankind?

Well, I do. To see why, let's start with a little history. If you compare what happened during the most recent crisis to what happened in the 1930s, there is one important distinction.

Back in the 1930s, roughly half of the decline in trade was due to interventions by governments taking discretionary measures to raise barriers. In the current crisis, notwithstanding the cries of protectionism, the fact remains that virtually all the decline in trade has been due to a fall-off in demand — and not due to discretionary trade measures.

In other words, the decline in trade in the current crisis could have been twice as bad, were it not for the fact that the WTO rules have by and large been followed. The measures that have been taken affect less than 1% of world trade. Plus, they are temporary and justified within the rules for actions regarding safeguards and against unfair trade practices.

As a result, global trade — which had peaked in April 2008 at $14 trillion, then fell 18% by August 2009 — started growing again at 2.6%.

One can make the case that the crisis of 2008-2009 is to the world of finance what the crisis of the 1930 was to the global trading system. Over 75 years, the nations of the world have been building on the lesson that trade protection exacerbated the economic downturn of the 1930s by evolving a set of principles into soft law and ultimately hard law to regulate trade.

The process started with Cordell Hull's idea of the Reciprocal Trade Agreements Program (1932), the GATT (1947), the WTO (1995) and the accession of China to the WTO in 2001.

By contrast, the IMF and the World Bank continue to struggle to provide leadership and legitimacy — with regard to a global framework for both finance and development.

Those who measure the success of the trading system against its ambitions to achieve free trade fail to appreciate the value of preserving the gains of over three quarters of a century of negotiations.

That system of trade law — what the European Union would call the acquis — represents the body of rules to which all members must adhere.

Indeed, it would be more accurate to talk about the benefits of a well-regulated system of trade rather than free trade because that is what we have.

Moreover, there is no uber-bureaucracy to enforce these rules. They are, in fact, self-enforcing — that is, the members ensure compliance through a very active dispute settlement mechanism that handles literally dozens of cases every year. Two-thirds of them are appealed — and fully half are brought by emerging market economies.

People who condemn the WTO solely for its failure to deliver on the Doha Round agenda make the same mistake as those who measured the success of the financial regulatory regime against its ability to facilitate financial innovation by opening markets to ever more exotic (and sometimes toxic) financial instruments.

There is great merit in pursuing a Doha Round deal to the extent it can truly contribute to global growth and recovery — but failure in this regard does not make the existing rules outmoded nor irrelevant.

On the contrary, for all those who earn their livelihood off trade, the WTO operates to reduce risk and thereby cost, eliminate uncertainty and provide a critical source of stability for the global economy. Moreover, that is why the WTO has become a magnet for global regulatory issues — from climate change to currency manipulation.

The point here is not that the WTO is perfect, because it is far from ideal — and the story is far from over. The weakness of its rule-making side is putting considerable pressure on the dispute settlement system.

But the greatest source of pressure on the global economic system is not coming from the "real" economy. Rather, it is coming from the failure of the financial system to come to terms with its fundamental problems.

These problems include inadequate safeguards against systemic risk at both the national and international levels and the persistence of global imbalances for which there are no agreed international rules or remedies.

Sometime in 2010, the U.S. Congress will vote on whether to continue U.S. membership in the WTO pursuant to a legislative mandate requiring such a vote every five years.

With unemployment near 10% and prospects uncertain for a dramatic improvement, the vote will almost certainly evoke considerable debate over jobs, global imbalances and the merits of multilateralism.

As the Obama Administration strives to develop a new narrative to guide U.S. policy toward globalization, it would do well to consider the WTO in the light of the financial crisis — and its role as a global systemic regulator.

In fact, the WTO could be an inspiration for those seeking a more stable regulatory regime for finance. This is a subject that is worth examining in a future analysis.