LESSON

5: OPERATIONS OF BRETTON WOODS INSTITUTIONS

POLITICS OF DECISION-MAKING IN INTERNATIONAL TRADE

Cooperation is hard because there is a lack of incentives and countries try to avoid being
exploited. The WTO tries to ensure compliance so countries are not exploited. Why does the WTO
exist?

1. US economic interest after the Second World War in creating GATT. 


2. Cooperation is in the centre of liberalized world. In order for cooperation to emerge, people

must be assured that cooperation on their part will be met by cooperation from others. 


3. Ability to ensure that all governments comply with the agreements they make. 


TRADE THEORY

We are told many things about how trade is better for everyone, but it is definitely a hard
situation to evaluate. It is important to understand some core concepts of trade:

Opportunity cost: since we have limited resources and factors of production in finite
amounts, the opportunity cost, as every resource could have different uses, is the benefit,
profit or value of something that must be given up to acquire or achieve something else.
Absolute advantage: compares the productivity of different producers or economies. The
producer that requires smaller quantity inputs to produce a good is said to have an
absolute advantage in producing that good.
Comparative advantage: ability of a party to produce a particular good or service at a
lower opportunity cost than another. Even if one country has an absolute advantage in
producing all goods, different countries could still have different comparative advantages.
The existence of a comparative advantage allows both parties to benefit from trading,
because each party will receive a good at a price that is lower than its opportunity cost of
producing that good.
Production Possibility Frontier: all combinations of the production two goods that
maximize production. The opportunity cost of the goods shapes that line/curve
(depending on whether opportunity costs are constant or change because of decreasing
marginal returns).
Consumption point: we assume that people want to consume the most they can, and so
we try to maximize collective utility. The combinations of goods that yield the same utility
are united in a curve of utility (U). There are many of them, some with higher utility than
others. We will consume and produce at the point where the utility curve touches the
slope of the PPF.
 Thus, in trade, each country will specialize in a good. For example, the USA will specialize
in computer production and stop producing shirts and China will do the opposite because they
both earn more because of this. The consumption is bigger than before: the greater U curve gives
us the gains from trade.

THE HECKSCHER-OHLIN FACTOR ENDOWMENTS THEORY

However, what determines what goods a country will produce relatively well? This is
explained by the Heckscher-Ohlin model.

The Heckscher-Ohlin model establishes that differences in factor endowments (basic tools
of production) are the ones that determine which goods a country will produce. These factor
endowments are labor and capital because they are the main tools to produce different goods. In
different countries, some factors are more abundant (and thus cheaper) than others. For example,
in the US and other developed countries, capital is relatively cheap and labor relatively expensive.
In China and most developing countries, labor is relatively cheap and capital is relatively
expensive. This makes production costs more or less cheap.

Thus, comparative advantage tells us that all countries gain from trade by specializing in
the goods that rely heavily on the factors of production that they hold in abundance and
exchanging them for the goods that make intensive use of the factors of production that are
scarce in their economy. Developing countries usually produce goods that are labor-intensive.

WORLD TRADE ORGANIZATION

BARGAINING

Although trade liberalization raises the standard of living, governments don’t liberalize
trade unilaterally: they tend to open foreign markets to export the competitive domestic
industries; and they are protectionist to less competitive industries from imports. They can,
however, reach agreements through trade bargaining, in which they exchange market access
commitments.

Reductions on agricultural and manufacturing barriers are the main issue in the Doha
Round. It looks simple, but it isn’t. According to spatial theory, the countries (the EU members and
the G-20 members) do not want to liberalize unilaterally, but if both groups do it, they could earn
some benefits instead of maintaining protections. After deciding to liberalize, there are different
agreements to be reached to distribute the earnings of trade. This depends on the bargaining
power of the blocs, which has two basic elements:

1. Patience: refers to the fact that since both parties of the negotiation would prefer to settle
today rather than tomorrow, if a country needs a quick deal, it will concede some of the
surplus to another country and the opposite (important in the Doha Round). 

2. Outside option: a government’s next-best alternative to agreement can be used for
 barganing. The US strategy of negotiating RTAs might be an attempt to demonstrate an
outside option to gain greater power within WTO negotiations, which could result in them
gaining a higher share of the gains.

ENFORCEMENT

Another problem to not conclude trade agreements is the enforcement, which refers to the fact
that governments cannot be certain that other governments will comply with the trade
agreements that they conclude. The prisoner’s dilemma tells us that, with an absence of a
mechanism to enforce an agreement, they won’t do it.

Both could earn more if both

liberalized. However,
unreciprocated access to
market liberalization is a sucker
payoff situation for the one
that liberalizes, and the P/P
situation is fine for both, so
their dominant strategy is to
protect although they would be
better off if they both
liberalized.

Thus, even if both gain from reciprocal tariff reductions, neither has an incentive to do so.
Political dynamics trap governments in a protectionist world (the producer is more important than
the consumer). The problem here is that, in a situation of an agreement for L/L, no one can
prevent one country from protecting: if there was an enforcement mechanism to force countries
to comply, L/L could be achieved. This is, however, not the case.

Nevertheless, cooperation is not impossible if three conditions are met:

1. Iteration: a game played repeatedly by the same governments (it’s not a one-time payoff).
2. Reciprocity strategies: used by governments to enforce the L/L outcome. Tit-for-tat is the
most known (each government plays what its partner played in the previous round of the
game). If you protect once, the next government will play protect.

3. Taking into account future payoffs: this will induce countries to cooperate.

The WTO helps ensure the two first conditions: it iterate the game by creating
expectations of repeated interaction through, for example, round, and it also disseminates
information about the compliance of countries to the agreements they have made. The third
condition must be met by countries.
DISPUTE SETTLEMENT MECHANISM

The dispute settlement mechanism of the WTO was created during the Uruguay Round. It
follows a distinct process. When there is an alleged violation of WTO rules, it leaves a timespan for
direct consultations between the countries. If there is no agreement between the countries, the
Dispute Settlement Board (DSB) creates a formal panel to investigate the complaint (composed by
3 experts in trade), which reviews the evidence, holds meetings with the countries and issues a
final report to the DSB. This body must accept the panel’s final report, unless all members vote
against its adoption. After this, the decision by the panel can be appealed by any of the
governments. An Appellate Body (3-5 experts) is created by DSB and it can uphold, reverse or
modify the panel’s findings, conclusions and recommendations. This body determines whether the
trade measure is inconsistent with WTO rules (and its decision can only be overruled by
consensus, again). If it is, the government must alter its policy to conform to the rule in question
or compensate injured parties. This process should not take longer than 15 months.

DISPUTE SETTLEMENT BOARD CASES

The American-Brazilian cotton: the US violated WTO rules, who determined the need for
policy modification. Brazil was unsatisfied with the modification made, so it spoke with a
compliance board who found Brazil to be on the right. Then, Brazil retaliated through
tariffs on US goods. This caused negotiations between Brazil and the USA: the USA
compromised to slowly change its policy and, meanwhile, pay Brazil $147 million/year for
improvements in agriculture. In return, Brazil stopped its retaliation.
Canadian scallops: it is a good example on how legal framing is a source of bargaining
leverage. The EC was taken to the DSB because they didn’t want to name Canadian
scallops “scallops”. The Board found that Canada and other countries were on the right, so
the EC, expecting a negative ruling, agreed to let scallops be named scallops if Canada
included the country where the scallops came from and the scientific name of the species.
Peruvian sardines: with discounted legal advice, the contribution of UK consumer group
and third party opinions Peru won a DSB case. They were allowed to name their sardines
as such if, again, they added the country they came from and the scientific name of the
species.
Vietnam catfish dispute: Vietnam is a non-WTO member, and it has a bilateral trade
agreement with the USA. When exports of catfish were very high, the US used its leverage
power to force Vietnam to stop calling it catfish and, later, to stop exporting since they
were accused – very controversially – of dumping. Not being part of the WTO harmed
them.
Argentina and Spanish biodiesel rules: Argentina has filed a complaint because of an
alleged trade restriction by Spain on biodiesel. This harms Argentina and Indonesia. The
EU represents Spanish interests.

THE FUTURE OF THE WTO: CRITICS AND CHALLENGING

From its birth in 1995, there have been great expectations from the WTO. The Doha Round
increased pressure and questioning on the clash of interests with a more diverse membership,
increasing propensity to liberalization unilaterally or bilaterally, backlash against liberalization in
Western countries and the climate of mistrust that is said to exist within WTO.

There are five central challenges to WTO:

1. Paradox between the continued liberalization and internationalization of the OECD

economies and a marked reduction in popular support for open markets (stagnant wages,
job losses, environmental degradation, growing income inequality). 

2. Increasingly multipolar nature of the global trade system: new G4 (US, UE, India, Brazil) +
China versus the smallest and poorest WTO members representation. Readjustment of
power relations in the global economy. 

3. Need to reconcile the sometimes competing objectives of WTO on developing countries
and environmental/human issues. 

4. There are critics to their decision-making process and transparency. There is a need to
balance the potentially competing demands of efficiency, fairness and legitimacy within
the system. 

5. RTAs are inherently discriminatory and thus at odds with the WTO’s fundamental norms of
non-discrimination, but they are still allowed. They might undermine the institution. 


IMF: BRIEF OVERVIEW

The International Monetary Fund or IMF has 189 members. It is the central multilateral
organization for promoting international macroeconomic stability. Its main tasks are:

1. Surveillance of financial and monetary conditions in its member countries and in the
global economy.
2. Financial assistance to help countries overcome major balance of payments problems.
3. Technical assistance and advisory services to member countries. 


It is financed through lending resources or quota subscriptions of member nations. The

new member quota is based on a country’s relative weight in the global economy.

DECISION-MAKING

The IMF counts with two main decision-making entities:

1. Board of Governors: it is the highest authority and all countries are represented. 

2. Board of Executive Directors: it handles operational daily activities and it has 24 members,

each representing a single or group of countries. 


The voting system is weighted based on a country’s quota. The counts with a 16.75% of
the final vote (it has the largest single vote). There are three kinds of votes:

1. 50% majority votes for EB and daily functions. 


2. 70% vote in EB decisions regarding financial matters (IMF facilities, changes of interest
rates 
on IMF loans, IMF budget, etc). 

3. 85% for Board of Governor and governance structure changes (as changing the numbers
of Executive Directors). In this case, the USA holds veto power.

CRITICS AND CHALLENGES

The IMF gives loans to face economic crises. These loans, however, have controversial
conditionality. Critics say that there is scant evidence of the success of IMF conditionality: studies
show that it mostly hurts economic growth and increases income inequality. This is so both
because the international political pressures generate low levels of compliance with IMF
conditionality and because IMF policies are the wrong ones. Instead of austerity, they should
promote economic stimulus packages so that developing countries can grow their way out of
economic problems. There are nefarious consequences for growth otherwise.

IMF EFFECTS ON BALANCE OF PAYMENTS

When a country has a deficit issue (imports are higher than exports), the IMF gives loans
to supply so that foreign debts and imports can be purchased. However, this comes with IMF
conditionality: cut the demand for imports and foreign financing through devaluation, raising
interest or limiting credit creation and fiscal austerity (raising taxes and spending less). A drastic
contraction of the economy takes place, although these policies succeed on addressing BOP
problems.

IMF CHALLENGES: REFORM

There are two motivations for IMF reform:

1. IMF resources have substantially declined as a share of the global economy, while
anticipated needs have increased. 

2. The voice and vote of many emerging and developing countries underrepresents their
current contribution to the global economy. 



ARGUMENTS FOR REFORM: they are necessary in order to maintain the effectiveness and
legitimacy of IMF as the central institution for international macroeconomic stability and financial
crisis.

ARGUMENTS AGAINST REFORM: the IMF has found other ways to supplement its
resources during the economic crisis, so there is no need to increase funds. Also, emerging
developing countries might be less aligned with US strategies and this is bad.

OUTCOMES OF THE 2010 QUOTA REFORM

§ All 188 member’s quotas will increase as a result of the agreed bolstering of the Fund’s
quota resources to about $659.67 billion from $329.83 billion.
§ Also, four emerging countries (BRICs) will be among the ten largest members of the IMF.
The other top 10 include USA, Japan, France, Germany, Italy and the United Kingdom.
§ The quota shares and voting power of the IMF’s poorest member countries will be
protected.
§ For the first time, the IMF’s Board will consist entirely of elected Executive Directors
(currently, the members with largest five quotas appoint an Executive Director).
§ There will be further scope for appointing a second Alternate Executive Director in multi-
country constituencies with seven or more members to enhance the constituency’s
representation in the Executive Board.
§ Advanced countries have committed to reduce their combined Board representation by
two chairs (European countries will rotate chairs).

The doubling of quotas, together with the shift in quota shares and the move to an all-
elected Board mark a significant step forward in the process of IMF quota and governance
reforms.