The World Before the System: Trade Law to 1944

What happened between the wars

The sequence is worth learning as a sequence, because the examiner rewards a candidate who can show cause and effect rather than list dates.

Two lessons were drawn, and both are written into the modern law. First, that protection is contagious: one large country's tariff increase forces others to follow, and everybody ends worse off. Second, that a promise which can be withdrawn at will is not worth much, so tariff concessions have to be bound in a schedule, and departures have to be disciplined.

The connection to the war, which the examiner likes

The economic collapse and the political catastrophe were understood as one story. Cordell Hull, American Secretary of State from 1933 to 1944 and the intellectual father of the Reciprocal Trade Agreements Act, held that unhampered trade made for peace and that high tariffs and unfair economic competition made for war. That belief is why the trading system was planned during the war rather than after it, and why it was planned alongside the monetary system.

Article 7 of the Anglo-American Mutual Aid Agreement of 23 February 1942 is the legal starting point. In exchange for Lend-Lease, the United Kingdom agreed to work towards the elimination of all forms of discriminatory treatment in international commerce and to the reduction of tariffs and other trade barriers. Imperial preference was the target and both sides knew it. Every later negotiation, at Bretton Woods, at Havana and at Geneva, is an argument about how far that undertaking went.

Distinctions to keep straight

A worked example

Follow one country's tariff through the interwar years and the case for the whole post-1944 architecture makes itself.

1929. A manufacturer exports machinery to the United States at an average duty of about forty per cent, high by later standards but stable.

June 1930. The Smoot-Hawley Tariff Act raises United States duties on some twenty thousand items to among the highest in the country's history, in the first year of a depression, on the argument that domestic producers must be protected from foreign competition while demand collapses.

Within two years more than twenty countries retaliate, some by tariff, some by quota, some by exchange control. World trade falls by roughly two thirds in value between 1929 and 1934.

The exporter now faces three barriers rather than one. A higher tariff; a quota that no price will pass; and an exchange control regime that may refuse the foreign currency to pay for the goods at all.

And there is no law to invoke. Trade obligations existed only in bilateral treaties of friendship, commerce and navigation, each with its own most favoured nation clause, its own duration and its own denunciation clause, and there was no institution, no adjudication and no multilateral obligation of any kind.

Every element of the 1944 to 1947 design answers a step in that sequence. Bound tariffs in schedules under Article II answer the unilateral increase. The Article I most favoured nation rule generalises every concession and makes the bilateral web unnecessary. Article XI forbids the quota outright. The International Monetary Fund answers the exchange control by lending reserves so a deficit need not be met by restriction. And Articles XXII and XXIII put a procedure, however weak, in place of retaliation.

That is why the examiner asks about the interwar years in a WTO paper. The rules are unintelligible except as answers to it.

What this does NOT mean

It does not mean there was no international trade law before 1944. There was a great deal of it, in bilateral treaties, and much of the vocabulary the WTO uses was already old: most favoured nation clauses go back to the seventeenth century, and the Cobden-Chevalier Treaty of 1860 between Britain and France set off a network of them across Europe.

It does not mean the interwar collapse was caused by Smoot-Hawley alone. Economists dispute how much of the fall in trade was caused by tariffs and how much by the collapse in demand, in credit and in the gold standard. The honest statement is that trade policy made a monetary and financial disaster considerably worse, and that this is what the founders believed.

And it does not mean the founders wanted free trade. They wanted managed, gradual, reciprocal liberalisation under rules, with escape valves for balance of payments trouble and for injury to domestic industry. Those escape valves are Articles XII, XVIII and XIX of GATT, and they were in the design from the first draft.

Quick revision

• Before 1944: bilateral treaties of friendship, commerce and navigation, no institution, no court, retaliation as the only remedy.
• MFN means equal treatment with the best-treated foreigner, not favourable treatment. Conditional MFN, passing benefits on only against compensation, never converges; the United States abandoned it in 1923.
• 1930 Smoot-Hawley, retaliation, world trade down by about two thirds in value 1929 to 1934, then quotas and exchange controls replace tariffs.
• 1932 Ottawa imperial preference; 1934 Reciprocal Trade Agreements Act starts the American turn to negotiated reduction.
• Article 7 of the Mutual Aid Agreement, 23 February 1942, is the undertaking from which Bretton Woods, Havana and Geneva all descend.
• The two lessons written into the law: protection is contagious, and an unbound promise is worthless.

Test yourself

1. Explain most favoured nation treatment and distinguish its conditional and unconditional forms. Most favoured nation treatment is a promise that the beneficiary will be treated no worse than the best-treated third State, so that any advantage given to one trading partner is extended to the beneficiary as well. The word favoured misleads beginners: the clause does not confer favourable treatment in any absolute sense, it confers equality with the most favoured. Under the unconditional form the advantage passes automatically and for nothing, which is what makes the network converge on a single schedule of rates, since any concession to anyone becomes a concession to everyone. Under the conditional form, used by the United States until 1923, the advantage passes only if the beneficiary offers equivalent compensation, so each pair of States settles at its own rate and no common tariff emerges. Article I of GATT adopts the unconditional form, and its words immediately and unconditionally are the deliberate rejection of the older practice.

2. What did the interwar experience teach the founders of the trading system? Two propositions, both of which are visible in the text of GATT. The first is that protection is contagious: the Smoot-Hawley tariff of 1930 provoked retaliatory increases across Europe and in Canada, the value of world trade fell by roughly two thirds between 1929 and 1934, and no participant gained. The system answers that with binding tariff commitments, most favoured nation treatment and a prohibition on quotas, so that a general escalation cannot lawfully begin. The second is that an obligation which can be withdrawn at will is worth little: interwar commercial treaties could be denounced on notice and had no remedy but retaliation. The system answers that by scheduling concessions as legal commitments, by disciplining the ways out through the balance of payments and safeguard provisions, and eventually by a compulsory dispute procedure.

3. Why is Article 7 of the 1942 Mutual Aid Agreement significant in the history of the trading system? It is the point at which the reduction of trade barriers became a war aim rather than a policy preference. In exchange for Lend-Lease assistance, the United Kingdom undertook to work with the United States towards the elimination of all forms of discriminatory treatment in international commerce and the reduction of tariffs and other trade barriers. The immediate target was imperial preference, agreed at Ottawa in 1932, and both governments understood that. The significance is that everything which followed, the monetary conference at Bretton Woods in 1944, the charter negotiations that ended at Havana in 1948, and the tariff negotiation that produced GATT at Geneva in 1947, was carried out in performance of that undertaking, which is why the trading, monetary and development institutions were designed as one project.