World Trade Organisation celebrates its 30th anniversary in a downbeat mood
In early 2025, the World Trade Organisation (WTO) celebrated its 30th anniversary. It turned out to be an anniversary in a downbeat mood, as the WTO can no longer properly fulfil its role as a neutral referee due to the blockade of its appellate body for trade disputes. This is part of a general trend reversal away from multilateral, rules-based international cooperation. That trend reversal started even before President Trump's disruptive trade policy, and is significantly intertwined with the strategic rivalry between the US and China. In any case, the current erratic US trade policy based on import tariffs is not apt to reduce the US trade deficit with the rest of the world. Indeed, import tariffs also have an indirect adverse effect on its own export sector. Moreover, the US trade deficit is not so much a problem as a necessary side effect of the dollar's dominant role as a reserve and transaction currency. That role provides the US with significant welfare gains. Current US trade policy threatens to undermine that dominant position of the dollar in the long run.
Post-war era of multilateralism coming to an end
In January 2025, the World Trade Organisation (WTO) celebrated its 30th anniversary. It was established in 1995 as an institutionalisation of the General Agreement on Tariffs and Trade (GATT). That multilateral agreement started in 1947 and was subsequently expanded and updated in several steps in the pursuit of multilateral, rules-based global trade. The GATT was part of the post-war framework of multilateral agreements that included the post-war Bretton Woods system with the US dollar as the core currency and supporting institutions such as the IMF and the World Bank. That multilateralism peaked in 2001 with China's accession to the WTO.
Since the start of his second term, US President Trump imposed import tariffs on just about all US trading partners. Thus, they concern not only China, the EU, the UK and Japan, but also Canada and Mexico. However, the US has a far-reaching free trade agreement (USMCA) with the latter countries, which was concluded by Trump himself in 2020 as a replacement for the NAFTA agreement that came into force in 1994.
The persistent trend of increasing protectionism is most tellingly reflected in the blocking of the WTO. This opposition by the US in particular is not new. It already started under former US President Obama. In practical terms, it happened by obstructing the dispute settlement process within the WTO. Trade disputes between WTO member states can be submitted to so-called arbitration panels. The ruling of such panels can be appealed to the so-called 'Appelate Body', whose ruling is binding on the parties involved. However, since the Obama administration, the US refused to extend the tenure of members of this appellate body on expiry. Presidents Trump and Biden made matters worse by also refusing to allow any new appointments. As a result, since 11 December 2019, the appellate body did not reach its quorum to make valid decisions. Currently, it does not even have a single member left, as its last pending mandate expired on 30 November 2020.
The motivations for the US to continue to paralyse the WTO in this way are more nuanced than just Trump's disruptive agenda. The fundamental motive is that the US has long had a problem in principle with handing over final sovereignty over trade disputes to a multilateral institution. Specifically, the US fears that the WTO, through its jurisdiction in trade disputes, could create precedents and thus new trade rules, which would then also apply to the US.
In terms of content, the US criticism focuses mainly on what it sees as the WTO's overly lax attitude towards state aid and subsidies, and its overly favourable treatment of developing countries. All these US accusations are mainly directed at China. This geopolitical dimension of the US-WTO disagreement suggests that a quick solution to the WTO stalemate may not be in sight.
Institutionalised lawlessness
The consequences of WTO paralysis can hardly be overstated. Indeed, in practice, it removes the enforceability of the multilateral and rules-based trading system. Indeed, parties involved in a trade dispute have the right to appeal first instance rulings under WTO rules. Without a functioning appellate body, appeals therefore take place, as it were, “in the void", which in practice prevents the WTO from enforcing applicable WTO rules in a binding manner. To make matters worse, this state of affairs is even abused in cases where the first instance ruling is not actually legally controversial. Indeed, the losing party at first instance can then appeal even then, knowing that the appeal will not be heard, and thus escape the consequences of the first ruling.
A number of WTO members, including the EU and its member states, try to preserve the functioning of the WTO by promising in bilateral trade agreements not to appeal WTO panel rulings, or to join a parallel arbitration body, the so-called "Multi-Party Interim Appeal" (MPIA) mechanism. However, that MPIA procedure is outside the multilateral framework of the WTO, and moreover, at least two major G7 countries, the US and the UK, are not part of it.
The conclusion therefore remains that the WTO as a multilateral institution is moribund, and may not be able to resume its role in the current geopolitical climate. In this sense, the WTO symbolises the end of the post-war economic era, and the beginning of an era of increasing fragmentation of world trade into separate trading blocs, with, at best, functioning regional trade agreements. The EU-Mercosur Free Trade Agreement of 2024, although yet to be ratified, is one of the rare bright spots in this context.
Inconsistent trade policies
The paralysing by the US of the WTO, and US President Trump's unhinged protectionist policies, are not only dangerous to the idea of free trade and its associated wealth creation. They are also inappropriate to achieve the stated goal of reducing the US trade deficit.
The fundamental reason for the persistent US trade deficit and current account deficit (see Figure 2) is excessive domestic demand relative to (potential) GDP. Indeed, the discrepancy has to be offset by imports from the rest of the world. In other words, the low US national savings rate (of both the private and especially the public sector) is not consistent with a balanced trade account.
Therefore, the most effective economic policy tool to reduce the external deficit would be a reduction of domestic demand. The demand component over which economic policymakers have the most direct influence is fiscal policy. In other words, to the extent that the US trade deficit is considered problematic, reducing the US budget deficit is the obvious priority policy measure.
In addition, political discussions on bilateral trade balances, as the US government is currently doing, make little economic sense. Only the overall balance is of economic interest. After all, the various bilateral balances are interlinked through trade in intermediate goods, among other things, and, in the case of trade barriers, through trade diversion.
Finally, US protectionist measures are not an effective policy tool to reduce the US trade deficit. After all, import restrictions through tariffs not only 'protect' the import-substituting domestic sector, but also indirectly harm its own export sector.
There are two ways to intuitively grasp this. The direct consequence of such an import tariff is that, ceteris paribus, the volume of imports falls and the supply of the domestic currency in international exchange markets decreases. As a result, the nominal exchange rate of the domestic currency will appreciate. This constitutes a drag (an implicit export tariff) on its own export sector. Such appreciation will also come about when the central bank raises interest rates due to rising imported inflation.
A second angle is through the sectoral reallocation of factors of production that an (permanent) import tariff causes. Following the introduction of an import tariff, production in the import-substituting sector will increase. Capital and labour are attracted by that sector. Unless this happens in a period of high unemployment and underutilisation of capital goods, that reallocation comes at the expense of production capacity in the other sector, in this case the export sector. Again, an import tariff has a adverse effect on its own export sector. This phenomenon is known in the literature as ‘Lerner's symmetry'.
Danger to the international dominance of the dollar
A fundamental question is whether the US trade (and current account) deficit is an economic problem for the US at all. After all, on the US balance of payments, by definition, that deficit is also reflected in a financial account surplus. In other words, there are very large net financial flows from the rest of the world to the US. This has everything to do with the dollar's dominant status as an international reserve currency and the size and attractiveness of US financial markets.
It is therefore a plausible hypothesis that this financial account surplus largely causes the current account deficit, and not vice versa. The mechanism that causes this is mainly the dollar exchange rate. As a result of net capital inflows, the dollar exchange rate is stronger than the exchange rate that would lead to a balanced trade and current account.
Based on this plausible hypothesis, the US current account deficit is not only not a problem, but even a necessary condition to provide the rest of the world with sufficient dollar liquidity. The willingness of foreigners to accept and hold dollars in exchange for foreign goods and services represents a significant welfare gain for the US (the 'exorbitant privilege').
It also means that if the US under President Trump's leadership were no longer willing to accept a current account deficit, the dollar's days as an international reserve and transaction currency would be numbered. In the longer term, therefore, President Trump's conflictual trade policy is dangerous for US prosperity. Moreover, it takes place in a geopolitical environment where a number of countries, including the BRICS+ states, are already looking for alternatives to the dollar. The status quo for the dollar will not be preserved just by threatening these states with high import tariffs if they no longer accept the dollar as an international transaction currency, as President Trump did. A status quo requires predictable and reliable policies based is enforceable legal norms and open capital markets. In this respect, the paralysis of the rules-based trade order is a step in the wrong direction.