1 - The economics of the most favored nation clause

Summary

Article I of the General Agreement on Tariffs and Trade (GATT), now a part of GATT 1994 in the treaty creating the World Trade Organization (WTO), prohibits discrimination among trading partners with respect to tariffs and other border charges as well as certain domestic taxes. This “most favored nation” (MFN) obligation has been called the “cornerstone” obligation of GATT. It is not without important exceptions, however, including those that permit some discrimination in the protection afforded to declining industries under the “escape clause” of Article XIX and, most importantly, the authority in Article XXIV for the creation of preferential trading arrangements known as “customs unions” or “free trade areas.”

The normative economics of discrimination in international commercial policy has been a subject of study for many decades, and is reasonably well understood at least for competitive markets. But little work has been done on the positive economics of trade discrimination generally, or of the MFN obligation and its exceptions within the WTO/GATT system in particular.

At the outset, it is perhaps useful to set forth the distinction between the positive and normative perspectives. The usual normative analysis of international trade rests on conventional welfare economics. An “optimal” policy will thus strive to maximize the sum of producer and consumer surplus, as well as government tariff revenue if not otherwise distributed to consumers or producers.