Richard Baldwin is Professor of International Economics, Graduate Institute, Geneva and University of Oxford, and a member of the Global Agenda Council on Global Trade Systems

The cross-border flows of goods, investment, services, know-how and people associated with international production networks – call it “supply-chain trade” for short – has transformed the world. The World Trade organization (WTO) has not kept pace. It is time to change that. I’ll come to some ideas on how shortly, but first consider the changes:

  • Since the 1990s, globalization has been associated with a sharp drop in the rich nations’ share of world income, world manufacturing and world exports.
  • The big winners are developing nations that industrialized by joining rather than by building supply chains.

This rapid industrialization also pulled up a wide range of developing nation commodity exporters.

The world of trade politics and trade governance also changed. If a high-tech firm is to locate production stages in a developing nation, the nation’s government must ensure the necessary free movement of goods, services, information and the protection of tangible and intangible property rights. Old-fashioned protection, anti-FDI policies, or lax property rights almost guarantee that the offshored stages will go somewhere else.

Developing nations that got the offshored factories became hyper-competitive and wiped out the exports of developing nations that clung to import-substitution industrialization. In the world of supply-chain industrialization, protectionism has become destructionism.

Having learned this lesson, developing nations unilaterally lowered tariffs and eagerly signed up for deep disciplines in regional trade agreements and bilateral investment treaties. It happened regionally, rather than multilaterally, since most supply chains are regional, a tendency that the WTO’s decade-long preoccupation with 20th-century trade issues (tariffs and agriculture) exacerbated.

The latest erosion of WTO centricity comes with the mega-regionals – such as the Trans-Pacific Partnership – that are being negotiated. On the current trajectory, rules for supply chain trade will be entirely outside the WTO’s ambit in a few years.

In my view, the WTO’s structure makes it incapable of hosting the new supply-chain trade rules. The WTO’s DNA is based on enlightened mercantilism whereby nations agree to open their markets if other nations reciprocate. Supply chain trade, however, turns on a much more asymmetric exchange. Advanced-technology firms move their tangible and intangible assets offshore and combine them with low-wage labour in developing nations. The firms get higher returns on their firm-specific assets and the developing nations get fast-track industrialization.

As the nature of cooperation is so different, the international organization that coordinates the necessary supply-chain trade rules must also be different. We will need a WTO 2.0. Membership in WTO 2.0 need not be universal, since supply-chain cooperation is not mostly global – it’s mostly bilateral and regional – even though there can be large gains from having the same rules everywhere. And unlike the WTO where developing nations are allowed laxer rules, WTO 2.0 must treat the offshorer and the offshores equally, as far as disciplines are concerned. Such assurances are the linchpin of cooperation.

 Image: An employee views the Port of Shanghai from an office window REUTERS/Carlos Barria