CHAPTER II

GATT/WTO AND THE PRINCIPLE OF

NON-DISCRIMINATION IN INTERNATIONAL TRADE
2.1 INTRODUCTION

International trade has been regarded as an engine of growth and prosperity by many
economists. First among them was Adam Smith who viewed it as a vent or outlet for the
surplus domestic production of a country which could be sold in foreign markets in
exchange for commodities that were demanded in the home country (Kurz 1992: 4 76).
This was essential for the productive employment of superfluous resources and was a
source of the wealth of nations. However an essential pre-requisite for such a way of
enhancing the wealth of nations is the free flow of goods and services from one country
to another. This is the chief objective of the non-discrimination principle of international
trade constituted by the MFN and national treatment rules. These two concepts have been
embedded in the free trade doctrine from the very early days and form the bedrock of the
GA TT/WTO multilateral trading system in the contemporary world.

This chapter looks at the historical evolution and the theoretical roots of non-
discrimination in international trade with a view to gaining a better understanding of its
importance in the present times. This is also essential to assess the implications of the
dilution of this principle for the multilateral trading system and the world economy as a
whole. The next section begins by placing non-discrimination in the broader realm of
economic theory as well as theory of international relations. It also looks at the
theoretical aspects of international political economy (IPE) in the study of international
relations which provides support and strength to the idea of non-discrimination in
international economic relations. The third section describes the genesis of the most-
favoured-nation and the national treatment clauses and traces their journey from their
early uses to their place in international trade today. It begins with the inception of the
idea of free trade and then moves on to the emergence of the MFN and NT clauses in
international economic relations. This section also attempts to revisit and explore the
conditions prevailing during the first half of the twentieth century when GATT was
signed between 44 countries. so as to understand the rationale behind the incorporation of
the non-discrimination principle in the GA TT/WTO system and to bring out the factors
which resulted in a general shift from a policy of high-tariff barriers and protectionism to

16
 that of non-discrimination and trade liberalization. The fourth section looks at the
operation of the MFN and NT clauses during the GATT regime. It looks at the manner in
which the non-discrimination principle was institutionalized in the multilateral trading
system and how and why exceptions to this principle were gradually brought into
operation and formalized over the years. The fifth and the final section concludes this
chapter.

2.2 THEORETICAL ROOTS OF THE NON-DISCRIMINATION PRINCIPLE IN

ECONOMICS AND INTERNATIONAL RELATIONS

Discrimination is a well-defined concept in classical trade theory. Adam Smith's concept

of absolute advantage and David Ricardo's comparative advantage theory were based on
the idea that the removal of discrimination in international trade will tend to benefit all
parties concerned. Their trade theories formulated a strong case for free trade and
reduction of trade barriers which have stood the test of time and are compelling even
today despite the counter views which have emerged in the context of opposition to
globalization and the deadlock in the Doha Round (Irwin, 1996: 3). Smith gave the theory
of absolute advantage in his seminal work titled An EnquiJT into the Nature and Causes
<~f the Wealth of Nations ( 1776) which, despite its shortcomings. was not only the first
step in the evolution of a theory of international trade but also laid the foundations of the
economic doctrine of free enterprise. 1 Four decades later, Ricardo in his Principles of
Political Economy and Taxation ( 1817) further strengthened the case for free trade by
demonstrating that trade among nations was beneficial even when a country did not have
an absolute advantage in the production of any commodity. The essence of these theories
was that international trade leads to greater welfare and prosperity, thus there should not
be any barriers to the exchange of goods between countries. Numerous improvisations
have been made to the theories developed by Smith and Ricardo but their ideas continue
to be relevant even today and provide the foundation for the generation of more complex
models of international trade and liberalization.

1
Adam Smith was an advocate of laisse=:faire or minimum government interterence in economic acti,·ity
and maintained that the economy if lcll to the ti·ec play of the market fc1rces of demand and supply will
tend to regulate itself. He suggested that all economic activity should be left to private enterprise which
should be kept free from state regulation. The activities of the state should be limited to providing its
citizens security from any kind of external threat and maintaining law and order internally.

17
 Adam Smith gave immense importance to division of labour and specialization
and the principle which gave occasion to this division of labour was the human
"'propensity to truck, barter and exchange one good for another (Smith 1776: 22)."
According to him, states that can produce a particular good or service at a lower cost than
other states have an absolute advantage in the production of that good or service. [Hence
they will benefit by specializing in the production of these goods and importing the goods
in which they have an absolute disadvantage, i.e., where domestic production is more
expensive than the cost of importing the good.] As all countries are differently endowed
with natural resources so each of them should specialize in the production of the good in
which they have an absolute advantage over others and should exchange the surplus
quantities of that good with goods from another country. This will ensure an efficient
utilization of resources along with a steady increase in the output of states due to
specialization and division of labour.

Smith emphasized the importance of free trade in increasing the wealth of all
trading nations. In fact one of the most important objectives of Smith's Wealth of Nations
was to demonstrate the fallacy of mercantilism, the economic thought that prevailed from
the sixteenth to the middle of the eighteenth century, which propagated the regulation of
international trade by the state. Thus it was considered desirable for a country to export
more than it imported from other countries so as to increase its stock of precious metals.
Exports were promoted by removing all kinds of taxes or custom duties on them while
higher tariffs were imposed on imported goods. As opposed to this, Smith advocated a
policy of laissez:faire or minimum government interference in economic activity and
maintained that free trade will enable the most efficient utilization of the world's
resources and will maximize the welfare and wealth of all nations (Salvatore, 2006: 33-
34). According to him, regulations that put restraints on the import of goods from foreign
countries aim at securing the monopoly of the domestic industries in the production of
such goods. But such restraints in almost all cases are either useless or hurtful because ··if
the produce of domestic can be brought there as cheap as foreign industry, the regulation
is evidently useless. If it cannot, it must generally be hurtful" (Smith 1776: 573). Free

18
 trade was also considered desirable for expanding the size of the market for goods and
services and thereby allowing greater division of labour and specialization. This in turn
leads to increase in productivity and thus promotes overall growth and development.

Four decades after the publication of Wealth of Nations Robert Torrens. David
Ricardo and J. S. Mill demonstrated that trade among nations can be beneficial even
when one country has an absolute advantage in the production of all goods and another
country does not have an absolute advantage in the production of any good. This is
possible due to the existence of the law of comparative advantage - a far weaker
condition than absolute advantage. Torrens was the first to anticipate this law when in An
Essay on the External Corn Trade ( 1815) he suggested that England \vould find it
advantageous to specialize in and export manufactures in exchange for corn even though
it had an absolute advantage. However, Ricardo is credited with articulating the principle
in clear and concise terms in his Principles of Political Economy and Taxation ( 1817).
According to this principle each country should specialize in the production of that
commodity in which it has a comparative advantage over other countries (Gomes. 2003:
40-41).

Ricardo expressed the desirability of this principle with a compelling numerical

example based on a model of two countries and two commodities in which England and
Portugal produce wine and cloth respectively using labour as the sole input of production.
Thus in both the countries the costs (and prices and exchange ratios) of both the
commodities are determined by their relative labour content. If England requires the
labour of 100 men for making wine and 120 men for making cloth in an year while
Portugal only requires the labour of 80 and 90 men annually for making wine and cloth
respectively, then it is quite evident that Portugal is more efficient in the production of
both wine as well as cloth as compared to England. However, Ricardo argued that it
would still be profitable for Portugal to specialize in the production of wine as it is
relatively more efficient in the production of wine as compared to cloth. In his words,
"Though she (Portugal) could make the cloth with the labour of 90 men, she would
import it from a country where it required the labour of 100 men to produce it, because it

19
would be advantageous to her rather to employ her capital in the production of wine, for
which she would obtain more cloth from England, than she could produce by diverting a
portion of her capital from the cultivation of wines to the manufacture of cloth'' (Ricardo
1817: 141 ). England on the other hand. should specialize in the production of cloth as it is
relatively less inefficient in the production of cloth and exchange it for wine produced in
Portugal. In this way both Portugal and England will end up better off and the gains from
trade will be maximised for both the countries (Ricardo 1817: 140-141 and Patrick
O'Brian 2004: 208-218).

Thus, the theory of comparative advantage demonstrated that mutually beneficial

trade is possible even when only comparative advantage exists, which is a much weaker
condition than absolute advantage. It established absolute advantage as only a special
case of the general principle of comparative advantage. This was a significant
improvement over the principle of absolute advantage as it recognized that foreign trade
is beneficial for all countries, whether or not they had an absolute advantage in the
production of any commodity, and thus carried the case tor foreign trade further
(Chacholiades 1990: 15-16).

Both these theories stemmed tl·om the idea that the removal of discrimination in
the conduct of international trade will be beneficial for everyone. Adam Smith talked
about the disadvantages of discrimination in trade in these words ( 1776, 688-89):

"When a nation binds itself by treaty either to permit the entry of certain
goods from one foreign country which it prohibits from all others. or to
exempt the goods of one country from duties to which it subjects those of
all others, the country, or at least the merchants and manufacturers and
merchants of the country, whose commerce is so favoured, must
necessarily derive great advantage from the treaty... Such treaties,
however, though they may be advantageous to the merchants and
manufacturers of the favoured, are necessarily disadvantageous to those of
the favouring country. A monopoly is thus granted against them to a
foreign nation; and they must frequently buy the foreign goods they have
occasion for, dearer than if the free competition of other nations was
admitted."

20
 Although Smith did not develop this argument fully, yet he recognized the drawbacks of
adopting a discriminatory trade policy. Thus he recommended non-intervention in
economic activity in all spheres - domestic as well as international. If the state did not
attempt to regulate the trade of goods among nations then it will not discriminate among
the imports of different countries and will prefer to buy the cheapest imports. This means
that the country which is most efficient and competitive in producing goods will be able
to sell its products while other countries will have to strive to increase their efficiency
and competitiveness.

However, Smith identified two exceptional situations in which some restrictions

on foreign trade could be advantageous. First, for the protection of a domestic industry
which was necessary for the defense of a country, like shipping, and secondly when there
was a tax on domestic products an equivalent tax could be imposed on like products
imported from foreign countries to offset the impact of the tax. Apart from these two
situations he also described two other cases in which restrictions on foreign trade could
be a "matter of deliberation" as to "how tar it is proper to continue the free importation of
foreign goods" (Smith 1776: 586). One was to retaliate against restrictions on foreign
trade imposed by other countries and secondly while restoring free trade after it has been
interrupted for some time freedom of trade should be restored .. by slow graduation and
with a good deal of reserve and circumspection" (Smith 1776: 589). But these were
clearly referred to as exceptional cases and were considered to be unfavourable to foreign
trade and for the improvement of the overall welfare of the masses. Nevertheless, it can
be said that the exceptions to the non-discrimination principle have a lineage which is as
old as the principle itself and that non-discrimination in trade was never envisaged as an
absolute concept.

David Ricardo also considered the policy of "leaving unrestricted the importation
of foreign corn, particularly in a country burthened with a heavy fixed money taxation"
(Ricardo 1817: x). He argued that such importation can be beneficial for a country only if
the "imported corn ... (is) so much cheaper than the corn that can be grown at home, as to
equal both the profits and the rent of the grain which it displaces. If it were not, no

~ ~ 0 1ll
21
 advant~ge to anyone could be obtained by importing it." 2 Again this indirectly implies
that corn should be imported from a country which is the most efficient in growing corn
and that there should be no discrimination in terms of a differential tariff policy for the
importation of corn. It also meant that no taxes should be imposed on the import of corn
as they would have the effect of increasing the price of corn. Ricardo was against
protective tariffs and believed that the British Corn Laws 3 should be abolished as they
ensured that less productive domestic land would be harvested and rents would be driven
up which would keep the food prices artificially high and thus be a burden for the
agricultural economy.

Smith and Ricardo have been primarily concerned with the normative economics4
of trade discrimination as they dealt primarily with the desirability or undesirability of
trade discrimination for maximizing the welfare of the economy. Their ideas are based on
the premise that government intervention in international trade creates economic
inefficiencies which result in reducing the welfare of the economy. Alan Sykes, along
with other economists, has done extensive work on the positive economics of trade
discrimination. He draws substantially from the public choice theor/ as he contends that
the political economy of trade policy recognizes that different interest groups have
different degrees of influence on political actors. Sykes and Schwartz ( 1996: 28) tried to
link normative trade theory with positive theory when they contended that if national
governments actually pursued policies to maximize national economic welfare, or nations
acting cooperatively pursued policies to maximize joint economic welfare, then such
normative analysis would also provide the basis tor positive theory. However, they

2
Ricardo makes this comment while criticizing the views of Malthus on rent. According to Ricardo. it
makes sense to import corn only when it is so cheap so as to cover the rent as well as the profits accruing
to corn. if it was grown domestically.
3
The Corn Laws were import tariffs designed to protect corn prices in the United Kingdom against
competition Jl·om less expensive foreign imports between 1815 and 1846. They were considered to be the
harbingers of trade protectionism in Europe (Schonhardt-Bailey 2006: 9).
4
Normative economics incorporates value judgements about \\hat the economy ought to be like or \vhat
particular policy actions ought to be recommended to achieve a desired goal. The usual normati\·e
analysis of international trade rests on com·entional wdt~trc economics. An "optimal'" policy will thus
strive to maximize the sum of producer and consumer surplus, as \veil as government tariff revenue if not
otherwise distributed to producers and consumers (Sykes and Schwartz. 1996: 2S).
5
Public choice theory is a branch of economics that developed tl·om the study of taxation and public
spending. It makes use of modern economic tools to analyse people's actions in collccti\·e decision
making and study problems that traditionally !~111 in the realm of political science (Shaw: 2002).

22
 realized that, this certainly was not true as it would have resulted in a unilateral abolition
of many, if not most, of the tariffs and other trade restrictions which typically lower the
sum of producer surplus, consumer surplus and government revenue in the importing
nation. Thus they concluded that since trade policy in practice cannot be explained as an
effort by governments to maximize welfare hence a successful positive theor/' of
discrimination must diverge considerably from conventional nonnative theory.

While attempting to develop a positive theory of trade discrimination economists

have devoted attention to determining the effects of discrimination on global and national
welfare. Their findings point out that the economic effects of discrimination on global
welfare can be mixed. On the one hand, discriminatory tariffs may enable the relatively
high cost producers in countries that benefit from lower tariffs to out compete lower cost
producers in countries subject to higher tariffs. This will lead to diversion of trade from
foreign producers which are most efficient in producing a good to relatively inefficient
domestic producers or producers from the countries subjected to lower tariffs. In this
situation, the generally applicable MFN requirement protects the expectations of
participants in multilateral bargaining by forbidding subsequent more favourable
treatment of other participants and avoids the 'deadweight loss' 7 resulting from trade
diversion.

However, this happens at the cost of preventing nations from discriminating when
it might be valuable to benefit certain politically powerful producer interest groups and at
the cost of substantial incentives for participants in multilateral negotiations to attempt to
free ride. Moreover, it is also possible that a reduction oftariffs on a discriminatory basis
will improve welfare relative to the maintenance of high non-discriminatory tariffs. This
will happen when any tariff reduction. discriminatory or otherwise. allows lower cost
foreign firms to displace higher cost domestic producers. thereby saving resources in
production and lowering the prices for consumers. This has also been termed as 'trade
creation'. Thus from a global welfare perspective. discriminatory arrangements are not

6
Positive theory in economies is primarily concerned \\'ith facts and cause-and-effect relationships and
includes the development and testing of economic theories. It is said to be fi·ee fi·om value judgments.
7
It refers to the net loss in economic wei fare resulting due to tariffs or other trade distortions.

23
 ideal and trade barriers of any sort are clearly incompatible with global welfare
maximization. However, they can serve as the second best option as compared to a
protectionist world without discrimination (Sykes, 1998: 77 -78).

Kamal Saggi (2004: 341-343) demonstrates that MFN adoption by each country
improves world welfare by eliminating trade diversion. He develops an economic model
which shows that welfare gains from MFN adoption can arise even when countries can
not (or do not) negotiate over tariff levels because the constraints implied by MFN lower
the inefficiency associated with the use of "beggar-thy-neighbour' 8 discriminatory tariffs.
This model also shows that MFN adoption by member countries (which was a
requirement for GATT membership) may have yielded welfare gains during early years
of the GATT despite the fact that tariffs of member countries were otherwise unrestricted
during these years.

In another article, Saggi along with Faruk Sengul and Halis Muray Yildiz (2007:
545-559) argues that multilateral cooperation is easier to sustain when defections are
punished by MFN tariffs relative to discriminatory ones since a deviation by the country
that is least willing to cooperate is penalized relatively more under MFN. They contend
that MFN makes a positive contribution as far as the sustainability of multilateral free
trade is concerned and that the incentives for multilateral cooperation are strongest under
the regime where the degree of non-discrimination practised is the most stringent.

In a more recent work, Saggi and Sengul (2009) gather useful insights regarding
the role of GA TT/WTO system by analyzing it as a club whose only requirement for
membership is that its members grant MFN to each other. They tind that the core WTO
rules such as MFN are valuable even if multilateral negotiations deliver limited trade
liberalization - this is because by requiring member countries to abide by several key
rules like MFN and NT, the WTO has an important effect on the policy environment

8
It refers to the policy by which a country seeks to increase its wei fare at the cost of its neighbours. The
commercial policies of the 1930s were characterized as ·beggar-thy-neighbour' policies as e\·ery country
tried to insulate its economy from the economic downturn by raising high tariffs which prevented the
import of goods from other countries (Irwin. Mavroidis and Sykes 2008: 6).

24
 under which international trade occurs. Even though an MFN club does not alter average
tariff levels, across countries, it increases aggregate world welfare, makes non-members
worse off and may even immiserize its high cost members. Thus, the emergence of such
an MFN club is in favour of aggregate world welfare and the larger the club, the more
desirable it is from the welfare perspective.

Bagwell and Staiger (200 I: 3 19-320) raise a very basic question - ''What can
governments hope to accomplish with trade agreements?" The authors argue that the
appeal of a trade agreement rests on the elimination of the inefficiency associated with
9
the terms-of-trade external ity that arises when governments set their policies
unilaterally. This externality induces governments to restrict trade. However Bagwell and
Staiger find that the representation of reciprocity as found in the WTO can enable
governments to expand trade and achieve an efficient outcome. They establish a link
between the principle of reciprocity and non-discrimination as they contend that a
multilateral system built on the principle of reciprocity can implement an efficient
agreement only if it also embraces the principle of non-discrimination.

However, despite the above discussed points which build a favourable case tor
non-discrimination in multilateral trade liberalization scholars and experts have also
devoted attention towards the problems and concerns which arise from the adoption of
the MFN clause. The most notable and long standing concern is the free rider problem. In
a multilateral trade agreement governed by the MFN rule, any concession negotiated with
a single trading partner or group of trading partners must be extended to all other trading
partners without any condition, even if the latter do not reciprocate. This opens the
possibility of countries "free riding" on the trade negotiations of other countries to the
extent that non-reciprocating countries benefit from improved market access to the
liberalizing countries. One view is that the free rider problem is in fact a source of
advantage for the developing countries as they can free ride on bilateral trade concessions

9
An externality is a cost or benefit arising fi·om any activity which does not accrue to the person or
organization carrying on the activity. For example damage to other people or the cnYironmcnt caused due
to a manufacturing plant located in the vicinity. These damages are not necessarily paid for by the
owners of the manufacturing plant. Terms of trade externality refers to the desire to manipulate
international prices in favour of the domestic economy by decreasing the relative price of imports.

25
 exchanged between the larger countries (Ghosh et al. 1998). This will also help them to
avoid bilateral trade bargaining with larger countries where they would be at a clear
disadvantage with their smaller markets and high production costs. However. free riding
is generally seen as being disadvantageous for multilateral trade liberalization. Ludema
and Mayda (2009: 13 7) identify two problems which emerge from free riding: tirst.
countries may avoid participating in negotiations in the hope of free riding on the
liberalization commitments made by other countries; and secondly. countries which do
enter into negotiations may reach inefficient agreements, as they do not fully internalize
the benefits oftheir liberalization.

If this free rider problem becomes acute, then a few options are available for
countries to change the structure of negotiations and to mitigate the chances of free riding
by countries (Sykes and Schwartz 1996: 39-40). One option is for the nations that might
be tempted to free ride on others to caucus and work out a collective offer for a desired
concession. But this procedure is obviously imperfect as each nation wi II still have an
incentive to understate its willingness to pay in formulating the collective otTer. Another
possibility is for countries to abandon product-by-product negotiations for concession and
instead agree that every nation will undertake tariff cuts in accordance with a mutually
agreed formula. For example, countries might agree to cut all tariffs by 50 per cent
subject to an exception Jist. Such a procedure has in fact been followed in several GATT
negotiating rounds. But, the difficulty in this case is that. across-the-board cuts fai I to
exploit the joint political gains from a more subtle and tailored set of concessions.
Moreover, once countries deviate from the formula with their exception lists, the free
rider problem re-emerges.

Ludema and Mayda (2009: 149) suggest a two dimensional approach for solving
the MFN free rider problem -first is to provide greater inducements for participation and
secondly, to isolate the free riders from the benefits of liberalization. They argue that the
principal supplier rule, 10 reciprocity, the use of formula negotiations and single

10
The principal supplier rule is a key aspect of the product-by-product request and offer method that has
been GATT's most common form of negotiation O\'Cr the years, It basically mandates that a country·s

26
 undertaking can all be seen as attempts for combating the free rider problems along one
or both these dimensions. However, they do not eliminate the problem completely and
more study is required to determine what effects these approaches will have and to
suggest preferable alternatives.

Another important criticism of the MFN clause is based on the fact that it is said
to generate asymmetric losses and benefits for adopting and recipient countries. Studies
have been conducted in this regard, to ascertain the effects of non-discrimination from the
perspective of underdeveloped and low income countries. They indicate that as there
exist myriad differences across countries, it is quite unlikely that a non-discrimination
requirement such as MFN affects all countries in a similar fashion (even if it increases
aggregate welfare).

Saggi and Sengul (2009: 268-269) contend that the desirability of membership to
an MFN club from a country's perspective depends upon how its production costs relate
to others. In general MFN is said to be of greater value for countries that have relatively
lower costs of production. Developing countries, which usually have high production
costs, have been granted S&D treatment ever since the Generalized System of
Preferences came into existence in the 1970s. These provisions allow developing
countries to receive better than MFN treatment from industrialized nations and are
considered to be necessary to undo some of the adverse distributional effects created by
the formation of an MFN club. An intriguing result of the model developed by Saggi and
Sengul (2009: 269-270) is that a high cost country can voluntarily end up joining an
MFN club even though its welfare as a member is lower than that under tariff
discrimination. This is because as per their analysis the fate of a high cost country as a
non-member can be even worse than that as a member and so those who do not join the
club are necessarily worse off relative to the status quo.

tariff on each product be negotiated with the exporters having a "principal supplying interest" in the
country's market for that product. Normally this is taken to mean the largest exporter, or group of
exporters, as measured by market share (Ludema and Mayda 2009: 138).

27
 It has also been contended that from the viewpoint of low income countries, MFN
and multilateral tariff cooperation are complementary in nature. Without tariff
cooperation MFN can have an adverse effect on low income countries and can make the
relatively small exporters worse off as their productions costs are relatively higher than
the large exporting countries with lower productions costs. However, if repeated
interaction enables countries to cooperate multilaterally then MFN benefits all countries
by facilitating the obtainment of free trade. For high income countries, MFN is beneficial
even if the scope for multilateral tariff cooperation is limited or missing altogether. But
despite its adverse distributional impact MFN has been said to yield higher aggregate
world welfare than tariff discrimination as it eliminates the global inefficiency caused by
the international price differentials that prevail under tariff discrimination. It constrains
the pursuit of "beggar-thy-neighbour" trade policies by individual countries and reduces
the magnitude of deadweight losses imposed by an individual country's optimal
discriminatory tariff (Saggi, 2009: 132-13 7).

Horn and Mavroidis (200 I: 268-270) conduct a survey of economic theory to

shed light on the widespread belief among policymakers that there are strong economic
rationales for the MFN provision. Their survey reveals that even though the positive view
of MFN generally seems to be based on the presumption that discrimination is inherently
undesirable from an economic point of view, the available literature on this subject does
not provide any clear cut answers due to the complexity of issues involved. However.
they do identify a few broad themes which emerge from this literature:

I. The rationale for the imposition of tariffs determines if a world welfare

maximizing tariff structure is non-discriminatory or not.
2. The problems which arise due to the unilateral imposition of discriminatory
tariffs by a country depend upon the manner of discrimination adopted by the
country.
3. The MFN clause is relevant even in situations where negotiations would not
result in discriminatory tariffs as it can affect 'out of equilibrium' events which
are not always apparent.

28
 4. Bilateral negotiations conducted under MFN do not take into consideration
· further restrictions that are associated with externalities, as the outcome of such
negotiations affects parties not present in the negotiations.
5. MFN might work in conjunction with reciprocity so as to render stability to
multilateral trade agreements in the GA TT/WTO system. It may also promote
multilateral trade liberalization by making bilateral liberalization unattractive.
6. MFN may promote multilateral trade liberalization by countering political
interests that would otherwise steer the political outcome towards the formation
ofPTAs.
7. MFN is likely to have distributional impacts and could also result in equalizing
the outcome in negotiations and benefiting smaller countries.

However, if forced to make an overall assessment of the virtues of MFN on the basis of
their findings, Horn and Mavroidis concede that the theoretical literature does tend to
support the clause. But at the same time they identify some critical gaps in the existing
literature on MFN and non-discrimination which should be studied and examined by
scholars, like, the strategic impact of MFN on bargaining between countries, the interplay
between MFN and informal bargaining procedures, the implications of the MFN clause
for administered protection etc.

Saggi (2004) develops a simple model which compares a world with MFN to one
without and asks whether MFN has value even when countries do not negotiate over
tariff levels. The analysis clarifies the role MFN plays within multilateral trade
agreements like GATT. The overall results deliver strong support for MFN from the view
point of global welfare. In particular it is shown that in a non-cooperative situation,
countries end up pursuing beggar-thy-neighbour policies under which discriminatory
tariffs divert trade from efficient producers to the inefficient ones. MFN improves upon
this outcome by reducing the inefficiency associated with the use of such discriminatory
tariffs.

29
 The non-discrimination principle is also strengthened and supported by the liberal
theory of international relations which is often termed as the "historic alternative'' to the
dominant theory in international relations - realism (Baylis, Smith et al. 2008: 11 0). As
opposed to realism, which gives more importance to power, national interest and security
issues, liberalism lays emphasis on liberty, cooperation among nations and a free market
economy as the best way of ensuring peace and stability in the international system. Early
liberal thinkers such as Immanuel Kant and Jeremy Bentham expressed their belief in a
natural harmony of interests between nations in their political and economic relations
with each other. The British statesman Richard Cobden ( 1804-1865) who played an
instrumental role in the conclusion of the Cobden-Chevalier Treaty (1860) between
England and France was of the opinion that free trade and market driven exchange of
goods and commodities between nations will instil friendly relations between them and
thus result in the maintenance of peace and prosperity in the international system. In the
twentieth century, the US President Woodrow Wilson and thinkers like Leonard Wolf
recognized that at times peace and prosperity required a consciously devised order which
could be maintained by an international organization or a general association of nations
where all states combined their etTorts and resources for the fulfilment of common goals
(Baylis, Smith et al. 2008: 113-115).

After the end of the Second World War and with the increasing pace of
globalization and modernization, liberals observed that the world was increasingly
becoming interdependent and integrated. A plethora of new actors, apart from the nation-
state, were emerging in the world arena such as transnational corporations, inter-
governmental organizations and non-governmental organizations making the
international system a complex web with multiple channels of interaction and
communication. This made scholars like David Mitrany, Ernst Haas. Robert Keohane and
Joseph Nye apprehend the importance of transnational cooperation and greater economic
integration which could be managed and maintained in a better fashion through the
creation and maintenance of international institutions. 11 regimes 1~ and norms 13 (Baylis.

11
Robert Keohane ( 1988: 383-384) defines institutions as "a general pattern or categorizatinn of actiYity or
a particular human-constructed arrangement. i'ormally or int(mllally organized." lle i'urther elaborates

30
 Smith et al. 2008: 113-115).

One of the most important liberal norms which has been recognized by scholars
and policymakers as being instrumental in promoting cooperation among states is that of
reciprocity which in simple words means "do unto others as they do to you". In the
economic arena reciprocity was operationalized in the form of the non-discrimination
principle which was considered as essential for ending the race to build protectionist
tariff walls after the end of the Second World War. The most-favoured-nation and
national treatment rules were expected to induce the reduction and eventual abolition of
barriers to the free exchange of goods and commodities between nations and to dissuade
the use of high tariffs by countries for safeguarding their domestic markets and industries.
They were aimed at fostering economic cooperation among nations and enhancing their
overall welfare through the growth of trade and commerce 111 the world economy as a
whole.

Another important theoretical perspective to the study of international relations is

that of international political economy which arose out of the institutional arrangement
and economic architecture of the world economy in the post world war era. It analyses
the realm of international relations through the prism of political economy and is
primarily concerned with "the reciprocal and dynamic interaction in international
relations of the pursuit of wealth and the pursuit of power" (Gilpin 1975: 43 cited by
Keohane 1984: 18). The late 1960s and early 1970s witnessed a series of developments
which highlighted the interdependence of economic forces and political outcomes, such
as the economic revival of European countries and Japan, increasing inflation in the
United States, breakdown ofthe Bretton Woods system in 1971 and the oil crisis of 1973.

that ·'in international relations some of these institutions are t(xmal organizations. with prescribed
hierarchies and the capacity for purposive action ... while others. such as the international regimes for
money and trade. arc complexes of rules and organizations, the core clements of which have been
negotiated and explicitly agreed upon by states."
12
Stephen Krasner ( 1983: 2) defines regimes as "sets of implicit or explicit norms, principles, rules. and
decision-making procedures around which actors· expectations converge in a given area of international
relations."'
1.1 According to Martha Finnemorc and Kathryn Sikkink. a norm is detincd as "a standard of appropriate
beha\·iour for actors with a given identity" ( 1998: 891 ).

31
These events were followed by a series of articles and books by international relations'
scholars on interdependence and transnational relations emphasizing the need to look
beyond the state-centric political and security concerns. The writings of Richard Cooper,
Raymond Vernon, Robert Gilpin, Joseph Nye, Robert Keohane, Susan Strange and
Stephen Krasner highlighted the implications of economic interdependence for
international relations among countries and made it clear that a lot of ''interesting activity
had escaped the attention of analysts imprisoned in the 'state-centric' paradigm"
(Katzenstein, Keohane and Krasner 1998: 655-656). 14 This resulted in the development
of IPE as an independent subject of study which was primarily concerned with the
interaction of the market and the state and which recognized that "whether one
emphasized the role of the markets or of states ... neither phenomenon could be
adequately analyzed without accounting for the other" (Katzenstein, Keohane and
Krasner 1998: 657).

Scholars have analyzed international political economy from three major

theoretical perspectives - the liberal perspective, the realist perspective (also known as
the mercantilist or economic nationalist perspective) and the socialist perspective. The
liberal perspective finds its origin in the ideas of Adam Smith which propagate free play
of the market forces of demand and supply and removing all restrictions on the exchange
of goods and services among countries. It is contended that this will remove all economic
distortions and will ensure the most profitable and efficient use of resources. Countries
will benefit from their natural comparative advantage as they are guided by the "invisible
hand" of demand and supply in the allocation and distribution of goods and services in
the world economy (Baylis, Smith et al. 2008: 248-249). The realist or economic
nationalist perspective is derived from the mercantilist doctrine which propagates the
regulation of markets by the state so as to protect national interest and increase national
wealth. According to this perspective raising protectionist trade barriers is considered to
14
Prominent among the works published in this league arc- The Economics 1J( fnterdependence ( 1968} by
Richard Cooper. Sovereignty at Bay: The Multinational Spread of CiS Enterprises ( 1971) by Raymond
Vernon, US Power and the .'vfultinational Cotporation· The Political Economy of Foreign Direct
Investment ( 1975) by Robert Gilpin. Power and Interdependence ( 1977) by Robert Keohane and Joseph
Nyc, ''State Power and the Structure of International Trade'' in World Politics ( 1976} by Stephen D.
Krasner and "The Management of Surplus Capacity: Or !-low Docs Theory Stand Up to Protectionism
1970s Style?" in International Organi::ation ( 1979) and States and Markets ( 1988) by Susan Strange.

32
be an effective method of increasing national wealth as it will reduce imports and
encourage exports thereby increasing the foreign exchange reserves of a country. The
state is considered to be more important and powerful as compared to the market since
market relations are believed to be shaped by political power and thus the state is
expected to exert regulatory control over the market. The socialist or Marxist perspective
also gives ascendancy to the state over markets, however it lays greater emphasis on class
and the interest of the workers as compared to state interests. It has been termed as the
"collectivist approach of the economic nationalist perspective" as it rejects the
individualism of the liberal theory and considers class to be the main actor in the global
political economy. Marxist IPE scholars like Robert Cox and Stephen Gill have
highlighted the role of social forces and ideas in liberalizing the world economy (Robert
O'Brian and Marc Williams 2004: 14-23).

The principle of non-discrimination also occupies an important place in the

framework of IPE as it has implications for the interaction between the state and the
market. The acceptance of this principle in international trade implies limits on the power
of the state as it is obliged to give up its sovereign right to discriminate against foreign
countries in economic affairs. With regard to the market, MFN is instrumental 111

minimising the distortions or imperfections in the free play of the market forces of
demand and supply in the international economy. Thus it gives ascendancy to the free
operation of market forces over the power of the state to discriminate against other
nations in the conduct of its economic affairs.

The above discussion demonstrates that the liberal theory of international

relations recognizes that free trade or lowering of barriers to trade among nations and
allowing the free operation of the market economy will improve net welfare and is a
positive step towards maintaining peace and prosperity in the international system
(Moravcsik I992: 21 ). Though this view has been contested and criticized by other
streams of theory both in international relations as well as economics, the tlow of goods
and services between nations has continued unabated for centuries. In recent times this
flow has been based, to a very large extent, on the non-discrimination principle of GATT

33
 and WTO as contained in the most-favoured-nation and national treatment provisions.
and has resulted in a tremendous growth in international trade. 15 It is plausible to view the
equal treatment provided by GA TT/WTO Members to each other irrespective of their
size or place in the international system as an element of change in the existing dynamics
of international relations among countries in the contemporary world. Newly independent
and developing countries with modest resources and lower levels of development have
stmied assetiing themselves before the stronger and economically developed countries for
not just equal treatment, but also special and differential treatment, in exceptional
circumstances. for integrating them into the world economy. Such differential treatment
despite being contrary to the non-discrimination principle is considered to be essential for
bringing about true equality between the developed and the less developed countries and
for bridging the gap between the level of economic development between the developing
and the developed countries.

The possibility of the use of non-discrimination in other realms of international

relations such as human rights or security and disarmament has not yet received much
attention from scholars, but an extension of the MFN and NT rules to these issue areas
cannot be completely ruled out in view of the growing influence and importance of the
WTO in the international system. Such a spill over of non-discriminatory behaviour will
result in changing the entire structure of the international system and will redefine the
manner in which the field of international relations is studied and practised. Hence it is
relevant for scholars of international relations to analyse this principle and understand its
evolution and incorporation in the realm of international economic relations.

2.3 HISTORICAL EVOLUTION OF NON-DISCRIMINATION IN

INTERNATIONAL ECONOMIC RELATIONS

2.3.1 INTERNATIONAL TRADE IN THE GRAECO-ROMAN TRADITION

As sea routes were discovered connecting various landmasses the possibility of

exchanging goods that were found in abundance at one place in return for goods that

15
According to the International Trade Statistics 2()()9 (p. 10) published by the WTO the value of world
merchandise exports has grown from $ 59 bi II ion in 1948 to $ 15 71 7 billion in 2008.

34
were in short supply arose. In fact the earliest views on international trade and commerce
were largely related to the views about the sea in the Graeco-Roman tradition, since land
transport was not very developed in those times and the sea provided easy access to tar
off and distant places. The early Greeks and Romans were ambivalent towards the sea -
one section of people regarded the sea as good as it enabled exchange of goods between
far off and distant places and thus resulted in prosperity while there was another section
that looked at the sea with suspicion as it led to contact with foreigners who brought with
themselves their bad manners and corrupt practices and resulted in the disruption of
domestic life. They considered the sea as a threat to the security of the nation and its
economy (Irwin 1996: 11-13). In fact, during the greater part of their history the Greeks
and Romans despised and looked down upon the trading classes (Haney 1911: 30). To
them, a trader or middleman who bought goods at one price and sold them at a higher one
without changing the nature of the product was engaged in a vulgar occupation.

The Greek philosopher Aristotle (384 BC - 322 BC) in his celebrated work
Politics maintains that the direct non-monetary exchange of commodities (i.e. barter of
goods) is natural as it satisfies the natural requirement of sufficiency. However, he
condemns the use of money for exchange of goods which arose due to exporting and
importing of commodities, as "justly discredited" as it is not in accordance with nature,
but involves men's taking things from one another. Shopkeepers and traders were
occupations reserved for the lowest rung of the social set up as these activities were
considered to be beneath the dignity of elite citizens (Irwin 1996: 12). The Athenian
philosopher Plato (429 BC - 327 BC) was also critical of trade and sea power as it
"breeds shifty and deceitful habits in a man's soul and makes the citizens distrustful and
hostile" (Stalley 1983: I 0 I). Thus it was assumed that people engaged in trade and
commerce acted out of concern for material benefits rather than for law and morality and
saw one another as competitors of objects of exploitation rather than as fellow citizens
(Stailey 1983: I 0 I).

Nevertheless, if the exposure to undesirable foreigners could be avoided then,

Aristotle agreed that trade is advantageous in respect of both security and the supply of

35
 necessary commodities. But despite its advantages he believed that import trade should
stop at the provision of essential items, such as food and timber. and should not be carried
beyond a point for the sake of profit. Plato in Laws is more articulate when he asserts that
no duties should be placed on exports and imports but the government should ban the
import of foreign materials "for a use that is not necessary" and should forbid the export
of any thing which should necessarily remain in the country. Thus the Greeks condemned
foreign trade and commerce due to the moral and civic dangers associated with it though
they reluctantly admitted that some foreign trade was imperative (Irwin 1996: 14-15). But
whatever limited foreign trade was carried out, was carried out in a non-discriminatory
manner. In fact "the very notion of a protective tariff. .. was utterly unknown to the
classical Greek world" (Hasebroek 1933: 39). So it can be said that the concept of non-
discrimination in international trade is as old as the concept of international trade itself.
In other words, non-discrimination in international trade is an age old principle which
was practiced in the very ancient times by the Greeks and Romans.

The favourable accounts of the sea gave rise to the doctrine of universal economy
which developed through the writings and teachings of philosophers and theologians in
the first several centuries (A.D.). This doctrine says that Providence deliberately scattered
resources and goods around the world unequally to promote commerce between different
regions. Jacob Viner defines the term Providence as an ·•an intelligent being external to
nature but governing nature" which also signifies the ·'pattern in which that supernatural
being conducts his operations" (Machlup 1972: 357). In the Jayne Memorial Lectures
delivered in 1966 Viner traced the history of two providentialist ideas relating to the
economic condition of man and economic relations among people. The first idea affirms
that providence endows people with a relative abundance of necessaries as compared
with luxuries. The second idea holds that providence favours trade among people as a
means of promoting the universal brotherhood of man. and has given to their respective
territories different endowments and products in order to increase the people's incentive
16
to trade (Machlup 1972: 357). Thus there was a section of thinkers in the pre-

16
Jacob Viner in the Jayne Memorial Lectures delivered at the University of Pennsylvania under the
auspices of the American Philosophical Society in 1966 looked at the connection between religious

36
mercantilist time which was of the opinion that trade between regions should be accepted
as beneficial and thus be permitted to run its course free tl·om interference. This
favourable view on trade became a part of natural law teaching and made its way into the
cosmopolitan doctrines of philosophers that flourished during the enlightenment and
thereafter.

2.3.2 EARLY CHRISTIAN AND SCHOLASTIC THOUGHT ON TRADE

The early Christian thinkers, just like the Greeks and Romans before them, condemned
trade and commerce. Traders were considered as ''men boasting of action, exalting
themselves because of business which admitteth no inaction, unquiet men rather than
good workmen" (Augustin 2004: 321 ). ft was said of the trader that "for the price of the
goods which thou art selling, thou not only liest. but even falsely swearest" (Augustin
2004: 320). Thus traders were considered to be associated with abetting fraud and
encouraging material gains. Sea borne trade was rejected in very strong terms as it was
believed that "God did not make the sea to be sailed over, but for the sake of the beauty
of the element. The sea is tossed by storms; you ought therefore to fear it, not to use
it. .. use it for purposes of food, not for purposes of commerce" (Clarke 1930: 224). The
primary reason for this apathy towards trade and commerce was not based on economic
reasoning but on the basis of moral and ethical considerations. Traders were associated
with fraud, avarice and other sins as the excessive pursuit of gain led to temptation and
potentially endangered one's soul (Irwin 1996: 18).

An ftalian catholic priest, Saint Thomas Aquinas (1225-1274) played an

important role in tempering down the negative view towards mercantile trade. He drew
attention towards the advantages, or rather the necessities, of dealing with merchants and
made a distinction between lawful trade, trade which is beneficial for the community as a
whole, and unlawful trade, which serves the worldly profit motives of the merchant. In
his most important work Summa TheoloKica he proclaimed that trade itself is not eviL
rather its moral worth depended on the motive and conduct of the trader. He justified

doctrine and economic theory and behaviour. His lectures were on ··The Role or Providence in the Social
Order: An Essay in lntellcctualllistory".

37
mercantile profit on the basis of the risk associated with bringing goods from where they
are abundant to where they are scarce. However he also advocated that the merchant
should 'direct his profits towards virtuous ends (Acton Institute for the Study of Religion
and Liberty 1998: 3). Aquinas is credited with addressing a number of economic
questions such as division of labour, property rights, just price, usury. labour theory of
17
value and insider trading. His concept of ''natural law", 18 which uses human reason to
interpret the divine plan of what is right and just, later proved influential in establishing
new grounds for allowing free commerce.

Francisco de Vitoria (1492-1546), a Spanish philosopher and theologian, applied

the concept of natural law to the relationship between nations. Vitoria is best known tor
his defense of the rights of the indigenous Americans of the New World against the
Spanish colonists. While defending the sovereign rights of the indigenous Americans he
also asserted that ''the Spaniards may lawfully carry on trade among the native Indians,
so long as they do no harm to their country ... by importing the goods which the
aborigines lack ... and taking away gold and silver and other at1icles in which the Indians
abound" (Vitoria 1917). He argued that "it is an apparent rule of jus gcntium 19 that
foreigners had the right to carry on trade, provided they did no hurt to citizens." Thus it
was asserted that trade, regardless of its moral implications is a right of nations. In fact it
was further stated that "lfthe Indian natives wish to prevent the Spaniards from enjoying
any of their. .. rights under the law of nations ... the Spaniards ought in the first place use
reason and persuasion (and) .... if it he necessary. in order to preserve their right that they

17
For a detailed analysis of Thomas Aquinas' economic ideas see McCiee. Robert W. ( 1990) ... Thomas
Aquinas: A Pioneer in the Field of Law and Economies··. Weslern S!a/e unil·ersily Lmr Review. IS (I):
471-483.
18
Aquinas has dealt with the concept of natural law in great length in his Summa Theo/ogica. He believes
that the eternal law governs all things. Howe\·er rational creatures are not only governed hut are capable
of governing themselves. Thus the rational creature has a natural inclination to its proper act and end: and
this participation of the eternal law in the rational creature is called natural law. See Aquinas, Thomas
( 1956). Treatise on Law: Summa Theo/ogica. Quest ins 9()-97, Washington: Regnery Publishing Inc .. pp.
11-19.
19
Jus gentium, which is the latin for .. law of nations" was originally a part of the Roman Law which was
applied by the Roman Empire in their dealings '' ith foreigners. Some rules of law which constituted the
jus gentium were- not attacking nations except in declared ,,·ar or similar situations: honouring truce.
peace treaties and boundaries: protecting \\Tecked ships and persons thereon: prosecuting piracy etc. Sec
Encyclopedia Britannica, Jus Gentium. IOnline: Web I Accessed on 20 March 20 I I liRL
http:/''\ ''w.hriwnnica.l·om/lc Bchcckcd tnpil> '08(J5·tij us-c:,~ntium.

38
should go to war, they may lawfully do so" (Vitoria 1917). Though the Spanish insistence
that free trade is a dictate of natural law in the sixteenth century, when it was a great
maritime power, can be dismissed as reflecting pure national interest (Irwin 1996: 21) yet
Vitoria's views marked a radical shift from the earlier thinking when trade was.
~

denounced on the basis of moral and ethical considerations.

2.3.3 NATURAL LAW PHILOSOPHERS AND THE LAW OF THE FREE

SEAS

The natural law philosophers of the seventeenth and eighteenth century applied Aquinas·
concept of natural law to the realm of international relations. Though they were primarily
concerned with formulating an objective code for the proper and just conduct of nations
they also made important prescriptions for the conduct of trade policy. Like Francisco de
Vitoria they believed that according to the law of nations there should not be any
restrictions on international commerce. Hugo Grotius, the most illustrious natural law
philosopher who worked as a jurist in the Dutch Republic, made a strong case in favour
of free trade in his Mare Liberum or ''The Freedom of the Seas or the Right Which
Belongs to the Dutch to Take Part in East Indian Trade" published in 1609. He
proclaimed that "the sea is common propeiiy" (Grotius 1916: 25) hence "by the Law of
Nations navigation is free to all persons whatsoever" (Grotius 1916: 12). He further
stated that ''By the Law ofNations every nation is free to travel to every other nation, and
to trade with it''. "Therefore freedom of trade is based on a primitive right of nations
which has a natural and permanent cause; and so that right cannot be destroyed ... For
surely no one nation may justly oppose in any way two nations that desire to enter into a
contract with each other" (Grotius 1916: 46).

However, despite being hailed as a figure of authority in the realm of international

law Grotius' specific views on the freedom of trade did not receive widespread support.
In fact some of his contemporaries and later followers went on to make substantial and
damaging exceptions to the case built by the law of nations case in favour of free trade.
Alberico Gentili (1552-1608), an Italian jurist, argued that imports could rightfully be
prevented if they were judged harmful by a country's moral code, exports of gold and

39
 silver could be forbidden, and foreign merchants could be denied access to the interior of
a country. Samuel Pufendorf ( 1632-1694), a German legal scholar who was greatly
influenced by Grotius, asserted that a nation is not obliged to trade in goods not essential
for human life, such as luxury goods and may prohibit export of such essential goods if
there is domestic scarcity or if''the commonwealth will prosper by forbidding them." The
natural law thinkers in the eighteenth century like Christian Wolff (1679-1754) and
Emmerich de Vattel ( 1714-1767) provided further support to the idea that state
restrictions on trade and commerce do not violate the natural law or the law of nations.
Thus gradually the right of all countries to engage in trade was transformed into the right
of all countries to regulate trade. Nevertheless the cosmopolitan doctrines of some
scholastics and natural law philosophers were an important intellectual legacy for the
later scholars and economists interested in trade policy (Irwin 1996: 22-25).

2.3.4 MERCANTILISM

The dominant economic thought that prevailed from the sixteenth to the middle of the
eighteenth century was a complete contrast to the cosmopolitanism of the scholastics and
the natural law philosophers. It developed primarily from the assorted pamphlets, studies.
treatises and tracts on a range of economic subjects. particularly international trade. by
English merchants, government officials and other pamphleteers. Beyond England. Italy.
France, and Spain had noted writers who had mercantilist themes in their work.

A distinguishing feature of the mercantilist period was that for the first time
economic phenomena were considered worthy of study in themselves and not just as a
by-product of ethical, moral and legal concerns unlike the earlier times. This is because
the pamphlets and tracts published during this period were written not by theologians or
legal philosophers but by merchants, bureaucrats and individuals interested in public
affairs (Irwin 1996: 26-27). So these writings were not ethical or legalistic but practical
and amoral in their analysis of economic issues. This could also have been due to the
20
decline ofthe Roman Catholic Church as a dominant player in sixteenth century Europe

20
In 1517 a German monk, Martin Luther, started a movement known as Reformation which was aimed at
reforming the Roman Catholic Church based in Rome. This was in response to the growth of false

40
which resulted in a revival of a non-religious study of Plato and Aristotle and thus made
room for the growth of a more rational conception of the state and social institutions
(Haney I 9 I I: I I 3- I I 4 ).

The central ideas propagated through the pamphlet literature of the mercantilists
were aimed at promoting state regulation of trade to accomplish any of the several
objectives in mind - the accumulation of treasure or bullion; the promotion of national
wealth and economic growth; the achievement of a favourable balance of trade; the
maximization of employment; the protection of domestic industry; and the increase in
state power (Irwin 1996: 26). Though some of these ideas were concerned with domestic
economic issues like increasing the production power and employment of the state yet the
focal point of mercantilist thought was foreign relations and foreign trade policy. Thomas
Mun (I57I-164I), J. B. Colbert (1619-1683), Alexander Hamilton (1755-1804) and
Friedrich List (I789-I846) were some ofthe prominent advocates of mercantilism who
were opposed to the idea of free trade and the laissezfaire principle. Furthering the
interests of the nation and state was the ultimate end for these mercantilists and this end
was to be achieved by regulating the state's foreign trade policy (Haney 1911: 117).

Tremendous importance was given to the accumulation of wealth which was

considered to be identical to precious metals like gold and silver and foreign trade was
considered to be the best means for increasing the wealth of a country. The notion of a
favourable balance of trade gained prominence which was considered to be the key
objective of a country's trade policy. This meant that a country should always strive to
expott more to foreigners than what it imports from them. Thus exports were promoted
by removing all kinds of taxes or custom duties on them while higher tariffs were
imposed on imported goods.

doctrines and various malpractices that had developed within the Church. There was also widespread
dissatisfaction with the growing wealth and power of the elite clergy. In 1533, the English monarch
Henery Vlll broke away fl·om the Roman Catholic Church and proclaimed himself as the Head of the
Church which was a severe blow to the authority and power of the Church in those times. Sec I listory
Learning Site. The Reformation [Online: Web] accessed on 8 October 2008 URL
11ltp:/iw\ \W. hi story learnings i lC.l'<l. u kirc1(mnat inn. h tm.

4I
 The commodity composition of trade was regarded as an important factor leading
to a favourable balance of trade. Exports of manufactured goods were promoted as they
fetched more value than exports of agricultural goods, raw materials and inputs. Similarly
it was profitable to import raw materials instead of manufactured goods as the imported
raw materials could be processed and manufactured at home and then exp01ied. This
implied low import duties on inputs and raw materials and high import duties on
processed goods. It also meant expoii taxes on raw materials to ensure a cheap and
abundant supply of inputs for domestic production. Export of manufactured products was
looked upon favourably as it promoted domestic manufacturing and led to employment
generation (Irwin 1996: 32-39).

However, though the mercantilists favoured restrictive trade policies and were
against liberal international trade policies yet they proved instrumental in the
development of international trade theory as the very first theory of international trade
was propagated in reaction to the mercantilist ideas and arguments for restricting trade.

2.3.5 PHYSIOCRATS AND ADAM SMITH

The physiocrats were the antecedents of Adam Smith's laissez:faire and free trade
doctrine and are also generally credited with developing the first organized and
comprehensive system of economics. The mercanti I ist I iterature, despite offering a
multitude of perspectives on commercial and trade policies, is largely categorised as a
'pamphlet literature' characterized by a few dominant themes and is thus not widely
regarded as an organized and systematic doctrine (Irwin 1996: 26). The physiocrats were
a group of economists who believed in the ordre naturae! or the natural order. an ideal
order of things dictated by the laws of nature whose arrangements were perfect as they
were regarded as the will of God. This stood in contrast to the ordre posit([ or the positive
or social order dictated by human ideals whose Jaws were imperfect as they consisted
largely of man-made practices and conventions. Physiocracy aimed at attaining harmony
between positive and natural law and thus creating a society in which both natural
economic Jaws as well as moral laws occupied an important place (Encyclopredia
Britannica 2008).

42
 The level of agricultural output was supposed to be the principal determining
factor of the general level of economic development of a country as agriculture was the
only activity which produced more than its input cost and yielded a produit net, a surplus
product over necessary costs which "directly supported the privileged classes by
providing the landowners with rent, the king and administration with tax revenues and the
clergy with tithes.'' Commerce and industry were considered 'sterile' or unproductive as
the value of their output was equal to their input. The rest of the country's inhabitants
were supported by agriculture indirectly as ''their incomes were dependent upon the
spending by the productive class of farmers as well as of all those who shared in the net
product of agriculture." Thus tillage was glorified as the only productive occupation and
source of all national wealth and landowners and cultivators were lauded as all the classes
and inhabitants of a country lived at their expense (Muller 1978: 150-151 ).

The physiocrats advocated free trade in the context of a general laissez~faire

approach and argued that market forces should determine the use of the society's scarce
resources. The government was not supposed to interfere in business activities as it would
disrupt the natural order and distort the orderly functioning of domestic and international
markets (O'Connor 2004: 32). It was believed that the complete lifting of all restrictions
on local and foreign sales of agricultural products was the best policy for promoting
agricultural prosperity and thus ''external trade should always be quite free, cleared of all
encumbrances and exempted from all impositions because it is only by means of the
communication between nations which it maintains that we can make sure of always
having the best possible price for the territory's product in internal trade, and the highest
possible revenue for the sovereign and the state" (Quesnay 1776 cited in Irwin 1996: 67).
Physiocrats provided a philosophical approach to society and market that proclaimed the
harmony of private actions with public welfare. However, despite making broad and
sweeping statements in favour of complete liberty in trade they were not successful in
providing an appealing justification for free trade. It is often contended that the
physiocrats were not primarily interested in the subject of foreign trade and that their
advocacy of free trade stemmed from a "disingenuous convenience" as free trade was
well suited for the attainment of their objective of increasing the agricultural output of

43
 France in those times. But nevertheless they constituted the first school of economic
thought and the doctrine of laissezfaire which was first popularised by them greatly
influenced the later economists like Adam Smith and prepared the foundation for further
evolution of international trade theory (Irwin 1996: 64-68).

After the physiocracy popularised the idea of free flow of goods among nations
there still remained a need to provide a logical and scientific justification for international
trade. This was fulfilled by Adam Smith's seminal work titled An Enquily into the Nature
and Causes of the Wealth of Nation (1776). In his magnum opus Smith laid the
foundations of the classical theory of international trade which provided a solid
theoretical basis for the development of the most-favoured-nation and national treatment
principles in international trade. Though the concept of non-discrimination in terms of the
MFN and the NT clauses had existed before Adam Smith, yet his ideas gave the
economic rationale and justification for their use which proved to be instrumental in
popularising their use in international economic relations.

2.3.6 EVOLUTION OF THE MOST FAVOURED NATION AND

NATIONAL TREATMENT CLAUSE

The MFN principle and the NT rule have been an important feature of international
economic relations for centuries. The concept of most-favoured-nation emerged in
Europe in the Middle Ages (International Law Commission, 1969: 159) while the genesis
of the national treatment rule can be traced back to the ancient Hebrew law for ''resident
aliens" that prescribed solicitude for the aliens which were to be subjected to the same
laws as the native people (Culbertson, 1925: 24). 21 Travel in those times was slow,
uncomfortable and usually dangerous and traders and merchants had to travel to distant
lands and undertake great risks for finding new markets and commodities to sell. Thus
when merchants from the trading cities of Italy, France and Spain found a new, far and
difficult market they tried to secure a monopoly for themselves in the first place. When
such eff011s failed and they were not successful in warding off competition fl·om a given
market, they tried to gain opp011unities which were at least equal to those of their rivals.

21
Also see .1. M. Powis Smith (2005), The Origin and History of !lebrew Law, New Jersey: The Lawbook
Exchange Ltd., p. 82.

44
So the jealousy and competition between them compelled them to contend themselves
with equal opportunities of trade in foreign lands. This was the inception of the concept
of most-favoured-nation (International Law Commission, 1969: 159). 22 It was against this
backdrop that various instances of rulers and Emperors granting special grants and
franchises to merchants are found which accord them the same trading rights and
privileges as granted to any other merchant or trader.

In I 055, Emperor Henry III of the Holy Roman Empire granted the city of
Mantua in Italy all customs privileges granted to 'whatsoever other town· (Trebilcock
and Howse 2005: 49). In 1226 Emperor Fredric II conceded to the city of Marseilles the
privileges previously granted to the citizens of Pis a and Genoa. The Arab princes of West
Africa, at the insistence of the Mediterranean French and Spanish cities issued franchises
in which the merchants ofthose cities were accorded the same treatment as granted to the
cities of Venice and later to those of Pisa, Genoa, Ancona and Amalfl. Similar rights
were solicited and received from the French princes of the Kingdom of Jerusalem by
several trading cities of the Mediterranean. Most of these arrangements related to the
personal rights of and jurisdictional favours for the merchants rather than to concessions
in respect of custom duties (International Law Commission 1969: 159).

The national treatment principle also appeared at around this time in agreements
signed between Italian city-states in the eleventh century (Trebilcock and Giri 2004: I).
Its initial development took place as a standard for international conduct set by treaties
signed between countries of similar structures and complementary interests. It was
primarily aimed at providing inland parity, or equality of treatment between the residents
of a country and foreigners (Schwarzenberger 1948: 41 0).

By the fifteenth century more elaborate texts appeared generally in the form of
treaties between European nations. Initially the reciprocal favours between contracting
parties were limited to concessions granted to certain specified nations only. But

cc Also see Trade and Trarel in the Middle Ages, [Online: Web] Accessed on 25 December 2008 lJRL
http:! /\\1\W.IllllSU.Cdu/cmuscumihistorv cln iddlcagcs'tradc .htm I.

45
gradually towards the end of the fifteenth century the stipulations were broadened in the
sense that the privileges granted to the beneficiary were no longer restricted to those
accorded to certain specifically named countries but were extended to any foreign nation
with which trade relations were established. For example the commercial treaty between
England and Brittany signed in 1486 and the Anglo-Danish treaty signed in 1490
conferred the most-favoured-nation treatment upon the signatories to these treaties as
well as any other nation with which trade was conducted (International Law Commission
1969: 159-160).

The concept of MFN was widely used by European powers in Asia and Turkey
when they were not successful in gaining monopoly rights in these markets. In the
sixteenth century English merchants sought MFN status and extra-territorial rights from
the Ottoman Empire to which the latter responded positively as they wanted access to
English silver, tin, gunpowder and ships in return (Goffman 2004: \95). When the
English and French East India Companies arrived in East Indies in the seventeenth
century they found a number of other European factories and settlements. So their policy
was to first obtain MFN treatment from Asian rulers so as to provide a sound legal basis
to their initial establishments in these foreign lands. This is evident from Article XVIII of
the draft treaty submitted by the English East India Company to the King of Burma in
1680 proposing free trade and the establishment of factories, which stated that ··if the
King shall hereafter grant any more or other privileges to any other nation than what are
comprehended in these Articles, the same privileges are to be granted to the English."
Another agreement between the East India Company and the Rulers of the West coast of
Sumatra stipulated the right of the Company to purchase spices and other goods .. at the
same prices the Dutch formerly paid."

In \666, the French East India Company reached an understanding with the
Mughal Emperor in India who granted them by firman the same privileges as those
enjoyed by the English and the Dutch, especially in relation to the factories in Surat and
Soually. Thus it can be said that in the seventeenth century the use of most favoured
treatment became common practice. However, even in those times MFN treatment gave

46
 way to discriminatory treatment whenever it was in the interest of the contracting local
ruler to rely entirely on one of the European companies to the exclusion of others or
when, even in the absence of such an interest, the European powers were able to persuade
a particular ruler to break ties with other European nations (Alexandrowicz 1960: 270-
271 ). .

MFN treatment was also a part of treaties of capitulation signed between the
Ottoman Empire and various European powers from the sixteenth to the eighteenth
century wherein it was extended unilaterally and without any expectation of reciprocity
from the other party. 23 In the earlier instances this concept was narrowly applied as it
assured the beneficiary of the same advantages as previously granted by the Ottoman
rulers to certain other cities or states expressly mentioned, while later on this clause was
drafted in a broad manner. For example, Article 83 ofthe French capitulation treaty states
that the ''privileges and honours granted to other European nations shall also be granted
to the subjects of the Emperor of France." This implied that the concessions given to any
other European nation, either previously or in future, will have to be extended to the
French also. This broadened the scope of the concept of MFN substantially and gradually
became a regular feature of the later capitulation treaties signed by the Ottoman Empire.
After the defeat of the Ottoman Empire by Russia in 1783 a peace treaty was signed
between them which also included a commercial agreement. This agreement granted the
most extensive privileges to Russia and thus became an impotiant document for the
foreign commercial relations of the Ottoman Empire (International Law Commission
1969: 161).

Despite the extensive use of the concept of MFN since the Middle Ages, the MFN
clause itself emerged in its modern form only in the eighteenth century with the phrase
"most favoured nation" being used for the first time in the Navigation and Commerce
Treaty signed between England and France in Utrecht in 1713 (International Law

2
' The Ottoman capitulatory regime emerged in the sixteenth century with the granting or the first
commercial privileges to the f-rench and the English. See Ed hem Eidem (2006 ). "Capitulations and
Western Trade" in Suraiya N. Faroqhi (eds.) The Cambridge f!islot)' of' Turkey.· Volume 3- The !.aler
01/oman Empire. 1603-1839, Cambridge: Cambridge llni\·ersity Press. p.28J.

47
Commission 1969: 160)?4 Article VIII of this treaty read as:

''Furthermore, it is agreed and concluded, as a general rule. that

all and singular the subjects oft he Serene Queen of Great Britain,
and of the most Serene most Christian KinK, in all countries and
places subject to their power on each side, as to all duties,
impositions. or customs whatsoever, concerning persons, good'i,
and merchandizes, ships, freights, seamen, navigation, and
commerce, shall use and enjoy the same privileKes, liberties, and
immunities at least, and have the like favour in all things, as 1vell
in the courts of justice, as in all such things as relate either to
commerce, or to any other riKhts whatever, which any foreign
nation, the mostfavoured, has, uses, and enjoys, or may hereafter
have, use, and enjoy. " (George Chalmers I 790: 396-397)
(Emphasis Added)

The British Parliament rejected this treaty as it was alleged that the MFN clause
contained in the treaty contradicted an earlier convention signed between Great Britain
and Portugal in I 703, known as the Methuen Treaty, which played an important role in
establishing trade relations between Britain and Portugal. The Methuen Treaty allowed
English woollen cloth to be admitted into Portugal free of duty in return for which
Portuguese wine was imported in Great Britain at one-third of the duty levied on French
wines. Both Britain and Portugal benefited from this arrangement as it gave a big impetus
to the port wine industry of Portugal while England, which was at war with France at that
time and thus could not import French wine, found a popular replacement for French
wine (Knight 1859: 267). Thus it was not before 1786 that the most-favoured-nation
clause was used again in a commercial treaty.

At around the same time, the conditional form of the MFN concept made its tirst
appearance in a treaty signed between France and the United States of America on

24
The Treaty of Utrecht, signed in 1713, put an end to the War or Spanish Succession ( 1701-13) II hich
resulted fi·om a dispute over who should inherit Spain and its possessions after its llabsburg rulers
became extinct in 1700. This treaty which established the Peace of Utrecht is not a single document but
comprises of a series of individual peace treaties signed between various European states in the Dutch
city of Utrecht in March and April 1713. The Treaty or Commerce and Navigation was signed between
Great Britain and France as the principal result of the establishment of peace and was aimed at fostering
friendly relations between them. For details see The Treaties of Utrecht ( 1713 ). [Online: Web] Accessed
on 15 January 2009 URL httr?: / 111'\1'\\ .heraldic~a.m52/toricsitJ·anc·l>Ulrccht. htm.

48
February 6, 1778. Article II of the treaty said that:

"The Most Christian King and the United States engage mutual~v
not to grant any particular favour to other nations, in respect of
commerce and navigation, which shall not immediately become
common to the other Party, who shall enjoy the same favour,
freely, (f the concession wasfreely made, or on allowing the same
compensation, if the concession was conditional. .. (International
Law Commission 1969: 161)

In simple words, if the concessions made by one trading partner to another trading
partner were granted unconditionally then they would be extended to the other trading
partners also without any conditions. However if the concessions or privileges were made
upon the fulfilment of certain conditions then they would be granted to other trading
partners only ifthey also fultilled the same conditions. Though the 'conditional' principle
is said to be formulated by the French statesmen so as to convince Europe and America
of French unselfishness, it did not become a permanent principle of French commercial
policy (Setser 1933: 323). The use of the conditional element in MFN treatment was
particularly dominant in the period between 1827 and 1860. It was particularly well
suited to American political and economic interests for a very long period of time and has
often been termed as the "American" interpretation of the MFN clause. In fact the phrase
•·freely, if the concession was freely made, or on allowing the same compensation (or the
equivalent), if the concession was conditional" was widely used in most of the
commercial treaties signed by the United States till 1923 (Snyder 1940: 79).

The Anglo-French commercial treaty of 1786 or the Treaty of Eden was one of
the most important trade agreements of the eighteenth century as it marked a break from
the existing commercial system that was characterised by prohibitions and high duties,
and which had been long accepted as the only method of regulating international trade. It
was also indicative of a serious attempt to end the traditional rivalry between Britain and
France. Through this treaty France agreed to the removal of prohibitions and excessive
duties on English products and at the same time French wines were to pay no more duty
than what Portuguese wines were paying at that time. MFN treatment was accorded to

49
certain specified products, like French olive oil and British and French millinery, and also
to all goods not definitely specified in the treaty. Unfortunately this treaty had a short life
and was in operation for only a period of five and a half years (from May 1787 to January
1793). Hostile public opinion in revolutionary France and eventually the outbreak of ·war
between France and Great Britain in 1793 led to the annulment of the Treaty of Eden and
a resurgence ofthe traditional Anglo-French rivalry in the political as well as commercial
sphere. But despite its short-lived existence this treaty demonstrated that prohibitions and
high tariffs were not the only road to prosperity and marked the end of an important
phase in commercial relations between European states (Henderson 1957: I 04-112). 25

The Cobden Chevalier Treaty of 1860 signed between England and France was
successful in bringing about more stable peace between the two countries. An essential
feature of this treaty was the unconditional MFN clause which resulted in not just the
lowering of tariffs between the two nations substantially but also provided a basis for
worldwide multilateral trade liberalization as it committed France and Britain to accord to
each other all the trade concessions and privileges that they accorded to any other third
party (Stein I 999: 294-295). This treaty, along with the repeal of the infamous Corn
Laws in I 846, marked a turning point in the realm of international economic relations as
this unprecedented and unilateral move towards free trade by Great Britain marked a
decisive shift in commercial policy which was soon emulated by other European nations
like Italy, Switzerland, Norway, Spain, Austria and the Hanseatic cities of North Europe
(Bernstein 2008: 3 I 4).

Britain concluded four more trade treaties with Belgium, Italy, Austria and the
Zollverein in the years following the Cobden Chevalier Treaty while the French signed
eleven more treaties and played a key role in expanding the bilateral treaty into a
multilateral free trade area (Stein I 999: 295). Thus the period from 1860 to the First
World War was characterized by the widespread use of the unconditional MFN clause in
commercial agreements concluded in Europe. This period witnessed the rise of the MFN

25
Also see Heekseher, Eli F. (1922). The Continental System, Oxford: Clarendon Press available [Online:
Web] URL hltp:i/\\W\\.econlib.ml!/librJrv!YPDHouh.s/llccbchcr/hksrCS').html Accessed on 15 January
2009.

50
 clause to its highest peak as it operated through a series of interconnected commercial
treaties spread over Europe and resulted in a substantial reduction of tariffs (Snyder 1940:
80). The US however, preferred the conditional form of the MFN clause till 1923 after
which it also switched over to the unconditional form (Barton 2006: 39).

2.3.7 THE RATIONALE FOR NON-DISCRIMINATION UNDER

GATT/WTO

The twentieth century witnessed the rise of non-discrimination in international trade as

the most viable option for pulling the world out of the post war economic depression as
the beggar-thy-neighbour policies adopted by most ofthe countries were not successful in
ending the political and economic rivalries among nations and fostering peaceful
cooperation between them. Though the initial decades continued to see the growth of
high tariff barriers, the call for the adoption of the non-discrimination principle in
international trade began and gathered momentum from the 1920s with the efforts of
Cordell Hull, the US Secretary of State from 1933 to 1944, who was a major driving
force behind the adoption of the unconditional MFN clause by the United States and
finally its incorporation in the GATT/WTO multilateral trading system.

The outbreak of the First World War was a big set back for trade liberalization
and the rising popularity of the MFN clause in the nineteenth century, as all commercial
treaties were terminated and most of the countries that had embraced the unconditional
MFN clause without any reservations went back to the old ways of protecting their
markets and products with high tariff barriers. These countries also denounced any efforts
to restore the pre-war economic relations in the immediate post-war period, as it was felt
that granting equal treatment to friends as well as enemy nations was not the best policy
(International Law Commission 1969: 162). Thus the Allied Powers 26 in order to ensure
that "none of the Allies should be hampered by any claim put forward by enemy powers
to most favoured nation treatment" .... decided in the Allied Economic Conference held
in Paris in 1916 that "'the benefit of this treatment will not be granted to those (enemy)

26
The Allied Powers consisted of Belgium, France, Great Britain, Italy, Japan and Portugal while the
Central Powers consisted ofGennany, Austria Hungary. the Ottoman Empire and Bulgaria.

51
 powers during a number of years, to be fixed by mutual agreement" (Recommendations
of the Economic Conference of the Allied Governments 1916: 229). On the other hand,
the Central Powers which lost in the war were compelled to grant non-discriminatory
treatment to the victorious countries through the terms of the post war treaties 27 which
imposed onerous conditions on the former (Snyder 1940: 80-81 ). However, this was not
particularly helpful in furthering the cause of free trade and non-discrimination as it was
intended to punish the Central Powers and not to propagate free trade. In fact the harsh
post war treaties are often said to have caused considerable bitterness among the Central
Powers thereby fuelling a desire to avenge them of the humiliation and suffering caused
through these treaties which ultimately resulted in the Second World War. So even after
the end of the First World War the trend towards protectionism continued.

At around the same time the then US President, Woodrow Wilson in a historic
speech to a joint session of the US Congress in January 1918 outlined a fourteen point
programme (hereafter Wilson's Fourteen Points) for the restoration of peace in the world.
The third of these points envisaged "the removal, so far as possible, of all economic
barriers and the establishment of equality of trade conditions among all the nations··
(Howard 2002: 120). The seriousness behind this was reflected by the fact that the US.
which had long been a practitioner of the conditional MFN clause, reversed its policy and
signed an agreement in 1923 granting unconditional MFN status to Germany
(Encyclopaedia of the New American Nation). Thus the MFN clause was universally
viewed as a positive and necessary step towards ending the bitter animosity and distrust
among countries and enhancing cooperation. Non-discrimination and equality in trade
was also endorsed by the Covenant of the League of Nations in a broad manner as it
mandated under Atiicle 23 (e) that "the Members of the League ... will make provision to
secure and maintain ... equitable treatment for the commerce of all Members of the
League." However, failure of the United States to join the League affected its credibility
and thus it was not very effective in attaining its goal of fostering peace and prosperity
(Trebilcock and Howse 2005: 50).

27
Three important treaties were signed in 1919 after the end of the First World War- the Treaty of
Versailles with Germany, the Treaty St. Germaine with Austria and the Treaty ofTrianom with Hungary.

52
 Also most of the countries at that time were more concerned about safeguarding
their own political and economic interests from their adversaries and were thus not very
supportive ofthe idea of equitable treatment of all countries. So the period from 1929 till
the end of the Second World War saw a further decline of the MFN clause (Trebilcock
and Howse 2005: 50). The US enacted the Smoot 1-Ia\vley Act in 1930 to combat the post
war agricultural recession raising tariffs to very high rates and ushering in an era of
protectionism and retaliation. Exchange controls, import quotas and monopoly purchase
tariffs became the order of the day as a lot of countries followed the US example. This
period also saw the advent of the Great Depression of 1929 which was the most
widespread and devastating economic depression of all times that originated in the US
and very soon spread to the entire world. It further deteriorated the situation and resulted
in a race to the bottom in which every country raised high tariff barriers to protect and
safeguard their war devastated domestic industries and insulate their economy from the
economic depression. However, these beggar-thy-neighbour policies, instead of having
the desired effect further aggravated the situation and precipitated the depression.

The protectionist sentiment was also dominant during the period of the Second
World War which started in 1939. Towards the end of the Second World War the
representatives of 44 countries met at Bretton Woods in 1944 to discuss and design a new
post-war international economic architecture for regulating and managing the world
economy. They agreed that building high tariff barriers and restricting the free flow of
goods and services across national borders was not conducive to promoting peace and
prosperity and that trade liberalization was essential for promoting economic cooperation
among countries. While the IMF and IBRD were established to manage international
monetary affairs and to aid countries in post war reconstruction and development
respectively, the ITO was envisaged to fulfil the objective of liberalization and free trade
by promoting non-discrimination and equitable treatment in international commerce.

In fact, the first step in this direction was taken by the United States much before
the Bretton Woods conference when it enacted the Reciprocal Trade Agreements Act in
1934. This Act gave the American President the authority to negotiate bilateral trade

53
concessions for raising or lowering the existing tariff rates by up to 50 per cent, if
reciprocal arrangements were made for American products by the other party (Kaplan
1996: 45). Consequently, the US entered into thirty-two bilateral reciprocal trade
agreements between 1934 and 1945 and each of them contained an unconditional most-
favoured-nation clause according to which all concessions made by either party were to
be freely and automatically extended to all other third parties (Jackson 1997: 35-36 and
Kaplan 1996: 45). In 1945. the US Congress renewed these agreements for a period of
three years after which the US government invited a number of countries to enter into
negotiations for a multilateral agreement for the mutual reduction of tariffs. which was
later signed as GATT.

In the very same year, the United Nations (UN) succeeded the League ofNations
and in February 1946, its subordinate body, the Economic and Social Council (ECOSOC)
adopted a resolution calling for a conference to draft a charter for an International Trade
Organization and the establishment of a preparatory committee for this conference (UN
ECOSOC Resolution 1/13, 18 February 1946). A draft of the suggested ITO Charter was
also published by the US at around this time and a preparatory committee was formed
which met in October 1946, in London for the first time (Jackson 1997: 36-37). The
second meeting was held at New York in early 1947 to edit and draft a charter in the light
of the London meeting, and the third meeting was held at Geneva from April to October
194 7. The fourth and the final meeting is known as the Havana Conference which took
place from November 21, 194 7 to March 24, 1948 to give final shape to the charter
(Jackson 2000: 21-22). Article sixteen of the ITO Charter (also known as the Havana
Charter) provided for general MFN treatment in commercial relations between the
members of the organization with regard to customs and the method of levying duties
while Article eighteen contained the national treatment rule and mandated that internal
taxes, charges or regulations should not discriminate between domestic and imported
products and accord equitable treatment to them.

It is important here to mention the contribution of Cordell Hull, the US Secretary

of State from 1933 to 1944, in the incorporation of non-discrimination as a fundamental

54
and core principle of the GATT/WTO multilateral trading system. He was "a
conscientious, far-sighted member of the Congress with a keen interest in international
affairs ·and a conviction that the chief cause of dissension and war was economic
discrimination among nations" (Bemis 1949: 317). Hull was the first among his
contemporaries to view protective tariffs as an issue of international concern which had
implications for other countries and not just the United States. Thus he strongly
denounced the Payne Aldrich tariff schedule introduced by the US in 1909 which reduced
the tariffs on some products and increased the tariffs on a large number of other products
(Encyclopedia of the New American Nation 20 I 0). In 1914, Hull wrote to the then US
Secretary of State, Robert Lansing to advocate the adoption of the unconditional MFN
clause by the US. In 1916, after the end of the First World War he called for an
international trade conference for negotiating lower tariffs and for formulating new trade
methods, practices and policies aimed at fostering international peace and cooperation.
This call was renewed in 1925 through a resolution in the US House of Representatives,
which was not accepted.

After assuming the office of the US Secretary of State in 1933, Hull intensified
his efforts towards the adoption of non-discrimination in trade by the US which
eventually resulted in the passage of the US Reciprocal Trade Agreements Act of 1934
and were also the motivation behind the non-discrimination clauses of GATT and WTO.
Hull was ofthe opinion that protective tariffs were a threat to world peace as they had the
potential for generating economic as well as political confiict among nations (Dam 2004:
2-3). He put fotth the idea of 'economic security' and linked it to the promotion of peace
and prosperity which could be attained through mutually advantageous trade among
nations (Hull 1938). Though this appeared to be a little far-fetched and too idealistic at
that time, in hindsight one can say that Hull was much ahead of his times in visualizing
the non-economic effects of protective tariffs.

Later, the key concepts underlying the US Reciprocal Trade Agreements Act
became the motive forces behind GATT and WTO as the MFN and NT clauses of the
ITO Charter were modelled on the non-discrimination provisions of this Act. The Act

55
also "furnished the template for Congressional advance authorization for the Executive
Branch negotiation of trade agreements" which became the standard template in later
years to expedite the process of multilateral trade liberalization (Dam 2004: 1-4).
However the ITO could not be established as the United States failed to ratify the Havana
Charter, but in its place GATT was signed by 23 countries assembled at Havana in 1947.
It was a multilateral treaty for the mutual reduction of tariffs barriers between the
signatories and, like the ITO, was based on non-discrimination in international trade.
With this the MFN clause and the national treatment rule were entrenched within the
General Agreement as its core principles which governed each and every aspect of the
multilateral rules formulated under its auspices.

2.4 THE NON-DISCRIMINATION PRINCIPLE UNDER GATT AND WTO

The GATT was envisaged as a temporary arrangement for safeguarding the tariff
concessions made by countries. It was supposed to function until the formation of the
ITO and was thus largely based on the provisions of the ITO Charter. So the MFN and
NT provisions of the ITO were also incorporated into GATT which were retained and
extended to all the other WTO agreements which came into force at the time of the
establishment ofthe WTO in 1995. So the non-discrimination principle forms the basis of
the entire WTO system and cuts across the entire spectrum of the multilateral rules on
international trade. Article I: I of the General Agreement lays down the MFN rule in
these terms:

"With respect to customs duties and charges of any kind imposed on or in

connection with importation or exportation or imposed on the
internationaltran4er ofpaymentsfhr imports or exports, and with respect
to the method of levying such duties and charges, and with respect to all
rules andformalities in connection with importation and exportation, and
with respect to all matters referred to in paragraphs 2 and -1 of Article III,
any advantage, favour, privilege or immunity granted by any contracting
party to any product originating in or destinedfhr any other counlly shall
he accorded immediately and unconditionally to the like product
originating in or destined .fhr the territories of all other contracting
parties."

56
 In simple words, this means that 'like products' originating in or destined for different
countries are entitled to non-discriminatory treatment with respect to:

>- .custom duties and charges of any kind imposed on or in connection to import or
export of goods;
>- international transfer of payments made for imports or exports;
-,. the method of levying such duties and charges: all rules and formalities 111

connection with importation or exportation;

>- internal taxes or other internal charges of any kind;
> laws, regulations and requirements affecting internal sale, offering for sale,
transportation, distribution or use of foreign products.

Thus, the MFN rule requires that every Contracting Party should grant to the ·like
products' of every other Contracting Party the most favourable treatment that it grants to
any country with respect to import and export of products. It reduces the negotiating costs
for WTO members and raises the cost of defecting from WTO commitments, because if a
country desires to raise trade barriers against another country, it must do so for all the
other countries which are members of the organization as well. This prohibits any kind of
discrimination against foreign goods in tariff and non-tariff matters thereby playing a
crucial role in ensuring reciprocal and mutually advantageous trade relations between
countries.

However, it is possible for countries to circumvent their tariff liberalization

commitments by imposing discriminatory taxes or internal regulations on foreign goods
after they have cleared all customs formalities. The national treatment principle ensures
that this does not happen as it requires that foreign goods, once they have satisfied
whatever border measures are applied, are treated no less favourably than like or directly
competitive goods produced domestically, in terms of internal taxation. According to
Article III: 4 ofGATT:

57
 ·"The products of the territory of any contracting party imported into the
territory of any other contracting party shall be accorded treatment no
less favourable than that accorded to like products of national origin in
re.spect of all laws. regulations and requirements affecting their internal
sale. offeringfor sale, purchase, transportation. distrihution or use . ..

Similarly, Article Ill: 2 contains a provision for domestic taxes which prohibits the
imposition of discriminatory internal taxes and other charges on imported goods. It states
that:
"The products of the territory of any contracting party imported into the
territory of any other contracting party shall not be subject, directly or
indirectly, to internal taxes or other internal charges of any kind in excess
of those applied, directly or indirectly, to like domestic products. "

This clause ensures that domestic tax and regulatory policies are not used as protectionist
measures that would defeat the whole purpose of reducing tariffs at the border. It applies
to all products and not just to bound products and thus assists the general rule of reducing
restraints on imports and providing equal treatment to products traded between countries
(Jackson, 1997: 2I3).

These provisions laid down the basic rules according to which trade was to be
conducted among the GATT signatories. Apart from Articles I and III which call for a
general obligation to the non-discrimination in international there are other provisions in
GATT 1994 which contain subject specific MFN commitments. They are:

• Article V: 5 and V: 6 of GATT extend MFN and NT obligations for

products in transit from one country to another
• Article IX: I calls for non-discrimination in marking requirements with
regard to marks of origin
• Article XIII: I provides for the non-discriminatory administration of
quantitative restrictions
• Article XVII: I instructs state trading enterprises to act in accordance with
the general principles of non-discriminatory treatment in its purchases or
sales involving either expotis or imports

58
 • The preamble of Article XX stipulates that even while applying the
exception to the non-discrimination principle contained in its sub-clauses,
the Members will adhere to the principle of non-discrimination and ensure
that these exceptions are not applied ·'in a manner which would constitute
a means of arbitrary or unjustifiable discrimination between countries
where the same conditions prevail, or a disguised restriction on
international trade."

Apart form these specific MFN commitments, other WTO agreements also contain their
own MFN and NT clauses or provisions that call for non-discrimination in the conduct of
trade in goods and services.

The General Agreement on Trade in Services also calls for non-discrimination in

trade in services. Article II of this agreement stipulates that with regard to the trade in
services "each Member shall accord immediately and unconditionally to services and
service suppliers of any other Member treatment no less favourable than that it accords to
like services and service suppliers of any other country". This provision requires that the
most favourable treatment accorded to services and service suppliers should be extended
to all other Members, whether or not their service sector has been the subject of a market
access or national treatment commitment (Footer and George 2005: 827). The national
treatment rule with regard to trade in services is contained in Article XVII of GATS and
is enunciated in the following words: "each Member shall accord to services and service
suppliers of any other Member. in respect of all measures affecting the supply of services.
treatment no less favourable than that it accords to its own like services and service
suppliers.'' It is said that the national treatment obligation under GATS is wider in scope
as compared to GATT as it addresses not just services but also service suppliers.
However, in terms of application it is narrow as compared to GATT as the GATS
national treatment obligation applies to only to the sectors specified in each Members
schedule of commitments while the GATT national treatment rule applies to all imported
goods whether or not they are specified in a Member's schedule of commitments (Footer
and George 2005: 849).

59
 With respect to trade in intellectual property rights. Article 3 of the WTO
Agreement on Trade in Intellectual Property Rights (TRIPS) prescribes that ·'each
Member shall accord to the nationals of other Members treatment no less favourable than
it accords to its own national with regard to the protection of intellectual property."
Article 4 of TRIPS stipulates that "with regard to the protection of intellectual property,
any advantage, favour, privilege or immunity granted by a Member to the nationals of
any other country shall be accorded immediately and unconditionally to the nationals of
all other Members." These two provisions operationalize the non-discrimination principle
in the sphere of intellectual property rights and have had a special impact on various
bilateral intellectual property agreements concluded between the WTO Members which
attempt to provide greater protection through ''TRIPS plus" provisions. To avoid any
incompatibility with the TRIPS agreement these provisions must be extended to all WTO
Members and cannot remain limited to the partners of the bilateral agreements (Cottier
2005: I 067).

Other WTO Agreements which contain MFN and NT provisions are The WTO
Agreement on Trade Related Investment Measures (TRIMS), the Agreement on Pre-
Shipment Inspection and the Agreement on Import Licensing Procedures. Article 2.1 of
TRIMS contains a general obligation to the national treatment rule as it states that. ·'no
Member shall apply any TRIM which is inconsistent with the provisions of Article Ill or
Article XI of GATT 1994." Article 2.1 of the Agreement on Pre-Shipment Inspection
stipulates that, "user Members shall ensure that preshipment inspection activities are
carried out in a non-discriminatory manner, and that the procedures and criteria employed
in the conduct of these activities are objective and are applied on an equal basis to all
exporters affected by such activities." Article 3.1 of the Agreement on Import Licensing
Procedures provides that "the rules for import licensing procedures shall be neutral in
application and administered in a fair and equitable manner."

Even though the WTO agreements related to technical barriers and sanitary and
phytosanitary measures do not contain separate MFN and NT provisions yet they do have

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 some provisions to ensure that technical standards and sanitary and phytosanitary
measures are not used to discriminate between countries. Article 2.1 of the WTO
Agreement on Technical Barriers to Trade (TBT) states that "Members shall ensure that
in respect of technical regulations, products imported tl'om the territory of any Member
shall be accorded treatment no less favourable than that accorded to like products of
national origin and to like products originating in any other country.'' This obligation
extends to the preparation. adoption as well as the application of technical regulations. In
the SPS Agreement, Article 2.3 requires that "Members shall ensure that their sanitary
and phytosanitary measures do not arbitrarily or unjustifiably discriminate between
Members where identical or similar conditions prevail" and that sanitary and
phytosanitary measures (SPS) are not "applied in a manner which would constitute a
disguised restriction on international trade."

It is important to note here that the concept of' like product' is central to the non-
discrimination principle of GATT/WTO as the requirement to provide the most
favourable treatment is limited only to 'like products' imported from two or more WTO
Members. However, GATT does not provide a clear definition of this term due to which
there have been some problems and disputes among Members both under GATT as well
as the WTO regime. Before going into the problems associated with the interpretation of
'like products' it is relevant to bear in mind that the term 'like products' is used in GATT
at several places. Apart from Article I and III of GATT which deal with MFN and NT
rules, this term is also used in Article VI dealing with anti-dumping and countervailing
duties, Article IX dealing with marks of origins, Article XI related to the general
elimination of quantitative restrictions, Article XIII related to the non-discriminatory
administration of quantitative restrictions and Article XVI containing multilateral
disciplines on subsidies.

Various GATT panels attempted to interpret the meaning of 'like product' on a

case-by-case basis and formulated different criteria for determining 'likeness' keeping in
view the context in which the term was used. 28 In the very first attempt to interpret this

28
See panel report of the following GATT cases: The A uslra!ian Subsidy on Ammonium Sulphate. CiA TT

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term a distinction was made between "like products' and 'directly compettttve and
substitutable products' on the basis of a combined reading of Article III: 2 and the
interpretative note for this provision contained in paragraph 2 of Ad Article' 1!!29 of Annex
I of the General Agreement (GATT Doc. No. GATT/CP.4/39 1950: 3). This was
understood to mean that MFN treatment should be limited to 'like products' and should
not cover 'directly competitive and substitutable products' (GATT Doc. No.
GA TT/CP.4/39 1950: 3 ). Attention was also paid to the treatment of products by the
disputing parties (GATT Doc. No. G/26- 1S/53 1952: 3).

The 1970 GATT Working Party on Border Tax Adjustments found that the term
"like or similar products" occurred around 16 times in GATT and that despite
considerable discussions GATT Contracting Patties had not been able to develop a
general interpretation of the term. Thus it was concluded that the ·'problems arising from
the interpretation of the term should be examined on a case-by-case basis" which would
allow "a fair assessment in each case of the different elements that constitute a 'similar'
product'' (GATT Doc. No. L/3464 1970: 3). Some criteria for determining 'likeness' on a
case-by-case basis were suggested. such as the product's end-uses in a given market,
consumer's tastes and habits and the product's properties, nature and quality. However, it
was also suggested that there was uncertainty with regard to the meaning of the term and
that it needed to be improved fUJiher (GATT Doc. No. L/3464 1970: 3). Thus additional
criteria were developed with every case for determining likeness some of which included
tariff classification. competitive conditions in the relevant market. the nature of the
differentiated products and consideration of the fact whether product differentiation was
being made to grant protection to domestic products.

Doc. No. GATT /CP.4/39. 3 I March I 950; Treatment hy Germany of Imports of Sardines. GATT Doc.
No. G/26- IS/53, 30 October I 952, United States- .\1easures Affecting Alcoholic and .\1alt Beverages
GATT Doc. No. DS23/R- 39S-206, I 6 March 1992; United States- Taxes on A utomohiles. GATT Doc.
No. DS3l/R. ll October 1994.
29
Paragraph 2 of the Ad Article Ill of Annex l of GATT states that ··A tax conforming to the requirements
of the first sentence of paragraph 2 would be considered to be inconsistent with the provisions of the
second sentence only in cases where competition was involved between. on the one hand. the taxed
product and, on the other hand, a directly competitive or substitutable product which \\US not similarly
taxed."

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 Even after the establishment of the WTO this question continued to pose a
significant challenge to various DSB panels. The Appellate Body in the .Japan _
Alcoholic Beverages dispute suggested a different approach for interpreting paragraph 2
of At1icle IlL It was ofthe opinion that •·the second sentence of Article III: 2 provides for
a separate and distinctive consideration of the protective aspect of a measure in
examining its application to a broader category of products that are not 'like products' as
contemplated by the first sentence ... " Thus the AB suggested that ·• ... the first sentence of
Article III: 2 should be construed narrowly so as not to condemn measures that its strict
terms are not meant to condemn" (WTO Doc. No. WT/DS8/ AB/R 1996: 19-20). It also
noted that "if sufficiently detailed" a uniform tariff classification could be relevant as a
measure of product likeness, but warned that there was risk in using tariff classifications
which were too broad in scope and included a range of products (WTO Doc.
WT/DS8/AB/R 1996: 21-22).

In several disputes related to environment and health the concept of like product
has given rise to a debate over process and production methods (PPMs). In many cases
the physical characteristics of some goods could appear to be very similar so that they
appear to be like products, however, they might be completely different with regard to
their process and production methods which could result in negative externalities or
negative side effects on a third party which is not directly associated with the product
(Read 2000: 127). In the Tuna Dolphin I case 30 the panel stated that "Article III: 4 calls
for a comparison of the treatment of imported tuna as a product with that of domestic
tuna as a product. Regulations governing the taking of dolphins incidental to the taking of
tuna could not possibly affect tuna as a product. Article 111:4 therefore obliges the United
States to accord treatment to Mexican tuna no less favourable than that accorded to
United States tuna, whether or not the incidental taking of dolphins by Mexican vessels
corresponds to that of United States vessels" (GATT Doc. No. DS21/R- 39S/155 1991:
3 I). Thus the US legislation for the protection of dolphins caught in the process of tuna
fishing was found to be incompatible with Article Ill of GATT as it did not influence the
nature of the product.

° For a detailed analysis of the Tuna Dolphin cases see Chapter Five.
3

63
 .In the Asbestos case, related to the use of asbestos and related products. the AB
employed all the different criteria developed by early GATT and WTO dispute panels for
determining likeness which included (i) the properties, nature and quality of the products
including the physical properties (ii) the end-uses of the products; (iii) consumers' tastes
and habits; and (iv) the international tariff classification of the product. Apart form these
it also included the consideration of health risks for determining the likeness of asbestos
and its related products which resulted in considerably broadening the scope of the term
'like products' (WTO Doc. No. WT/DSI35/AB/R 2001: 39-45). This was done primarily
to address the health and safety concerns of Members while conducting trade in products
which could be harmful for human health.

The concept of likeness becomes even more complicated and difficult with regard
to trade in services as the non-discrimination provisions under GATS deal with not just
'like services' but also 'like service suppliers'. Thus. the non-discrimination obi igation
under GATS is wider in scope as compared to that under GATT as it applies to both the
product (the service) and the producer (the service supplier). Mireille Cossy (2006: 2)
identifies several factors which complicate the determination of likeness with regard to
trade in services, such as intangibility of services, difficulties in distinguishing between
the service and the service supplier, existence of four modes of supply, lack of a detailed
nomenclature of services and the customized nature of many services.

The concept of 'like products' is a critical element in the application of the non-
discrimination principle of the WTO. Hmvevcr, WTO Members have yet to develop a
clear and well defined approach tor its interpretation. But developing such an approach
will not be easy as the Appellate Body in .Iapan Alcoholic Beverages rightly remarked.
that the concept of likeness is similar to an accordion which '"squeezes and stretches at
different places" as different provisions ofthe WTO agreements are applied (WTO Doc.
WT/DS8/AB/R 1996: 21).

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 Other practical problems that have been encountered in the implementation of the
non-discrimination principle were those related to the classification of goods for customs
and tariff purposes and the determination of rules of origin of goods. The tariff
classification of goods is essential for identifying the exact duty rates that should he
levied on specific goods and are also crucial for determining the kind of treatment that
would be accorded to those goods based on their 'likeness· to other goods. In fact the use
of a uniform and objective tariff classification nomenclature is considered to be the
starting point ofthe determination of'like products' (Choi 2003: 101). Though the WTO
does not require its Members to follow any particular system of tariff classification. yet
most of them follow the Harmonized System (HS) of tariff classification which is
administered by the World Customs Organization (WCO). This has helped in making the
tariff classification of different states uniform and objective and has thus reduced the
problems that arise out of the tariff classification of goods. However, in some instances,
such as in the case of goods not covered under the tariff schedule of WTO Members or
the use of an insufficient tariff classification by developing countries. it becomes difficult
to determine the likeness of goods.

Rules of origin (ROO) are required to determine the country from which a
particular good originates and are needed for the purpose of the imposition of anti-
dumping and countervailing measures and for determining whether certain goods will be
accorded MFN or preferential treatment under various regional agreements or the
Generalized Scheme of Preferences (GSP) 31 (Imagawa and Vermulst 2005: 603). They
are also related to the tariff classification of goods as a change in tariff heading of a good
in a country is viewed as conferring the product origin on that country (Forrester Q.C and
Kaul 2005: 1586). The GATT Contracting Parties were not regulated by any regulations
on rules of origin due to which they faced many problems in determining the origin of
goods entering international trade. So. in 1995 the WTO Agreement on Rules of Origin
was adopted for harmonizing the complex. overlapping and conflicting rules used by
various countries for determining the origin of goods and to ensure that such rules are not

1
' The WTO allows its Members to confer non-reciprocal preferential treatment to de\'eloping countries
under the Generalized Scheme ot'Prelcrences. For details sec Chapter Three.

65
used as trade barriers. However, this agreement is not free from doubts and ambiguities
which allow a lot of discretion to the WTO Members, especially with regard to
determining the origin of goods that are produced in more than one country.

2.5 CONCLUSION

The above sections reveal that the non-discrimination principle is not a recent concept but
is almost as old as the idea of free trade itself. It is deeply entrenched in the liberal
economic as well as international relations theory and despite being criticized and
contested by competing theoretical perspectives. has stood the test of time. Its
incorporation in the GATT/WTO trading system after the end of the Second World War
was an acknowledgement of the fact that the protectionist and restrictive policies adopted
by countries during and before the World Wars were not conducive for economic growth
and development as well as for the maintenance of peace and harmony in the
international system. The MFN and NT provisions of GATT and WTO can also be
viewed as containing the seeds of the present wave of globalization and trade
liberalization which has now spread to all parts ofthe world.

The MFN and NT principles run across the entire gamut of WTO Agreements and
thus form the basis of all multilateral trade liberalization in the contemporary world.
Although the substantive content of the non-discrimination principle is fairly well laid
out, implementing the principle has led to several problems such as those related to the
concept of 'like products', classification of goods and rules of origin. An important
aspect of the operation of the non-discrimination principle under GATT and WTO has
been the concept of 'like products' which has been interpreted on a case-by-case basis in
various GATT and WTO disputes related to the operation of the non-discrimination
principle. This calls for further negotiations among the WTO Members for developing a
well-defined approach for the interpretation of 'like products'. However, such an
approach will have to bear in mind the use of the term 'like products' in different
provisions in various WTO agreements and the different contexts in which it is used.

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 Another major challenge in the implementation of the non-discrimination
principle has arisen from the working of the exceptions to this principle. Despite making
a clear commitment to unconditional MFN treatment, GATT did not completely prohibit
all kinds of trade discrimination. In fact right from the days of the Havana Charter certain
exceptions to non-discrimination had been envisaged for allowing some forms of trade
discrimination by countries. These exceptions were permitted under GA TT/WTO for
enabling the Member countries to deal with the requirements of post-war reconstruction
and development and to address various other non-trade concerns. Exceptions were also
made for countering unfair trade practices like dumping and subsidization and for the
continuation of preferences granted by some countries to their dominions and colonies
and the formation of customs unions and free trade areas.

Thus, most of the significant exceptions to non-discrimination that we see today

as an integral part of the WTO trading system were instituted and adopted at the time of
the formation of the Havana Charter itself and were gradually carried over and
institutionalized in the framework of GATT and WTO Agreements. The next chapter
describes these exceptions and attempts to understand the rationale behind their
incorporation in the multilateral trading system.

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