What is the Most-Favoured-Nation Clause?

If you have followed the Brexit debate closely, you will have heard of the term “most-favoured-nation clause” before. While the term sounds wonderfully positive, none of the things it does appear to be good: people warn of falling back on most-favoured-nation (MFN) tariffs, they suggest that this measure or that would not be possible because of our “most-favoured-nation obligations”. And, in October, Ambrose Evans-Pritchard reported in the Telegraph that most-favoured-nation clauses in the EU’s free trade agreements could make the quest for a “CETA-plus” solution for the UK impossible.

Silently you might have wondered why treatment as a most-favoured nation should be so negative. What does the most-favoured-nation clause actually say? What are its consequences? This is a Trade 101, explaining what the most-favoured-nation clause is, where you can find it and what it does.

The history of the most-favoured-nation clause

Since at least the Middle Ages, sovereigns – from medieval trading cities to modern nation states – have tried to negotiate better conditions for trade in their goods and services. But so have their competitors.

Imagine this hypothetical scenario. The ruling family of the medieval city-state Florence manages to negotiate a deal, in which Florentine goods are granted preferential access to the Republic of Pisa and tariffs on goods from Florence are fixed at half the standard rate. While the Florentines celebrate their success, representatives of the Venetian city state contact the rulers of Pisa. As a powerful Republic, they insist on starting their tariff negotiations with the rate offered to the Florentines and manage to negotiate an even better rate for Venetian goods. The Florentines are back where they started.

Historically, the solution for this problem was as elegant as it was effective: trading cities started to negotiate agreements that their goods and services would be granted at least the same treatment as those of their competitors. What does this clause mean for Florence in our hypothetical scenario? If Pisa had agreed to such a clause, it would now immediately have to offer Florentine goods the same conditions as those offered to Venice. Problem solved.

While clauses like this originally were used sporadically, sometimes referred to specific competitors (“granted the same treatment as France”), were granted unilaterally by a ruler and might have been subject to conditions, by the 19th Century they had evolved to become the most-favoured-nation clauses we still know today. One of the most famous treaties of the 19th Century, in which both parties promised to treat each other as well as the most favoured foreign nation, is the 1860 Cobden-Chevalier Treaty between the United Kingdom and France, which led to the conclusion of a number of similar bilateral treaties between nations.

Most-favoured-nation treatment in the WTO

Today, when people speak about “most-favoured-nation treatment”, what they refer to most commonly are the most-favoured-nation clauses in the Agreements that form the law of the World Trade Organization (WTO). Most-favoured-nation treatment is a cornerstone of the 164 member organization and – as the WTO actually covers several areas of trade, through different agreements – it contains not one, but several clauses guaranteeing most-favoured-nation treatment.

The most important are: Art. I GATT (General Agreement on Tariffs and Trade), covering trade in goods and dating back to 1947; Art. II GATS (General Agreement on Trade in Services), covering trade in services; and Art. 4 TRIPS (Agreement on Trade-Related Aspects of Intellectual Property Rights), covering intellectual property.

Let’s look at one of these clauses in more detail: the one referring to trade in goods. If you simplify that provision, it reads: With respect to all rules important to trade, any advantage granted by a WTO member to any product originating in any other country shall be accorded immediately and unconditionally to a like product coming from any and all other members”. What does this mean? If state A grants better conditions to products from state B, it immediately and unconditionally has to accord that same, more preferable treatment, to all WTO members. It is “multilateralized”. Unconditionally.

The exceptions to most-favoured-nation treatment

But wait a second, if this were true, the EU would have to offer tariff-free trade and free movement to all WTO members, the US would have to treat all WTO members like Canada and Mexico, and it would be impossible to grant any benefits to least-developed-countries without extending that largesse to all other WTO members.

This is, of course, correct. Most-favoured-nation treatment prevents you from granting better treatment in free trade agreements. You have to multilateralize that treatment. It also prevents you from granting better treatment to poor countries. You have to multilateralize that, too. Finally, it prevents you from sanctioning a country.

But the fathers of the world trade order did not want to prevent these policies so they created exceptions to Art. I GATT. These range from exceptions for particular policy objectives and for essential security interests, to exceptions for preferential treatment for developing and least-developed countries. Exceptions also cover customs unions and free trade areas, and interim agreements leading up to their formation (for GATT these are Art. XX, Art. XXI, the so-called “Enabling Clause”, and Art. XXIV respectively).

However, all of these exceptions come with their own conditions attached. To name only one of them: for a free trade area to be permissible it needs to, among other things, eliminate the duties and other restrictive regulations of commerce on “substantially all the trade between the constituent territories in products originating in such territories” (Art. XXIV:8 (b) GATT).

What the WTO’s most-favoured-nation clause means for the UK

Equipped with this short explanation we can now tackle some of the riddles that the introduction refers to. Let’s start with “MFN tariffs”. These tariffs are the lowest that a WTO member offers to another WTO member and accordingly has to multilateralize and offer to all WTO members. We now know that this sounds good, but that exceptions to the most-favoured-nation clause allow states to offer better tariffs – to developing countries and through free trade agreements, for example. In this way, trading with a WTO member under MFN rules means less advantageous trade than trading through a free trade agreement.

MFN also teaches us that it would not be feasible for the UK to drop out of the EU without agreement and then unilaterally treat EU goods better (everywhere or just in Northern Ireland), hoping the EU would do the same with respect to UK goods. Without a free trade agreement between the UK and the EU, the UK is obligated under WTO law to treat EU goods like the goods of all other WTO members. The EU is under the same obligation. If either party decided to not impose tariffs on the other, it would be compelled to treat all other WTO members the same, removing all tariff protection from its domestic industry and, consequently, its leverage in trade negotiations.

Dr Holger Hestermeyer

@hhesterm

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