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Reform at the WTO — Development Status Classification

Sep 12, 2019
  • John Gong

    Professor at University of International Business and Economics and China Forum Expert

On July 26, the United States government issued an official document for the U.S. Trade Representative entitled “Memorandum on Reforming Developing-Country Status in the World Trade Organization,” to basically challenge the dichotomous development status classification system at the WTO. It calls for reform of the WTO but also threatens a series of unilateral actions if substantial progress toward reform has not been made within 90 days to the satisfaction of the U.S. government. The Trump administration claims that if the latter scenario happens, it would “no longer treat as a developing country for the purposes of the WTO any WTO Member that in the USTR’s judgment is improperly declaring itself a developing country and inappropriately seeking the benefit of flexibilities in WTO rules and negotiations.”

The memorandum claims that the WTO development status classification system is outdated, and describes the extent of misalignment between members’ development status and the economic circumstances as broad and extensive. “Nearly two-thirds of WTO Members have been able to avail themselves of special treatment and to take on weaker commitments under the WTO framework by designating themselves as developing countries. While some developing-country designations are proper, many are patently unsupportable in light of current economic circumstances,” the memorandum declares.

The memorandum lists several countries in particular as bad examples whose developing economy status is unwarranted — “7 out of the 10 wealthiest economies in the world as measured by per capita GDP on a purchasing-power parity basis,” including Brunei, Hong Kong, Kuwait, Macao, Qatar, Singapore and the United Arab Emirates.

Not surprisingly, China also becomes America’s punching bag, as usual. The memorandum goes into a lengthy diatribe about various reasons, some of which are fairly tenuous if not totally irrelevant, as to why China should no longer be treated as a developing economy.

The thrust of the American argument is essentially based on the idea of change. Countries develop, economies expand and national incomes increase. Economists have long since proposed the convergence theory that developing economies can grow at much faster speeds than developed economies, such that eventually both camps will somehow converge at more or less the same growth rates. Therefore, aside from the unilaterally hegemonic tone embedded in the memorandum, the American argument does appear to have some merit, particularly with respect to the need for WTO reform. Without a doubt, the WTO needs a lot of reform in a lot of aspects, not the least of which is the development status classification issue. This sentiment appears to be shared by many low-income developing countries in Asia, Africa and South America, as I have personally learned from polls in my class of many government officials from countries in these regions.

Instead of defending the current system without any compromise, it is my opinion that China would be better off proactively proposing an alternative based on a proven system, preferably from a West-dominated international financial institution that is difficult to reject by the U.S. in the the absence of any concrete reform proposal of its own. The White House memorandum is long on whining about reform but short on substance. China is probably also better off by putting up this issue for negotiation with the U.S., hopefully for something in return to alleviate some pressure on the China-U.S. trade negotiations.

Therefore, I proceed by assuming that some kind of WTO reform with respect to the development status issue is inevitable. A new classification system under consideration needs to be fair, objective, credible and globally accepted. The system also needs to enrich the set of national development statuses into more categories, and look at WTO obligations accordingly. The current dichotomy of putting all nations into only two categories indeed portrays a too simplistic picture of the global economic landscape.

A new classification system also needs to insist on characterizing development status from a per capita perspective. Fundamentally, development is a national level phenomenon, and needs to be felt and spread to every community, every household and every citizen. Development is ultimately of the people, by the people and for the people. In that regard some kind of economic characterization on a per capita basis remains the most appropriate approach and must lie at the center of any development status classification system at the WTO.

A new classification system also needs to reflect the dynamic nature of country-specific economic development, in that a “graduation” mechanism needs to be instituted for countries to move up from one category to another based on true economic performance.

With these considerations in mind, I propose a possible alternative to the self-identification framework currently used at the WTO that is based on the World Bank Gross National Income analysis framework. This causes less controversy in terms of addressing issues of objectivity, impartiality, openness and other possible credibility issues. From China’s perspective, the GNI framework places it in a reasonable development status category that preserves much of the country’s flexibility. It is unlikely to meaningfully erode China’s current WTO rights and obligations. Under the GNI framework, China should also be able to buy a few more years before it is elevated moderately to the next category up.

The GNI framework provides four categories of classification — low income, lower-middle income, upper-middle income and high income — using gross national income per capita valued annually in US dollars and a three-year average exchange rate. The cutoff points between each of the groups are fixed in real terms and are adjusted each year in line with inflation. The World Bank publishes a similar GDP per capita list based on a purchasing power parity calculation. In addition, aggregate GDP and population data are published as part of the World Bank’s Open Data Catalog.

The World Bank’s current form of national income classification has been used since 1989. The four-category classification structure can be traced to a published essay by E. Reid in 1965. This method was presented in the first World Development Report (World Bank, 1978) — The Future of the World Bank — and was approved by the World Bank’s board of executive directors in 2000.

In 2018, the threshold points for the four categories were set as follows: per capita income of less than $995 for low-income economies; $996 to $3,895 for lower-middle-income economies; $3,896 to $12,055 for upper-middle-income economies; and above $12,055 for high-income economies. The World Bank published data on 217 nations and regions in 2018, of which 31 are classified as low income, 46 as lower-middle income, 51 as upper-middle income and 79 as high income. Last year, six countries (Argentina, Panama and Croatia) moved up into high income, while Armenia, Guatemala and Jordan moved into upper-middle income. Three countries unfortunately moved down to low income (Syria, Yemen and Tajikistan), apparently because of war or political instability.

The importance of a graduated mechanism is self-evident in reflecting the dynamic nature of economic development. Even relative to other economies, a country’s development status can change dramatically over a long time span. From 1989 to 2016, the number of high-income economies nearly doubled from 41 to 80 and the number of upper-middle-income economies nearly doubled from 27 to 53. The number of low-income economies decreased by one-third. Therefore, it makes a lot of sense to institute a graduated system, where a country’s development status can move up from one category to another based on fair, objective and globally recognized standards. Fortunately, a graduated system already exists within the annual World Bank GNI analysis.

Based on this methodology, China — with its nominal per capita GDP of $9,771 and $18,210 PPP per capita GDP in 2018 — will fall into the upper range of the upper-middle-income category. In terms of future growth trends, China is probably a few years away from graduating from the upper-middle-income category.

The benefits of the proposed GNI system are obvious. The World Bank uses readily available and highly reliable data to develop these national account estimates. It is done by an internationally recognized authoritative organization as part of a set of international financial institutions responsible for today’s global economic governance. The data, its analysis and the thresholds for classifications are updated every year based on real price levels. Therefore, it is thought to be objective, impartial and devoid of political tampering by power states.

It also provides an already implemented graduated mechanism based on timely per capita national income data vis-à-vis the updated category thresholds. Countries might also move down because of war, political instability or disastrous economic policies.

A final nice feature of using the World Bank GNI system for the WTO is its synchronization with the lending policies of the World Bank. The proposed classification system is used for developing different lending policies for World Bank members. The fundamental philosophy of the WTO is essentially the same as at the WTO — poor countries need help with development, and lending conditions thus need to be more favorable. It’s akin to the idea of giving developing countries flexibility at the WTO with regard to certain entitlements, such as longer timeframes for the imposition of safeguards, transition periods, export subsidies, softer tariff cuts and procedural advantages in WTO disputes.

In conclusion, the World Bank GNI classification system essentially provides two resounding features that the Trump administration is seeking. First, the classification is much more closely inline with the economic realities in each country on a timely basis. Second, it has a built-in graduated mechanism to reflect the dynamics of economic development around the globe. By addressing both issues that the Trump administration is concerned about, China can probably find a middle ground between reaching an agreement with the U.S. on WTO reform and being able to preserve some of the flexibility associated with China’s current developing status at the WTO.

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