Legal and Economic Principles of World Trade Law brings together some of the most prominent scholars in the fields of international trade theory and international trade law to provide an interdisciplinary analysis of WTO law. This volume is part of a project to improve the interpretation of WTO law that is sponsored by the American Law Institute (ALI). The volume begins with two preparatory chapters, one summarizing a previous ALI volume on the history of the GATT and the other providing a non-technical analysis of the economic approach to trade agreements. The remainder of the book is split into two sections that analyze how the economic approach can be applied to understand the WTO rules and to critique the case law. The topics covered in these studies are border instruments (trade taxes and quantitative restrictions) and domestic instruments (through national treatment), respectively.

In the preparatory chapter ‘Why the WTO’, Gene Grossman and Henrik Horn provide a clear exposition of the international externalities approach to trade agreements. This approach argues that countries will ignore the negative effect of their trade policies on their trading partners when setting trade policy, so that all countries can gain from a trade agreement that results in mutual reduction of protectionist policies. In a broad class of trade models, including many where political considerations play a role, the negative externality from tariffs operates through the terms of trade and will be larger the greater the market power of the tariff-setting country. Grossman and Horn also discuss the commitment approach to trade agreements, which emphasizes the potential for trade agreements to be used by governments to alleviate domestic protectionist pressure. They argue that the commitment approach is primarily a complement to the market power model, since it requires partner countries to use their market power to enforce commitments.

A main theme addressed in this chapter and the study on border instruments by Kyle Bagwell, Robert Staiger, and Alan Sykes is the ability of the terms-of-trade theory to explain the features of the WTO agreement. The terms-of-trade model has produced a number of successes in explaining trade agreements. The notion of reciprocity follows naturally from the terms-of-trade theory, since unilateral tariff reductions can be welfare reducing for countries that have market power. Models based on the terms-of-trade approach have also been useful in providing insights about the role of the most favored nation clause, the incompleteness of trade agreements, and the gradual nature of tariff reduction. The empirical predictions of the terms-of-trade model have also been born out in several recent studies.

On the other hand, critics of the terms-of-trade approach have noted that the model does not do as well in explaining the treatment of export policies in the WTO. Export taxes have a favorable effect on the terms of trade for countries with market power, so the theory would predict that governments with market power would impose export taxes and eschew export subsidies. The one WTO complaint involving export taxes arose in the case of China's mineral exports, which were limited as part of China's Accession Protocol. The case suggested that export taxes are limited by the WTO when they provide an international externality, so the puzzle is why they are so rarely used. One explanation is that the presence of politically powerful interests in the export sector, which will mitigate the terms-of-trade incentive for exports. In addition, much of the market power effect may be exercised by the use of tariffs.

As Bagwell et al. note, the ban on export subsidies is harder to explain. Although the introduction of political economy concerns and imperfect competition in export markets can create an incentive for governments to use export subsidies, the ban on export subsidies does not seem to be an efficient response. They do note that recent work focusing on the impact of trade policy on the exit/entry decisions of imperfectly competitive firms may provide an explanation.

Bagwell et al. also provide a careful analysis of the case law involving border instruments, including the analysis of preferential trading agreements, special and differential treatment, and the MFN clause. They generally find the case law to be consistent with the economic approach to trade agreements, with the caveats noted above.

In contrast to the generally favorable conclusions about the case law on border instruments, Gene Grossman, Henrik Horn, and Petros Mavroidis find the case law concerning national treatment under Article III of the GATT agreement to be seriously lacking. The negotiating history indicates that Article III was intended to prevent countries from using domestic instruments to offset the effects of trade liberalization, and to outlaw practices that were intended to favor domestically produced goods. However, Grossman et al. question whether the case law interpretations support the intended purpose of the national treatment provision. Somewhat surprisingly, the decisions rarely consider either the motives of the legislation or the magnitude of the trade impact, which would seem to be important in satisfying the intent of Article III.

Part of the difficulty with evaluating complaints is that the language in Article III is vague. For example, Article III distinguishes between ‘like’ products and ‘directly competing or substitute’ (DCS) products, and provides a stricter standard for establishing violations of national treatment in the latter case. However, panels have not been consistent in their rulings on the relative importance of statistical evidence (e.g. cross price elasticities of demand) as opposed to product characteristics (end uses or HS classifications) in establishing the extent to which products are competitive. Similar difficulties arise in the interpretation of what amounts to ‘less favorable treatment’ of imported goods.

The authors also make the important distinction between goods that are ‘policy-like’ and those that are ‘market-like.’ The prototypical example here would be the case of a ‘clean’ domestic good and a ‘dirty’ imported good. If the external effect of the imported good is being ignored by consumers, economic efficiency would call for a tax on the ‘dirty’ good equal to the value of its negative externality. Such products are market-like from the point of view of consumers but not policy-like because of the externality. Whether the fact this policy results falls more heavily on imported goods than domestic goods would be interpreted by panels as a violation of Article III due to a higher tax on imports is less clear. In a case involving construction materials, a panel ruled that imported products containing asbestos, a known carcinogen, were ‘like’ domestic products that did not contain asbestos because their end uses were similar. This conclusion was overturned by the Appellate Body on the reasoning that consumers would not view the products as competing because of the presence of carcinogens. The conclusion in this case is the right one from the view of economic efficiency if consumers are really ignoring the externality, but not necessarily if the buyers are builders who are aware of the possibility of being sued for damages for external effects.

In light of these inconsistencies in the interpretation of Article III, Grossman et al. propose two methodologies for dealing with complaints related to Article III. Both methodologies use the economic approach by focusing on whether a domestic fiscal or regulatory policy creates an international externality, and thus should be constrained under a trade agreement. In particular, establishing that imports that receive less favorable treatment would require that they be both market-like and policy-like to the domestic products. The main difference between the two approaches they propose is whether domestic authorities are limited to the exceptions listed in Article XX for determining the acceptable reasons for putting a higher burden on imported products than domestic products. For example, is it compatible with Article III to tax imported luxury goods at a higher rate than non-luxury domestic goods? Such a policy would not follow an Article XX exception, but might be considered to fall within the domain of domestic policy choices. The authors prefer the interpretation that allows the government a broader scope in setting domestic policy objectives, as that will add to the legitimacy of the WTO and is likely to facilitate trade liberalization. Whether or not one agrees with this ranking, the authors have clearly identified an approach for dealing with Article III complaints that is consistent with the economic approach to trade agreements.

The chapter concludes with an illustration of how this methodology can be applied to some of the most significant national treatment cases, and how the two approaches might differ in their evaluations. These cases all involve alcohol taxation, which has the potential to reflect both externality and income distribution motives for taxation. It may serve as some comfort that the authors conclude that the eventual decisions were generally correct, although not necessarily for the preferred reasons.

I found this book to be an important contribution to the interdisciplinary analysis of the WTO. For non-economists, it provides a clear explanation to the economic approach to trade agreements and how it can be used to provide a basis for evaluating trade disputes. For the economist, the detailed analysis of the cases provides an appreciation of the importance of issues such as the choice of contractual language and the allocation of the burden of proof that are typically abstracted from in economic models. The structure of the book is such that each of the chapters can be read independently. This is useful if the reader is interested primarily in one topic, although it does result in some repetition of topics across chapters when read as a whole. This, however, is a minor concern. Overall, the book is a valuable contribution to the legal and economic literatures on the WTO, and its critique of case law provides a number of important insights about the role of national treatment.