Conflicting Goals: Economic Sanctions and the WTO

Maarten Smeets is a counsellor in the World Trade Organisation. The views expressed here are his alone and do not necessarily reflect those of the WTO.

The notion of trade sanctions is often directly associated with retaliatory action resulting from the conclusion of a World Trade Organisation dispute settlement process. One example is the withdrawal of trade concessions by the United States in retaliation against the European Union’s banana regime, which was found to be inconsistent with WTO rules. Another is the retaliatory US action against the European Union’s import restrictions on hormone treated beef from the United States. Washington acted after the WTO ruled that the safety concerns cited by Brussels lacked scientific justification.

 

However, economic sanctions cover boycotts and embargoes, which can be adopted by countries under WTO provisions but which are unrelated to the WTO dispute settlement process. They are part of the exceptional measures invoked by members of the WTO in specific circumstances. These measures mostly, if not exclusively, find their origin in political developments that lead one country to take action against another by severing trade links in whole or part. The (authorised) retaliatory action resulting from WTO trade disputes follows the logic of restoring a balance in rights and obligations between members when these are affected by a country’s applying policies that violate WTO rules. But this same logic does not hold when economic sanctions are invoked: these are justified under the security exceptions of Article XXI of the General Agreement on Tariffs and Trade (GATT).

 

The tension between sanctions and the WTO lies in the fact that the WTO was designed to liberalise trade, whereas the direct purpose of sanctions is to restrict trade for non-economic, essentially political, reasons. This article will thus look at the relation between economic sanctions and WTO provisions. It will briefly discuss the main features of sanctions, how they work in theory and in practice and how they relate to the fundamental principles of the WTO multilateral trading system. Finally, some conclusions will be drawn.

Features of Sanctions

Economic sanctions, generally speaking, cover all direct trade-restricting policies between sovereign nations, and often include financial or investment restrictions. Sanctions can take the form of an embargo, in which case exports from one or more countries to the target country are prohibited, or a boycott, when imports from the target country are blocked, or both, in which case all trade relations are cut off. For sanctions to be effective, they should comprise a mix of embargo and boycott. The choice of which instrument to use will naturally depend on the goals of the sanctioners. The effectiveness of sanctions will largely depend on the economic vulnerability of the target country and on the instruments available in the sanctions campaign.

 

Economic and trade sanctions are rarely imposed in isolation, but are often complemented by accompanying measures intended to affect unrelated, non-trade areas. Thus, the target country may be barred from cultural or sports events. Sanctions are widely seen as being part of “soft” international diplomacy and as providing an alternative to war. For that reason they are a popular policy tool. At the same time, however, economic sanctions are seen as a more powerful expression of disapproval than purely verbal declarations. Sanctions are intended to give teeth to such declarations, but to what extent do sanctions really bite? Although sanctions are politically popular, the empirical evidence suggests that the number of successful sanctions campaigns is limited.

 

The record also shows that economic sanctions do not necessarily provide a substitute for war, but are often merely a prelude to it. When it is felt that economic sanctions cannot do the job, stronger means are often deployed. This was the case following Iraq’s 1990 invasion of Kuwait, and also later with Yugoslavia. In both cases, however, it could be argued that sanctions were not given sufficient time to bite. It would also seem that other, mainly political factors provided the chief incentive to intervene militarily, irrespective of whether the sanctions would be effective or not.

 

What, then, is the main purpose of sanctions? Trade sanctions result from political decisions to act against another country. They are meant to isolate a country economically, thus providing one way of expressing disagreement with a country’s policies. The objectives of sanctions vary for each individual case, but generally are related to achieving changes in the internal or foreign policy of the target country. Economic sanctions should be seen as an instrument to exert pressure to bring about such policy changes. The objectives of sanctions can range from the “soft”, i.e., simply expressing dissatisfaction with a country’s behaviour, to the “hard”, i.e., securing a fundamental change in such behaviour. Trade sanctions are thus an economic instrument for achieving political objectives.

 

How can sanctions be made effective? Although there is no strong empirical evidence to support the claim that economic sanctions are a successful policy instrument, they remain popular with governments, who believe they are a useful means of expressing disapproval. Sanctions also show the domestic electorate that politicians are taking their responsibilities seriously and not merely watching “evil” occur without acting. Sanctions are thus often seen as a policy instrument intended to impress a domestic audience. However, they can backfire on the sanctioning country by depriving its businesses of market, trade and investment opportunities in the target country. This is particularly the case when the sanctions are not unanimously observed by all trading partners.

 

For sanctions to be effective, common sense indicates that the scope of the sanctions and the objectives at stake should be closely linked. In other words, the more ambitious the objectives, the larger the sanctions package should be. Nevertheless, experience shows that even when full-scale sanctions are applied and a country seems to be totally isolated, there is still no guarantee of success.

 

One of the problems encountered in analysing the success rate of sanctions is the absence of clearly defined objectives. Governments make political declarations justifying the imposition of sanctions, but often omit to specify the objectives of the sanctions so as to allow their impact to be measured and a decision made as to whether the objectives have been achieved. This explains why sanctions tend to stay in place for long periods, as it is easier to decide to impose sanctions than to judge that they have succeeded and thus resolve to lift them.

 

While sanctions are mostly imposed for political reasons, the legal basis of their justification under WTO rules is the protection of “national security”. The relevant legal text is Article XXI of GATT, which under the heading of security exceptions (i.e., exceptions permitting the imposition of trade restrictions) refers to action which a country “considers necessary for the protection of its essential security interests”. As will be discussed further, the notion of “essential security interests” is rather flexible and some observers have expressed the fear that the open-ended manner in which the relevant article is drafted paves the way for protectionist measures. Let us turn first, however, to the question of the mechanism of sanctions.

Economic Warfare

How are sanctions imposed? By their very nature, economic sanctions are meant to distort, or fully interrupt, economic ties between two or more countries. Thus, economic sanctions run counter to the fundamental principles that the WTO defends, which aim at opening up markets and providing for stable, secure, transparent and predictable trade relations. The WTO’s purpose is to liberalise trade and maintain harmonious trade relations between members, thus improving overall levels of economic welfare.

 

The mechanism by which economic sanctions achieve their ultimate objectives is based on a reversal of the international trade theories which assume that world economic welfare can be maximised under conditions of free trade. GATT (1947) and its successor the WTO (1995) are based on the same principle, namely, that economic welfare can be enhanced by liberalising trade. The Marrakesh Agreement establishing the WTO confirms this in its preamble, which states that parties to the agreement recognise that their

 

relations in the field of trade and economic endeavour should be conducted with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income and effective demand, and expanding the production of trade in goods and services.

 

The theory implies that any limitation of trade, and in particular the protection of individual markets by raising tariffs or applying direct import restrictions through quotas, will ipso facto reduce the general level of welfare. Theories of economic warfare build upon this implication. An embargo will create a supply shock, a boycott will isolate the target country from the world market. The result will be a net loss of welfare. Depending on the balance of power between the countries involved and the nature of their economic interaction, the sender can depress the income and welfare level of the target country to an unacceptably low level. The weaker party will face a deterioration of its terms of trade and will be forced to comply with the demands of the sanctioning country.

 

The analysis of economic warfare theory is based on a number of assumptions similar to those applied in trade theory, which do not necessarily comply with reality. Thus, it is assumed that there is no time lag between the moment sanctions are decided upon, their implementation and their impact on the target economy. In other words, sanctions are expected to bite immediately. This could only occur in ideal conditions in which the decision‑making process was a mere formality, with immediate and unanimous positions adopted in the country imposing the sanctions. Moreover, it is assumed that there can be no escape route for the target. Although WTO rules allow for immediate action, this can hardly be achieved. The democratic process followed in most countries and preceding the decision to adopt measures is inevitably time consuming. This gives the target time to organise, to anticipate the effect of the sanctions and to seek trade relations with new partners or to intensify existing ones with friendly countries that refuse to observe the sanctions.

 

Another question that arises is whether a minimum welfare level can be defined below which threshold the target country will be forced to comply. Experience has shown that countries can tolerate considerable hardship without giving in. This is largely because the pain of sanctions is chiefly felt by the civilian population and not by the political leadership. Whereas in most Western countries democracy allows unpopular governments to be ousted, this is not the case in sanctioned countries with dictatorial regimes. In fact, it seems that the hardship inflicted on the people is often exploited by the leadership to cement its grip on power.

 

In sum, while the trade theory provides solid underpinning for the belief that trade liberalisation raises the level of welfare, it doesn’t necessarily hold that restricting trade will significantly reduce welfare levels. Despite the lack of economic evidence for the efficacy of trade sanctions and despite the fact that they run counter to key principles of the WTO, countries have still shown themselves willing to exercise their right to apply and enforce sanctions.

Undermining WTO Principles

Since the inception of GATT in 1947, all efforts have been geared to eliminating obstacles to international trade. This process is the result of a deliberate policy of governments to open markets, to liberalise trade and to remove barriers to the enhancing of overall levels of welfare and the consumer’s wellbeing. It is based on acceptance of the notion that trade liberalisation comes to benefit the world at large, underpins peace, strengthens the interrelation and interdependence of nations, and has a wider than strictly economic impact. This was explicitly recognised by US president Harry Truman in 1947, when he supported the creation of the International Trade Organisation, arguing that trade and peace were “inextricably linked”. It took half a century to establish the WTO, which was the institutional result of the Uruguay Round negotiations, begun in 1986 in Punta del Este (Uruguay) and concluded in 1995 in Marrakesh (Morocco). The nexus trade–peace is still valid today, and maybe even more so, given the closer trade links characteristic of contemporary international relations.

 

The Uruguay Round represented a major multilateral effort by more than one hundred countries to liberalise world trade and address a series of problems facing the trading system. It was the broadest round of multilateral trade negotiations in GATT history, with active participation from developed and developing countries alike. The successful conclusion of the Uruguay Round has enhanced the predictability and transparency of the trading system and created substantial new market opportunities. The foundations of the trading system have been solidified by the creation of the WTO. While largely based on the same principles, including most-favoured-nation treatment, non-discrimination and transparency, the WTO goes well beyond GATT. Its structure should ensure enforceability, notably through revamped dispute settlement procedures, and provide a forum for addressing an almost unlimited agenda of trade and trade-related policy issues. Although recognising the needs of developing countries, and especially those of the least developed, a level playing field has been established, with all rights and obligations in the trading system now applicable to all members of the WTO, and all members having equal recourse to all disciplines to enforce their rights and entitlements.

 

Other main achievements of the Final Act of the Uruguay Round include the liberalisation of trade by reducing tariffs; the strengthening of rules on non-tariff barriers to trade, and the elimination of grey-area measures, thus reinforcing the use of price-based measures for trade restriction; the return of two major sectors into the ambit of the multilateral trading system (agriculture, and textiles and clothing); the expansion of the scope of multilateral rules and disciplines to embrace trade in services and trade-related aspects of intellectual property rights; the sharpening of rules in the field of trade-related investment measures and the enhancement of the credibility of the multilateral trading system through strengthened dispute settlement procedures.

 

These achievements don’t square well with the use of economic sanctions, which are normally applied in the form of a trade embargo or boycott. The key feature of such sanctions is that both directly affect the quantity of goods exported and/or imported, and in theory and practice are far more distorting of trade than the imposition of import duties, which act at the level of the price of a good or service. A total boycott/embargo will typically prevent any trade from occurring, whereas the imposition of a tariff, irrespective of its level, amounts to adding to the price tag of the final good, with the consumer ultimately deciding whether to pay the higher price. Tariffs are thus “price-based” instruments; quantitative restrictions are not, and so are far more discriminatory and harmful.

 

While a high tariff may effectively reduce demand to zero, a tariff per se does not prohibit countries from trading with each other. Quantitative restrictions do, and this is why they are considered more damaging in economic terms, “unfair” from a trade policy perspective and among the greatest sins in the WTO. Article XI.1 of GATT effectively prohibits trade restrictions other than duties, taxes or other charges, with some exceptions defined in Article XI.2.

 

The WTO agreements and disciplines thus constitute a complex set of binding commitments between all WTO members. Moreover, these are enforceable through the dispute settlement process, which has been strengthened by the Uruguay Round negotiations. Any trade concession that is affected or undermined automatically requires compensation in order to ensure that the overall level of concessions is not affected. In other words, if a country needs to increase its import protection for any one good or service, it can only do so in accordance with specific WTO provisions so as not to disturb the overall balance of rights and obligations. The only exception to this rule is notably that of economic sanctions, where previously GATT and currently the WTO allows members to take emergency action to protect their national security interests.

Article XXI

How do the efforts to liberalise trade square with the provisions under Article XXI that allow a country to impose sanctions, and hence restrict trade, in order to ensure its national security interests? The short answer to this would simply be that they don’t. The reality, however, is somewhat more complex.

 

What does Article XXI on security exceptions say? It states that

 

Nothing in this Agreement shall be construed

(a) to require any contracting party to furnish any information the disclosure of which it considers contrary to its essential security interests; or

(b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests

(i) relating to fissionable materials or the materials from which they are derived;

(ii) relating to the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment;

(iii) taken in time of war or other emergency in international relations; or

(c) to prevent any contracting party from taking any action in pursuance of its obligations under the United Nations Charter for the maintenance of international peace and security.

 

The WTO provisions in Article XXI thus entitle a member to interrupt its trade relations immediately, without prior notice and without leaving much room for the target country to dispute the measures under the relevant dispute settlement procedures. Such action thus breaks virtually all fundamental WTO principles: it is a unilateral action, in breach of the WTO’s basic non-discriminatory multilateral trade principles. The sanctions are by definition selective and deny only the target country of any benefit and privilege granted to other members.

 

The most-favoured-nation clause has been the pillar of the system since the inception of GATT in 1947. Just as the contracting parties to GATT were bound to grant each other’s products equal treatment, so WTO members have entered into similar commitments concerning the trade in goods, the supply in services and the protection of intellectual property rights.

 

The national treatment principle condemns discrimination between foreign and national goods or service suppliers, or between foreign and national holders of intellectual property rights. In practice this means that once duties on goods have been paid, imported goods must be given the same treatment as domestic products in relation to any charges, taxes or administrative or other regulations (GATT Article III). The national treatment principle is dealt with slightly differently in the General Agreement on Trade in Services (GATS) because of the special nature of such trade. National treatment is covered under Part III of GATS (Article XVII), where it becomes a negotiated concession and may be subject to conditions or qualifications that members have inscribed in their schedules on specific commitments in trade in services.

 

For as long as sanctions are in force, tariff bindings no longer apply. This nullifies the tariff concessions that were exchanged between the parties and are contained in respective schedules of concessions. This goes to the very heart of the GATT/WTO system. One of the fundamental principles of the WTO system is the desirability of predictable and growing access to markets for goods and services. Security and predictability in trade and goods are achieved through the commitments embodied in the binding of tariffs, which is a legal commitment not to raise tariffs beyond the bound level. Mutatis mutandis, service commitments no longer apply.

 

Initially, there was no strict obligation on WTO members to provide advance notification to other members and/or engage in consultations with them prior to imposing economic sanctions. Notification obligations were an important consequence of the Uruguay Round negotiations. They are meant to strengthen transparency, which has become an ever more important WTO principle. Affected parties must now be informed about trade measures taken under Article XXI (see below).

 

Furthermore, economic sanctions are not time bound and can affect any sector, good, service and trade-related intellectual property right alike. They largely escape multilateral control as they are not subject to any multilateral surveillance mechanism.

 

There has been much discussion of when security exceptions may be invoked to impose sanctions, but it has remained inconclusive. In the absence of a clear definition as to what constitutes “essential security interests” it would seem that Article XXI more or less provides a blank cheque to WTO members to disrupt trade relations for non-economic reasons. This is not to say that sanctions cannot be challenged under the dispute settlement procedures; they have been, but the record shows that that recourse has only limited value for the target country.

 

During discussions in Geneva, in response to an inquiry as to the meaning of “essential security interests”, one of the drafters of the original GATT Charter said:

 

We gave a good deal of thought to the question of the security exception which we thought should be included in the Charter. We recognised that there was a great danger [in] having too wide an exception … because that would permit anything under the sun. Therefore we thought it well to draft provisions which would take care of real security interests and, at the same time, … limit the exception so as to prevent the adoption of protection for maintaining industries under every conceivable circumstance ... It is really a question of balance.¹

 

Invoking Security Exceptions

The ensuing discussion of several sanction episodes draws on the WTO’s Guide to GATT Law and Practice (Analytical Index), which summarises a number of cases in which Article XXI was invoked.

 

Security exceptions were first discussed in 1949, following a complaint by Czechoslovakia. It was ruled that every country must ultimately be the judge on questions relating to its own security. At the same time, however, all the contracting parties were urged to be careful not to take any step which might have the effect of undermining GATT.

 

On the occasion of Portugal’s accession to GATT (1961), Ghana argued that a country’s security interests might be threatened by a potential as well as by an actual danger. Accordingly, the situation in Angola was considered a constant threat to the peace of the African continent and any action which, by bringing pressure to bear on the Portuguese government, might lead to a lessening of this danger, was deemed legitimate.

 

The GATT contracting parties did not discuss the matter again until the Falklands (Malvinas) crisis erupted. During the 1982 GATT Council discussions of trade restrictions applied for non-economic reasons by the European Economic Community, Canada and Australia against imports from Argentina, it was indicated that the rights under Article XXI constituted a general exception and did not require notification, justification or approval. Again, it was stated that every contracting party was in the last resort the judge of when it should exercise these rights and that GATT had neither the competence nor the responsibility to deal with the political issue which had been raised. These views were broadly supported by other major trading partners, including the United States.

 

Argentina, contesting this position, argued that trade restrictions could not be applied without notification, discussion and justification. As a result of these debates, ministers considered the issue during their annual deliberations in 1982 and adopted specific language in Paragraph 7(iii) of the Ministerial Declaration: “[T]he contracting parties undertake, individually and jointly … to abstain from taking restrictive trade measures, for reasons of a non-economic character, not consistent with the General Agreement.”

 

On the issue of notification, the contracting parties adopted in 1982 the following “Decision Concerning Article XXI of the General Agreement”:

 

1. Subject to the exception in Article XXI(a),² contracting parties should be informed to the fullest extent possible of trade measures taken under Article XXI.

2. When action is taken under Article XXI, all contracting parties affected by such action retain their full rights under the General Agreement.

3. The Council may be requested to give further consideration to this matter in due course.

 

Several economic sanctions have been justified under the provisions contained in Article XXI(b)(iii) relating to war or other emergencies in international relations. Members of the Arab League justified their boycott against Israel and the secondary boycott against firms having relations with Israel by the exceptional circumstances of the Middle East conflict. They argued that the state of war which had long prevailed in the area necessitated resorting to the boycott. In view of the political character of the issue, the United Arab Republic did not wish to discuss it within GATT.

 

That the security provisions have their limitations and cannot be taken as providing a blank cheque to justify import restrictions is shown by a case concerning global import quotas imposed by Sweden on certain types of footwear in November 1975. Sweden argued that maintaining a minimum domestic production capacity in vital industries was indispensable to securing the provision of products essential for meeting basic needs in time of war or other emergency. The argument was not found convincing and Sweden was effectively obliged to terminate the quotas on leather and plastic shoes.

 

It should be recalled that the drafters of GATT and later of the WTO had foreseen other provisions to cover such situations, including safeguard measures that allow a country to impose temporary relief import restrictions to protect domestic industry from unwanted competition. The conditions attached to the use of these safeguard provisions were often considered too onerous by GATT contracting parties and were therefore side-stepped. The shortcomings of the safeguard provisions were largely remedied by the establishment of the WTO Safeguard Agreement during the Uruguay Round.

 

In yet another case, the United States notified the contracting parties in 1985 that it was blocking all imports of goods and services of Nicaraguan origin, and all US exports to Nicaragua and transactions relating thereto. The United States justified the measures by invoking the national security exceptions of Article XXI. Again, the terms of reference of the GATT panel established to investigate the US embargo precluded it from examining or judging the validity of Washington’s invocation of Article XXI. The trade embargo was lifted in April 1990, as the United States felt that the conditions necessitating action under Article XXI had ceased to exist and that the national security emergency with respect to Nicaragua was over.

 

Another sanctions episode relates to trade measures applied under Article XXI by the European Community and its member states against Yugoslavia in 1991. The measures comprised suspension of trade concessions granted to Yugoslavia under its bilateral trade agreement with the European Community; the imposition of certain limitations (previously suspended) on textile imports from Yugoslavia; the withdrawal of preferential trade benefits; and action to suspend the bilateral trade agreements between the European Community and its member states and Yugoslavia. Similar economic sanctions or withdrawal of preferential benefits to Yugoslavia were also taken by Australia, Austria, Canada, Finland, Japan, New Zealand, Norway, Sweden, Switzerland and the United States.

 

Yugoslavia requested the establishment of a panel under Article XXIII, arguing that the measures taken by the European Community were inconsistent with Articles I, XXI and the Enabling Clause; that they departed from the letter and intention of Paragraph 7(iii) of the Ministerial Decision of November 1982; and that they impeded the attainment of the objectives of the General Agreement. Moreover, Yugoslavia claimed that there had been no decision or resolution of a relevant UN body to impose economic sanctions against Yugoslavia. The panel was established in March 1992, but as a result of the subsequent transformation of the Socialist Federal Republic of Yugoslavia into the Federal Republic of Yugoslavia, consisting of the Republics of Serbia and Montenegro, the European Union felt that until the succession to Yugoslavia’s contracting party status had been resolved, the panel process which had been initiated no longer had any foundation and could not proceed.

Some Conclusions

The discussion above permits a few general lessons to be drawn:

 

• Despite the lack of conclusive evidence that economic sanctions can help achieve mainly political objectives, they remain a favourite policy instrument.

 

• While economic sanctions explicitly run counter to the fundamental principles of the WTO multilateral trading system, the founders of GATT and later of the WTO deliberately left room for members to have recourse to the exceptions allowed under Article XXI, mainly as a tool to secure essential security interests.

 

• What constitutes “essential security interests” is not defined in the General Agreement and is left to the judgement of members. Debates on the matter in the WTO Council have shown that it is not considered desirable to pin down the concept, but rather that it should be left fairly open to cover different situations that might otherwise be excluded.

 

• WTO rules do not preclude members targeted by economic sanctions from having recourse to the dispute settlement procedures, but the record shows that such recourse yields only moderate results. It has mainly produced clarifications of the rights and obligations of members, particularly relating to transparency.

 

• Economic sanctions are used relatively infrequently, and although they undermine the principle objective of the WTO, which is to liberalise trade, they can in no way be considered a threat to the system itself.

Endnotes

1. Guide to GATT Law and Practice (Analytical Index) (World Trade Organisation: Geneva, 1995), p. 554.

 

2. Article XXI(a) says that nothing in the General Agreement shall be construed “to require any contracting party to furnish any information … disclosure of which it considers contrary to its essential security interests”.