There is a great amount of discussion on international business and politics, as well as on the topic of international trade, and the rules and agreement associated with international trade. Arguably, one of the most interesting and highly discussed aspects of international economic trade is the notion of the most favored nation clause that exists in many bilateral and multilateral trade agreements around the world. In this article, we will examine the concept of “most favored nation clause” as it pertains to international relations, and more specifically, international economic trade between countries. The most favored nation clause has continued to gain importance and relevance in international economic trade agreements. Here, we will explain what is a most favored nation clause, discuss areas in international trade where most favored nation treatment takes place, and also discuss other issues related to the most favored nations principle.
What is the Most Favored Nation Clause?
The most favored nation clause (it is also often referred to as the most favored nation principle, or the most favored nation treatment) is the idea that a country (often in an economic trade agreement) is given the same trade conditions as any other country, and is not given worse trade deal conditions. Those in an agreement with an MFN (or multilateral national clause) receive the same economic benefits as any other country would receive. Others have defined the most favored nation clause as
“Non-discriminatory trade policy commitment offered by one country to another on a reciprocal basis. Both countries apply that lowest import-duty and quota restrictions on imports from each other which they apply on the similar imports from any other country. Under Article I of the General Agreement on Tariffs and Trade (GATT) and its successor World Trade Organization (WTO), all signatory states must extend this treatment to one another. [C]ommon markets, customs unions, and free trade areas, however, are exempt from MFN provisions” (Business Dictionary).
There are often a few core elements or features to a most favored nation clause, which are that:
It is a treaty-based obligation that must be contained in a specific treaty.
It requires a comparison between the treatment afforded to two foreign investors in like circumstances. It is therefore, a
relative standard and must be applied to similar objective situations.
An MFN clause is governed by the ejusdem generis principle in that it may only apply to issues belonging to the same subject
matter or the same category of subjects to which the clause
The MFN treatment operates without prejudice to the freedom of contract and thus, States have no obligation under the MFN treatment clause to grant special privileges or incentives granted through a contract to an individual investor to other foreign investors.
In order to establish a violation of MFN treatment, a less favourable treatment must be found, based on or originating from the nationality of the foreign investor. (UNCTAD, 2010).
There is an interesting reason as to why the Most Favored Nation Clause was created. Namely, “The inclusion of most-favoured-nation (MFN) treatment provisions in international investment agreements (IIAs) followed its use in the context of international trade and was meant to address commitments made by States in free trade agreements (FTA) to grant preferential treatment to goods and services regarding market access” (UNCTAD, 2010). However, it is important to note that “MFN clauses do not have a universal
meaning. Indeed, the formulation and application of MFN clauses varies widely among investment treaties. In some cases, the scope of application of the clauses extends to the entire content of the treaty; in others, the clause is limited to only some of the matters
addressed by the treaty. The proper application and interpretation of a particular MFN clause in a particular case requires a careful examination of the text of that provision undertaken in accordance with the treaty interpretation rules as set out in the Vienna Convention” (OECD, 2004: 16).
History of Most Favored Nation Clause
While much of the attention to most favored nation principles has been concentrated on the Post World War II period and in the years and decades after, the idea of a most favored nation clause in international relations and international trade has been around for hundreds of years. For example, “MFN treatment has been a central pillar of trade policy for centuries. It can be traced back to the twelfth century, although the phrase seems to have first appeared in the seventeenth century. MFN treaty clauses spread with the growth of commerce in the fifteenth and sixteenth centuries. The United States included an MFN clause in its first treaty, a 1778 treaty with France. In the 1800s and 1900s the MFN clause was included frequently in various treaties, particularly in the Friendship, Commerce, and Navigation treaties. MFN treatment was made one of the core obligations of commercial policy under the Havana Charter where Members were to undertake the obligation “to give due regard to the desirability of avoiding discrimination as between foreign investors” (OECD, 2004).
Looking at the idea of the most favored nation treatment in recent decades, the idea of an MFN was strongly advocated for following World War II. Part of the reason was that before the formation of international organizations such as GATT in the 1940s, (which later converted into the World Trade Organization), countries were not trading with one another freely in the time period following the First World War, but before World War II. The reason for this was because “conflicts of interests among the great powers impeded their efforts to organize a collective response to the Great Depression. Instead, the global economic order disintegrated into a series of discriminatory blocs, each of them anchored by a single great power. As they adopted “beggar-thy-neighbor” policies in efforts to shift demand and raise domestic income, the blocs are widely believed to have contributed to the fall in world trade and real income and the exacerbation of great-power tensions that followed the onset of the Great Depression” (Gowa & Hicks, 2012: 248). Interestingly, “
in the 1930s, measures were taken that limited the functioning of the MFN principle. It is said that these measures led to the division of the world economy into trade blocs” (meti.go.jp).
One of the most known Most Favored Nation Clauses in the international economic system is through the World Trade Organization. The WTO is an international organization that attempts to promote trade openness in the international system. The WTO states that “With respect to customs duties and charges of any kind imposed on or in connection with importation or exportation or imposed on the international transfer of payments for imports or exports, and with respect to the method of levying such duties and charges, and with respect to all rules and formalities in connection with importation and exportation, and with respect to all matters referred to in paragraphs 2 and 4 of Article III,* any advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties” (WTO).
Most Favored Nation Clause Exceptions
However, and as the individual in the video above also explains, there are (and have been) exceptions to most favored nation clauses in international economic agreements between countries. For example, speaking on this issue of the most favored nation principle as it pertained to the GATT, Gowa & Hicks (2012) say that despite attempts to eliminate trade biases through a most favored nation treatment, “Discrimination would nonetheless become the modus operandi of the postwar regime. Over time, a steady stream of de jure and de facto exceptions to MFN treatment eroded the lessons of history that had motivated its adoption. Among the earliest and most consequential was the principal-supplier rule that members adopted to govern their tariff bargaining. Because it allowed only the state that was the major supplier of a good to the market of another country to request a tariff cut on that product, the series of negotiating rounds held under GATT auspices produced a highly skewed distribution of tariff concessions and trade expansion” (248). In addition, these sorts of exceptions were not limited to the years after World War II, but were also present during the Cold War, for example (Gowa & Hicks, 2012).
GATT allowed exemptions if there were economic regional integration structures in place. But because of regional integration, it “may
lead to results that are contrary to the MFN principle because countries inside and outside the region are treated differently. This may
have a negative effect on countries outside the region, and is at odds with the liberalization of trade. Therefore, GATT Article XXIV provides that regional integration may be allowed as an exception to the MFN rule only if the following conditions are met. First, tariffs and other barriers to trade must be eliminated with respect to substantially all trade within the region. Second, the tariffs
and other barriers to trade applied to outside countries must not be higher or more restrictive than they were prior to regional integration” (meti.go.jp).
Interestingly, when looking at the history of the most-favored nation clause, with particular attention GATT, what one finds is that it seems that the most favored nation treatment was strongest in the early years of the economic deal, and become less powerful in the following years and decades. For example, Cebi and Ludema (2001) write that
“Since 1947, MFN has been steadily weakened. The first blow came in 1958 with the inclusion of Article 24, permitting customs unions and free trade areas. This was followed by the US-Canada auto pact in 1965 an d the Generalized System of Preferences in 1971. However, these were relatively minor exceptions compared to the experience since the mid-1970s” (1-2). They go on to say that “
In the Tokyo Round (1973-79), industrialized countries began to complain of a “free rider” problem—smaller countries opting out of trade-barrier reductions, while continuing to benefit, through MFN, from the trade-barrier reductions of the large countries. The US Congress, in particular, mandated in the 1974 trade act that the US apply conditional MFN to the Tokyo Round (Jackson, 1998, p. 170). As a result, several codes were negotiated as “plurilateral” agreements, applying to only to GATT members that signed them (Winham, 1986, p. 355). The Uruguay Round (1986-1994) side-stepped the free-rider problem by abolishing the GATT per se and requiring all countries to join a new agreement, the WTO, containing the GATT, GATS, TRIPs and TRIMs. Moreover, these new agreements contained numerous exceptions to MFN, notably in financial services and information technology.
Further weakening of large-country support for MFN can be seen in variousunilateral and regional initiatives since the 1980s. The 1980s and 1990s saw a dramatic expansion in the use of discriminatory trade instruments, most notably VERs, anti-dumping and countervailing duties, and US Section 301. Managed trade in textiles and agriculture openly violates MFN (1-2).
In conclusion, the most favored nation principle grants countries within a particular trade agreement the right to be treated no worse economically than other states that the initial country is trading with. Thus, for example, if county A, for example, is granting trade rights to other countries, if country A has a trade agreement with country B (and that trade deal has a most favored national treatment clause in it), then country B is guaranteed the same trade conditions as any other country that state A is trading with. Again, the idea behind a most favored nation principle is that such a stipulation in an economic deal will foster additional trade opportunities between countries, since they will not only receive the lowest trade tariffs for those countries, but the belief is that it will foster additional trust and international cooperate.
Again, there are of course a number of criticisms to the activities of international organizations as it relates to most favored nation clauses (which is related to discussions on the pros and cons of globalization), particularly if the belief is that the most favored nation treatment will actually primarily benefiting the economically rich, Global North countries (and often at the expense of the economically poorer Global South states) (this is one criticism of the World Trade Organization). For every most favored nations clause that exists in the various international agreements, it is important to examine what this specific Most favored nation clause entails. In addition, from an international relations and human rights perspective, it is also important to examine the pros and cons of a most favored nation clause, thinking about how a most favored nation principle might be economically beneficial for workers and countries, and also if there are any negative consequences to the policy advocacy of a most favored nation agreement within international economic trade agreements.
Business Dictionary (2015). Most Favored Nation (MFN). Available Onhttp://www.businessdictionary.com/definition/most-favored-nation-MFN.html
Cebi, P. & Ludema, R.D. (2001). The Rise and Fall of the Most Favored Nation Clause. Office of Economics Working Paper. U.S. International Trade Commission. No. 2002-06-B, pages 1-28. Available Online: http://www.usitc.gov/publications/332/ec0206b.pdf
Gowa, J. & Hicks, R. (2012). The most-favored nation rule in principle and practice: Discrimination in the GATT. Review of International Organizations, No. 7, pages 247-266.
OECD (2004). Most Favored Nation Treatment in International Investment Law. OECD Working Papers on
International Investment, 2004/02, OECD Publishing. Available Online: http://www.oecd.org/daf/inv/investment-policy/WP-2004_2.pdf
UNCTAD (2010). MOST-FAVOURED-NATION TREATMENT: A Sequel. UNCTAD Series on Issues in International Investment Agreements II. Available Online: http://unctad.org/en/Docs/diaeia20101_en.pdf