1. Introduction

A quote, from Stephen P.Osborne in The Future of Governing: Four Emerging Models, “Governance must evolve to meet the challenges of changing environment” [1] captures the essense of challenges faced by the World Trade Organization (WTO) in modern trade, specifically under the Most Favored-Nation treatment (MFN). According to the World Trade Organization, the MFN principle or the Most Favored-Nation treatment mandates that any trade concessions that were granted to one country must be extended to all other participants in the global trading system [2]. A prominent example of the MFN clause is the requirement imposed on the United States to extend the same lower tariff rates to all WTO members that it granted to China upon China’s accession to the WTO in 2001. Thus, it ensures that the U.S. applies the same non-discrimination standard and equal treatment in its trade relations with all WTO members. However, the commitment to promoting "fairness" and "non-discrimination in international trade" through the MFN principle brings a range of significant and complex challenges that require thorough examination and potential reform. While the MFN principle was designed to ensure equal trade concessions among WTO members, its application has led to unintended negative effects, such as dampening competition in global markets and exacerbating economic inequalities between developed and developing countries. These issues highlight the need for a careful reevaluation of the MFN principle to address its shortcomings and adjust its framework to better support fair trade practices and the developmental needs of less advantaged nations.

2. Damping Competition: An Economic Theory

Based on the academic paper “On the economic effects of price parity clauses - what do we know three years later?”, author explores economic implications of MFN provisions, highlighting concerns that in highly competitive markets, these clauses can paradoxically lead to higher prices [3]. Specifically, the implementation of MFN clauses can result in dumping or damping competition, where manufacturers sell items abroad at lower prices than domestically if these provisions cause firms to compete less aggressively, as depicted by Team in the year 2020 [4]. As noted in "The Competitive Consequences of Most-Favored-Nation Provisions”, “for instance, if a bottle maker includes an MFN in its contracts with brewers, it obligates itself to lower prices uniformly across all customers”, which diminishes its incentive to reduce prices for any single customer [5]. This reduction in aggressive price competition can be expected by rival bottle makers, who may adopt similar MFN provisions, leading to a general increase in prices as all firms in the market compete less vigorously, which aligns with the "dampening competition" theory indicated above, which posits that reduced competitive pressure leads to higher overall prices, thereby negatively impacting multiple distinctive economic systems.

3. Economic Disadvantages for Developing Countries

It is particularly notable as outlined by the World Trade Organization (WTO) about its tenet that poorer economies are to be granted more flexibility and extended timelines to implement WTO rules to support their economic development [2]. However, the principle of the Most Favored Nation, in practice, has often betrayed its original purpose or undermined this mentioned tenet, exacerbating the economic disadvantages faced by developing countries. This issue is further compounded by instances where developed nations intentionally exploit the MFN principle to serve their own economic interests at the expense of poorer nations.

3.1. Systemic Flaws

Developing countries face unprecedented health and economic crisis. According to a report in the journal The impact of the global financial crisis: What does this tell us about state capacity and political incentives to respond to shocks and manage risks [6]. However, under the MFN principle, due to its inherent rigidity—requiring that new laws and concessions apply equally to all WTO members—combined with existing economic disparities, developing countries are placed at a comparative disadvantage in competing with more developed countries with more bustling economies. One illustrative example is the imposition of tariffs, defined as a tax on imported goods that the importing business pays to its home country's government. Between the years 1996 and 2021, the average tariff rate applied to all WTO members was approximately 8%–9% presented by a graph launched by the International Federation of Customs Brokers Association, signifying that this consistent tariff level can impose a heavier economic burden on developing countries [7]. Despite the reduction in average trade-weighted effective tariffs from 13% in 1996 to 4% in 2021, as evidenced by the same graph, the MFN principle remains insufficient in addressing the economic disparities of developing countries. Thus, reforming the MFN principle to allow greater flexibility could assist developing countries in industry development and global economic integration.

3.2. External Influences

Moreover, the MFN principle, by mandating equal trade concessions for all WTO members, can make developing countries vulnerable to exploitative trade practices by more developed nations. A study by the Organization for Economic Co-operation and Development (OECS), titled "Trade Preferences for Developing Countries: New Empirical Evidence,” provides evidence of the challenges faced by the developing countries under the MFN principle, highlighting that these countries often struggle to benefit from trade preferences due to various factors, including complex rules of origin and non-tariff barriers [8]. For instance, in the early 2000s, the European Union imposed import restrictions on textiles from developing countries to protect its domestic textile industry, further exemplifying the adverse impact of such practices. While these measures were justified as a response to surges in textile imports, they often resulted in unfair competitive disadvantages for the developing countries whose textile industries were already less developed or sold less. Bhagwati’s Free Trade Today illustrates that the EU’s import restrictions demonstrate how the MFN principle’s uniform application can be leveraged by developed nations to disadvantage developing countries [9]. This example underscores the emergent need to reform the MFN principle to prevent its misuse and to better balance trade relations in the global economy.

4. Possible Solutions

To address the three issues discussed above, three distinctive solutions to alleviate such a phenomenon are needed: enhancing competition through differential pricing strategies, allowing tailored trade policies for developing countries, and empowering these nations to challenge unfair trade practices by richer countries.

4.1. Addressing the" Damping Competition" Problem

The issue of "damping competition" can be profoundly addressed by allowing companies to implement differential pricing strategies while transparently explaining the cost structures underlying these prices. This approach facilitates more effective price competition among firms by moving beyond the constraint of universally matching the lowest price offered to all customers. In the Price Discrimination and Competition, author Jean Tirole reveals that by that transparency strategy can help alleviate concerns regarding anti-competitive behavior by ensuring that consumers understand the rationale behind price variations [10]. By openly communicating the cost-based rationale behind pricing decisions, companies can cultivate a more dynamic and competitive market environment, empowering customers to assess the true value of products or services.

4.2. Mitigating the Disadvantages for Developing Countries

According to the concept of “policy space” discussed in The Purpose of Policy Space for Developing and Developed Countries in a Changing Global Economic System, developing countries should have the flexibility to use trade policies and measures that suit their unique circumstances and development goals [11]. Thus, to tackle the problem of disadvantages for developing countries, creating an exception within MFN rules for the poorest countries would be an excellent approach. This would allow them to protect and develop their industries through tailored trade policies, which provide these economies with more flexibility to grow without immediately extending the same benefits to all WTO members.

4.3. Preventing Exploitation of MFN by Developed Nations

Reducing trade restrictions can be seen as a comprehensive approach to diminishing economic disparities between developing and developed countries. However, an outstanding paper published on the National Bureau of Economic Research argues that trade liberalization alone cannot address roosting economic disparities and may worsen existing inequalities in developing counties due to underlying structural challenges, such as inadequate infrastructure and limited educational access [12]. Empowering developing countries to challenge trade policies imposed by richer nations that unfairly harm their economic interests can help address these disparities and promote more inclusive economic growth. This could prevent wealthy countries from exploiting the rule of the Most Favored Nation in ways that unfairly disadvantage poorer nations.

5. Conclusion

The Most Favored Nation (MFN) principle, conceived to promote non-discrimination and fairness in international trade, has revealed critical shortcomings in its real-world application. While intended to ensure that trade concessions granted to one World Trade Organization (WTO) member are extended to all, the MFN principle can lead to unintended negative outcomes. Specifically, the MFN principle can inadvertently stifle competition, compelling firms to maintain uniform pricing that reduces market dynamics and inflates consumer costs. Moreover, its rigid implementation often overlooks the unique economic challenges faced by developing nations, thereby exacerbating global economic disparities. These poorer countries, striving to compete against more advanced economies, frequently find themselves at a disadvantage, struggling to achieve equitable growth and development. Furthermore, the exploitation of MFN rules by more developed nations results in unfair competitive disadvantages, reinforcing economic inequality. To address these issues, it is essential to reform the MFN Principle to allow exceptions for the poorest countries, enabling them to implement tailored trade policies that support their unique developmental goals. This resolution would grant them the flexibility to implement trade policies tailored to their developmental needs without immediate, stringent constraints.

Additionally, empowering these nations to challenge exploitative practices imposed by wealthier counterparts is crucial. Such reforms would ensure that the MFN principle truly upholds fairness and non-discrimination, promoting a balanced global trade system that fosters inclusive economic growth. By addressing these critical issues, the global trade framework can be adjusted to support fair trade practices and the developmental needs of less advantaged nations, contributing to a more equitable and prosperous international economic landscape.