The Rise and Fall of the Most-Favored-Nation Clause

The United States and other industrialized countries were once strong proponents of generalized, unconditional Most-Favored-Nation (MFN) treatment as a fundamental GATT rule. Today that support is much diminished, and industrialized countries routinely adopt policies that circumvent MFN. This paper develops a model of multilateral trade negotiations to illustrate some of the trade-offs large countries face in adopting MFN and how these trade-offs may change over time. Two large countries (the North) negotiate a trade agreement with each other and with a continuum of smaller countries (the South). Under unconditional MFN, northern tariff reductions must be extended to all southern countries regardless of whether or not the southern countries agree to reciprocate. This raises the cost to the North of inducing southern countries to join the agreement. On the other hand, MFN treatment, by ensuring access to the northern market, induces factors of production in the South to move into the export sector. This increases the gains to trade and also reduces political opposition to trade liberalization in southern countries, thereby reducing the cost to the North of inducing them to join the agreement. Over time, as capital accumulates in the export sectors of the South, the cost of MFN to the North rises relative to the benefits. Thus, the very success of MFN in promoting comparative advantage may cause the North to switch from being a net beneficiary to a net loser from MFN over the course to time.