Most Favored Nation Status

How It Lowers Your Grocery Bill

most favored nation status
The most favored nation status is granted to all parties of a trade agreement. Photo: VCL/Chris Ryan/Getty Images

Definition: Most Favored Nation status is when a country enjoys the best trade terms given by its trading partner. That means it receives the lowest tariffs, the fewest trade barriers, and the highest import quotas (or none at all). In other words, all Most Favored Nation trade partners must be treated equally.

The Most Favored Nation clause in the two countries' free trade agreements confers that status.

That clause is also used in loan agreements and commercial transactions. In the former, it means that interest rates on a subsequent loan won't be lower than on the primary one. In the latter, it means the seller won't offer a better deal to another buyer. (Source: "Most Favored Nation Clause," Practical Law.)

Advantages

MFN status is critically important for smaller and developing countries for several reasons. It gives them access to the larger market. It lowers the cost of their exports since trade barriers are the lowest given. That makes their products more competitive.

The country's industries have a chance to improve their products as they service this large market. Their companies will grow to meet increased demand. They receive the benefits of economies of scale. That, in turn, increases their exports and their country's economic growth.

It also cuts down on red tape. Different tariffs and customs don't have to be calculated for each import since they are all the same.

Best of all, it reduces the ill effects of trade protectionism. Even though domestic industries may not like to lose their protected status, they will become healthier and more competitive as a result.

Disadvantages

The downside of Most Favored Nation status is the country must also grant the same to all other members of the agreement or the World Trade Organization.

This means they cannot protect their country's industries from cheaper goods produced by foreign countries. Some industries get wiped out because they just can't compete. For more, see Pros and Cons of Free Trade Agreements.

Without tariffs, sometimes countries subsidize their domestic industries. That allows them to export them for incredibly cheap prices. This unfair practice will put companies out of business in the trade partner's country. Once that happens, the country reduces the subsidy, prices rise, but now there's a monopoly. This practice is known as dumping, and it will get you in trouble with the WTO.

Many countries were excited to get Most Favored Nation Status, so they could export goods cheaply to the U.S. market, only to find they lost their local agricultural industry. Local farmers could not compete with subsidized U.S. and the European Union food. Many farmers had to move to the cities to find jobs. Then, when food prices escalated thanks to commodities traders, there were food riots.

Examples

All 159 members of the WTO receive the Most Favored Nation status. That means they all receive the same trade benefits as all other members.

The only exceptions are developing countries, regional trade areas, and customs unions.

Developing countries receive preferential treatment, without having to return it, so their economies can grow. That is in the best interest of the developed countries in the long run. Consumer demand for imports will grow along with these economies. That provides a bigger market for the developed countries' products. 

The United States has reciprocal Most Favored Nation Status with all WTO members. That means 37 countries are left out. None of these countries has bilateral trade agreements with the United States. See the list at Why Is WTO Membership So Important?

The General Agreement on Trade and Tariffs was the first multi-lateral trade agreement to bestow Most Favored Nation status. 

China

The United States gave Most Favored Nation status tp China in 2000. Soon afterward, it helped the country become a WTO member.

 U.S. companies wanted to sell to the largest population in the world. As China's GDP per capita grew, so would its consumer spending.

That didn't reap the bonanza U.S. companies had hoped for. First, the Chinese don't receive Social Security or other entitlement programs. As a result, they frantically save each and every penny to have enough for their old age.

Second, the Chinese government does not allow companies to sell products to its people without paying a price. To gain entry to China's market, exporters must build plants and hire Chinese workers. That grants Chinese companies knowledge of how the products are made. As a result, there are often cheap local knock-offs of the products. The U.S. company can't compete, and eventually packs up and goes home.