Most Favored Nation Status: Pros and Cons

How It Lowers Your Shopping Bill

most favored nation status
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Most-favored-nation (MFN) status is an economic position in which 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 MFN trade partners must be treated equally.

The most-favored-nation clause in 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.

In the U.S., it's more common to hear the term "permanent normal trade relations." This is simply another way to refer to a country with MFN status.

Background of Most Favored Nation Status

All 164 members of the WTO receive 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. Developed economies benefit in the long run—as economies grow in developing economies, so too do their demand for imports. That provides a bigger market for the developed countries' products. 

The United States has reciprocal most-favored-nation status with all WTO members.

The General Agreement on Trade and Tariffs was the first multilateral trade agreement to bestow most-favored-nation status.

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 it lowers trade barriers as much as possible.
  • As a result, their products become more competitive and businesses have more opportunities for growth.

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 could become healthier and more competitive as a result.

Disadvantages

The downside of MFN status is the country must also grant the same trade benefits 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. It’s one of the disadvantages of free trade agreements

Countries sometimes subsidize their domestic industries. That allows subsidized companies to export at 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—no other companies remain in the industry to keep prices competitive. This practice is known as dumping. This can get a country in trouble with the WTO.

Many countries in the past were excited to get MNF status and begin cheaply exporting goods to the U.S., only to find they lost their local agricultural industry. Local farmers could not compete with subsidized food from the U.S. and European Union. Many farmers had to move to the cities to find jobs. Then, when food prices escalated, there were food riots.

China's MFN Status

The United States gave China permanent MFN status in 2001, the same year that China became a WTO member. U.S. companies wanted to sell to the largest population in the world. As China's GDP grew, they thought, so would its consumer spending.

Despite the friendly start to the 21st century, the two countries have since become locked in an ongoing trade dispute. Citing unfair trade practices, including intellectual theft, the Trump administration began imposing tariffs on Chinese imports in 2018. China soon introduced tariffs in retaliation. More rounds of tariffs from both sides followed throughout 2018 and 2019.

In January 2020, the U.S. and China signed a "Phase One" trade agreement, citing multiple structural reforms to China's trade practices. As part of the agreement, China committed to purchasing an additional $200 billion in American products over 2017 levels in four sectors: manufactured goods, services, agricultural products, and energy. In turn, the United States conceded in lowering tariffs from 15% to 7.5%.

Article Sources

  1. World Trade Organization. "Principles of the Trading System." Accessed Aug. 15, 2020.

  2. World Trade Organization. “Members and Observers.” Accessed Aug.15, 2020.

  3. World Trade Organization. “The General Agreement on Tariffs and Trade (GATT 1947).” Accessed Aug.15, 2020.

  4. World Trade Organization. “The WTO Agreements Series 2, General Agreement on Tariffs and Trade,” Page 3. Accessed Aug. 15, 2020.

  5. World Trade Organization. “Anti-Dumping, Subsidies, Safeguards: Contingencies, Etc.” Accessed Aug. 15, 2020.

  6. The White House, President George W. Bush. “President Grants Permanent Trade Status to China.” Accessed Aug. 15, 2020.

  7. The White House. “Statement by the President Regarding Trade With China.” Accessed Aug. 15, 2020.

  8. Tax Foundation. “Tracking the Economic Impact of U.S. Tariffs and Retaliatory Actions.” Accessed Aug. 15, 2020.

  9. U.S.-China Economic and Security Review Commission. "The U.S.-China 'Phase One' Deal: A Backgrounder." Accessed Aug. 15, 2020.